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. Last Updated: 07/27/2016

U.S. Economy Hurt by More Than War

WASHINGTON -- Federal Reserve officials are wagering that once fears about a war in Iraq lift, U.S. economic growth should return to a healthy clip.

But a sizable group of private economists wonders if the economy's problems run deeper than geopolitical worries and argue that the main force depressing growth is a hangover from the boom years.

Nor is Iraq the sole geopolitical stress for the United States, some analysts say. Tensions with North Korea and worries about terror attacks on U.S. soil are also keeping consumers and businesses on edge and these may not disperse any time soon.

No matter how the crisis with Iraq plays out, the economy could well remain mired in sluggish growth throughout 2003, these economists contend.

"If, suddenly, we were to wake up tomorrow to the news that Saddam Hussein has quietly left Iraq, I don't think we'd necessarily see a return to trend growth for the economy," said Ed McKelvey, economist with Goldman Sachs and Co. in New York.

"The best way to think about the economy right now is it is still working out the imbalances that came alongside the stock market bubble of the late 1990s," he added.

McKelvey sees boom-time overspending by businesses and households fueled by the "wealth effect" of soaring stock prices as the key imbalance. Sobered up by three years of falling equity markets and helped by low interest rates, businesses and households have been repairing their balance sheets but they still have more work to do, he said.

Paul Kasriel, chief economist at Northern Trust in Chicago, agreed.

"I would say the debt hangover and the loss of net worth from the stock market are the main problems facing the economy," said Kasriel, who has often likened consumers appetite for credit to an addiction.

Since its peak in March 2000, the Wilshire 5000 -- the broadest measure of U.S. stock performance -- has lost $7.9 trillion, or 46 percent of its market capitalization.

But Fed Chairman Alan Greenspan and some of his colleagues, who were concerned enough about the economy's health late last year to slash interest rates to a new four-decade low, are now taking a guardedly optimistic stance.

Greenspan, in fact, felt strongly enough that the fundamentals could be in place for a recovery that he warned Congress last month to hold off on plans for fresh stimulus.

The Fed chief's remarks angered many allies of U.S. President George W. Bush and spurred speculation that Bush might balk at reappointing the Fed chairman when his term is up in 2004.

Greenspan said the most "probable" scenario for the U.S. economy is that it would begin to pick up momentum once the "transitory" geopolitical factors begin to lift.

Also subscribing to that guardedly upbeat view was Fed Governor Ben Bernanke.

"The enormous uncertainty regarding the situation in Iraq and other foreign hot spots still continues to cast a heavy pall on firms' planning for the future," he said in a recent speech.

Philadelphia Federal Reserve President Anthony Santomero went even further during audience questioning after a speech in Pennsylvania on Monday. The regional bank chief said: "The reality is this will be behind us, the geopolitical risk will subside and the economy will have a recovery that will be robust and long."

The Fed is far from alone in highlighting the impact war fears are having on the recovery.

In its latest projections for the U.S. economy, the well-regarded Blue Chip panel of economists in February trimmed its growth forecast for 2003 to 2.7 percent from the 2.8 percent it had been predicting in January.

The Blue Chip Economic Indicators newsletter said in its outlook summary that "fears about the inevitability of a U.S. Iraqi conflict" were behind the reduction in the forecast.

The Business Council, a group comprising chief executives from some of the largest U.S. corporations, cited both war worries and fear of terrorist threats as factors that could put a damper on growth this year.

How big a role war worries are playing in the economy's performance may be clarified within coming months as the United States, which has been massing troops in the Gulf, has signaled that it does not want to wait much beyond mid-March to take action against Iraq.

Some economists have contended that American households are in better financial shape ahead of this conflict than on the eve of the Gulf War. Incomes are rising rather than falling this time, inflation and unemployment rates are lower while borrowing costs are much cheaper.

Inflation is about 4 percentage points lower than in 1990. The jobless rate in December 1990 was 6.4 percent, versus 5.7 percent in January 2003. Thirty-year mortgage rates are below 6 percent now, compared with 9.7 percent in late 1990.

Still, Sung Won Sohn, chief economist at Wells Fargo Bank in Minneapolis, said the outcome of any Iraq war might not be as clear-cut for the economy as was the resolution to the Gulf War in 1991.

He said that with America intent on "regime change," even a quick victory would give way to rebuilding with the cost possibly reaching into the hundreds of billions of dollars.

"In the meantime, the geopolitical tensions will not go away," Sohn said.