Wednesday, February 07, 2007

The Cost of War

On Monday, February 5, 2007, The Wall Street Journal carried a very interesting article on the President's budget proposal, focusing on its very large military component.

The heading of the article ("How War Expense Didn't Strain The Economy") and the graph on the front page seemed to be saying that there was nothing to worry about. They seem to say that the U.S. is spending less, per-capita, on military than before. However, reading the article gives a totally different sense.

The subtitle is a bit more subdued ("Foreign Lending; Lessons From LBJ; How Long Will It Last?"), and the story has a rather thorough analysis of macroeconomics of war. There is little wonder here as Greg IP, WSJ's macroeconomics correspondent contributed to the article written by Deborah Solomon. (To access it online, you'll need a subscription. Personally, I find the paper edition much easier to read. An online subscription also seems to give a much faster download rate of WSJ pages.)

The article notes, in one of its early paragraphs, that it is unknown for how long foreigners will finance U.S. budget deficit.

Interest rates rose when Lyndon Johnson raised the level of government borrowing to fund the Vietnam War.

This time, interest rates haven't risen as much, because foreigners, particularly in Asia, are eager to lend to the U.S. economy at fairly low rates. The economy as a whole is a heavy borrower from the rest of the world....

Mr. Bush's ability to sustain spending and tax cuts depends largely on the willingness of foreigners to continue lending the U.S. money. Mr. [Menzie] Chinn, the economist, says that at some point, global investors will lose their appetite for ever-larger amounts of American debt. That would trigger a decline in value of the U.S. dollar and an increase in interest rates.

"So far it's not a problem because foreigners are willing to lend, but you've got to wonder what happens when the rest of the world says, 'We're tired of taking paper that loses value pretty quickly,' " says Mr. Chinn.

And, of course, war can bring an economic relief and an infusion.

The Bush era upturn in defense and homeland-security spending came not during a 1960s-style boom, but in a lull in the U.S. economy, which had tumbled into recession even before the Sept. 11, 2001, attacks. That meant the economy had plenty of slack to absorb increased government spending without sparking inflation. Lee Price, an economist who until recently was research director at the Economic Policy Institute, a liberal Washington think tank, says defense spending created 1.3 million private-sector jobs between 2001 and 2005 while all other private-sector employment fell by 1.2 million.

However, such relief is short-term and short-lived, if "lived" at all. After all, a bumb drop, is only a bomb drop and nothing productive comes of it as an economic tool. Hence, Nobel laureate Joseph Stiglitz' prediction.

Some academic economists are beginning to gauge what the sums spent on Iraq could have financed -- a down payment on a Social Security fix, for instance. Nobel laureate Joseph Stiglitz predicts Iraq will cost at least $1 trillion, assuming troops are withdrawn by 2010. "Half that sum would have put Social Security on a firm grounding for the next 75 years," he wrote last year in a paper. "If we spent even a small fraction of the remainder on education and research, it is likely our economy would be in a far stronger position."

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