The Iraq Recession
I'm not sure how to analyze this topic, and invite others to participate. Surely, there's a column here for Dr. Krugman.
Starter theses:
1. Spending $1 trillion over the last 5 years, funded with debt, has contributed to long term interest rates remaining higher than the Fed would like;
2. Incurring additional costs of $1 to $2 trillion in payments including, inter alia, medical care for veterans, military equipment replacement, and new weaponry, also contributes to a higher cost of capital for investment by Americans in America.
3. The extra spending on the war has contributed to inflation in commodities.
4. All this extra governent spending represents a very large opportunity cost: if we had spent even $500 billion
on infrastructure, we would now have a more efficient transportation system, cheaper and cleaner water, and cheaper and more efficient electric utility systems.
4. Productive and useful public goods investment would have generated many new jobs in America, buffering the impact of globalization and increasing the size of the economy and the tax base -- another huge dimension of opportunity cost.
5. Spending on the Iraq occupation will continue to increase inflation, raise the cost of capital, and generate opportunity cost: as long as the occupation continues, the United States will have limited resources to use in funding the converstion from carbon to non-carbon energy generation and distribution.
6. The war itself appears to have reduced oil supply and contributed to rising oil prices.
Are these theses correct? Is there available research on these topics?
I'm not sure how to analyze this topic . . . .
Consider starting with Wild Ass Guesses.
March 14, 2008 11:40 AM | Reply | Permalink
The initial premise of item 1 in your list is wrong. You write that, "long-term interest rates remaining higher than the Fed would like." Maybe the Fed would like them lower, but at a 4.3% nominal rate on the 30-year Treasury and a 3.4% rate on the 10-year T Note, the "real rate" -not the "nominal rate"-are really at low levels. Calculate the real rate of interest as the nominal rate (4.3) less the inflation rate (wanna take a stab at 3%) and you get a real rate of 1.3%. Pathetically low. And these rates are higher than they were months ago because of the pressures exerted by the collapse in the fixed income markets - sub-prime et al. The Fed controls short-term interest rates and they have been moving lower and will likely continue to do so.
Your point that spending on the Iraq tragedy has cost us money and dramatically affected our quality of life can not be disputed. We are running massive budget deficits and don't have money available for government programs.
But add to that, the negative trade imbalance with China and you complete the picture. China and foreign governments have bought American treasury bonds - ie, lending back our money - which has kept rates low and subsidized our continuing consumption.
The sub-prime crisis was fueled by low long term interest rates, in my opinion, in two ways. First, the availability of low cost money made or a very competitive market for mortgages to first-time, marginal homebuyers.
Secondly, and this may be my own unique perspective, is that the recent period of what I feel have been low real interest rates, discouraged saving -(the US savings rate is the lowest in history and far lower than other industrialized countries)- and forced retirees, pensioners and those needing to live on income to reach for more speculative investments - speculating in flipping condos and fixer-uppers
which are now coming back to haunt them.
Massive budget deficits have weakened the dollar, which has been, along with strong emerging market demand, a major factor in global commmoditiy prices inflation. Oil prices for Euro nations have risen and are only at a fraction of what they are here, and oil producers, paid in dollars need more of those dollars to maintain price parity as the dollar falls.
This is complicated stuff and I'm no Krugman, but he and I would agree that the situation stinks!
I know that you as former head of the FCC could sharpen your thinking on this.
March 14, 2008 12:46 PM | Reply | Permalink
It's true that one calculates real rate of return as nominal rate minus inflation rate. It's also true that the nominal rate is around 3.5%. I believe the problem here lies in determining "inflation rate". There are a whole slew of numbers one could use, including PPI, CPI, PCE deflator, and so on, and they all give different results. Fundamentally, though, they are all "just as wrong", because the inflation rate that matters to you depends on what you will buy, and the rate that matters to me depends on what I will buy, and so on, and these differ from one individual to the next.
One can argue that we can take the individual rates and average them together and arrive at a "group rate" of inflation. This is the justification for any of the various indicators above. It is a reasonable thing to do, but it still misses a few key items. There is the problem of the "hedonics" adjustment to the CPI, which is sensible and yet also utter nonsense, but most fundamentally of all, there is the problem that the CPI or PPI or PCE of the moment is not the one that matters. If you are saving for your kids' college, the number that matters is not even the college inflation rate of "right now": the number that matters is the college inflation rate over the life of the savings. In other words, to figure out the real rate of return, we need to know what inflation is going to be in the future.
March 14, 2008 2:49 PM | Reply | Permalink
Nice analysis, prmco. I think you're right that low interest rates contributed to the sub-prime crisis by encouraging people to take overly large mortgages and home equity loans. Your idea that low interest rates also contributed to the problem by encouraging more speculative investing in real estate is interesting. You're right that the returns from real estate looked particularly attractive when compared with returns from more conservative investments. Maybe even more significant, however, was the fact that low interest rates encouraged "leveraged" investing in real estate--since the cost of borrowing the funds to invest was so low. I doubt, however, that the percentage of Americans doing such speculative investing was very high. At the same time, though, I suspect that that small group had a disproportionate influence on housing prices, especially in booming markets. "Flipping" increases demand for homes and drives prices up. And rising prices mean an overall increase in the size of mortgages, even for people not buying homes for investment purposes. So large mortgages may have been at least indirectly a result of speculative investment, which in turn was driven, in part, by low interest rates.
I do think, however that low interest rates, while contributing to the current credit crisis, weren't the primary cause of the problem. For that, I think we have to look at the increased willingness of lenders to give credit to people who can marginally afford it (in return for above-market interest charges) and the increased willingness of Americans to take on large amounts of debt to fund spending, even at absurdly high interest rates (like those charged by the credit card companies). The problem in some ways is a cultural problem. Americans have become obsessive consumers. Consumption is encourged, of course, by corporations (which depend on it to drive top and bottom line growth) and by the government. For a lot of factors (but mostly competition from lower-cost labor markets), American wages (in the lower and middle classes at least) have not increased proportionately with consumption. So the gap between greatly increased consumption (spending) and flat or slightly increased wages has been filled by debt and reductions in saving. Lenders, who can make big profits by encouraging excessive borrowing, have been quick to exploit the trend, encouraging ever more risky borrowing behavior through easy access to high-interest (often variable) loans.
What we've seen over the past few years, then, is an economy that has looked relatively healthy because of high consumption. That consumption has resulted in reasonable profitability for corporations and reasonable stock market performance. However, the foundation on which this consumption has been built is very weak (constructed of debt rather than income)--and is highly unstable. A small downturn in the economy (maybe caused by the cost of the Iraq war?) was all it took to send the whole ediface into rapid collapse. The government, in desperation, is sending out tax rebates to try to get the consumption cycle restarted. I doubt that will work, but even if it did, it wouldn't do anything but delay the coming reckoning. Ultimately, consumption and income must get back into balance or the economy will remain unstable. For consumption to stay high, income must increase--which means American workers need to have higher paying jobs. And this can happen only if Americans are producing stuff that people inside and outside America want to buy. Right now, however, production is shifting in the other direction--to places outside America. And by production, I don't just mean manufacturing--even service and management jobs are shifting overseas. And corporate ownership is also shifting away from America. So what's left for us here to generate the income we need? I don't know, but we need to seriously start reinvesting in America. And sending trillions to Iraq can't possibly be helping us do that.
March 15, 2008 10:46 AM | Reply | Permalink
You hit the pointy fastening device ("nail") right on the flat striking surface ("head") here. Let me just add one more item:
Lenders ... encouraging ever more risky borrowing behavior through easy access to high-interest (often variable) loans.
Lenders really like variable rate loans, as this transfers all of the interest-rate risk to the borrower.
March 15, 2008 3:33 PM | Reply | Permalink
Absolutely right, ct, at least in periods (such as the last decade or so) when interest rates are low, since any variation is likely to be in an upward direction. Lots of upside for the lenders with little downside risk, except in the extreme case when rising interest rates contribute to a rash of defaults (as is happening now).
March 15, 2008 5:42 PM | Reply | Permalink
Heh, reminds me of a point a friend of mine made once, when he had gotten an adjustable rate mortgage more than a decade ago, back before they were so popular. It basically boils down to: "pay attention to which options the bank is selling the hardest, and go for the other ones."
March 16, 2008 1:24 AM | Reply | Permalink
prmco,
this is NOT a dispute of your post as I'm completely unqualified to comment on matters this deep, but I do have a question (benign;
You said:
-(the US savings rate is the lowest in history and far lower than other industrialized countries)-
I've been hearing this same comment on savings for years and years and I just don't know what to make of it. Apart from so many wanting to buy everything in sight (spend spend spend), could it also be because more and more of the country's entire wealth is being transferred upwards leaving little left for the rest of the populace to use as savings?
March 15, 2008 11:21 AM | Reply | Permalink
I have been surprised that the campaigns haven't been making more out of the argument in the new Stiglitz book on the ultimate $3 trillion price tag for the war. They should really be talking this up. $3 trillion substantially exceeds the total national health care expenditures for all of 2007. It also exceeds total US household debt (everything except mortages).
March 14, 2008 12:57 PM | Reply | Permalink
There is another factor that could be added to the cost of the war. The dollar is losing its value. This is a measure, in part, of the confidence that the world has in the US. There is no single factor bigger than the war in Iraq that has undermined America's credibility this past decade.
Credibility and confidence are psychological factors and very difficult to measure. Indeed financial panics are by their very nature unpredictable. But in retrospect it is often clear what the causes are. If the US dollar loses its reserve currency status in the next year or so, I suspect the war in Iraq will be up there in reasons for the loss.
March 14, 2008 1:50 PM | Reply | Permalink
I have been saying something that I am pretty sure is true, but I'm not certain: The money spent on the Iraq invasion and occupation has largely gone to Americans, generally to American corporations. This is a massive drain of borrowed money, to eventually be paid back in inflated dollars by taxpayers, to a favored few US corporations.
I think most of us think of a pipeline carrying our tax dollars to Iraq when we think of the wasted money spent invading and occupying Iraq. But, in my view, the bulk of the money is still in American hands. I'm not sure how this fits in your thesis.
March 14, 2008 1:54 PM | Reply | Permalink
Chalmers Johnson has a recent essay on this topic What you describe is called military keynsianism. If the $800 billion spent really did leave the country we would be in much deeper trouble. But pissing the money away on the military is still not good for the economy.
March 14, 2008 3:22 PM | Reply | Permalink
What it definitely does do is help make the growing gap between the superwealthy and everyone else even worse.
March 15, 2008 9:12 AM | Reply | Permalink
I think most of us think of a pipeline carrying our tax dollars to Iraq when we think of the wasted money spent invading and occupying Iraq. But, in my view, the bulk of the money is still in American hands. I'm not sure how this fits in your thesis.
You are brushing up against the broken window fallacy here. Occupying Iraq consumes resources. The resources that are being used to occupy Iraq are not being used for other things. Every time some corporation which is making war machines is enriched, that money is not going to enrich some other company making civilian software, more efficient civilian cars, etc.
March 16, 2008 12:55 AM | Reply | Permalink
I'm with prmco up to "The subprime crisis . . . " I think there's more to it, but I don't have a great answer as to what.
On saving, the double-bubble experience made ordinary saving less interesting. Meanwhile, the rich had their own consumption boom, the middle class had less income growth, ergo less saving.
I don't think budget deficits have been or are much of a problem, yet.
The finance/credit market problems have to do with regulation, not my expertise, but I don't think they get fixed with low interest rates or lower deficits. What the big fix is, I don't know, but it's somewhere in financial regulation, not in fiscal or monetary policy. And whatever it is won't preclude the downturn that has begun.
A key weak spot now is state-local government finances, which are starting to feel the pain and could pass along a lot more to everyone else. There was no aid for them in the first stimulus package. There ought to be some in subsequent ones. And there will be more.
March 14, 2008 2:27 PM | Reply | Permalink
September 1, 2007, a day that shall live in . . . ?
March 14, 2008 2:57 PM | Reply | Permalink
January 2001 until we get Bush's butt out of office in January 2009 - 8 years that will live in infamy!
March 15, 2008 9:14 AM | Reply | Permalink
I am quite sure that in the years and decades to come it will be recognized that 9/11 and Iraq will have changed this country in ways that most assuredly indicate we took a wrong turn.
Yes, we need to worry about money but there are other things that have to come before money. The aspect of a recession, even a bad one, is a lesser problem than some others we face.
There is no argument that 9/11 was bad but to depart so dramatically and so thoroughly from the things we espouse to believe is not something that can be undone. I think of our national anthem that ends with "the land of the free and the home of the brave" and realize we are neither. Our government is absolutely overrun by criminals and liars who have only their own interests driving their every word and action. I'm a Vietnam vet and I thought things were bad then but it's not even close to what we have today. It is unbelieveable that Bush doesn't even pretend to give a damn about this country or it's citizens. Our constitution and our laws aren't even in the picture. Congress is ethically and legally incapaciated by a core group of republican senators and a few democrats who care not a bit what they've done. If anyone were to have told me forty plus years ago as a green recruit that I would be witness to crimes of this magnitude or that not a thing could be done to correct it I would have said no fucking way. Yet here we are in the most awful state we have ever faced and because we have no honorable men (or women) willing to perform their sworn duty we are most certainly screwed good and proper and forever. There will be no going back from this because government, no matter who is at the helm, will not give back the power it has so illicitly taken. It's like jumping off a cliff. You take that fatal step and...
March 14, 2008 2:30 PM | Reply | Permalink
I have a question as I am no economic guru and have not studied economics in acedemia but is there a question to be asked regarding the theories which many of the top economic advisers have promoted over the last 30 years. I was reading a blog by Mark Thoma between him and some other notable economic experst such as Glabraith, Krugman and others discussing the differences in economics during the late 70's and early 80's. One of the things that they pointed out is that the Friedman school of thought is not particularly interested in the dollar/monetary value but focuses on other types of factors which support a trickle-down economic principles. Maybe I am not remembering correctly? Is there a school of Keynesian thought that is resurfacing to save our collective economic butts so to speak? Our economist looking back to fundemental principles that have lead to these bubbles over the last thirty years?
March 14, 2008 2:40 PM | Reply | Permalink
Yes, there is research on the impact of the Iraq War
If anyone cares, we commissioned Global Insight to project the impact of a sustained increase in military spending equal to 1 percent of GDP, approximately what we have been spending on the Iraq War. It raises the trade deficit and costs jobs, but it did not cause the recession. That was Alan Greenspan and his housing bubble.
Anyhow, the paper is available here http://www.cepr.net/index.php/publications/reports/the-economic-impact-of-the-iraq-war-and-higher-military-spending/
March 14, 2008 3:11 PM | Reply | Permalink
"I think most of us think of a pipeline carrying our tax dollars to Iraq when we think of the wasted money spent invading and occupying Iraq. But, in my view, the bulk of the money is still in American hands."
Well, if the money went to KBR, we know they didn't pay their share of Social Security/Medicare taxes. And untold billions was stolen by Bu$hco cronies, not to buy American-made products, but to sit in some offshore account in the Caymans.
March 14, 2008 4:06 PM | Reply | Permalink
I think I disagree with points 4 and 5. There seems to be an assumption that if the money wasn't spent on Iraq, it would have been spent usefully in the US. I think this assumption is false. It's borrowed money, so we simply would not have borrowed and spent it.
It would have been a good idea to borrow and spend - the only reason I know of to borrow money is for capital improvements. But, as country, we almost never do it.
With the Republics in charge for six years, and having a block in the Senate, there has been no hope of spending money to improve the infrastructure.
March 15, 2008 1:25 AM | Reply | Permalink