Thu, Oct 11, 2001 page19

• Not all spending is created equal

  If war was beneficial, we'd regularly bomb our cities so we could command resources to rebuild them. Instead, wars create shortages as the government impedes on the free market's ability to allocate resources efficiently

  • By Caroline Baum / BLOOMBERG
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  It's different this time. The nature of this conflict with terrorism presumably will prevent the economy from "being revived by the developments that fueled previous wartime booms, like surging orders for tanks and airplanes or demand for workers to replace those who go off to fight," according to Tuesday's New York Times.

  It's always different this time. True, this is not a war of tanks and airplanes, but it will be a war of high-technology military equipment. This is not a war for Rosie the Riveter, but it is a war of Dot-Com Dan turned Security Man.

  Spending is spending. Granted, not all spending is created equal. Money spent on bombs and missiles doesn't add to the capital stock or contribute to our well-being, except in as much it enhances our lives by ensuring their longevity.

  

  Deck crew hang a missile on an F/A18 fighter on the USS Carl Vinson aircraft carrier in the Arabian sea on Tuesday. Aircraft are flying sorties from the Carl Vinson as part of Operation Enduring Freedom.

  PHOTO: REUTERS

  After all, if wars were so beneficial, we wouldn't wait for an external enemy to attack. Instead we'd regularly bomb our cities so we could command resources to rebuild them.

  For the purposes of gross domestic product, however, the government's war effort should be no different from that during previous wars. And there's already evidence from the dwindling budget surplus that spending has vaulted into high gear.

  In August, the Congressional Budget Office projected a US$176 billion surplus for fiscal year 2002, which started Oct. 1. Eight months earlier in its January budget outlook -- before the Bush tax cut was enacted and at a time when the slowdown was expected to be short-lived -- the CBO projected a US$313 billion surplus for next year.

  Two weeks ago, the CBO informed senators that the surplus was likely to be about US$50 billion, based on the performance of the economy and newly enacted spending measures in the wake of the Sept. 11 terrorist attack on the US. Many private-sector economists expect next year's budget to show a deficit, the first since 1997.

  What's good about this war is that it will increase demand for things of which there is a surfeit: information technology.

  "Spies need computers," says Henry Willmore, senior economist at Barclays Capital Group. So do the businesses that were quartered in and around the World Trade Center. (Industry analysts say this will be a drop in the bucket in terms of annual sales.) "You're already hearing about increased demand for face-recognition software," says Chris Low, chief economist at First Tennessee Capital Markets.

  While the plunge in travel is making all the headlines, with nationwide layoffs announced by major hotel chains, just think what a bonanza the cleanup and rebuilding of lower Manhattan will be for the construction industry, a survivor of the economic slowdown. Anyone who is thinking of doing some minor renovations on his co-op will probably be on a waiting list for some time in 2005.

  Then there's the small matter that wars tend to be inflationary, not deflationary.

  "You show me a country that had a war that was deflationary," says Jim Bianco, president of Bianco Research in Barrington, Illinois. "The Gulf War, the Cold War, the Vietnam War, World War I and II -- wars cause an increase in inflation." Wars create shortages and a misallocation of resources, Bianco says. "The government is impeding on the free market's ability to allocate resources efficiently."

  Right now there is no shortage of factory workers. In fact, 1.1 million manufacturing jobs have vanished into thin air since July of last year -- and that doesn't include temporary workers assigned to factories, which account for about half the temps in the US (The personnel supply services industry is included under services industries.) On the other hand, security is being beefed up everywhere: at airports, at businesses, on the streets. The stepped-up security registers as an increased cost of doing business, which companies aren't going to absorb given their ailing profits.

  Many forecasters are taking comfort in the decline in oil prices following the Sept. 11 attack. In the month since the attack, crude oil futures are down about US$5 to US$22.45. Driving prices lower is the idea is that decreased demand for oil with the world economy in a slump is offsetting any fear about the interruption in supply.

  If I were a betting woman (and I am), I'd bet that oil prices are going up. If the Bush administration is serious about waging a war against terrorism, at some point the missiles are going to be aimed at the perpetrators of terrorism, including Iraq and Iran.

  That should challenge the complacency about a guaranteed supply of cheap oil.

  Now, higher oil prices are not inflationary per se. They only become inflationary if the Federal Reserve accommodates the increase. Since the central bank targets an overnight rate, supplying whatever reserves the banking system demands, a rise in oil prices will get accommodated unless the Fed decided to raise the overnight rate.

  Judging by the explosion in the money supply, even before the Sept. 11 attack, the Fed is not about to deny anyone anything.

  While the US$166 billion increase in the broad monetary aggregate M2 in the Sept. 17 week was "technical" -- the Fed provided adequate reserves to ensure the smooth functioning of the payments system since the disruption in transportation prevented checks from clearing -- M2 declined by only US$67 billion in the following week.

  It is not fashionable right now to talk about inflation. At some point, however, all this money printing will come home to roost.

  "It may not be fashionable, but inflation is going to be higher than it otherwise would," says Paul Kasriel, director of economic research at the Northern Trust Corp in Chicago. "War wrests resources from other uses." Even if the Fed had held the funds rate steady, the extra spending would have been accommodated, he says. "As it is, the Fed lowered rates so that other rate-sensitive borrowers will find it attractive to borrow more." Every war is different in the same way that every business cycle is different. Still, some things stay the same. Current monetary and fiscal policies may be disadvantageous in the long run. In the short run, it's hard to see why printing and spending won't perform their usual functions.
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