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Some say there are two issues in the coming American
elections: the Iraq war and the economy. On days
when the war seems to be going better than expected,
and the economy worse, the economy eclipses the war;
but neither is faring well.
In
some sense, there is only one issue, and that is the
war, which has exacerbated America’s economic
problems. And when the world’s largest economy is
sick - and it is now very sick - the entire world
suffers.
It
used to be thought that wars were good for the
economy. After all, World War II is widely thought
to have helped lift the global economy out of the
Great Depression. But, at least since Keynes, we
know how to stimulate the economy more effectively,
and in ways that increase long-term productivity and
enhance living standards.
This war, in particular, has not been good for the
economy, for three reasons. First, it has
contributed to rising oil prices. When the United
States went to war, oil cost less than 25 dollars a
barrel, and futures markets expected it to remain
there for a decade. Futures traders knew about the
growth of China and other emerging markets; but they
expected supply - mainly from low-cost Middle East
providers - to increase in tandem with demand.
The war changed that equation. Higher oil prices
mean that Americans (and Europeans and Japanese) are
paying hundreds of millions of dollars to Middle
East oil dictators and oil exporters elsewhere in
the world rather than spending it at home.
Moreover, money spent on the Iraq war does not
stimulate the economy today as much as money spent
at home on roads, hospitals, or schools, and it does
not contribute as much to long-term growth.
Economists talk about “bang for the buck” - how much
economic stimulus is provided by each dollar of
spending. It is hard to imagine less bang than from
bucks spent on a Nepalese contractor working in
Iraq.
With so many dollars going abroad, the American economy
should have been in a much weaker shape than it
appeared. But, much as the Bush administration tried
to hide the true costs of the war by incomplete and
misleading accounting, the economy’s flaws were
covered up by a flood of liquidity from the Federal
Reserve and by lax financial regulation.
So
much money was pumped into the economy and so lax
were regulators that one leading American bank
advertised its loans with the slogan “qualified at
birth” - a clear indication that there were, in
effect, no credit standards. In a sense, the
strategy worked: a housing bubble fed a consumption
boom, as savings rates plummeted to zero. The
economic weaknesses were simply being postponed to
some future date; the Bush administration hoped that
the day of reckoning would come after November
2008.
Instead, things began to unravel in August 2007.
Now it has responded, with a stimulus package that
is too little, too late, and badly designed. To see
the inadequacy of that package, compare it with the
more than 1.5 trillion dollars that was borrowed in
home equity loans in recent years, most of it spent
on consumption. That game - based on a belief in
ever-spiraling home prices - is over.
With home prices falling (and set to continue to fall), and
with banks uncertain of their financial position,
lenders will not lend and households will not
borrow. So, while the additional liquidity injected
into the financial system by the Fed may have
prevented a meltdown, it won’t stimulate much
consumption or investment. Instead, much of it will
find its way abroad. China, for example, is worried
that the Fed’s stimulus will increase its domestic
inflation.
There is a third reason that this war is
economically bad for America. Not only has America
already spent a great deal on this war - 12 billion
dollars a month, and counting - but much of the bill
remains to be paid, such as compensation and health
care for the 40pc of veterans who are returning with
disabilities, many of which are very serious.
Moreover, this war has been funded differently from
any other war in America’s history - perhaps in any
country’s recent history. Normally, countries ask
for shared sacrifice, as they ask their young men
and women to risk their lives. Taxes are raised.
There is a discussion of how much of the burden to
pass on to future generations.
In
this war, there was no such discussion. When America
went to war, there was a deficit. Yet remarkably,
Bush asked for, and got, a reckless tax cut for the
rich. That means that every dollar of war spending
has in effect been borrowed.
For the first time since the Revolutionary War, two
centuries ago, America has had to turn to foreigners
for financing, because US households have been
saving nothing.
The numbers are hard to believe. The national debt
has increased by 50pc in eight years, with almost
one trillion dollars of this increase due to the war
- an amount likely to more than double within 10
years.
Who would have believed that one administration
could do so much damage so quickly? America, and the
world, will be paying to repair it for decades to
come.
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