The Relationship Between War and the Economy

Chris Lee
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Many factors have contributed to geopolitical tensions in 2017, but the threat of nuclear war has to take the top spot on the scale of concern for investors and citizens. A belligerent President in the White House has done nothing to pacify global tensions and when you add a weapons-crazed despot into the mix in the form of North Korea’s Kim Jong Un, it makes for jittery markets, writes FXTM Senior Staff Writer, Nikola Grozdanovic.

The dollar index, which measures the USD against a basket of other major currencies, has shown that the dollar is taking strain. Many forex traders have lost confidence in the USD and have been toggling between safe havens like gold and the Yen, and even cryptocurrencies like Bitcoin have benefited.

Over the course of the year, Trump has not minced his words about his disdain for policies adopted by his global counterparts, which he believes may adversely affect the U.S. His litany of tweets and his unreserved rhetoric in media interviews, targeting China, Syria, Russia, Canada, Mexico and North Korea, has put international markets on high alert.  The most heated of the arguments that he has precipitated, is the escalating spat with Kim Jong Un, and for the first time in decades, the U.S. faces the threat of war on its own turf.

Kim Jong Un has conducted his sixth nuclear missile test of the year in early September, and his narrative is that he is prepared to take the U.S. head on. These increasing tensions are raising questions about a possible war. While most people are worried about the impact on their safety, economists are speculating on the impact it may have on global economies. In the past, there have been many missives and academic papers on the merits of war for an ailing economy, and while some old school thinking still prevails, the consensus is that war is a bad idea.

Many economists have used the United States’ recovery after the Great Depression, as an example of how war can revive a flailing economy. This case study was required reading in many economics classes. The U.S. recovery post-WWII was attributed to declining unemployment rates, increased spending, and a re-balancing of supply and demand after the country underwent its worst ever economic period. However, not all areas of the economy benefit from war, the WWII case study has a fatal flaw, because it does not take into account where the extra money would have been spent if there was no war. The extra money does not live in some secret war chest reserved for international squabbles, it has to come from somewhere. A war can be funded in a combination of three ways, increased taxes, decreased spending in other areas of the economy, or debt.

Increasing taxes has a knock-on effect because it reduces consumer spending, and this comes with its own set of problems. Decreased spending by government to fund a war, means that less will be spent on other programmes and it is often social spending that gets cut, i.e. welfare, health, subsidies and education. So, you lose the benefits those social programs provide and the recipients may have less money to spend on other items, putting a strain on them and the economy at large. Increasing the debt means that they will have to pay for it down the road and the interest payments will undoubtedly leave a hole in the fiscus.

Independent researchers Capital Economics conducted a study on how a potential war between the U.S. and North Korea could affect global economy. Gareth Leather and Krystal Tan use past examples, after the Second World War, to prove that wars more often than not lead to big GDP drops. As a primary example, it is estimated that the war in Syria caused that country’s GDP to fall by 60%. Going further back, South Korean GDP fell by a massive 80% during the Korean War in the 1950s.

There are, however, schools of thought that still subscribe to the notion of a beneficial war economy. American defence and technology company Lockheed Martin recorded net profits of $2.7 billion in 2011 as a result of the American military involvement in the Middle East.

You cannot ignore the profits achieved by the technology and arms industries during war. Aside from the ethical debate, the relationship between government and industry have a directly proportional effect. Not only does fighting in wars benefit certain industries, the period after the conflict is resolved presents opportunities for construction companies and equipment producers.

War is big business and a Keynesian argument would be that military spending is the stimulant countries need to boost their economies in periods of slow growth. War causes intense industrial activity and definitely influences GDP.  The Arms Race’ during the Cold War precipitated a growth of 7.6% GDP in 1984 in the U.S. There is no doubt that GDP in the short-run grows after a war.

Another way in which wars effect a positive impact is employment. It is estimated that in 2011, $1 billion of military spending alone created 11,200 jobs both directly and indirectly in the U.S. While North Korea employs over 7 million people in the military – a staggering 31% of their total population. North Korea is clearly an anomaly compared to other countries in the world; but it does reveal that military spending can provide a lot of jobs albeit in an uninspiring sector.

If a new war does break out, South Korea would probably take the biggest hit by virtue of their location and their bickering history with the North. Despite numerous attempts to reconcile their differences since 1945, they remain fast foes. Having South Korea under siege would have severe repercussions and the side-effects would trickle down to the larger world economy. South Korea compromises 2% of the world’s GDP and it is home to the world’s three biggest shipbuilding corporations. They are also the world’s largest producer of LCD screens and semiconductors. These components are vital to the global car manufacturing industry and if the country falls prey to war, multiple supply chains and trading routes around the world would be disrupted and damaged.

The U.S. economy would most probably feel negative repercussions as well. The Iraq War in the early 2000s cost the country an estimated $1 trillion — that would go a long way to pay off their crippling budget deficit. If a North Korean-U.S. war materialises, federal debt hikes would be devastating for national debt, which is already estimated to reach a whopping $65 trillion by the end of the year.

Tensions between the U.S. and North Korea are intensifying, with North Korea’s Foreign Minister Ri Yong Ho recently accusing Donald Trump of declaring war when the U.S. president said Kim Jong Un “won’t be around much longer”. Despite White House denials, commodity investors and forex traders are gearing their strategies for wartime. Since he entered office, Trump’s rhetoric has been holding back the dollar, with the Mexican peso gaining 8%, and Canadian dollar gaining 21%, against the greenback since January. Despite a recovery on 11 September after Hurricane Irma caused less damage than expected, the dollar index has been on a steady 6-month decline. While there are arguments for and against war to improve an economy, notwithstanding the trauma it would cause, experts are reluctant to nail their predictions to a post. A war now, with the technology we have available, would be a game changer, and a sluggish world economy would be the least of our problems.

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Disclaimer: The content in this article comprises personal opinions and ideas and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. FXTM, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.

Risk Warning: There is a high level of risk involved with trading leveraged products such as forex and CFDs. You should not risk more than you can afford to lose, it is possible that you may lose more than your initial investment. You should not trade unless you fully understand the true extent of your exposure to the risk of loss. When trading, you must always take into consideration your level of experience. If the risks involved seem unclear to you, please seek independent financial advice.

Chris Lee

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