The price of war and peace for US economy

Stock market has rallied in part on hopes for diplomatic solution in Iraq. A war could be costly to the economy.

By , Staff writer of The Christian Science Monitor

The recent stock market rally - a 21 percent increase in the Dow since the five-year low reached in early October - has been fueled by a variety of factors, not the least of which is that US troops are not yet marching on Baghdad.

A drop in jobless claims, profitable signs from high-tech firms and manufacturing, and an overall growth of confidence are also propelling the economy forward. But economists worry that a war with Iraq may derail the nascent recovery. Their concerns center on federal deficits, oil prices, and, in turn, the stock market.

The threat of war - "heightened geopolitical risk" - is already a reason for the "soft patch" in the economy, Federal Reserve Chairman Alan Greenspan has said.

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With this in mind, economists are buoyed by the possibility that the United States' dispute with Iraq could be settled by diplomacy.

But if there is fighting, economists are unsure what it will cost the US. The only public estimate by the administration of the cost of an Iraqi war is $100 billion to $200 billion over several years, made by Lawrence Lindsey, the economist in residence in the West Wing. That's small compared with the size of the entire US economy.

"I would be very doubtful if the impact on the economy is more than modest, largely because this is not Vietnam or Korea," Mr. Greenspan said. A war's cost would be "a concern, but not an overriding one."

Mr. Lindsey's estimate is within the ballpark for a short war, private economists say. But it doesn't include the costs of a prolonged occupation of Iraq, if necessary.

Thinking how massive rearmament for World War II lifted the industrial nations from the Great Depression, some believe a war with Iraq will boost the faltering American economy.

To many economists, that view is false. The uncertainty of conflict has slowed consumer spending and business investment, overwhelming any stimulation to the economy from today's extra defense spending.

"The stock market was relieved that we might not go to war," says William Quan, chief economist of Wall Street's Mizuho Securities USA.

Analysts are even encouraged by the prospect that, if there is war, it will be delayed to late winter or even spring.

"On the whole, later is better than sooner," says David Wyss, chief economist with Standard & Poor's Inc. in New York.

The hope is that the vigor of the economic recovery will pick up in coming months, thus ameliorating the shock of war to the economy.

The prize: oil

One key reason why these economists see a diplomatic solution involving effective weapons inspections as best for the economy is the impact of war on oil prices.

When the rhetoric from the White House was threatening, the price of oil moved above $30 a barrel last month, up 40 percent for the year. With the rhetoric now softened and the acceptance of the United Nations' resolution by Iraq, the price has dropped back to about $25.

Peace means more money in the pockets of Americans and others abroad as the price of gasoline and energy decline, helping keep inflation down.

"Peace would give the world economy a boost," says Kate Warne, senior energy analyst with Edward Jones, a brokerage firm based in St. Louis.

William D. Nordhaus, a Yale University economist, argues that a key factor in the economics of an Iraq war is whether the United States fights it with only Britain as an ally, or waits until it has the support of other nations. With broad support, some of the war's costs will be borne by others. Further, he suspects, a broader coalition could dampen hostility in the Middle East, perhaps having fewer side effects for oil prices.

Forecasting in the dark

Economists, of course, do not know whether the war will actually happen, or if it does, whether it will be over quickly or drag on.

To deal with this uncertainty, Mr. Quan has drafted three economic forecasts for next year.

"This is forecasting in the dark," he admits.

In the "best-case scenario," the war is settled by diplomatic means with the inspectors completing their mission successfully. In that case, the US gross domestic product (GDP) will grow more than 4 percent in real terms. The price of oil will fall to $20 or below a barrel. There will be a "significant rebound" in stock prices. Bond prices will fall. And the Federal Reserve will raise interest rates about mid-year to slow down the pace, Quan says.

If the war is quick and Saddam Hussein is ousted, GDP will grow 3.5 to 4 percent, oil will fall to $20 to $23, and thus consumers and business will do well.

But if a war is prolonged, GDP could shrink as much 2 to 3 percent. The Fed would respond with more interest rate cuts. Consumer spending would tumble. Business investment would stall.

Oil could rise above $50 a barrel if the war goes badly, suspects S&P's Mr. Wyss. During the Iranian hostage crisis when President Carter was in the White House, oil spiked to $75 a barrel in terms of today's dollars.

The peace dividend

Aside from calming oil prices, peace would trim the federal budget deficit, thereby restraining interest rates.

During fiscal year 2002, the deficit grew to $159 billion. Quan sees the deficit continuing to 2005 or 2006, and rising as high as $220 billion. War would worsen that picture.

Already, putting war materials and troops in the Middle East in preparation for war is costing $10 to $15 billion, Quan says.

But looking further than that is imprecise. Professor Nordhaus complains that "there has been no systematic public analysis of the economics of the coming conflict in Iraq."

His study of the war costs estimates the direct military cost of a short and favorable invasion of Iraq would be $50 billion; but if the war is protracted and unfavorable, that cost could reach $140 billion. But, he cautions, that doesn't include the price of victory: Occupation costs will be much higher, he warns.

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