www.news-miner.com72521205844,00.html Article Published: Wednesday, February 26, 2003 - 3:03:45 AM AKST By DOUG REYNOLDS

A number of Europeans and Americans are saying that the United States wants to go to war with Iraq for cheap oil.

While that may or may not be the only justification for war, it could be one goal. Nevertheless, it is important to look more critically at the ramifications of war on the international oil market.

Since 1973, when the first oil shock hit the industrial world, no feasible oil substitutes have been developed. Electric power and space heating have oil alternatives, but fuel for cars, planes, boats and trains is derived mainly from oil.

We don't have economically feasible oil substitutes, even though plenty of research and development dollars have gone into these alternatives from government, big oil and many smaller firms. That is why in the 30 years since the first oil shock, oil substitutes technology has been relatively marginal, especially in comparison to information technology. We still depend on oil.

In fact, the proof of the pudding of our oil dependence can be seen by watching the world's economic performance every time the oil market changes radically. Three of the last five major world economic growth slowdowns have occurred after an oil market shock. (Four out of six if we include the economic collapse of the Soviet Union and Eastern Europe that occurred after an internal oil shortage.) And the biggest growth spurts occurred during times of very low oil prices. Even the current world slowdown is being exasperated by higher oil prices. Thus, economic growth and oil price volatility are highly correlated.

Even if we are instrumental in creating a nascent democracy in Iraq (a big "if" considering the complexity of the nation and region), it does not mean that oil production will be put under a competitive oil leasing regime similar to what the United States and Canada have. Mexico, Venezuela, ostensibly Iran and even Norway are all democracies and still oil production is completely government controlled. Likewise, Iraq probably will have a government-controlled oil company after a war.

Iraq likely won't produce much more oil than it did before 1991, when Iraq was free to produce as much oil as it could and only got up to 3 million barrels per day, which is only a half million barrels per day higher than its current average output. That only adds a half a percent to world output. Plus, repair and development of the infrastructure will likely be as slow as it would be in any of the major underdeveloped oil producing countries. So if our country's goal is fast, cheap oil, victory in Iraq will not soon provide us with that end.

Another danger, however, is Iraq's potential for wreaking havoc in the Persian Gulf, where 65 percent of the world's proven reserves of oil reside. While it is possible that within the Middle East, Israel and Iran already posses nuclear weapons, Iraq's possession of a nuclear capability is more troubling.

Unlike other potential nuclear powers, Iraq could try a quick strike with conventional arms in order to take Kuwait again, and even go on to Saudi Arabia, the United Arab Emirates and Qatar in order to control over 20 percent of the world's petroleum exporting supply potential. Then they can sit back and threaten nuclear explosions on the oil fields if they are attacked. The fields would be ruined and radioactive if that happened. It would be blackmail.

There are four solutions: continue to contain Saddam Hussein with devastating economic embargoes while the Iraqi people suffer; try to increase United Nations weapons inspections and possibly insert United Nations peacekeepers; let Iraq free of embargoes so that it can rebuild its military for another attack on Kuwait with the addition of nuclear threats; or engage in a regime change intervention.

The costs in terms of money, military buildups, human suffering and oil supply stability in the long run are hard to determine for each of the options. Interestingly enough, the only way that the United Nations has been able to keep up an economic embargo at all and be able to put weapons inspectors on the ground in Iraq is when the United States threatens a credible military intervention. Unfortunately, with higher oil prices and the ability of Iraq to smuggle oil out and trade for arms, the regime change option could become harder in five or 10 years. The war is troubling, so are the other options.

Doug Reynolds is an associate professor of oil and energy economics at the University of Alaska Fairbanks. He can be contacted at ffdbr@uaf.edu.

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By: Walter Russell Mead March 01, 2003

When Saddam Hussein dominates American newspapers, the economy tanks. That was true during the first Bush Administration, when the crisis over Iraq's invasion of Kuwait set off the Gulf War and started a U.S. recession. It's been true so far under the second Bush Administration, as talk of another war with Iraq drove oil prices above $32 a barrel by early 2003 and sent gold over $350 an ounce. Between the war on terror and the looming war with Iraq, the American economy reeled into recession in 2001 and limped through 2002 in a halfhearted recovery. As the North Koreans jumped into the act (and as the third member of Bush's "axis of evil," Iran, stepped up its nuclear purchases from Russia), the international situation is casting ever darker shadows over the U.S. economy.

Yet the most immediate major international conflict -- war with Iraq -- is likely to have the least harmful effect on the economy. To some degree, we have already suffered much of the damage -- high oil prices and skittish financial markets. While I would never support waging war to stimulate the economy, in my conversations and studies conducted as a senior fellow at the Council of Foreign Relations, I have come to the conclusion that a short war leading to Iraqi reconstruction and re-entry into world oil markets is more likely to signal the beginning of a new boom than another recession. Small and growing companies, with just a few exceptions discussed later, stand to benefit as quickly as the rest of the business world.

Since the oil shortages and price hikes of the 1970s, doom-laden oil scenarios have riveted the attention of American business. This isn't surprising; swings in notoriously volatile energy prices can quickly turn flourishing enterprises into debt-ridden disaster cases. Surging oil prices have often been blamed for triggering the recession after the first Gulf War; why shouldn't the same thing happen again?

Some say it will. William Nordhaus, professor of economics at Yale University and a member of the U.S. President's Council of Economic Advisers from 1977 to 1979, argues that the Bush Administration "marches ahead, heedless of the fiscal realities" and that there is a serious risk of economic disruption from upheavals in the oil markets. Bears like Nordhaus say that Gulf War II will lead to Recession II for two main reasons: the effect of war on oil prices and the costs of the war. With oil prices solidly over $30 a barrel in the fall and early winter, there are fears that war could cause shortages and supply disruptions that would push prices over $40 a barrel. Gas prices would surge past $2 a gallon, heating-oil prices would skyrocket, and both consumers and businesses would stagger under the blow. Energy-dependent businesses could face ruin; the overall economy might then tank.

That's what the bears think. Thankfully, they are wrong.

A recent study published by the Center for Strategic and International Studies (CSIS), a well-connected think tank based in Washington, D.C., looked at the economic impact of a new Gulf war, including on oil prices. In the best-case short-war scenario that most U.S. military experts predict, Iraqi oil production would stop for three months but hit 2 million barrels a day by the third quarter. Oil prices would spike to about $36 a barrel during the war before falling to $22 by year's end.

Stephen Levy, vice chairman of Titan Industrial, a $400 million international steel-trading firm, says heavy consumers of oil in the industrial and manufacturing sectors currently expect no major war-related supply disruptions. "I am confident that an overwhelming show of U.S. superiority in Iraq will help shorten the length of any spike in oil prices, and I am upbeat about the prospects of a robust economy by this coming summer," Levy says. In fact, he says, the biggest concern is not a war in Iraq but rather, a continued Venezuelan oil crisis. (Last year the United States imported roughly 1.4 million barrels a day from Venezuela compared with less than half a million barrels a day from Iraq.)

Bottom line: Barring unforeseen complications, countries like Saudi Arabia will keep their promises to pump excess oil to replace any Iraqi shortfall. "Saudi Arabia has been a reliable source of extra oil throughout the past few decades," says Rachel Bronson, Olin senior fellow and director of Middle East studies at the Council on Foreign Relations. "They sell themselves to consumers as being extremely dependable, and it is in their self-interest to fulfill this promise." U.S. businesses and consumers can expect that the current spike in oil prices will yield to a downward drift soon after the shooting stops.

Somewhere between 100,000 to 200,000 reservists from the National Guard may be used either to help the war effort in Iraq or to fill vacancies at home left by deployed active-duty officers.

A longer war would, of course, have more of an impact. If Iraqi resistance prevents renewed oil production, or if Saddam sabotages the oil fields, the CSIS projects that oil prices would reach $42 a barrel at the height of the war and would then slowly drop to $30 by the start of 2004.

Either way, the outlook is for improving oil prices as the year runs on. Optimists make a good case for expecting a short war, although pessimists worry that the combat phase could drag on for months, or even years, with Iraq becoming this generation's Vietnam. That would be bad news, but most military experts are quick to explain that while Saddam Hussein could be packing some alarming chemical and biological weapons, the United States is better prepared this time around than it was in the first Gulf War.

U.S. military and intelligence agencies have built up extensive knowledge about Iraqi tactics and military potential. The terrain of key objectives such as Baghdad, the oil fields, and Scud missile sites is well known. U.S. relations with internal opponents of Saddam's regime are also much tighter than they were during the first Gulf War.

Simply stated, oil prices will fall with a swift U.S. victory, although even a somewhat longer conflict is unlikely to inflict permanent economic damage through higher oil prices.

The deficits will get us if the oil doesn't, say the bears: War is expensive, and this one could be ruinous. The last Gulf War, bears note, came in over budget -- but at least we had allies to help pick up the tab. A new war will cost much more, and the allies aren't nearly as eager to help, some say. With the budget surplus already just a memory and mountainous deficits stretching as far as the eye can see, won't war spending trigger inflation or raise interest rates?

There have been many attempts at predicting the cost of the Iraqi war. The estimates produced by congressional budget analysts are the commonly cited ones. Taking it all together -- putting troops in, fighting, maintaining a presence postwar, reconstruction, bringing troops home -- the Congressional Budget Office (CBO) figures add up to $13 billion to deploy troops and $9 billion a month to carry out the war. Bringing home the armed forces could cost another $7 billion. The cost of an occupation of Iraq could run between $1 billion and $4 billion a month, CBO says.

At the end of December, the White House Office of Management and Budget estimated the cost of the war could range between $50 billion and $60 billion. A higher-end estimate of up to $200 billion is also floating around Washington, endorsed by, among others, Larry Lindsey, President Bush's former senior economic adviser.

Doom spinners point to these numbers and prophesy ruin.

Relax. Even the higher estimates would have no significant economic impact. There are two ways that government budget deficits impact the economy: inflation and higher interest rates. Fortunately, we have little to fear right now. Inflation (hovering at about 2.2%, according to the consumer-price index) is not a threat, and not only are interest rates historically low, they are unlikely to rise significantly even with a $200 billion war bill.

Why? Partly because the economy is slow. With business still working off the excess capital investments of the technology boom, private-sector demand for credit is relatively soft. Short term, there is room for more government debt in the money markets. And war with Iraq is a one-time expense -- an expense, incidentally, that even at $200 billion will increase our $6.3 trillion national debt only about 3%. Raising the permanent level of government spending by $200 billion a year could reignite inflation and would certainly force interest rates up; a temporary increase does not pose the same kind of threat.

Moreover, the high-end estimates are probably wrong. The Bush Administration has so far surprised critics by its ability to build international support for its policy in Iraq. Even Syria joined in the unanimous vote on the U.N. Security Council's tough Resolution 1441 mandating renewed and expanded arms inspections in Iraq. If allies don't pay for the cost of the military campaign, Iraq -- and the United States -- can expect much more help with reconstruction costs. "Iraqi postwar reconstruction will not solely be an American enterprise," says a well-placed U.S. government official. "Although the sale of Iraqi oil will help offset almost all of the reconstruction costs, United Nations member states have made preliminary preparations to provide the necessary funds for the humanitarian, economic, and physical costs of rebuilding Iraq."

Some small companies face real threats from war with Iraq. They are not macro-threats like recession, inflation, and rising interest rates, but are more localized. Businesses that operate in communities near military bases will suffer as U.S. forces are deployed overseas and local economies are stressed. National Guard call-ups are another potential worry for employers. Key workers could be asked to report to duty for prolonged and unpredictable periods. Somewhere between 100,000 to 200,000 reservists from the National Guard may be used either to help the war effort in Iraq or to replace the vacancies left by deployed active-duty officers at home. Although no official plan has been released by the Bush Administration, using more National Guard reservists for occupation and reconstruction duty in postwar Iraq would enable full-time army forces to concentrate on domestic security and other global issues -- such as any confrontation with North Korea. Small companies are much more vulnerable to the loss of key employees than large corporations; providing relief for small businesses impacted by any long-term National Guard call-up could be a priority issue for politicians in both parties when facing the 2004 campaign.

Those are the costs of war, but there are benefits too. There will be a flood of new orders to small companies connected with military operations and reconstruction spending in Iraq. The first Gulf War taught the federal government a valuable lesson: American prowess in 21st-century combat depends largely on small-company high-tech products. And high- tech products provided by small companies were often significantly better designed and better priced than large-company goods.

The pace of innovation is faster in small companies as well. Small companies produce almost two and a half times as many innovations per employee as large companies, according to a 1990 study by economists Zoltan Acs and David Audretsch. As a result, the military has been able to improve submarine sonar-processing equipment, update satellite and radar components, increase the speed and accuracy of target-recognition munitions, and protect missile silos from nuclear shocks.

Appreciation for the technical potential of small companies has led to two federally funded programs to enhance small-business access at the Pentagon: the Small Business Innovation Research (SBIR) program and the Small Business Technology Transfer (STTR) program. With $773 million in funding last year from the Pentagon, SBIR assists early-stage R&D projects at small technology companies, while STTR (funded by the Pentagon at $42 million) fosters cooperative R&;D projects between small companies and research institutions.

The increased federal interest in small-business technology encourages small outfits to find commercial applications for their military innovations. The result is success stories like the one at Savi Technology in Sunnyvale, Calif. This company recently developed the SaviTag, a radio computer tag that can be attached to military cargo containers to track the containers' location and contents.

The SaviTag was created with $2.5 million in SBIR funding, but Savi Technology has since received military contracts totaling more than $185 million. According to the Pentagon, use of the SaviTag would have saved approximately $2 billion if it had been available during the Gulf War. Savi Technology has also been able to market the SaviTag in the private sector, specifically in the commercial trucking, rail, and shipping industries. Savi's private-sector sales (half of all sales) are estimated to reach up to $20 million by the end of the year.

A new war with Iraq will provide further opportunities for small-business products to prove themselves in combat and lead to large restocking orders for small businesses involved in producing items such as components for joint direct attack munitions (JDAMs), ballistic-missile targeting systems, meals ready to eat (MREs), and contamination suits.

War Economies: During the past five decades, for the most part, the gross domestic product has not shown any consistent drag during periods of conflict. But GDP did dip at the time of Gulf War I.

It may not be politically correct to say so, but historically wars have more often helped American business than hurt it. The two world wars and the Civil War ended up boosting the economy; arguably the Gulf War, which paved the way for low energy prices throughout the 1990s, had a similar impact. Even the cost of the long war in Vietnam didn't hurt the economy as much as Lyndon Johnson's tax policies did.

American business has plenty to worry about. In 2002 the Dow fell 17.3%, corporate scandals rocked the world, the dollar depreciated, and consumer confidence dwindled to its lowest point in nearly a decade. Security threats, some of them hard to defend against, are breaking out all over.

In this kind of atmosphere, it is important to keep a clear head. Whether or not war on Iraq is good foreign policy, it does not pose a fundamental threat to a healthy U.S. economy. We have been living through a kind of storm before the calm; the turbulence leading up to war is likely to have proved more difficult and expensive than war itself.

Walter Russell Mead is a senior fellow at the Council of Foreign Relations. Mead is the author of Mortal Splendor: The American Empire in Transition (Houghton Mifflin, 1987) and Special Providence: American Foreign Policy and How It Changed the World (Knopf, 2001), winner of one of the world's top prizes for foreign policy writing, the Lionel Gelber Prize. Daniel Dolgin assisted in the research of this article.

Winners and Losers

Companies that supply the Pentagon are in luck. Not so, heavy consumers of energy.

War often provides a springboard for growing companies, particularly those dealing with emerging technology that might prove useful on the battlefield. "Money is flowing," says John Williams, spokesman for the National Defense Industrial Association. Williams's organization lobbies Congress and helps companies navigate the convoluted bidding process that goes along with government contracts. One such company is HemCon, a start-up based in suburban Portland, Oreg., which has developed a line of bandages that can control hemorrhaging almost immediately. Its first big test could come on the frontlines in Iraq. The four-inch-square bandages are made from chitosan, a byproduct of shrimp shells that clings to the wound and causes red blood cells to clot rapidly. As it stands, today's battlefield medics carry bandages that are not so different from those of their Civil War counterparts. While the standard gauze dressings can absorb blood from an open wound, finding a way to actually stop the bleeding has long frustrated the military.

Since its founding in June 2001, HemCon has inked deals with the Department of Defense totaling about $800,000. More recently, a Defense Department spending bill authorized $2.45 million for additional research in the area and $2.8 million to buy bandages -- funds likely to go to HemCon. The company's 11 employees scrambled to complete the military's initial order of 5,000 bandages, and HemCon CEO Jim Hensel expects that the breakneck pace will only continue in the coming months.

BUILDING A BETTER BANDAGE: Oregon-based HemCon is working in partnership with the Department of Defense to make medical bandages that promote blood clotting. The company has experienced a surge in activity, in part because of the Iraq situation.

The pliable HemCon bandages, made to survive the subzero temperatures of the Arctic or the scorching heat of the Sahara Desert, were invented at the Oregon Medical Laser Center through a U.S. Army research grant. Kenton Gregory, a medical doctor and the center's director, helped develop the bandage; he eventually founded HemCon. He says that while the military has been searching for a new and improved bandage for years, the nation's latest conflict is forcing his company into overdrive. "We've made some business decisions very rapidly because of the situation with Iraq," says Gregory.

For example, HemCon decided to open an 11,000-square-foot facility that includes office space, labs, and a manufacturing plant. Should orders continue to roll in, Hensel says, the company would be forced to further expand its payroll and facilities. HemCon currently outsources one-third of its manufacturing operation and is looking for a distributor to help reach more customers.

Outfitting the military remains HemCon's primary focus for now, but Hensel and Gregory are eager to test the waters of other, potentially more profitable markets. With newfound emphasis on preparedness following September 11, HemCon bandages, which will retail for more than $100 each, could make their way into the hands of various homeland security agencies, along with paramedics and emergency workers. And because the bandages are absorbed by the body, the hope is that one day they will be used by surgeons in the operating room to stop internal bleeding.

Rod Kurtz

The uncertainty of the oil market is likely to continue to cause short-term pain for manufacturers, the trucking industry, and other heavy users of energy.

Most small trucking companies juggle keeping their debt at a minimum and operating on the slimmest of margins. Dwight Warner, CEO of Warner Supply, a trucking company based in St. George, Utah, says fuel is his largest budgetary item; he pays roughly $1.45 per gallon for the 27 trucks he runs daily to cities in the Midwest, Florida, and on the West Coast. "A two-cent swing costs me $1,600 a month," he says. "Ten cents costs me $16,000 a month, and we are a small company."

OIL SHOCK?: Like many trucking companies, Warner Supply of St. George, Utah, is wary of the short-term oil price hikes that come with conflict in the Persian Gulf.

Between war in Iraq and the Venezuelan oil crisis, Warner isn't optimistic about his short-term prospects. During the Gulf War, Warner said, his business was stable because there were few surprises: His customers knew what to expect and were less skittish about spending. Now, because war in Iraq could bring more terrorist attacks to the United States, that's changed.

Insurance costs in the trucking industry have more than doubled, and costly security measures have yet to be implemented. Warner says he doles out $17,000 monthly for insurance and isn't sure how far he can stretch to cover all costs. The company is already about $1 million in debt, with about $4 million in annual revenue.

"In our industry we've lost 3,000 to 3,500 trucking companies in the last two years," says David Owen, president of the Tennessee-based National Association of Small Trucking Companies. "That's not one guy with a truck. There used to be a driver shortage. Now there's going to be a truck shortage."

Nicole Gull

Please E-mail your comments to editors@inc.com.

This is the text-only, printer-friendly version of 'The Storm Before the Calm' Its permanent web address is: www.inc.com

www.abs-cbnnews.com Tuesday, February 25, 2003 10:42:13 p.m

NEW YORK - Crude oil futures rallied again Monday, boosted by record intraday prices for heating oil and continued fears about war in Iraq. Natural gas futures also surged

On the New York Mercantile Exchange, the front-month March heating oil contract climbed to a record of $1.1535 a gallon, surpassing the previous all-time high of $1.15, set in November 1979. The contract closed at $1.1467 a gallon.

The rally gave the rest of the petroleum complex a lift. Nearby April crude rose 90 cents to close at $36.48 a barrel. March gasoline settled at $1.0475 a gallon, up 3.47 cents on the day.

Across the Atlantic on London’s International Petroleum Exchange, the gains were just as strong.

Nearby April North Sea Brent futures closed up 88 cents at $33.15 a barrel.

“The crude oil market continues to trend higher, pulled along by a strong heating oil market and the continued drumbeat for war with Iraq,” said Tim Evans, senior energy analyst at research firm IFR Pegasus in New York.

The heating oil surge mirrored a rally in natural gas futures, which climbed to 25-month highs on forecasts of cold weather and expectations of a sharp drawdown in storage. The March contract shot up $2.531, or 38 percent, to settle at $9.137 per 1,000 cubic feet.

“What’s concerning the market today is that the weather is not giving us any signs of spring,” said Phil Flynn, a trader and analyst at Alaron Trading Corp.

Although heating oil’s climb to record territory was part of the reason for Monday’s rally, the market’s main focus remained Iraq, analysts said.

War jitters heightened after the US, the UK and Spain introduced a UN Security Council resolution today that finds Iraq in breach of its disarmament obligations and warns the rogue nation of “serious consequences.”

The resolution says that Iraq has failed to “take the final opportunity” afforded it to disarm.

“People view that as another step toward war,” said Tom Bentz, an analyst at BNP Paribas Futures.

Traders worry that an attack will result in a disruption of Iraqi oil exports and cause a supply disruption in the Middle East, the world’s principal source of oil.

Western officials say they expect a vote on the resolution within the next two weeks.

But approval is far from guaranteed. Earlier Monday, key UN Security Council members France, Germany and Russia submitted an alternative proposal for step-by-step disarmament of Iraq.

Despite the opposition, however, the US has said it is prepared to lead an attack on Iraq without a new resolution.

With the market’s focus on Iraq, traders shrugged off news of continued increases in Venezuelan oil output.

On Sunday, state oil company president Ali Rodriguez said Venezuelan crude oil output, crippled by a strike in December and January, has risen to more than 2 million barrels a day.

Before the strike, Venezuela exported about 3.1 million barrels a day of crude oil. AP

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www.economist.com Feb 20th 2003 From The Economist print edition Getty

Last weekend, American shop shelves were cleared of drinking water and duct tape. What next?

“IRAQNOPHOBIA”—fear of the consequences of a probable war with Iraq—is being blamed for the sick state of the world economy and for the fall this year in the dollar and in most big stockmarkets. If fear is to blame, then a short, successful war should remove the uncertainty that is holding back consumer and corporate spending, allowing economic activity and share prices to bounce back again. Alan Greenspan, the chairman of America's Federal Reserve, appeared to suggest as much last week. But Iraq is only one of the problems facing the global economy. Others will continue to weigh it down even after the tanks and bombers have gone home.

An American-led attack on Iraq looks highly likely. But trying to assess the economic consequences of such an attack is tricky because of the vast number of unknowns and contingencies. For instance, how long will the conflict last? Will it escalate outside Iraq? Will there be any damage to oilfields, as there was in the Gulf war in 1991? Will other OPEC countries increase their oil production to compensate? And how badly will business and consumer confidence be hit? These are not questions that can be answered by plugging numbers into a computer model. Yet several investment banks and think-tanks have made a stab at it.

Most of them maintain that the likeliest scenario is a short, successful war. Oil prices would spike briefly at around $40 a barrel, but then plunge as the war ends. In turn, share prices and the dollar will rally, and confidence will revive, spurring a strong economic recovery. Several economists reckon that a war might actually be good for the world economy: it will eliminate today's mood of uncertainty, boost government spending, and push oil prices lower in the medium term as new Iraqi production comes on stream.

John Llewellyn, chief economist at Lehman Brothers, is much less sanguine. He argues that the risks to the global economy, taken together, are now greater than at any time since the 1973-74 oil crisis. Even if the war goes well, he argues, it will probably not be the panacea that investors are hoping for. The aftermath of war will be uncertain; the risk of terrorist acts will remain; and there are plenty of other worries too, not least over North Korea. The cost of fighting

The economic costs of a war can be broken into three types. First, there are the direct military costs. The six-week Gulf war in 1991 cost $80 billion in today's prices (most of it paid for by America's allies). Assuming a similarly short war, America's Congressional Budget Office and the House Budget Committee have both estimated a total military cost of around $50 billion, or 0.5% of America's GDP. Others reckon that a more protracted war could cost America as much as $150 billion.

Second, there are the potentially far larger indirect costs of peacekeeping, humanitarian assistance and reconstruction. William Nordhaus, an economist at Yale University, thinks that these could cost America between $100 billion and $600 billion over the next decade*.

Last but not least, there are the macroeconomic costs of lost output. Especially if the war goes badly, these could be far bigger than the others, which are really just efficiency losses from the diversion of resources. Mr Nordhaus estimates that the total cost of a war to America could range between $100 billion and $1.9 trillion, spread over a ten-year period. That could be as much as 2% of American GDP for every year of the decade.

The hardest of the three to pin down is the macroeconomic cost—to the world economy, not just America's. Broadly speaking, a war in Iraq could affect economies through four main channels: oil prices; stockmarkets; the dollar; and business and consumer confidence.

Oil prices have already reached their highest level for two years. West Texas Intermediate has risen above $36 a barrel, up almost 50% from last June. So far, though, this is a much smaller rise than in the run-up to the 1991 war. In real terms, oil prices today are less than half their 1980 peak. The conventional wisdom is that prices will fall sharply once a war is over, just as they did in 1991. Then they fell from over $40 to below pre-war levels after the ground war had begun. Optimists today argue that a victory will liberate Iraqi oil as well as its people. (This assumes that the Iraqis do not sabotage their own oilfields or those of their neighbours.)

So it is widely hoped that oil prices might this time also fall towards $20 a barrel once war is under way. But is 1990-91 the appropriate model? Even if the war is as short, oil prices may not fall as much this time because the background environment is different. Economists at Goldman Sachs argue that the recent rise in oil prices has had more to do with the disruptions in Venezuela than with worries about Iraq.

Venezuela's oil-industry strike may be over, but the country is unlikely to restore more than two-thirds of its output this year. Goldman Sachs reckons that the combined impact of Venezuelan and Iraqi disruption has the potential to be the biggest shock in oil-market history, even after allowing for some offsetting increases in supply from other producers.

Another reason why oil prices may not fall as sharply as in 1991 is that the oil market is much tighter. An exceptionally cold winter right across the northern hemisphere has boosted demand at a time when American oil stocks are at their lowest level since 1975. In 1991, oil stocks were well above normal.

OPEC also has less spare oil-production capacity this time to fill the gap. The cartel had spare capacity of 6m barrels a day when Iraq invaded Kuwait in 1990, compared with only 2m today. The continuing shortfall in Venezuela, plus even a small loss of output from Iraq, could rapidly exhaust that. In any case, Iraq will not be able to turn its oil taps on fully the moment that war ends. Goldman Sachs estimates, therefore, that oil prices may average no lower than $27 over the next 12 months.

Although the rich world uses half as much oil per dollar of GDP as it did in the 1970s, higher oil prices still have the power to hurt its economy. According to the IMF's ready reckoner,a $10 increase in oil prices, if sustained for a year, reduces global GDP by 0.6% after one year. That impact sounds fairly modest, but the snag with all such calculations is that they consider only first-round effects. They ignore the potentially much bigger impact on confidence and stockmarkets, and they ignore the effects that follow from changes in monetary and fiscal policy. Consistent underestimation

Even taking account of such factors, however, most forecasters still reckon that the American economy will slip into a new recession only if there is a more prolonged war, a much sharper rise in oil prices than now expected, and a stockmarket slump of at least 20%. Yet in the past, economists have consistently underestimated the economic impact of oil shocks.

Over the past three decades, oil prices have jumped sharply on four occasions: in 1973, after the first OPEC embargo; in 1979, after the Iranian revolution; in 1990, after Iraq's invasion of Kuwait; and in 1999-2000 as the world economy boomed and OPEC cut its production. Each time the price more than tripled, contributing to a global recession.

Higher oil prices hurt the economy in two ways. In the first place, the increase acts like a tax, raising firms' costs for any given output price. So if demand is unchanged, prices rise and firms produce less. Secondly, higher oil prices transfer income from oil-importing countries to oil producers, squeezing spending in the oil importers. In the economic jargon, both the aggregate demand and aggregate supply curves shift backwards. Output falls, but the impact on underlying inflation, and hence the appropriate policy response from central banks, is uncertain.

Whether central banks should raise interest rates to curb inflation, or cut rates to cushion output, depends on the cyclical position of the economy. The four previous oil shocks all took place during booms, when economies were already overheating and inflation was rising. This forced central banks to raise interest rates.

Today, the rise in oil prices is occurring in an environment of excess capacity and falling inflation. Firms have little pricing power, so it is harder for them to pass on higher costs. Rising oil prices are therefore more likely to erode profits than to push up inflation. That, in turn, would further delay a recovery in corporate investment and hiring. The correct response at such a time is to reduce interest rates, not raise them.

The Fed seems to understand this better than the European Central Bank, which frets more about its inflation target. But with interest rates at 1.25%, the Fed has little room to cut further. Euro-area rates (at 2.75%) leave more room to cut, but the ECB is likely to be slow to act. At its most recent press conference (earlier this month) its president, Wim Duisenberg, declared that “a rate cut now would be a mere drop that would drown in the sea of uncertainties”, referring to oil prices and geopolitical risks. Yet Germany, the euro area's biggest economy, may be back in recession again. The Bundesbank confirmed this week that German GDP fell slightly in the fourth quarter of 2002. And many private-sector economists reckon that output will shrink again in the current quarter. Bubble trouble

America has more room to ease fiscal policy. Indeed, a successful war will help George Bush to get congressional approval for his tax cuts. On the other hand, Japan (thanks to its already hefty public debts) and the euro area (thanks to its stability pact) have little room to ease policy, even in the event of a further downturn.

Underpinning the hope of a strong economic rebound after a war is the unstated assumption that America's economic fundamentals are sound. However, America has yet to complete its post-bubble adjustment. Record consumer debt leaves the economy vulnerable to shocks. American consumer confidence is at a nine-year low. Some blame this on the threat of war (in which case confidence could later rebound). But, in fact, more of it may be due to consumers' heavy debts, poor underlying job prospects, and falling stockmarkets.

Economists are using war fears as a convenient explanation for slower than expected growth—just as they (wrongly) blamed America's recession in 2001 on the September 11th attacks. Bill Dudley, an economist at Goldman Sachs, argues that war fears are not the biggest reason why the economy is soft. Instead, the problems lie deeper: in the excesses built up during the bubble years, such as huge private-sector debts, excess capacity, low saving, and a massive current-account deficit.

America's over-indebted households, Japan's deflation and its crippled banks, Europe's structural rigidities and its overly tight fiscal and monetary policies: all these mean that the world economy is horribly vulnerable to shocks of any kind. Moreover, after the Gulf war America's initial recovery was sluggish, due to the need for firms to reduce their debts from the excesses of the 1980s. Yet the excesses of the 1990s were much larger. America's fragile economy is, in a manner of speaking, being held together by duct tape. The 1.3% jump in retail sales (excluding cars and petrol) in January may partly reflect precautionary stockpiling of canned foods, bottled water and other goods. Trading blows

Most stockmarkets have fallen in each of the past three years, and many investors are hoping that getting the war out of the way will stop the rot. Between the start and finish of the Korean war, American share prices rose by 28%. In 1991, the S&P 500 rose by more than 20% within four months of the start of the air attack.

But America's stockmarkets looked cheaper in 1991 than they do today. A market with a p/e ratio of 28 on historic profits, and an average forecast of double-digit profit growth despite slow nominal GDP growth, is not exactly discounting bad news. Another big difference from 1991 is that analysts have already assumed a quick and painless war. Before the Gulf war they were much less confident. So the downside risk today is much greater. A prolonged war could drive property and share prices sharply lower.

How might exchange rates react? The sharp fall in the dollar in recent months may in part be related to war worries. So a quick victory, it is argued, would help the dollar to rally. The dollar bounced by 10% in trade-weighted terms within two months of the end of the Gulf war.

However, there is a big difference this time. In 1990-91 the net cost of the war to America was reduced from $80 billion, at today's prices, to only $4 billion after contributions from friendly Arab countries and Japan. These transfer payments flattered America's current-account balance in 1991 and so helped to lift the dollar. This time, America will have to foot most of the bill itself. In 1991, it had a small current-account surplus. Today, with its deficit running at more than 5% of GDP, any dollar recovery is likely to be short-lived.

Beyond the macroeconomic fall-out from war, there is one other big concern: that diplomatic tensions between America and Europe over Iraq could spread beyond war to trade. The two sides already have a string of bilateral trade disputes: over America's steel tariffs and its tax breaks for foreign sales by big multinationals; and over the EU's ban on imports of hormone-treated beef and genetically-modified foods, for instance.

German firms are particularly worried about a loss of business in America. Last week, the American Chamber of Commerce in Germany celebrated its 100th anniversary. In between the champagne and canapés there was much talk that the political rift between the two countries could harm commercial links. A few American congressmen have already called for restrictions to be imposed on the import of European wine, cheese and military equipment.

There is also talk that American firms might shift their future investments from “old Europe”—France and Germany—into “new European” countries—such as Britain. More realistically, however, Germany and France are already seen as hostile business environments because of their high labour costs and taxes, and their rigid markets. To some extent, the political rift is just another excuse.

What is clear, however, is that the spat over Iraq will not help to speed up trade negotiations in the Doha round, which already seem to be heading for gridlock. Last weekend, trade ministers meeting in Tokyo made almost no progress towards liberalising farm trade. Yet agriculture is the central issue for the Doha round. Failure to liberalise farm trade would be a big blow to the poor world. Even worse would be an associated tit-for-tat trade battle between the rich.

• “The Economic Consequences of a War with Iraq”. American Academy of Arts and Sciences, December 2002. Available at www.amacad.org/publications /monographs/War_with_Iraq.pdf (see chapter three)

www.kansascity.com Posted on Tue, Feb. 25, 2003 By CHRIS LESTER Columnist

This may seem rather small and petty as the world dances on the knife's edge of war, but it's also true. For the vast majority of Americans, the single most tangible consequence of our ever more menacing geopolitical moves is higher energy prices.

War jitters stemming from our plans to invade Iraq, possessor of the world's second-largest pool of proven oil reserves, combined with the ongoing general strike in Venezuela, another major oil producer, has driven crude oil prices uncomfortably close to $40 per barrel.

We're paying for it at the pump. Collectively, Economy.com reckons that Americans are on track to spend $50 billion more on energy than they did last year because of spiking gasoline and home heating prices.

Such an increase in energy expenses at the margin of a weak economy effectively acts as a tax increase for consumers, shifting funds from spending or saving into a commodity that they would purchase in good times or bad. Higher energy prices also gnaw at the profit margins of many businesses, discouraging hiring and capital spending.

Bottom line: Higher energy prices threaten to extend the slow, grinding wallow of recession that is about to officially mark its second anniversary.

The link between energy prices and the broader economy remains remarkably strong, despite the fact that our economy is somewhat less reliant on energy as a percentage of economic activity than in the past. Each of the last four recessions has been preceded by an energy shock of some form, making spiking energy prices one of the most reliable predictors of recession.

The ongoing debate at the United Nations already has delayed a resolution of the current Iraq crisis and appears likely to do so for some time to come, increasing the risk to the economy.

From an oil politics perspective, the fact that the French are leading the opposition to war in Iraq is no small matter. The French have longstanding economic ties to Iraq and a stake in future oil development of the country. Understandably, the French dread both scorched-earth defensive tactics and growing American influence in Iraq.

Here are three possible oil scenarios resulting from the current face-off over Iraq:

• Best-case scenario: A quick and decisive victory in Iraq, with Saddam Hussein captured or killed and the creation of a more democratic Iraq devoted to economic development. This outcome would pop the bubble in crude oil prices, providing a much needed short-term economic spark. Over the longer haul, such an outcome could free up vast oil reserves that would keep a cap on oil prices even with our ravenous energy appetite.

• Worst-case scenario: We get bogged down in a messy, unsuccessful invasion that destabilizes the entire Middle East and drives oil prices to previously unimagined levels, pushing the entire world economy into a deep recession.

• Most-rational scenario: We win militarily but quickly realize that Iraq was merely one conflict in a war on terror likely to last generations. Oil prices moderate for now, but it remains a very dangerous, unstable world prone to oil shocks. America belatedly adopts a strategy that diversifies our energy sources and encourages greater energy efficiency at the industrial and consumer level.

Various hawkish types emphasize that war in Iraq is about deposing a tyrant with designs on acquiring weapons of mass destruction, countering global terrorism or even the lofty aim of liberating an oppressed populace.

But the elephant in the room remains oil, plain and simple, a commodity for which Americans already have displayed a willingness to kill.

To reach Chris Lester, assistant managing editor-business, call (816) 234-4424 or send e-mail to clester@kcstar.com.