Fed tight-lipped on the war's economic impact

Economists are trying to figure out what the start of the Iraq war means for the economies of the US and the world. It's not easy.

In 1724, a French soldier, Chevalier Folard, wrote about the "fog" of war, referring to unexpected events during battle. But it could also apply to the thick cloud that obscures the political and economic consequences of war.

Federal Reserve policymakers, meeting last Tuesday in Washington, didn't even dare a forecast, at least in a statement to the public announcing no change in short-term interest rates.

"In light of the unusually large uncertainties clouding the geopolitical situation," the central bankers wrote, "the [Federal Open Market] Committee does not believe it can usefully characterize the current balance of risks with respect to the prospects for its long-run goals of price stability and sustainable economic growth."

"What a craftily worded press statement!" comments Merrill Lynch economist David Rosenberg. It didn't upset the financial markets. It left the door open for interest-rate cuts in the future. An expert "high-wire act."

But private economists are paid to stick out their necks with predictions.

"We know the future is the future," says Donald Straszheim, a consulting economist in Santa Monica, Calif. "We don't forecast because we know the future, but because we are asked to."

Fed policymakers have an economic viewpoint, but they didn't express it, complains Mr. Straszheim. By bailing out of that risky task, the Fed "didn't add to the public discourse or to the confidence of the financial community."

Straszheim's own view is that the US economy is sluggish, with growth in gross domestic product running at a 1 percent annual rate in the first half and 2 percent in the second half.

Girard Miller, an economist who is president of ICMA Retirement Corp., in Washington, sees a 50-50 chance of a mild recession, especially if some terrorist launches a successful retaliatory action in the US.

"Right now the economy is ... on very thin ice," says Mr. Miller, manager of $15 billion in city and state retirement funds. A terrorist strike would further clobber the transportation and leisure industries, keeping uneasy Americans in their homes.

Mickey Levy, chief economist of Bank of America Securities, is more optimistic - 2.25 percent growth rate first half, 3.25 percent second half.

Key questions for the economists include: What will happen to the price of oil in the weeks ahead? How long will the war last - and the occupation?

Energy prices are already up about 25 percent since the end of 2001. But Mr. Levy points out that recent energy cost swings, though significant, pale when compared with the oil shocks imposed by OPEC in 1973 and 1979.

Saudi Arabia's promise to provide extra oil has calmed oil markets considerably. Nonetheless, because of low inventories of gasoline, Levy expects the price of crude to only gradually retreat toward $26 to $28 a barrel.

Moreover, he notes, the share of energy costs in total consumption in the US is about 40 percent less than it was in the 1970s - 4.5 percent now compared with about 7.8 percent then.

That reduces the vulnerability of the US to oil-price spikes. Yet much hangs on how vulnerable Middle East oil supplies are to war-related disruptions. Iraqi oil is already on hold.

Oil consultant Michael Lynch says that techniques learned to put out oil-well fires in Kuwait in 1991 could help extinguish wells torched in Iraq. (An air cannon mounted by a East European firm onto a remote-controlled old Soviet tank was used to blow out some of the smaller fires in Kuwait, he says.)

Mr. Lynch, president of Strategic Energy and Economic Research in Winchester, Mass., calculates that destruction of moderate amounts of Iraqi oil capacity would add $5 to the price of a barrel of oil; and wholesale destruction $15. If the Saudis up their production to 10.5 million barrels daily, it would cut the price $8 a barrel.

If crude's price rises above $40, he suspects President Bush will start releasing oil from the nation's strategic reserves for political reasons.

"Bush's father didn't release oil until too late," he says. The higher price helped push down the economy, costing him his reelection.

Besides oil prices, the war has implications in other areas:

• The war's cost, estimated for a start at nearly $100 billion, has given ammunition to those members of Congress wanting to cut by about half the tax cuts proposed by Bush. They are concerned about the swelling budget deficit.

• If the war stirs up more terrorism in the US, it adds to domestic security costs, leaving less money for other government programs.

• The political and diplomatic bitterness surrounding the war could lead to a slowdown in globalization. Negotiators in the Doha Round of world trade liberalization may be inclined to be tougher and less willing to compromise with what they see as a too-dominant US.

Another concern is that foreigners may be more inclined to invest money in other locations than the US, hurting the dollar.

Mr. Miller speaks of "the law of unintended consequences." Though the US will win the war, the ensuing occupation of Iraq is "more problematic" for the US.

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