US Economy at a Crossroad: Challenges and opportunities posed by the wars – Investing Abroad News
By Nishant Chandra
President Joe Biden has asked the US Congress
The request comes amid escalating wars in Ukraine and Palestine that pose serious challenges and opportunities for the US economy
One of the most obvious effects of war is its impact on trade and investment. War can disrupt the normal flows of goods, services, and capital across borders, affecting both the supply and demand sides of the economy. War can also create new opportunities for trade and investment as countries seek to secure their strategic interests or take advantage of new markets.
For example, during World War II, the US economy benefited from its role as a major supplier of weapons and materials to its allies, as well as from its access to new markets in Europe and Asia after the war. On the other hand, during the recent wars in Afghanistan and Iraq, the US economy suffered from the diversion of resources to military spending, as well as from the instability and violence in the region that hampered trade and investment.
However, in 2023, the US is no longer the world’s manufacturing hub. China, with its unparalleled manufacturing capability, will benefit, similar to how the US economy benefited during World War II.
According to the latest projections by the Federal Reserve, the US GDP is expected to grow by 2.1 %. However, as per the World Economic Forum Report on World Economy 2024, 61% of the Chief economists surveyed affirmed further weakening of the global economy. This report is prior to the Israel- Palestine conflict, and now, most certainly, the world economy will deteriorate beyond the projections.
The current wars in Ukraine and Palestine present different challenges and opportunities for the US economy. The war in Ukraine involves a confrontation between NATO and Russia, two major trading partners of the US.
The US has imposed sanctions on Russia for its annexation of Crimea in 2014 and its support for separatists in eastern Ukraine since then. Russia has retaliated with counter-sanctions and other measures.
The trade war between the US and Russia has reduced bilateral trade by more than 50% since 2013, according to data from the World Bank. The war in Ukraine also poses a threat to the energy security of Europe, which depends heavily on Russian gas supplies. The US has been trying to reduce Europe’s dependence on Russian gas by promoting alternative sources such as liquefied natural gas (LNG) from the US or other countries. The US has also been supporting Ukraine’s efforts to diversify its energy sources and reform its energy sector.
The war in Palestine involves a long-standing conflict between Israel and the Palestinians, as well as a broader regional rivalry between Iran and Saudi Arabia. The US has been a staunch ally of Israel, providing it with military and economic aid, as well as diplomatic support.
The US has also been trying to broker a peace deal between Israel and the Palestinians based on a two-state solution. However, the recent escalation of violence in Gaza and Jerusalem has undermined the prospects for peace and increased the risk of a wider regional war.
The war in Palestine also affects the oil market
Though the US has been trying to reduce its dependence on oil imports from the Middle East by increasing its domestic production of shale oil and gas, as well as by promoting renewable energy sources, the most recent Palestine-Israel conflict will only increase crude prices further. The increase in crude will be the single most significant factor in increasing inflation and further depriving the people of their savings.
Another effect of war is its impact on inflation and interest rates. War can cause inflation by increasing the demand for goods and services, especially those related to defence and security, while reducing the supply due to disruptions or shortages.
War can also cause inflation by increasing government spending and borrowing, which can lead to higher deficits and debt levels. Inflation can erode the purchasing power of consumers and businesses, as well as reduce the real value of debt. Inflation can also prompt central banks to raise interest rates to curb inflationary pressures, which can have negative effects on economic growth and employment.
The US economy has experienced different inflationary episodes due to war in the past. During World War II, inflation reached double digits due to massive government spending and borrowing, as well as price controls and rationing. The Federal Reserve was constrained by an agreement with the Treasury to keep interest rates low to finance the war effort.
After World War II, inflation moderated due to post-war reconstruction and productivity growth, as well as monetary policy tightening by the Federal Reserve. During the wars in Afghanistan and Iraq, inflation remained relatively low due to low oil prices, globalisation, technological innovation, and monetary policy easing by the Federal Reserve. However, inflation has recently surged due to supply chain disruptions caused by COVID-19 pandemic lockdowns around the world, rising commodity prices, fiscal stimulus measures, and pent-up demand.
The current wars in Ukraine and Palestine could have different inflationary impacts on the US economy depending on their outcomes. If these wars escalate into a wider regional or global conflict involving major powers such as China or Iran, they could cause a severe supply shock that could drive up oil prices, disrupt global trade, and increase defence spending.
This could lead to higher inflation that could force central banks, including the Federal Reserve, to raise interest rates more aggressively to contain inflationary expectations. This could, in turn, slow down economic growth and increase unemployment. On the other hand, if these wars are contained or resolved peacefully, they could have a limited or even positive impact on inflation. For example, a peaceful resolution of the war in Ukraine could ease the sanctions on Russia and improve trade relations between the US and Europe. A peaceful resolution of the war in Palestine could reduce the tensions in the Middle East and stabilise the oil market. This could lead to lower inflation, which could allow central banks to keep interest rates low to support economic recovery.
A third effect of war is its impact on exchange rates. War can affect exchange rates by influencing the demand and supply of currencies, as well as by affecting the expectations and confidence of investors. War can also affect exchange rates by altering the relative economic performance and monetary policy stance of countries involved in or affected by war.
Generally, war tends to weaken the currency of the country that is directly involved in or affected by war while strengthening the currency of the country that is perceived as a safe haven or a beneficiary of war.
The US dollar has experienced different exchange rate movements due to war in the past. During World War II, the US dollar appreciated against most other currencies due to its role as a major supplier of goods and services to its allies, as well as its status as a safe haven for investors. After World War II, the US dollar depreciated against most other currencies due to the Bretton Woods system of fixed exchange rates that undervalued the dollar relative to other currencies. During the wars in Afghanistan and Iraq, the US dollar depreciated against most other currencies due to the twin deficits of budget and current account, as well as the loose monetary policy of the Federal Reserve.
The current wars in Ukraine and Palestine could have different exchange rate impacts on the US dollar, depending on their outcomes. If these wars escalate into a wider regional or global conflict involving major powers such as China or Iran, they could cause a flight to safety that could boost the demand for the US dollar as a safe haven currency.
This could lead to an appreciation of the US dollar against most other currencies, especially those of emerging markets that are more vulnerable to external shocks. On the other hand, if these wars are contained or resolved peacefully, they could reduce the demand for the US dollar as a safe haven currency. This could lead to a depreciation of the US dollar against most other currencies, especially those of advanced economies that have stronger economic fundamentals and tighter monetary policies.
In conclusion, the wars in Ukraine and Palestine pose significant challenges and opportunities for the US economy, depending on their duration, intensity, and outcomes. These wars could affect the US economy in various ways, such as trade and investment, inflation and interest rates, and exchange rates. As Winston Churchill once said, “The price of greatness is responsibility.” The US has a great responsibility to use its economic power wisely and effectively in dealing with these wars, not only for its interests but also for the world economy.
(Author is a former investment banker with Standard Chartered, having expertise in Economics and Finance and running multiple Tech ventures.)
