The currency markets have felt the sting of geopolitical tension in 2017. As soon as Donald Trump placed his hand on the Bible and officially became the 45th President of the United States on 20 January, temperatures began to rise in the global pressure cooker. Thanks to Washington’s latest feuds with North Korea , the dollar index – which records the USD against 6 other major currencies – has been slumping in the wake of weaker U.S. producer prices, making forex traders lose confidence in pairs like the USDJPY, writes Nikola Grozdanovic, FXTM’s Senior Staff Writer.
Trumps twittering thumbs have let loose a litany of criticisms against Mexico, Canada, China, Syria, Russia and North Korea and his rhetoric has done nothing to assuage jittery world markets. These ongoing tensions, especially with North Korea, who seem determined to continue with their ill-advised nuclear missile testing programme, have had investors thinking about the possibilities of actual war breaking out. Edwin Starr’s classic protest song from the 70s answers the ‘War, War, What is it Good For?’ question with a resounding ‘Absolutely Nothing!’ – but a lot of experts and market analysts aren’t as quick to answer, wondering if it could be a good thing for a world economy that’s growing at a snail’s pace.
Ever since the Second World War followed the Great Depression, it’s been a popular notion amongst economists that war stimulates economic growth. The way the U.S. recovered during and after WWII has been studied for decades, as unemployment rates declined and spending increased, the scales of supply and demand balanced out. Frederic Bastiat’s parable about a broken window, however, dispels the myth that destruction is good for stimulating growth. In Bastiat’s story, a shopkeeper’s window gets broken and onlookers agree that it’s actually good for the wider community, because the shopkeeper has to pay the glassmaker to replace it, which means the glassmaker will have money to spend on something else. This cycle continues until overall economic growth is stimulated. But what Bastiat points out – and what turned his story into the ‘Broken Window Fallacy’ – is that replacing the broken window is maintenance cost, not a purchase of a new item, and that industries not in the glassmaking business lose out. Similarly, wars stimulate growth and employment only in some industries, ultimately leading to more costs in the long run due to the destruction caused by war. The onlookers in Bastiat’s story, just like investors and economists who argue that war is good for the economy, fail to realise that they’re only concentrating on parties involved in the short-term effects and not the unseen third parties that lose out in the short and long terms.
The Broken Window Fallacy is a timeless example that is applicable to today’s world. Capital Economics, an independent research house, assessed what an actualised conflict between the U.S. and North Korea would do to the world’s economy. Noting that countries involved in wars after WWII have seen significant dips in economic output. Gareth Leather and Krystal Tan point to Syria as a prime example, noting that the country’s GDP fell by 60% due to war. The Korean War in the 50s was even worse; South Korea’s GDP dwindled by a devastating 80%.
Capital Economics’ assessment claims that the Korean Peninsula would feel the biggest economic shock in case of war today. This would however have a ripple effect on the global economy, since South Korea makes up 2% of the world’s GDP. The country is also the biggest producer of LCD screens, semiconductors, home to the world’s three biggest shipbuilding companies and an essential hub for car manufacturing. A war-torn South Korea would affect global supply chains, and there would be heavy damage across global trading routes and widespread shortages.
The U.S. economy could also feel negative impacts; as seen with the cost of the Iraq War in 2003 (an estimated $1 trillion). If a potential war between North Korea and the U.S. starts and get prolonged, federal debt would increase, which would be catastrophic for national debt (already predicted to rise to $65 trillion by the end of 2017, without war).
It is difficult to justify the merits of war on any level, as the outcome would be economically devastating, but the more tensions ratchet up, the more investors in the forex and commodities world will be gearing their investments for possible war scenarios. The U.S. president’s rhetoric has lost its bite on the markets since January, which can be seen in the gains of the Mexican peso and Canadian dollar (21% and 8%, respectively) against the USD. Since Trump’s inauguration, we have seen a six-month decline of the dollar index – the longest losing streak since 2003. The potential devastation of war, and its long-term negative effects on the world’s economy, would only pile on more negative sentiment for the greenback. So it’s more than likely that we’ll all be singing along with Edwin Starr in the not-too-distant future.
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