Allocation and the U.S.-Iraq War

The Achilles heel of U.S. investment prospects isn't its credit debacle but its war in Iraq.

The war's costs are driving the dollar lower (and import inflation higher, including oil), crowding out productive investment, sending interest payments and corporate ownership stakes (and the related technology and dividends) abroad, and driving future tax rates much higher.

These are some of the reasons why we've been underweight U.S. equities for most of the past five years -- though not underweight enough -- and why we'd remain beneath the commonly-prescribed 40%+ weightings for U.S. equities. No other nation in the world bears anything approaching the staggering and wasteful losses that the U.S. will continue to bear until the war ends, and well beyond.

Thus our latest post on the war argued that Bush's latest "defining moment" for the Iraq war was also a defining moment for America. Yet recent fighting hasn't improved matters.

A new book by Nobel prizewinning economist Joseph Stiglitz and Harvard's Linda Bilmes argue that the total costs of the war will be $3 trillion, narrowly speaking in terms of direct costs to the U.S. This includes $845 billion in Congressional appropriations thus far (including the $200b '08 supplemental). What's more, Stiglitz and Bilmes write in The Guardian:

• We are not looking at McCain's 100-year scenario - we assume that we are there, in diminished strength, only through to 2017. But neither are we looking at a scenario that sees our troops pulled out within six months. With operational spending going on at $12 billion a month, and with every year costing more than the last, it is easy to come to a total operational cost that is double the $600 billon already spent.

  Second, we include war expenditures hidden elsewhere in the budget, and budgetary expenditures that we would have to incur in the future even if we left tomorrow. Most important of these are future costs of caring for the 40% of returning veterans that are likely to suffer from disabilities (in excess of $600 billion; second world war veterans' costs didn't peak until 1993), and restoring the military to its prewar strength. If you include interest, and interest on the interest - with all of the war debt financed - the budgetary costs quickly mount.

  Finally, our $3 trillion dollars estimate also includes costs to the economy that go beyond the budget, for instance the cost of caring for the huge number of returning disabled veterans that go beyond the costs borne by the federal government - in one out of five families with a serious disability, someone has to give up a job. The macro-economic costs are even larger. Almost every expert we have talked to agrees that the war has had something to do with the rise in the price of oil; it was not just an accident that oil prices began to soar at the same time as the war began.

  We have been criticised, but for being excessively conservative, for including only $5 to $10 of the $75 to $85 increase in the price of oil since then....

Their article continues:

• With the exception of a few lonely surviving supply-siders, most economists believe that deficits matter, and the huge deficits to finance the war will have their toll in the long run. Deficits matter in both the short run and the long. They help crowd out private investment that would have stimulated the economy far more than the war expenditures; and the reduced investments reduce long-run productivity. With 40% of the funds borrowed from abroad, Americans will be sending interest payments abroad - lowering living standards at home. Finally, even Fed Chair Bernanke (formerly the president's economic adviser) admits that the deficits have reduced the room to manoeuvre - the ability of the government to respond to the looming economic crisis.

  Spending so much on the war has economic consequences, even if you don't think there is any connection between the war and the economy's current woes.

  In adding up the quantifiable costs of the war, it is hard not to come up with a number in excess of $3 trillion. In putting a $3 trillion price tag on the war, we believe we have been excessively conservative - a $4 or $5 trillion tag would be more reasonable. And remember - this is just the cost for America.

The Stiglitz/Bilmes estimate does not seem to count the costs to America of having its leaders so mired in war that it impairs its ability to negotiate in its national interest in many other spheres, while other nations such as China intensively procure access to natural resources, build precious reserves, create new alliances and trade agreements, and so on. Nor can Stiglitz/Bilmes or anyone estimate the cost of millions of Islamic adherents' increased antipathy toward the U.S., the increased potential for anti-American terror acts for generations into the future. (America's increased fear of that potential that has also led it to slowly close its borders to thousands and thousands of extraordinarily talented foreign workers seeking H1-B visas.)

As we wrote in our post "A Defining Moment for Iraq" Is a Renewed Risk for America (and for Financial Markets):

• Failing to help stabilize Iraq now, only months before the troop increase was to be tapered off, could significantly prolong the costs to the U.S. and Iraq, or present a new set of even less-appealing options, such as partitioning Iraq into militarily "self-governed" entities, which could cause a new wave of misery.