America’s war could induce recession

Industrial production is rising, exports are booming, foreign exchange reserves have gone through the ceiling. Even sectors like steel and paper that got trashed during the recession of 1991 are now surging into high profits.

Business confidence surveys show an upbeat mood. I hate to spoil the party, but the coming American war on Iraq could create another global recession.

Some people think that wars stimulate rather than depress economies. World War II ended the Great Depression of the 1930s. The Vietnam War did not depress the US economy, and may have boosted it. US bombing of Serbia and Afghanistan did not depress the world economy. Why should a war against Iraq be any different?

The answer lies in oil. Wars may not cause recessions, but high energy prices do. The first oil shock of 1973-74, when prices quadrupled, led to a major global recession. So did the second oil shock of 1979-80. So did high oil prices in 1990-91, related to Saddam Hussein’s invasion of Kuwait and subsequent expulsion. The rise of oil prices to $30 per barrel in 2000 was one cause of the global recession in 2001.

Today, the US oil price has crossed $32 per barrel. This partly reflects fears of an Iraq war, partly a strike in the Venezuelan oil industry, and partly a surge in consumption generated by cheap oil in most of the 1990s (the price fell to $10 per barrel in 1998). It also reflects a cold wave in most of North America that has increased energy used for heating.

Remember that a similar cold wave hit the US in the winter of 2000-01, sending energy prices soaring. Remember that the US economy slipped into recession immediately afterwards. So, global prospects would be murky even without an Iraq war. The war could ensure that high oil prices continue for a year or more.

In 1991, George Bush Sr steamrollered into the region. Saddam set fire to Kuwait’s oilfields as he retreated, and it took more than eight months to repair the damage and start the oil flowing again. The recession that followed cost Bush Sr the next presidential election. What an irony, that Saddam Hussein kept his job while Bush lost his.

History could just repeat itself. George Bush Jr plans another war on the same enemy, and will surely win again. But he could create another global recession at the very start of the campaign for the next presidential election in 2004, and so end up committing political suicide.

In the event of a US attack, Iraqi artillery will try to blow up Kuwait’s oilfields, which are in easy range. Iraq could set fire to its own giant Rumaila field, which stretches down to the Kuwait border and beyond. This will create an inferno of smoke and fire that acts as a barrier to US tanks, and disrupts the working of US heat-seeking missiles, infra-red weaponry and laser-guided weapons. Huge oilfields are also located in Northern Iraq, which may experience another US armed thrust via Turkey.

Those fields too may be set on fire. Dictators often follow a scorched-earth policy as they retreat to make a final stand. Saddam is likely to do the same. Iraq’s entire oil industry is likely to go up in flames.

It took eight months to put out the fires in Kuwait in 1991. It may take two years to put out all the fires in Iraq and resume production. Much has been said in the press of Iraq’s huge geological reserves, of the prospect of greatly increasing Iraq’s output once Saddam is deposed, UN oil sanctions are lifted, and foreign investment floods in. Very true, but that process will increase oil flows and reduce prices only after two years or so. War will immediately mean slashed production, and oil prices could spike to $40-50 per barrel.

However, that will be temporary. Saudi Arabia can, with a month or two of notice, increase its output to make good much of the Iraqi shortfall. Yet it is in Saudi Arabia’s interest to keep oil prices above $30 per barrel.

Every OPEC producer knows that prices may crash when Iraqi oil floods the market, and will want to cash in on the preceding scarcity. That could cause a global recession, or at least reduce global growth to a crawl.

Maybe events will turn out differently. Maybe Saddam will not set fire to his oilfields. Maybe he will die of a heart attack, go into exile, or be toppled by a coup. In that case oil prices will drop and the world economy could boom. But I would not bet on it.
For all investors, I have a warning. Fasten your safety belts. We are entering turbulent weather.

What do you think?