PAYING FOR ITSELF:

Iraq War: What is the Cost? (Lincoln Anderson, Chief Investment Officer, LPL Financial Services, 3/20/02, Lincoln's Commentary)

A number of commentators and politicians have been hand wringing over the cost of the war and subsequent infrastructure repair in Iraq. They point to cost estimates in the $200 to $300 billion range as being possibly dangerous to the U.S. economy and to the Federal budget. Of course, they generally neglect to point out that these cost estimates are the undiscounted sums of multi-year outlays. Also, they neglect to mention that these are gross, not net, estimates (for example, the military gets paid whether it is fighting in Iraq or stationed in Germany).

But these systematic cost overestimates are reduced to mere quibbles amongst the green eyeshade accounting crowd compared to the true cost / benefit calculation that should, and is, being made by the marketplace. That marketplace is, of course, the U.S. stock and other markets.

Over the last five days as it became apparent that President Bush had reached the conclusion that the U.N. peace process was not going to work and that the U.S. was going to have to disarm Saddam by force, markets have rallied. Over the last five days, the U.S. stock market has risen by more than 8%. The market capitalization of the stock market five days ago was approximately $11 trillion. Now it is about $900 billion higher.

Hypothetically speaking, suppose investors cashed that gain in at the long-term capital gains tax rate. Then the Federal government gets an immediate cap gains tax payment of $180 billion. That would surely pay for most, if not all, of the discounted present value of Iraq war and reconstruction expenditures.

But, as they say on TV, that is not all you get! Oil prices have also come down over the last five days from $38 to about $30 per barrel. The U.S. imported 3.4 billion barrels of crude oil last year. An $8 drop in oil prices translates into $27 billion per annum in reduced costs for imported oil. That saving alone would pay for most, if not all, of Iraq’s annual reconstruction expenses.

But that is not all! The reduction in uncertainty over the last five days has caused a rally in the corporate bond market. Ford Motor Co. bond yield spreads, for example have tightened by 20 basis points. This eases the financing burden on U.S. companies as well as handing bondholders a substantial (taxable) capital gain. Based on the market cap of the fixed income market and the average spread tightening over the last five days,
investors have gotten a capital gain of about $160 billion.

But that is not all! Whether they liked it or not, our European "allies" have also benefited from the U.S. decision to disarm Iraq and from lower oil prices. Over the last five days, the French CAC and the German DAX stock price indices have rebounded sharply. This provides a clear example of the "free rider" problem. At least we cannot claim that these government’s anti-war positions were motivated by a desire to increase investor wealth.

The bottom line is that, setting aside all the non-monetary national security benefits associated with disarming Iraq, it is clear to me that this action is being priced in securities markets around the world as hugely beneficial. Those who worry about the direct dollar cost of war and reconstruction are missing that point.

Now let us pray for the men, women and children in harm’s way in Iraq.

Our favorite estimate was the one last week that if things dragged on for a couple months it could cost $2 Trillion--that's how much all of WWII cost us in adjusted dollars. Posted by Orrin Judd at March 20, 2003 2:06 PM