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The Gloom Patrol

New York and Washington elites are worried about the economic ramifications of the worst-case Iraq scenarios.

11:00 PM, Feb 10, 2003 • By IRWIN M. STELZER
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I CAN'T RECALL WITNESSING such all-pervasive gloom as pervades Washington and New York. Washingtonians are focused on the coming war, and the disintegration of the space shuttle Columbia jolted them into a realization that risks taken can result in deaths realized. New York businessmen, surrounded as they are by laid-off investment bankers, on-going investigations of CSFB technology banker Frank Quattrone and some of the city's once-superstar analysts, and a city budget that suggests massive tax increases and service cuts cannot be far behind--watch share prices and convert their board rooms into bunkers from which edicts about "hold the line on hiring and investing" are issued.

One source of discontent is the hard numbers being produced by the White House and other analysts as war with Iraq comes closer. The effect on oil prices has long been known, or at least guessed at. If the war proves to be a quick--surgical excision of the Saddam regime--analysts expect the oil price to surge at its outset, and then quickly retreat to something like $20 per barrel as the "war premium," now estimated to account for some $10 of the current $35 price, is eliminated, and as Venezuelan production continues to recover. Under this scenario, an investment (estimated by the Council on Foreign Relations and the James A. Baker III Institute for Public Policy) of $5 billion will be needed over the next two years to modernize Iraq's oil fields and maintain capacity at something close to three million barrels per day. Adam Sieminski, a London-based oil analyst at Deutsche Bank, is a bit more optimistic: He thinks that in two-to-three years Iraq can increase its ability to produce by 1-2 million barrels a day.

Since only 15 of Iraq's 74 known fields have been developed, international oil companies should be willing to fund investment of the estimated $40 billion needed over the next decade to double current output from the nation's low-cost reserves. If that proves to be the case, the prospect is for an increased flow of oil that, along with other new sources, will exert a restraining influence on oil prices in the long term.

That's the scenario believed most likely by defense planners in Washington. But the crash of the Columbia shows that bad things happen to good scenarios. Should it all go wrong--the war becomes prolonged, Saddam sabotages Iraq's wells--prices might soar to as much as $80 per barrel, and fall back to $40 rather than $20 (according to another CFR-Baker analysis).

Moreover, even if all goes well, it is not certain that a new Iraqi government will put out the welcome mat for foreign investors. Daniel Yergin, author of the Pulitzer Prize-winning "The Prize: The Epic Quest for Oil, Money, and Power," points out that Kuwait promised to be host to foreign companies when America, Britain, and their allies drove Saddam out. "Eleven years later that has yet to happen--because of nationalistic opposition in Kuwait's parliament." That nationalistic pattern is not peculiar to Kuwait: Saudi Arabia has yet to allow foreign oil companies to enter the country, and Mexico has chosen to become a net importer of oil rather than allow American companies to invest in the development of its cash-starved oil industry.

So the era of peace and low prices might elude us. Also, this war will not have the same demand-boosting impact as have others. There is no massive ordering of hardware by the military: Much of the financial cost will be incurred by supporting personnel stationed overseas. It is true that stepped-up military spending accounted for nearly two-thirds of the slight 0.7 percent growth recorded by the economy in the fourth quarter of last year. But the president asked for only a $16 billion increase in the defense budget he submitted to Congress last week, an increase of less than 5 percent. Throw in the guess that war in Iraq--which is not included in the budget--will cost some $100 billion, and the added defense outlays still come to a trivial percentage of the $10 trillion U.S. economy.

When matched against the unnerving effect the prospect of war is having on investors, businessmen, and consumers, the stimulus provided by defense spending pales into insignificance. Franklin D. Roosevelt may have seen the onset of World War II lead to massive spending and an economic recovery, but George W. Bush won't get any such cheery byproduct from the grim process of putting American troops in harm's way.