Fearflation: When Leadership Wobbles, Uncertainty Rules

February 18, 2022

Real Estate

Fearflation: When Leadership Wobbles, Uncertainty Rules
A leading headline these days is the situation on the Russia/Ukraine border, which seems to be on the verge of something big, ugly and painful at any moment. Many sources point to Russia’s escalation of troops as proof of impending military action; others say that even if Putin is egotistical and driven, he’s not likely to put Russia, Europe, the US and, of course, Ukraine and others – including possibly Russia’s ally, China – into World War III.
And therein lies the rub: No one actually knows what will happen. 
But there’s one seemingly tried-and-true point that financial analysts and investors and others quietly point out: It’s long been thought that all the terrible impacts aside, war is good for the US economy which is an awful thing to say.
But is it? And more confusing still, what about the threat of war? 
Let’s take a look.
Stock markets and the threat of war
If I’ve said it once, I’ve said it a thousand times in this blog: Markets like certainty. And over the last several days and weeks, the markets have experienced incredible swings because of the current geopolitical unknowns between Ukraine and Russia and, more specifically, because of that vast unknown who is known as Vladimir Putin.
And it’s the threat of war that keeps things jumpy. 
There’s the question of whether sanctions would have any real weight with Putin (logically speaking, they should, because millions of Russians could suffer, but large egos are rarely logical). There’s uncertainty about how an actual war could impact Europe, for example, which is significantly dependent on Russia for oil. And there’s uncertainty about a million other things related to Putin’s next moves, however those play out.

The Wall Street Journal, February 17, 2022, 4:42pm
Don’t take this next statement as me being callous to the realities of the threat of war, because I’m not. But I’m often asked my opinion on how things can impact the markets, so I’m going to give a quick answer. In times like this, commodities are a good bet, as are the ancillary businesses that serve them. For anything else, I think a slow-and-steady approach, more so than a wait-and-see, is the way I’d go. Many money managers are calling for cash, but as you know from previous posts, I think too much cash is corrosive. And I’ve never really been one to hedge with gold.
US economic performance and recovery from war since WWII
As we all know but often ignore, the markets are not really an accurate reflection of the US economy. Yes, they’re a barometer of sentiment but to use or confuse market performance as a data set on whether or not war (or the threat of it) is good or bad for the economy is kind of off-kilter. 
And although I love studying history, I’m not a scholar, so I’ll point you instead to some interesting research about the US economy and war. 
A multinational think tank, the Institute for Economics & Peace, has spent a lot of time studying the true costs and benefits of war, at least in part in the hope of persuading decision-makers and public sentiment away from the long-held belief that war stimulates the economy. 
In their 2015/16 report titled, Economic Consequences of War on the U.S. Economy, the data that they cite (from five US wars waged – WWII, Korea, Vietnam, Iraq/Afghanistan) points to potentially different conclusions: While there may be short-term economic gains in the form of increased employment, there are longer-term costs that outweigh the perceived economic benefits. 
(All this said, no one is making the argument that war is simply about economics – clearly, there are often moral, ethical and human rights and other issues at stake. And as the report states, “The paper does not debate the moral, political, or philosophical justifications for these conflicts, but simply highlights some of the key macroeconomic ramifications of the U.S.’s policies during the relevant conflict periods.”)
Still, because it’s such a long-held belief, it’s worth exploring. Here’s what they found in their research:
“To analyze the effects of these conflict periods on the U.S. economy, changes in a number of macroeconomic indicators have been analyzed both during and after each conflict period. The indicators analyzed were: 
  • GDP 
  • Public debt and levels of taxation 
  • Consumption as a percent of GDP 
  • Investment as a percent of GDP 
  • Inflation • Average stock market valuations 
  • Income distribution 
Heightened military spending during conflict does create employment, and additional economic activity and contributes to the development of new technologies which can then filter through into other industries. 
These are some of the often-discussed positive benefits of heightened government spending on military outlays. However, it can be argued that programs specifically targeted at accelerating R&D or creating employment would potentially have the same effect but at a lower cost.”
One area that I’ve discussed extensively in this blog is inflation and this report points out that one of the major challenges of war on the US economy is, in fact, that significant government spending spurs inflation:

From the Institute for Economics & Peace report
“Economic Consequences of War on the U.S. Economy”
This begs the question: If we’re already in a period of significant inflation due, in part, to government spending, how much worse could it get if, in fact, we did go to war? And what could be the long-term impacts? The report concludes:
“For each of the periods after World War II, we need to ask, what would have happened in economic terms if these wars did not happen? On the specific evidence provided, it can be reasonably said, it is likely taxes would have been lower, inflation would have been lower, there would have been higher consumption and investment and certainly lower budget deficits. Some wars are necessary to fight and the negative effects of not fighting these wars can far outweigh the costs of fighting. However, if there are other options, then it is prudent to exhaust them first as once wars do start, the outcome, duration and economic consequences are difficult to predict.”
What’s next is anyone’s guess, but we know what everyone wants
I’m concerned about what’s ahead because in my mind, I can’t imagine spending the kinds of resources that Putin has, just to grandstand and it’s been said often enough that his true desire is to reunite the Soviet Union, to bring back its ‘glory days.’
But in the end, maybe all Putin really wants to do is present the threat of war. 
The U.S. and our allies will continue to work toward a diplomatic solution, of course, and in the end, that’s the best outcome for all. 
Let’s hope that Putin thinks so, too.

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