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The Price of War

Removing the uncertainty surrounding Iraq could be the best economic stimulus out there.

11:00 PM, Jan 27, 2003 • By IRWIN M. STELZER
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THIS WEEK BEGAN with Hans Blix's report to the U.N. Security Council, will proceed to President Bush's State of the Union message tonight, and will end with Tony Blair's visit to Camp David. Which means that talk of war and its possible economic consequences will continue to dominate the news.

The president will again make his case for disarming Saddam Hussein, whether or not the United Nations--having just chosen Libya's Colonel Qaddafi to head its human rights commission--throws its questionable moral force behind him. Blair will sign on, meaning that "war, war" might very soon replace "jaw, jaw." This has investors nervous, is causing consumers to defer purchases and businessmen to hold back on investments and inventory building, and is roiling oil markets. Or so we are told by the myriad analysts required to divine the reasons for daily swings in share prices and short-term fluctuations in economic activity.

These seers do, of course, have a point. A protracted war in the Middle East, combined with the continued absence of strife-torn Venezuela from world markets, might drive oil prices well above even current $30-plus-per-barrel levels. Especially if the OPEC cartel, its press releases to the contrary notwithstanding, continues to refuse to increase production sufficiently to offset the shortfall.

Many observers also lay the decline in the dollar at the feet of the war threat. They, too, have a point: The flight to gold that has driven its price to a five-year high (the spot price in London has risen 40 percent in the past year) is typical of a period in which investors prefer the safety of the tangible metal to the apparent insubstantiality of paper dollars. The result is an exacerbation of the effect of America's huge trade deficit: a falling dollar that might, just might, raise enough concerns about a renewed bout of inflation to force the Fed to hold off on any further cuts in interest rates, even if the economy fails to dig itself out of the "soft patch" in which Fed chairman Alan Greenspan says it is mired.

The weakening dollar, or the strengthening euro (call it what you will), is also a worry to some. Europe's politicians prefer a strong euro because they see that strength as some sort of evidence that euroland is catching up with the United States. But European manufacturers know that a strong euro, now at a three-and-one-half-year high against the dollar, makes it harder for them to peddle their wares in America.

A closer look at these developments suggests that the threat of a war with Iraq cannot completely explain the gloom that seems so pervasive these days. During the first Gulf War the dollar fell by some 10 percent, and recovered most of its value within a few months. Oil prices rose from around $15 per barrel to about $40 dollars in the autumn of 1990, but fell to $20 and less by the spring of the following year. War may be hell, but for the huge U.S. economy it is a passing phenomenon--especially since policymakers have learned to cope with high oil prices by loosening monetary policy. Unfortunately, Europe's central bankers are less likely to have taken past experience on board, making it probable that the temporary effects of war will hit European economies harder than in America and Britain.

In short, it is more than the prospect of war that has economy-watchers worried. Consumers, until now the engine of U.S. economic growth, are showing signs of weariness. Non-auto sales are weakening, and when the boost to spending provided by the latest round of mortgage refinancings has played itself out, America's consumers might begin to spend less time in the nation's shopping malls and more time paying down their credit card balances.

Investors see little to cheer about in recent profits reports, even though the vast majority of some 500 companies that have thus reported have exceeded expectations. For one thing, those expectations were quite modest, and the margin by which reported figures exceeded even those low expectations is lower than it has traditionally been. For investors, the glass is half empty rather than half full, and they are shifting their funds into low-yielding treasuries (under 4 percent on 10-year treasury bonds).

Perhaps a more important damper than both the prospect of war and the uninspiring earnings reports is the realization that President Bush's so-called stimulus package, even if passed as proposed--an extremely unlikely prospect--won't provide much of a stimulus after all. As analysts at Goldman Sachs point out, "A tax cut averaging $36 billion per year over the next decade is quite small in an economy that will produce more than $12 trillion a year."