Thursday, February 28, 2008

The Iraq war caused the global credit crisis?

This article on claims by Joseph Stiglitz regarding the economic implications of the Iraq war is worth reading. It repeats Stiglitz's claims that the war will cost the US $3 trillion and that it has raised oil prices by at least $5-$10 (but more plausibly by $35) per barrel.

It also claims that to fund the war the US central bank flooded its economy with cheap credit leading to a housing bubble and a consumption boom.

Finally, Stiglitz notes that the war leaves the next US president with the largest budget deficit in history. Of course the significant deficit will also in part be generated by US tax cuts. Interesting 'big picture' claims. Stiglitz and Linda Bilmes have written a book expanding on these themes - The Three Trillion Dollar War. I pre-ordered a copy today.

Linking the issue of war financing to global macroeconomic conditions has been a recurring theme in the economics literature given the inflationary consequences of the Vietnam War. This time around the flood of money creation has driven down interest rates and created an asset price boom rather than cost-push inflation. Wage and other costs I assume have been pegged by the expanding role of cheap Chinese labour.

I have made several posts on the cost of the Iraq war (here, here, here) and January 2007 had a discussion concerning the Stiglitz estimates with JS himself.

The Stiglitz-Bilmes estimated costs have increased steadily over time from early estimates of about $1 trillion. They are at the upper end of the range of estimates I have seen and ignore possible benefits from the war and the costs saved by not pursuing the earlier containment approach using sanctions.

The source of the high costs in the Stiglitz-Bilmes study is partly due to the high incidence of costly injuries to US service people from the war. These should not put immediate pressure on US budgets - the main implications of injury costs will be drawn out over the coming decades.


Anonymous said...

A trillion dollars, a trillion dollars there. Pretty soon we'll be talking about real money.


Anonymous said...

He's over egging everything and isn't thinking straight.

The war has cost the US about 1.5% of GDPannually which is large but not horrifically so.

The US is a US$ 14 trill annual GDP economy these days.

Over the 4 years of war the US has produced approx. (in todays dollars) about $56 trill in GDP.

To suggest the Fed has run an easy monetary policy because of the war is quite frankly a silly exaggeration and only the most extreme DailyKos readers would ever believe in such nonsense.

Moreover the US budget position isn't all that bad as they are/were running a budget deficit of around 1.5% of GDP until the slowdown.

There is nothing similar in the way the Vietnam War was handled to the present day.

The fed and the US government tried to monetise the Vietnam War by simply printing the money. That doesn't happen now and the US treasury borrows the money from the market. Easy fed policy has been a mistake, but it hasn’t been running easy credit to finance the war and that suggestion simply is not supported by the facts.

Joe needs to sit down and have a cup of tea.


Anonymous said...

I agree with Spiros. A trillion here a trillion there. Maybe it is only 1.5% of GDP, but since it was borrowed from China, Saudia Arabia, and some of the other oil producing states, there are big political costs involved. "you do something that we don't like, and we'll just sell a few hundred billion dollars of your currency". It seems like a good investment for those countries in terms of their own safety and future foregin political power. In addition, given that its essentially a loan taken out on the income of future generations for no apparent benefit to them, its hardly especially ethical.

Anonymous said...

What's wrong with having estimates of the cost of the war increase as time goes on? After all, the war is dragging on. Those estimates of the cost of future disability were one thing when there were a few hundred wounded GIs, another now there are over 25 thousand of them. Not to mention - perish the thought - that one day a more moral US might wish to repair some shattered Iraqi lives.

Now it's true that the complaisance of foreign lenders allowed the war to be funded without printing money. But apart from arguments over the long-term wisdom of such borrowing, wouldn't those borrowers have been even more accommodating if the call on their services had been less? An opportunity cost is still a cost.

And that's not even thinking about the benefits to both the US and the world that $3 trillion spent peacefully could buy. A Marshall plan for Africa? Buying the Palestinians and Israelis off with sheer weight of money? Alternative energy? Really making sure no American child is left behind?

Anonymous said...

Not to mention - perish the thought - that one day a more moral US might wish to repair some shattered Iraqi lives.

Oh no not another one who was pushing for the reinstatement of Saddam. I think Chemical Ali is still alive, would he do?

One can be against the war like I'm for the way it u-turned by mishandling. But the argument used by DD is almost too shallow to even laugh at. It's actaully tragic as the obvious extension of is that Saddam was more acceptable altnerative.

Anonymous said...

That was me


steven rix said...

The spending on Iraq was a hidden cause of the current credit crunch because the US central bank responded to the massive financial drain of the war by flooding the American economy with cheap credit
Could somebody explain to me how it really works?
It does not work this way I believe. There are 2 ways to finance a war, it depends on if you are with Ricardo or Keynes in economics. The 1st way is to tax people, but under Bush this did not happen, there has been tax cuts. So instead the US government preferred to borrow money with T-bonds (not from the US central banks) with foreign central banks, such as the Chinese, the Russians and the Europeans. The credit was not cheap, like they say, at least not for the real consumer in the house market. The housing market demand was artificially inflated because the interest rates were low. While people were accessing the house market, the ARMS did not kick in yet, but in reality the credit is not cheap.
I still don't understand the interconnection between "cheap" credit and the war in Iraq honestly, it does not make sense to me. Maybe he meant that the credit was cheap because it was over-estimated than the real value. At this time it's not cheap credit, it's called "swindle".

There are many factors that caused the slowdown of the US economy. Oilprices for example, the US spends more than 400 billions dollars on oil while it was only costing 40 billions dollars 10 years ago. Also notice that since the invasion Iraqis never recovered their economy and oil fields should produce more, thus, having an impact on the worldwide oil prices. The oil price will keep rising because new countries such as China and India need more oil.

Anonymous said...

"One can be against the war like I'm for the way it u-turned by mishandling"

What U-turn are you talking about? I thought it was pretty much all one way. What was the mishandling? How could the US have won within a decent amount of time? They can't win in Afghanistan (as the Soviets couldn't either), let alone Iraq.

Anonymous said...

Wow, JC, I think you just took out the Agincourt award for drawing the longest bow. I imply that the US has a moral duty to repair some shattered Iraqi lives, you trot out the old "you must want Saddam back" slander.

Maybe it's time you took your medication, mate.

Anonymous said...

DD, I've been taking Lipator from a youngish age and it hasn't had any effect on me in the way you describe. Can you suggest alternatives?

Look DD, the Americans are not killing the Iraqis in huge numbers that you imply. So stop it with the blame game.

But I ask you again, if you don't support the Americans, do you then see the Ba'áth party as the legit government of Iraq. So do you therefore support its reinstatement?

You may also answer my other question while you're there. Was Iraq better off under Saddam?


Anonymous said...

1) Iraq currently has a legitimate government. So does Cuba, Zimbabwe and Sudan. Legitimacy doesn't always mean a lot.

2) As a matter of objective fact, most Iraqis were better off under Saddam. Evil as Saddam was, he didn't kill a cool million in just five years and displace, according to the UN, 3-4 million people. Most Iraqis tell the pollsters they want the yanks out, and they should be in a better position than us to judge what's good for them.

None of which, JC, means I want Saddam back.

Now can you try, just once, to make a positive point rather than repeat tired old slanders and RWDB talking points?

Hector A. Maquieira said...

Hi, this is in response to JC anonymous:
He writes:
"The fed and the US government tried to monetise the Vietnam War by simply printing the money. That doesn't happen now and the US treasury borrows the money from the market."

I'm not an economic expert but I took a intro to macroeconomics course and one of the first things we learned is that when the government borrows money, it crowds out private borrowers. While in the short-term this can be avoided by dropping interest rates etc. maybe the reason they had to drop them so low was because of the borrowing the government was doing because of the war. Furthermore, while $500B or whatever the numerical fiscal costs of the war have been so far seems mighty massive in light of the fact that saving Bear Stearns from insolvency took only $30B of Federal (aka taxpayer) financing. If the war had only cost half as much, there might have been enough credit left for private companies to avert the whole crisis in the first place.

Hector A. Maquieira said...

Sorry, I'd like to rephrase a sentence

Furthermore, while $500B or whatever the numerical fiscal costs of the war have been so far is only a small fraction of the GDP, it seems mighty massive in light of the fact that saving Bear Stearns from insolvency took only $30B of Federal (aka taxpayer) financing.

Hector A. Maquieira said...

Hi politiques,
I'd like to try to answer your question...

So, in classical theory, if the Gov't borrows money interest rates should go up.
You already explained this yourself...

One thing that you should notice right away though, is that the US treasury sets a FED Funds rate and they will lend up to any amount to any institution willing to borrow at that rate.
That is to say, while the interest rates should move, the Treasury, since Greenspan took over I think, has maintained a steady interest rate as a tool to control the economy.
So... right away, you see how the link between Gov't borrowing and the interest rate in the US is very complicated. I'm not entirely sure of the consequences of this, but my point is that it's a very difficult question indeed.

Another idea is that when the US government had the war, it limited its own ability to use spending to try to stimulate the economy. e.g. there was inevitably less spending on highways, infrastructure, etc. that could have helped the economy without lowering interest rates. So, in that sense part of the reason the government had to lower rates was because there was really no other way to try and stimulate the economy, at least spending wise.

Another idea is that because of the war spending and higher oil, maybe the government had to lower interest rates much farther than otherwise to maintain economic activity, unfortunately these interest rates proved to be too low.

And finally, I'm not sure the credit crisis simply caused the recession. My understanding is that the credit crisis stemmed from a fall in US housing sales and prices. I think,(although again, I'm hardly an expert) that the housing problem stemmed from the middle class getting hammered by high Oil prices. In that sense, if the war caused higher oil prices, it may have then caused the housing problem which then lead to the credit crisis.

Of course, I think that all of those things above had some effect in differeing amounts, and I'm sure I'm missing a lot of the picture too.

In general, I believe that the macroeconomy is like a huge truck and every piece of economic news is a small bump on the road guiding us towards one direction or another. When we do hit an economic wall, in all likelihood we were headed in that direction for a while.
Finally, one last point, we should consider that maybe the war didn't cause the credit crisis or the recession, it might have happened anyway, and then question becomes, to what extent did the war make it worse/better?