HOW WE GOT HERE
Economists Debate Link Between War, Credit Crisis
Tuesday, April 15, 2008; Page A03
For House Speaker Nancy Pelosi, the connection between the Iraq conflict and the U.S. economic downturn is simple: "The president has taken us into a failed war," the California Democrat said recently. "He's taken us deeply into debt, and that debt is taking us into recession."
This assessment was put to powerful political effect in the latest congressional hearings on the war, when Democrats and Republicans alike told Army Gen. David H. Petraeus that the oil-rich Iraqi government should relieve the United States of the conflict's financial burdens. And Sen. Barack Obama (Ill.) echoed the theme yesterday at a manufacturing forum in Pittsburgh.
"If we can spend $10 billion a month rebuilding Iraq," the Democratic presidential contender declared, "we can spend $15 billion a year in our own country to put Americans back to work and strengthen the long-term competitiveness of our economy."
But this logic may have more political salience than economic validity, according to many economists, who say that the assertions linking the five-year-old conflict in Iraq to the domestic economic slide have been oversimplified.
"You should support the war or oppose the war, which I do and have done from the start, on the merits of the war itself," said Martin N. Baily, a former chairman of President Bill Clinton's Council of Economic Advisers. But, he added, "the current problems the United States is facing have very little to do with the war in Iraq."
Even so, the theme resonated in Congress last week. "We're kind of bankrupting this country," Sen. George V. Voinovich (R-Ohio) told Petraeus, the top U.S. military commander in Iraq, and Ambassador Ryan C. Crocker. "We're eating our seed corn. We're in a recession, and God only knows how long we're going to be in it."
The link between Iraq and the downturn reflects a growing public perception that individual economic anxieties must stem somehow from the unpopular war -- a unified theory of political misery, said Peter D. Hart, a Democratic pollster.
"It's a sour economy, it's a sour mood and it's a sour situation in Iraq," he said. "The public has for the last two years been told about the cost of Iraq in terms of human life. But then there was a direct and important switch, when we went into what I call the surge period, where the budget costs became front and center. While the administration was touting military successes, what the American public saw directly were the costs."
Joseph E. Stiglitz, a Nobel Prize-winning economist who wrote the new book "The Three Trillion Dollar War," contends that the connection is real. Even with a growing energy demand from China, the United States and elsewhere, oil traders anticipated before the war that the price of oil would remain about $25 a barrel. Instead, it has soared to more than $100 a barrel. Iraqi oil production has not risen with demand, in part because investment in the Middle East has been stunted by war-related unrest.
Those price increases are self-perpetuating, Stiglitz argues. Oil-rich Persian Gulf states are so awash in money that they are not sure what to do with it all. By holding back oil production, they make more off what they do produce and keep their greatest asset -- oil -- in the ground as they search for ways to spend their cash.
That cash, through state-owned sovereign wealth funds, has flowed into stocks, bonds and other investments, creating incentives for lenders to offer low-interest loans, many of which have now gone sour.
But that is only one factor, by Stiglitz's accounting. The federal government has sunk deeply into debt, first with tax cuts, then with accelerating war expenditures that have easily topped half a trillion dollars. That limited the government's ability to keep the economy on track through tax cuts or domestic investments, so the Federal Reserve Board used low interest rates and the free flow of money to keep the economy growing. Cheap credit sparked rash loans, a housing bubble and the current crisis.
"The war played a very important role," Stiglitz said.
To economists on the left and the right, his analysis strains credulity. Traditional economics hold that large budget deficits "crowd out" private lending, raising interest rates and making lending scarce, not profligate.
"The credit crisis we got into is because of the housing boom, the relaxation of lending standards and certainly a lack of adequate supervision," Baily said. "I don't see a connection with government borrowing."
And most economists still think that oil prices are soaring because of rising demand, not constrained supply.
"I guess you can argue there's been a contagion of foolishness" sparked by a spendthrift federal government, "but that seems like a stretch," said Kevin A. Hassett, an American Enterprise Institute economist and an adviser to Sen. John McCain (Ariz.), the presumptive Republican presidential nominee.
Republicans have tried their best to beat back the argument before it takes hold, even citing one of their ideological nemeses, Princeton University economist and liberal New York Times columnist Paul Krugman, who has raised doubts about any link between the war and the credit crunch.
"While both parties agree that middle-class families and small businesses are struggling with skyrocketing costs of living, this latest argument from Democratic leaders smacks of political opportunism at its very worst," House Minority Leader John A. Boehner (R-Ohio) said last week.
The analysis is politically powerful because people believe it. A CNN poll last month found that 71 percent of Americans say government spending in Iraq is a factor in the economic downturn.
"When you're spending over $50 to fill up your car because the price of oil is four times what it was before Iraq, you're paying a price for this war," Obama told an audience last month at the University of Charleston in West Virginia. "When Iraq is costing each household about $100 a month, you're paying a price for this war."
The analysis will drive the debate on the $108 billion in additional war spending that President Bush is now requesting. Congress is set to begin debate on war funding before the end of the month.
"I think there is a connection between the state of our economy and Iraq, and what we're spending over there," said Rep. Baron P. Hill (Ind.), a leading Democratic budget hawk. "We're limited as to what we can do to stimulate the economy. We're limited as to what we can do on health care or any other program. We need to spend more money on infrastructure, on roads and bridges that would have a stimulative effect on the economy, and we're not doing those things because of all the money we're spending in Iraq."