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As the conflict in Iran
continues, one of the areas to focus on is the economic impact
of being in a war like that.
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Pleasure to be joined right now by
Kent Smetters, who is Faculty Director of the Penn Wharton
Budget Model. Kent, thanks for a
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couple of moments today. Yeah. Good to do this. Well, so I guess, where do we start?
Because there's obviously an
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investment made by the
government in taking these actions and the resources that
they're using.
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- Yeah.
- But when you're thinking about the the public back
here in the United States, I
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think as simple as gasoline
prices and oil prices, the way they have risen sharply in the
last few days.
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That's right. So there's really
kind of two dimensions when we talk about the cost of
everything. One is the budgetary
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costs. And we're saying, over
the next couple of months, it really comes down to how much
things are going to get
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escalated. We broke it down to
the four different categories of resources. And we're saying
maybe on the low end, it could
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be about $40 billion of costs.
And that could go up on a very high end, up to $95 billion, if,
in fact, by month two, there are
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boots on the ground and so
forth. Right now, this is more about not having that many boots
on the ground. Our best guess
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right now, what we're using
internally, is around $65 billion. But when we think about the
economic cost— and most of
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that's driven by higher oil
prices. And so in the long run, by the way, the United States is
actually better off with higher oil
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prices, believe it or not. This
is very different than the 1970s. The 1970s, we were a big importers.
Now we're— we actually are big
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producers of oil, and also big
producers of equipment. Think about fracking, for example. The
equipment that actually goes
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into oil exploration and
extraction. But the problem is, is that that takes a long
time for that to happen. Oil
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prices would have to be high for a
long time. Whereas in the short run, we're generally worse off.
Because what happens? Higher oil
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prices means gas prices go up,
heating prices go up. The economy takes a bit of a hit.
And so we're basically saying,
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how much will GDP fall as a
result of this, over— if this lasts for, say, a couple months?
We're saying it could— our best
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guess right now is about $115
billion. Which, you know, in a $30 trillion economy, that's not
a huge amount. But on the lower
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end, about $50 billion. On the
high end, as much as $210 billion in GDP loss. It all comes down.
I mean, right now the futures
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market actually has a 20% chance
that oil will exceed $100 per barrel. And so that's where you
can kind of get those
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higher end
numbers. But even with the $110 or $115
billion number, potentially— - Yeah.
- as you kind of alluded to,
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we are also in a time where we are continuing to see the
country's deficit grow and grow
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and grow. And here we are
adding, you know, $100 plus billion dollars that we were not
expecting to add in, probably,
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you know, three or four
months ago. Right. And part of that is— so
when it comes to budgetary
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costs, yes, we're basically
saying between $40 and $95 billion, probably our best guess
right now, $65 billion. And lot
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of that is just the
replenishment of munitions and things like that. Obviously,
there's deployment costs and so
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forth. We have these four
different categories. And it's true, when it comes to
replenishment of munitions, it
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actually turns out how fast
you do that, it really affects the cost a lot. If you really
want factories to replenish within
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a couple months, they have to
pay a lot of overtime, they have to really crank up things, and
those costs really go quite
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high. But if you're willing to
wait a year to replenish, you know it can be kind of spread
out a bit, but the United States
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being a bit low on munitions to
begin with, they're going to have to replenish pretty fast.
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So then when you think about the
different dynamics and segments of the economy, where is the
greatest impact as we move
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forward here? Obviously the— as
you alluded to, the timing of this is very important.
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You know, depending
on how long this continues. That's right. Worth saying
right now, you know, it's going
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to be at least two months. And
so— this is only two months. We obviously know this
could go longer. On one hand,
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this is not Venezuela. Another
hand, it's not Iraq. It's something in between those, for
sure. But nonetheless, this
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could go on for longer. And I
think we are going to take some hit to the economy. It's going
to be a bit negative, and the
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biggest hit will be in the form
of gas prices or heating prices. Fortunately, mostly beyond
winter at this point. But
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nonetheless, that's— those are
going to be the biggest impact. So there's definitely a lot of
upside uncertainty there. You
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know, the big balance, though— I
mean, in all of this— I mean, this is the problem with security
investments, is that they— they—
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they always look bad,
right? Because if you're actually successful, people say,
"We spent all this money and
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nothing happened." Well, that's
the whole point of security investments. You know, if Iran
actually did get the bomb, and
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you know, they were— clearly had
the enrichment capacity for a bomb. And yes, you said, "Well,
we had those inspections years
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ago." We all know how easy it is
to fool those things. Even inspectors themselves are saying
we're probably not seeing
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everything. If they really think,
you know, these 13 bombs, which was the SMF capacity, even if
they only had a 10% chance of
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using those bombs, the cost of
that, the extreme cost of that, is just tremendous. And so from
a cost-benefit perspective,
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we're not saying that this
doesn't pass muster. It could easily pass muster. But the
point is, is that there is a cost.
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What— is there an area that maybe
us as the public, or even myself as a journalist, that is going
to be impacted, that we don't
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necessarily think of, that maybe
is kind of underlying as something that's going to be
impactful in terms of financial
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as we move forward here? Yeah, it's a great question. I
mean, there is always those
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unknowns. And higher oil prices
will also mean, you know, airline costs as they've gone up
with demand and so forth. This
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will be a negative supply shock,
and so that will help drive up costs, but at the same time,
less quantities will be sold
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there. So I think anything that
kind of depends on oil prices in the short run will be negatively
impacted. If this really does
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sustain higher oil prices over
the longer term, believe it or not, that is actually usually a
positive for the United States,
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because we're a big oil producer
now, and also we produce all the equipment that, you know—
fracking was a US thing. - Yeah.
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And so that often is very
positive. Very different than the 1970s. But it's more of the
scenario that we're planning for
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that oil prices may not be high
enough for a long enough period, that there's going to be a lot more
equipment built. Well— you don't
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uncap wells very quickly, unless
you know oil prices are going to be up there for a long time.
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I'll finish on this quickly. But
what about the impact on the Federal Reserve and their
decision making process? Because
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I think the loss of GDP plays
into a role there. Yeah. And in particular, how the
GDP gets lost with this negative
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supply shock. And in particular,
that will definitely be inflationary, not deflationary.
And so it's— you know, when we
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have negative demand shocks, that
tends to lower GDP and lower prices. Or, that is, place less
pressure on inflation, when you
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have these oil supply shocks
that we typically think these are negative supply shocks, and
that actually lowers GDP and
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raises prices. So all the more
reason that they probably will be pretty modest in their rate
setting going forward, and
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probably are not encouraged to
lower rates. Kent, great to talk to you as always. Thanks very much.
- Pleasure.
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Thank you. Kent Smetters, who is
Faculty Director of the Penn Wharton Budget Model.