Monetary cost of war mounts for US

AT a fascinating presentation in Dublin last week, the Vice-President of the European Central Bank Dr. Lucas Papademos discussed the euro’s future, focusing on how the applicant States of eastern Europe will be incorporated into the Eurozone over the coming years, without weakening the reputation or strength of the single currency or the Eurozone.

You may remember our own struggle with the ‘Convergence Criteria’ of European Monetary Union, which stipulated that we had to bring our inflation down to European levels; which forced us to cut our annual deficit to levels below 3% of our Gross Domestic Product (GDP); and which dictated that our currency had to remain within a tight exchange rate band for two years prior to the euro’s introduction.

Now Poland, the Czech’s and eight other states must meet these standards if they want to join the Eurozone.

And of course, as soon as they adopt the euro, they will then be subject to the conditions of the Stability and Growth Pact, which effectively limits the amount these states will be allowed to spend.

But there are good reasons for imposing strict fiscal discipline on the states that share a currency.

If states that were traditionally profligate spenders (Italy, for example) were allowed to continue to borrow unchecked while sharing a currency with us, our common currency would suffer, because external investors would take the view that the Eurozone was allowing unsustainable deficits to mount.

Consequently, the European Central Bank imposes tight rules on the 12 countries of the Eurozone, to protect our shared reputation. If only America were forced to obey such rules. Last week, President Bush sought approval for $75 billion in funding to fight this war.

However, that amount will only pay for 30 days fighting and the war could well cost more if it lasts longer. The White House estimates that the US will post a budget deficit of $300 billion in 2003 before it even pays for the war, so the total deficit is likely to top $400 billion, or 4% of US GDP. This deficit is unsustainable, and it will damage America’s reputation. Yet instead of taking steps to reduce this deficit (such as raising taxes), America is introducing tax cuts and increasing spending. America believes international investor’s will purchase the bonds issued later this year to offset war costs. That belief may be misguided.

America has never before been so indebted entering a war, and investors might prove hesitant to purchase more bonds unless America is seen to be taking steps to correct its deficit, rather than exacerbate it.

American bulls blithely dismiss the argument, saying Iraqi oil will be used to pay for the war.

But will the UN allow this? And it will take time to bring the Iraqi oil industry up to full capacity. So even if Iraqi oil does fund this campaign, it won’t happen anytime soon.

In the meantime, a more expensive than anticipated war will likely restrict US economic growth in the year ahead, which given our dependence on the multinational sector, will impact our growth as well.

Niall Dunne, economist, Ulster Bank.