April 2003
By ROBERT PEGG
With the U.S. war in Iraq winding down, it is becoming clearer that the outcome will entail a high human cost and additional uncertainty for the economy. Few if any economic scholars would endorse the view that war must bring prosperity. Some experts have predicted that a relatively short war would lead to lower oil prices and increased consumer confidence. The removal of uncertainty could help some businesses to make investment decisions. However that may take some time and the war could lead to higher mortgage rates, deepening government deficits and lower economic growth.
In past wars, such as World War II, the Keynesian thinking was that the Depression in the 1930s had persisted because New Deal spending had not been enough to sufficiently restart the nation's economy. The war forced the government to abandon fears of large-scale deficit spending. World War II boosted demand for unemployed workers and under-utilized factories. The nation's capacity, for example, to build automobiles was only being half used, so it was relatively easy to pump up production of military equipment such as tanks and planes. The wartime demand for military production was so strong that after the war, many economists feared that the economy would quickly slip back into the recession.
However, postwar demand came from a revitalized consumer and their rapidly multiplying children, the baby boomers. The Cold War also kept military spending higher. At the time, government spending was viewed as a positive factor because the Depression left scars on the public psyche, producing the fear that, without continuous large government outlays, the private economy would falter. Mainstream Keynesian theory held that government spending was needed to bolster the economy during recessions. Few economists argued that the government should keep spending large sums even when the private economy was expanding. The stagflation of the 1970s and the prosperity of the 1990s reversed these popular perceptions. The 1990's boom demonstrated that a strong economy can persist not only amid budget surpluses, but also after substantial post-Cold War military cuts.
A comparison of the period around the Persian Gulf War in the early 1990s may be informative. In the months leading up to the current conflict, financial markets and the economy performed much as it did then. Between the time Iraq invaded Kuwait in August 1990 and the U.S.-led coalition responded militarily in January 1991, the Wilshire 5000 fell about 15 percent. This is about the same percentage decline that the Wilshire suffered between last July, when it first became clear that the current armed conflict was a real possibility, and in mid-March when the invasion began.
Other items also have been similar, such as commodity prices. A decade ago, the price of West Texas Intermediate (WTI) oil rose from less than $20 per barrel to a peak of about $40 per barrel. WTI was trading below $20 a barrel little over a year ago, and its recent peak was just under $40 per barrel. Consumer confidence fell 40 percent as troops massed in the Middle East leading up to the Gulf War. This appears very similar to the decline in confidence experienced over the past year. Moreover, consumers turned increasingly cautious in their spending in both periods as hostilities intensified.
If history is any guideÑand if the current conflict is resolved relatively quicklyÑconsumer and business confidence may soon rally. Although the recession induced by the first Gulf War was over in early 1991, the recovery that followed was anemic. The economy was growing by the spring of 1991, but its growth rate was too slow to result in any measurable job growth. The year after the end of the Gulf War became known as the "jobless recovery."
The coming year may very well end up like the jobless recovery of a decade ago. The principle weight on the jobless recovery during the Gulf War was the credit crunch at that time, induced by an undercapitalized banking system that was hurt by overbuilt real estate markets. Most businesses had difficulty obtaining the credit necessary to expand their operations and resume hiring. This time the banking system is better capitalized and healthier, although the financial markets have been hurt by the 1990s technology bubble. As a result, the economy may be in store for another year of disappointment depending on the course of the war, the fast approaching presidential election and the possibility of another fiscal stimulus package by the federal government.
About the author: Mr. Pegg is president of Kirkbride Asset Management, the New York City-based investment advisory firm which serves businesses, institutions and private individuals.