A stock market commentator recently noted, "the commonly held view that stocks will rally and oil prices will plunge as soon as bombs start dropping." Another alluded to the view "that stocks soar once the uncertainty over Iraq is resolved -- either through military action or through a peaceful settlement." An economist on CNBC promised the economy would rebound "once we get the Iraqi situation resolved."
These comments assume the start of war would "resolve uncertainty." That is because uncertainty was oddly defined as wondering whether the United States will attack Iraq. That is surely one of the least uncertain prospects in a world of ubiquitous uncertainty. It is no coincidence that stocks collapsed worldwide as uncertainty about "a peaceful settlement" virtually vanished. Investors rushed into "safe" gold and Treasury bonds, driving bond yields to a 44-yield low (bonds are safe only if you like to buy high and sell low). Markets clearly anticipate serious economic damage from war.
Once we define actual war worries more sensibly than the mere probability of war, it is obvious the beginning of war cannot possibly be the time when "uncertainty over Iraq is resolved." That is when the most ominous uncertainties begin. War may increase risks of terrorist counterattacks in the United States and Britain, for example. But stocks have fallen just as sharply over the past month in Japan, Germany and France. That suggests it is higher oil prices, rather than terrorist reprisals that have mostly accounted for anxieties depressing world stocks. That is potentially good news because high oil prices are something we can easily do something about, as I explain later.
Opinions about the economic impact of war are unavoidably tainted by opinions about its desirability, making it difficult to separate propaganda from analysis. Some say an Iraq invasion would be over in weeks, because Iraqi troops and government officials are thought to be eager to surrender. Others say laying siege to Baghdad, a city the size of Los Angeles, could be as risky as "Blackhawk Down" and prolonged for many months by U.S. commitments to minimize civilian casualties. After getting past that urban warfare hurdle, we would then face uncertainties about refugees and occupation.
Iraq's southern Shi'ites, western Sunni and northern Kurdish tribes have been held together by brute force, and they may prove no more cohesive a "nation" than Yugoslavia. Some Iraqis who welcome liberation may violently resist occupation. Despite heroic talk about building a model democracy in Iraq, just keeping the place from coming unglued could be a chore.
Army Chief of Staff Gen. Eric Shinseski estimates occupation may require "several hundred thousand" troops. Central Command had earlier predicted that up to 200,000 troops would be needed for occupation. Top Defense officials nonetheless hope 100,000 would suffice. My judgment is that at least 200,000 would be needed for at least a year or two, which raises another uncertainty: Would U.S. voters put up with that?
Proponents of war define just about anything as a weapon of "mass destruction," but what happens to U.S. and world support for a prolonged occupation if U.S. troops (who lack the scientific training of U.N. inspectors) fail to turn up much of anything? Alternatively, what happens if invading troops discover Iraq really does have effective chemical weapons -- aimed at them -- so the invasion becomes far more difficult and deadly than we have been led to expect?
What if Saddam proves as difficult to snare as Osama bin Laden?
Starting a war resolves none of these uncertainties. That explains why estimates of the budgetary costs of war and occupation have a very wide range. William Nordhaus, an economist at Yale, has estimated war, reconstruction and occupation could cost the U.S. government anywhere from $151 billion to nearly $1.6 trillion. The government keeps estimates below $100 billion by assuming no unpleasant surprises and ignoring related costs (e.g., bribing nations for U.N. votes).
My judgment is that the costs would be closer to $200 billion. Because the expense is temporary and unpredictable, it is appropriate to leave it out of the federal budget and smooth out the financing with a mix of nonmilitary spending cuts and debt.
What about oil? George Perry at the Brookings Institution estimated an Iraq war could push oil prices up to $75 to $161 a barrel. Industrial economies would implode before oil prices got that high. Besides, traders anticipate trouble, so prices rise long before trouble starts. Oil prices jumped 90 percent before the last Iraq war, and 75 percent before the next one (if it happens).
Some take false comfort from fact that futures contracts for oil delivered in the fall have been well below the recent spot price. Both spot and future prices will move up or down depending on good or bad news. In any case, temporary oil spikes hurt, too. Industries with big energy bills have an even stronger incentive to cut production if they think cost increases are temporary.
There is one upbeat surprise that may accompany the start of war, although it would be better without war. At the start of Desert Storm, the elder President Bush ordered sales from the Strategic Petroleum Reserve of up to 33.75 million barrels, which briefly amounted to more than 1.1 million barrels a day. Those who had been speculating that war would boost oil demand more than supply were suddenly eager to sell oil cheap. Oil prices fell, and stocks rose. That was not because of bombs. It was because of oil.
Iraq's oil production of 2 million barrels a day could be off the market for a long time unless U.S. troops took command of Iraqi oil fields before Saddam blew them up. Saudi Arabia could make up for half that loss, but that would still leave oil dangerously overpriced. The critical wild card is the unknown willingness of President Bush to quickly tap the U.S. Strategic Petroleum Reserve (SPR) and the doubtful willingness of "Old Europe" to tap the much larger reserves of the International Energy Agency.
On Nov. 13, 2001, Mr. Bush ordered the Energy Department "to fill the SPR up to its 700 million barrel capacity." The reserve is 100 million barrels shy of that level, but it would be absurd to keep buying oil. If war comes, it will be absolutely critical to simultaneously announce rapid sales from strategic reserves. To have the maximum impact, the president should say we are willing to sell as much as necessary even if Texas whines.
I tend to believe this will happen. But governments have a long history of hoarding stockpiled materials during crises on the argument that the rainy day reserves must be saved for an even nastier storm. Desert Storm was the only time U.S. oil reserves have been used, despite the fact that oil surged to about $39 in 1980-81 and to $34 in the fall of 2000, followed by recessions.
If there is swift and aggressive deployment of strategic oil reserves, I doubt oil would go even as high as $50, and I would expect any price spike to be brief.
That leaves me in the strange position of agreeing with those who say this is a good opportunity to buy stocks on the cheap, even though I believe the probable costs of war have been seriously underestimated and that the promised benefits are apt to prove illusive.