Talk of war makes mark on faltering economy

The rising drumbeat of war against Iraq is taking a toll on the U.S. economy. Oil prices are climbing, consumer confidence is falling and Wall Street is suffering stomach-churning days.

With the economy still struggling to emerge from last year's recession, there is growing concern that the potential adverse effects from a war with Iraq could push the country into another downturn.

Much will depend, economists say, on how the fighting unfolds. A quick U.S. victory, they believe, would likely translate into a quick retreat in oil prices. And the end to the uncertainty over the war's outcome should help bolster consumer and business confidence. These developments probably would mean an invasion of Iraq would have little long-lasting effect on the U.S. recovery.

But if a war with Iraq takes longer than the quick victory in Afghanistan or if the U.S. invasion provokes terrorist attacks in this country or a cutoff in oil supplies, the economic impact would be much more severe.

"There are many dark scenarios one could construct that would have a much greater debilitating impact on the economy," said Mark Zandi, chief economist at Economy.com.

"The military action could get bogged down or the U.S. invasion could send the rest of the Middle East into turmoil or incite increased terrorism in the United States," Zandi said.

Recession triggers

Economists note the sobering fact that America's last four recessions were triggered in varying degrees by problems in the Middle East. U.S. downturns in the mid-1970s and the early 1980s were caused by sharp spikes in oil prices. And a big jump in the price of oil triggered by Iraq's invasion of Kuwait was a prime culprit in the 1990-91 recession, which doomed the re-election chances of President Bush's father.

Even last year's recession, which ended a decade-long stretch of prosperity, is seen as having Middle East origins, with the shock from the September terrorist attacks proving the final blow that turned a period of sluggish activity into a full-blown recession.

"If you include the most recent downturn, then we have had four out of the past four recessions caused by the Middle East," said David Wyss, economist at Standard & Poor's in New York.

The International Monetary Fund, releasing its latest economic forecast Wednesday, said a $15 increase in the price of a barrel of oil, if sustained, would shave 1.2 percentage points off annual growth in the United States.

All the talk about a U.S. invasion of Iraq has sent world oil prices climbing to $30 per barrel, up 45 percent over the past year.

Macroeconomic Advisers, a St. Louis forecasting firm, estimated that if war causes oil prices to rise to $41.50 early next year and a rattled stock market falls by 6 percent more than it already has, the gross domestic product would fall back into negative territory for one quarter, keeping the jobless rate above 6 percent for all of next year. The firm's baseline forecast is for the unemployment rate, currently at 5.7 percent, to fall to 5.5 percent by the second half of next year.

Even without factoring in the recent jump in oil costs, the IMF in its new forecast shaved its estimate for U.S. growth to 2.6 percent for 2003, down by 0.8 percentage point from its April forecast.

It said the downward revision reflected the U.S. economy's disappointing performance this summer with weak growth, rising job layoffs and a renewed swoon on Wall Street all rattling consumer confidence, which fell in September for a fourth straight month.

The Federal Reserve took note of the new difficulties facing the recovery and the rising possibility of war when it said Tuesday that "considerable uncertainty persists" about the strength and timing of a rebound, including "the emergence of heightened geopolitical risks."

Many analysts saw this apparent reference to the Middle East as a signal the Fed will cut interest rates quickly to shield the U.S. economy if the country does invade Iraq.

The spike in oil prices and the shakiness of Wall Street investors and consumers tell only part of the story of the potential economic impact of a war with Iraq, analysts said.

They see a return of large-size budget deficits, reflecting the huge costs of a military engagement. The Democratic staff on the House Budget Committee estimated the price tag could hit $93 billion if the war lasts 60 days and requires 250,000 U.S. troops, the upper range of troop strength the Pentagon is considering.

Treasury Secretary Paul O'Neill told reporters Wednesday that focusing on the cost was "irrelevant" because freedom was at stake.

"There is no price at which we should think about giving up freedom because we can't afford it," he said. In addition, he said, cost estimates cannot be made until the president decides what military options he wants to pursue.

Analysts for the most part don't believe bigger budget deficits and an oil price spike will have long-lasting impacts on the economy as long as the war is contained to Iraq and there are no serious terrorist attacks.

Some analysts said there could actually be an economic payoff in the long run by getting rid of Iraq President Saddam Hussein.

"Iraq is sitting on top of large oil reserves which could produce several million barrels of oil daily," said Kenneth Mayland, head of ClearView Economics in Cleveland. "Once a friendly government is installed in Iraq, they will be pumping a lot of oil and that will mean lower prices for American consumers."