Will defeat in Iraq herald a repeat of post-Vietnam economic ills?

Will defeat in Iraq
herald repeat
of post-Vietnam
economic ills?

By Ambrose Evans-Pritchard
The Telegraph, London
Wednesday, October 25, 2006

http://www.telegraph.co.uk/news/main.jhtml;jsessionid=KKHZ2LKM3ILEBQFIQM...

The slow agony of American defeat in Vietnam was intertwined with almost all the economic ills of the 1970s, the decade when capitalism veered off the rails and stock markets slumped.

So, with noises of US withdrawal from Iraq growing louder by the day, it has to be asked whether investors are pricing in the likely fall-out as the world's hegemonic power once again fails to impose its will in a region that contains two-thirds of all known oil reserves.

Wall Street has reached record highs this week. The appetite for risk is near its historical peak.

The Vietnam effects emerged before the final scenes of refugees clutching helicopters at America's Saigon embassy in 1975. By then, OPEC had already begun to play oil politics, emboldened by semi-paralysis in Washington.

Equally emboldened, the Soviet Union cranked up the Cold War, ultimately invading Afghanistan and fomenting revolutions in Central America and Africa. Iranian students taunted the White House by holding US embassy hostages for 444 days.

It was America's unwillingness to pay the costs of Vietnam by tightening its belt that incubated the inflation virus of the 1970s, shattered the gold-based currency system created after the Second World War and prompted the first push for European monetary union.

Overstretch in Iraq is arguably worse, whether or not one accepts the claims by Nobel economist Joseph Stiglitz that the full cost of the war is running at near £214 billion a year.

The US is now living further beyond its means, with a current account deficit of seven per cent of gross domestic product. It has switched from being top creditor nation to top debtor, owing the world £1.32 trillion.

For now the world's dollar-based order is being held up by the £522 billion reserves of the Chinese central bank. But Beijing is tiring of this policy and traders expect the dam to burst when the US starts to cut interest rates. "The dangers are that the fall in the dollar becomes precipitous and asset markets are severely damaged," said David Bloom, HSBC's currency chief.

President George W Bush's "war on terror" has yet to impinge on America's consumption habits and has been lucrative for some: chiefly the army of defence contractors, or Beltway Bandits, ringing the Virginia suburbs of Washington. The share price of 34 large US contractors sampled by the Institute for Policy Studies rose 48 per cent on average from early 2001 to early 2006.

The pay and bonuses of their chief executives rose 108 per cent as they shared £523m between them.

The lion's share of Iraqi funding has gone to US giants such as the oil services group Halliburton, recipient of £5.1 billion in contracts.

However, the "Baghdad bubble" is already losing its fizz and could go flat fast if the Democrats win control of Congress in the mid-term elections next month. The next wave of bumper profits may go elsewhere: hedge funds betting on the dollar denouement or gold; to oil companies with reserves far from the Middle East, and bio-fuel groups poised to exploit surging use of corn and sugar as an ethanol subsititute.

So far, the Iraq effect on global oil prices has been slight. Sabotage has kept Iraqi output at 1.9 million barrels a day, roughly what it was towards the end of Saddam Hussein's rule.

The step change in oil costs from $20 to $60 a barrel over the past four years is almost entirely due to explosive growth in China, India, and the emerging world. Oil has slipped back a little but excess capacity remains wafer thin at a million barrels a day, down from seven million earlier this decade.

Gal Luft, director of the Analysis for Global Security in Washington, said Iraqi output would slide in sectarian battles over oil revenue once the West has left.

"One thing is for sure: There is not going to be any new investment into an area facing civil war," he said.

"But the main risk is a spill-over into Saudi Arabia where most of the reserves are in Shia areas. The Shia are feeling powerful and this may have whetted their appetite, so we could even see an insurgency spreading across the border. That is a major threat."

A de-facto partition of Iraq would refashion the Middle East along a cleavage between Sunni and Shia, the latter backed by an ever-more supremacist Iran.

The sky did not fall after Vietnam. The free-market West slowly got back into its stride and Iran released its hostages in time to avoid the wrath of Ronald Reagan's resurgent America.

Yet it was a scary time when nobody seemed in charge. Most investors suffered a lost decade, or worse, but those who switched from stocks to hard assets before the storm hit in the mid-1970s came out smiling.

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