A terrorist attack on the U.S. would weaken its economy. A weaker economy comes because of the reduced valuation of stocks, as the country would be in a crisis. Moreover, capital flows in the country would be affected since investors would expect less investment. In addition, investors would expect less return on their investments because of terrorism. Terrorism would increase insecurity to potential investment segments, resulting in lower valuation and lower stock rates.
This would increase the risk of investment in the country, which would generally discourage investors from foreign investments. Investors would also imagine that existing investments would give poor returns, which may be because of expected loan defaults or lower stock valuations. Since interest rates depend on the country’s demand and supply of funds, the lower financial flow would result in lower interest rates. In essence, terrorist attacks on the country would lower interest rates and lower stock prices.
If terrorism has resulted in lower stock prices and lower interest rates, capital flows between the U.S. and other countries would be lowered. Weak stock prices and lower interest rates would result in a reduced return on investments for potential foreign investors. In turn, reduced return on investment would discourage foreign investors from purchasing U.S. securities. The lower the real interest rates of a country, the weaker its home currency when other factors are constant. In essence, a weak U.S. economy would lower demand for foreign products.
Moreover, lower demand for foreign products will also result in lower demand for foreign currency. Therefore, reduced interest rates and stock prices would reduce capital inflows to the United States. Moreover, reduced capital inflows will result in a weak local currency for the United States. Inherently, reduced stock prices and interest rates would reduce capital flows between the U.S. and other countries.