Economic Lessons of War

“War is God’s way of teaching Americans geography,” Ambrose Bierce, the eccentric author of The Devil’s Dictionary, told a Carnegie Hall audience one year before America entered World War I. He might have added economics to the disciplines about which we learn something from wars.

One lesson we have already learned from the current war is that even the best monetary policy gurus find themselves groping for direction when the fog of war descends upon them. The Federal Reserve Board’s monetary policy committee, until now able to reach decisions even when faced with contradictory economic signals, says it can’t decide whether the economy was recovering when the war broke out, or was in deep trouble and in need of a further cut in interest rates. So the members have thrown up their hands and decided to do nothing, which suits Chairman Alan Greenspan, who is believed to be sufficiently optimistic to feel no rate cut is needed.

This is making President Bush decidedly cross. He wants to see interest rates come down in order to pep up the economy. According to one knowledgeable source, “The White House is now of the view that ‘the bottom fell out’ of the U.S. economy in February.”

The Fed’s failure to cut interest rates puts the burden on fiscal policy. So the president is ramping up the pressure on so-called moderates among his party’s senators to go along with the total tax-cut package he has proposed, rather than persist in their insistence that it be cut in half. So far, he remains a chief executive spurned.

Meanwhile, his economic team is urging him to speed the recovery of the manufacturing sector by pressuring the Chinese to abandon their policy of pegging the renminbi to the dollar. American manufacturers, their fortunes at the lowest ebb since the aftermath of the September 11 attack, just cannot compete with the combination of the undervalued Chinese currency and that nation’s cheap labor. Thomas Duesterberg, president of the Manufacturers Alliance, a trade association, is a staunch free trader. He estimates that the renminbi is undervalued by between 20 percent and 40 percent, and says, “It is a perversion of the idea of free trade to manipulate the value of your currency rather than let it float and respond freely to fundamental economic forces.” Were the renminbi free to float, Chinese goods would be more expensive in the United States and elsewhere, and American firms might have a better chance of surviving in the global economy in which they compete.

This war has also taught us that it is one thing to become involved with an enemy that cannot reach the American homeland, and quite another to take on an enemy capable of inflicting damage on mainland U.S.A. The Federal Reserve Bank of New York estimates that the cost of the earnings lost and property destroyed in the attack on the World Trade Centre came to $33-36 billion. With luck, that will be a one-time cost. But other costs are on-going, and will reduce the economy’s efficiency. Public and private sector organizations now must spend money and time on things that do not add to national productivity—security at airports, millions to modify airplanes so that they are less susceptible to in-air high-jacking and ground-to-air missile attacks, guards at commercial buildings, cross-border checks that slow truck, rail and sea traffic. The New York Fed puts these costs at some $84 billion. That is pretty close to a not insignificant 1 percent of GDP. And these costs will go on, and probably mount, even after Saddam’s regime has been toppled.

We also learned that where war is waged matters. It is one thing to take on resource-poor Kosovo, or Afghanistan, and quite another to wage war in the oil-rich Middle East. The prospect of war sends oil prices soaring to recession-inducing levels, and should events take a turn that reduces the flow of Saudi, Kuwaiti, and other Arab countries’ oil the U.S. economy would find itself in considerable difficulty.

Finally, the war teaches—or should teach—economic seers that a bit of extra humility is appropriate in times of crisis. When the war started, and data from weather-racked February became available, there was a good deal of expert talk about a collapse in consumer confidence and spending. In still another proof that it is better to watch what consumers do rather than what they say, auto sales in March held at year-earlier levels, and are expected to pick up in the spring’s auto-buying season.

Experts were also predicting that war would bring a flight to gold, the traditional safe haven in times of trouble. War came—and gold prices fell by some 15 percent from their February high of $390.80 per ounce. More a flight from the precious metal by speculators than a flight to it by frightened investors.

Finally, this war has taught us—reminded us, would be more precise—that the best laid plans of domestic economic policymakers unravel quickly when the first shot is fired. Bush seemed to have a good chance of getting his tax cut through Congress until Democrats were able to argue that it is foolish to cut taxes and increase budget deficits when we are engaged in a war of unpredictable cost. If the first casualty of war is truth, the second may be the keystone of George W. Bush’s economic stimulus package.

His free trade agenda is equally threatened, not so much by the war itself as by the prelude that saw America unable to gain support in the UN from Mexico, Canada, Chile, and other countries to which America has opened its markets. Never convinced that free trade is what U.S. Trade Representative Bob Zoellick tirelessly reminds them is a win-win situation, many congressmen want to tell those countries that failed to rally ‘round our flag to peddle their wares elsewhere.

From the White House economic policy folks’ point of view, war is proving somewhat more hellish than they had hoped.

This article first appeared in London's Sunday Times on April 6, 2003.