Eyes are on Iraq war's effect on U.S. economy
By Sue Kirchhoff, Barbara Hagenbaugh and Adam Shell, USA TODAY
WASHINGTON — More than a year after the U.S. invaded Iraq, the dire consequences some economists predicted — a possible worldwide recession or sharp drop in U.S. consumer spending — have not materialized.
The nation is in a period of strong growth, and business investment is surging. Federal defense spending is contributing to bottom-line economic expansion, jumping 20% from 2002-2003 and rising at a 13% annual rate in the first quarter of 2004. Individual companies are profiting from military contracts.
"Certainly, the war in Iraq and the events leading up to the war, including 9/11, have had an impact on our business," says Mark Deasy, director of public relations for MSA (Mine Safety Appliances) in Pittsburgh, which makes safety equipment such as respirators, gas detectors and other products. The firm has had record annual revenue and earnings since 2001.
Still, the increasingly tough Iraq occupation is taking a toll on the USA in some ways that are obvious, such as higher federal deficits and higher oil prices, and others that are more difficult to see, including investor unease.
The situation in Iraq, which has the world's second-largest proven oil reserves, has added $4 to $5 per barrel to oil prices, which recently set a record, not adjusted for inflation, some analysts say.
"Today, we still have a lot of uncertainty. A lot of that uncertainty is being offset by faster growth, but (growth) would be higher if it were not held down" by unease about Iraq, says Anthony Chan, chief economist of Banc One, who adds the surge in domestic business investment is being driven, in part, by tax breaks.
Restraining stock prices
More than 50% of those responding to the UBS May Index of Investor Optimism said the situation in Iraq was hurting the investment climate a lot. Only gas prices and outsourcing jobs overseas were cited more frequently. The 800-respondent monthly index tracks wealthier consumers, those with at least $10,000 in investments or savings.
Continued fighting in Iraq has held stocks in a narrower trading range.
Donald Straszheim, president of investment firm Straszheim Global Advisors, in a recent warning to clients said: "We see a series of unhappy global news events undermining any real investor enthusiasm. This is steep uphill territory for stocks in the short run."
The 24-hour diet of mostly negative news out of Iraq has not been lost on Wall Street. Stock traders' daily mood swings, which range from euphoria to angst and manifest themselves in buy-and-sell decisions, are driven largely by market-moving news nuggets that filter through the electronic veins of trading desks.
Setbacks in Iraq have weighed both on investor confidence and stock prices. The uncertainty caused by so-called Iraqnophobia is one reason the Dow Jones industrial average has experienced some tough days this year, after soaring 25% in 2003.
Iraq is one of the three "I's" — with rising interest rates and inflation — cited as major weights on the stock market, says Kim Goodwin, chief investment officer at State Street Research.
The major negatives associated with bad news out of Baghdad, such as investors' lower tolerance for risk and a possible change in the White House, helped put a lid on stock prices, she says. It has also prompted investors to focus their attention on war rather than stellar corporate profits.
"It is overdone, but the market hates uncertainty," Goodwin says.
Keitaro Matsuda, senior economist at Union Bank of California in San Francisco, says Iraq isn't the biggest issue affecting business confidence, but it is a factor. Fears of terrorism, the rise of the Chinese economy and improving technology worldwide are all leaving people with a "wait-and-see attitude," he says.
"Customers generally feel that they are facing a lot of uncertainty right now in the global economy," Matsuda says.
Oil prices have biggest impact
Some economists say the biggest impact on the U.S. economy is through oil prices. But it's hard to determine how much of the increase in the price of oil can be attributed to Iraq directly. Other issues, including terrorism fears, tight supplies, increased demand by China, uncertainty about OPEC output and political problems in key producer Venezuela, are contributing to price gains.
"There is great concern about Middle East stability in general," says James Williams of WTRG Economics in London, Ark.
"If I had to put a number to Iraq and the extra risk associated with our occupation, I would say about $4 per barrel," Williams says. But "I think it is a more general uncertainty than just Iraq."
The price for a barrel of crude oil hit a high of $42.45 on June 2 in trading in New York but has since edged lower after a pledge by OPEC to raise output. Oil closed at $37.28 a barrel Tuesday, off $1.38. Williams and other energy analysts note that in some ways Iraq might be helping rather than hurting. After falling to just a trickle, Iraqi oil output is at about the same level as before the war began.
Higher energy costs are seen as a tax on the economy. When consumers and businesses have to pay more for air conditioning or gasoline, they have less money to spend in other parts of the economy.
The Federal Reserve Bank of Dallas recently said expectations for higher oil prices are up 20%. That would reduce the growth in economic activity 0.7 percentage points over two to three years, the Dallas bank said.
Surging defense spending
The Iraq war and Homeland Security have contributed to a surge in federal defense spending, which has added a percentage point to U.S. economic growth since 2001. But higher defense spending is also adding to record federal budget deficits, with this year's deficit expected to top $400 billion.
The cost of U.S. operations in Iraq is approaching $150 billion. That includes two special spending bills, one including $71 billion and the other $56.4 billion for Iraq. Congress is now considering a White House request for $25 billion.
Higher federal deficits have not translated into higher long-term interest rates for a number of reasons, economists say, including slack in the economy, global competition and the Fed's drive to keep rates low. But some warn that could change as the economy rebounds.
"Both political parties are telling us they're going to cut the deficit in half over the next five years. If we're bogged down (in Iraq), that becomes more challenging," Chan says.
Warwick McKibbin, a professor at the Australian National University and a visiting scholar at the Brookings Institution, last year estimated the potential costs of a war in Iraq based on two scenarios: a quick victory and exit and a long war and occupation of up to five years, with five years of rebuilding financed by major countries. Under McKibbin's second scenario, the occupation had an adverse impact on investment, growth, consumption, interest rates and stocks for the decade of involvement.
"Unfortunately, the long-war scenario looks more probable," McKibbin says, adding his projections seem broadly on track "except that we factored in more non-U.S. funding, especially from Germany and France, which has still not emerged."
Contributing: Shell reported from New York
