US failure in Iraq would be a disaster for Ireland

It goes without saying that $1.5 billion is a lot of money.This is how much Americans borrow per day from the rest of the world to pay for their McDonald’s, SUVs and cheap holidays in Acapulco.

This type of economic delinquency is not sustainable – neither for them nor for us.

America’s financial incontinence is getting worse as it grows older.Very soon its free-spending babyboomers will reach retirement age without the capacity to pay for themselves.What will happen then is anyone’s guess but two things are certain: the dollar will be weaker and interest rates higher.

Images of abused Iraqis, a beheaded American and unctuous, squirming politicians dominated the news this week and so the deteriorating economic situation was understandably overlooked. But bad politics begets bad economics.The mirror image of the shambolic, irresponsible and utterly shortsighted US foreign policy has been a similarly disastrous, lopsided and inexplicable economic policy.This gives substance to those critics of the US administration who argue that the people on the top in Washington are not only foolhardy, but actually quite stupid.

In the past few days, stock markets around the globe have fallen, bond markets have sold off dramatically and gold prices have fallen, as have many of the other precious metals that had been roaring ahead until recently. Investors are rightly worried that the leaders of the world’s only superpower are out of control without any appreciation that globalisation makes the world a sensitive, interdependent ecology where one blunder has significant ramifications.

To trace how political stupidity is amplifying economic problems through global financial links,the best place to start is Saudi Arabia.While the world’s attention is focused on Iraq, Saudi Arabia is the lynchpin of the region and if it comes unstuck, the game is over for theYanks and Europeans in the Gulf.

In the past two weeks, al-Qaeda’s campaign against the Ibn Saud family business (which constitutes the kingdom itself) moved up another notch when it succeeded in blowing up the Riyadh headquarters of the main internal security service.

Clearly, Osama’s mates intend to knock out the House of Saud. However, from a Western viewpoint, that is not the true measure of how serious the threat is. In the past, the assumption has always been that even if there was a revolution of some kind in Saudi Arabia, the new rulers – however anti-Western they might turn out to be – would need, and want, to sell oil to survive.Therefore, the oil would end up in the consuming countries of theWest no matter who were in power.

However, al-Qaeda is not interested in selling oil. People who film the decapitation by kitchen knife of a radio repair man live by different rules.They do not negotiate.Their main aim is to purge the Muslim world of Western influence in general, and in the Arabian peninsula in particular. Destroying theWest’s economy and culture is the secondary one.

At some point, the regime will crack and then even the most determined ostriches will have to face the harsh realities. The US has unleashed forces in Saudi Arabia that appear not only to be beyond the control, but beyond the comprehension, of Rumsfeld et al.

(Regular readers will know that this column has never been anti-American and believes fundamentally that the US has been the most benign empire the world has ever seen. I want to see the US pull out of this tailspin, but it seems to be beyond the ken of theWhite House incumbents.)

If Saudi Arabia cracks, the oil price could see $80 a barrel in the short term. Even if the regime clings on, the uncertainty will keep oil above $40 for some time.The higher the oil price, the greater the threat of inflation in theWest. It is interesting that in this cycle, the high price of oil has not yet caused prices to rise in theWest. In fact the de-coupling of interest rates from oil prices is one of the key differences between this cycle and others. However, this may be about to change because the other way in which bad politics begets bad economics is through American government spending.

Even before the Iraqi quagmire, Bush had overturned Clinton’s fiscal surpluses with ridiculously biased tax cuts. Arguably, this was the right thing to do back in 2001 when the dot.com bubble burst but the incontinence has so deteriorated since, and the war spending increased to such an extent that no one is quite sure how much military spending will be this year.

Where does this money come from? Who pays forAmerica’s adventures? Well, the rest of the world lends to the US via the US bond market. Foreign buying of US treasuries has been one of the main features of global markets since 2002. Normally,this would cause US interest rates to rise, but Alan Greenspan has been doing his best to prevent this. In the past few days, his bluff has been called. Investors have sold US bonds, causing long-term interest rates to rise rapidly.This means

the rate of interest charged to those who want to borrow over 20 years is now close to 5 per cent and with banks fees added on, this is likely to be close to 7 per cent. This is up a net 4 per cent on last year.

How has the US economy reacted to this? The first thing to appreciate is that the Bush recovery has been built internally on borrowed money and for the average punter, this has mainly been through mortgage equity withdrawals which is also what is happening in Ireland whereby people borrow against the value of their houses. America is awash with credit derived from the inflated price of US property.

Many commentators are focusing exclusively on the affect of higher interest rates on stock markets, but this misses the point.The property market is where the real action is and in the US, there is a great leading indicator of the property market called the REITs market.

REITs stands for Real Estate Investment Trusts and these are assets that are, plainly speaking, a bet on the property market.They are listed property trusts. They operate like old-fashioned warrants. If you want to get into property but don’t have the $300,000 to buy, you can invest $30,000 in REITs and watch the market soar.This highly liquid market has performed well since the late 1990s,but in the past six weeks REITs have fallen by 20 per cent as investors re-rate property to take into account the new higher interest rate environment.Whether real property falls by 20 per cent is open to question, however it would be irresponsible to ignore the REITs signals.

Optimists and sellers are saying that the US will pull through. No doubt it will, but at what price? Traditionally there are only two ways of rectifying a massive current account and budget deficit.The first is a recession which Bush will not allow to happen before an election and the second is via a significant fall in the currency and higher interest rates.

As Bush issues more government debt to pay for his election, the Federal Reserve has to print more money to prevent short-term interest rates from rising in tandem.This will cause long-term interest rates to rise further as the market cops on to what is happening. Obviously the dollar will fall precipitously against such a background, because the US will have to make its debt look cheap for foreigners to buy the stuff.

This week the Chinese government said that it would take steps to cool the economy.Up to now the Chinese have been huge buyers of US debt. If this investment reduces because a slowing China generates less excess cash (the very cash that was finding a home in US government treasuries) the dollar will fall quicker and further.

This has serious ramifications for Ireland.We have always done well when the dollar is expensive and the euro cheap. This is because we look a lot better value to corporate USAwhen our labour priced in euros is falling against their labour priced in dollars. If this occurs simultaneously with falls in the stock and bond market, corporate America will find it harder to finance expansion in Ireland or elsewhere around the globe via the issuance of paper.

However, if this economic hardship coincides with an American defeat in Iraq,we will get an oil whammy plus serious and possibly lasting damage to the American psyche and an emboldened and victorious al-Qaeda in the Middle East.The first economic victim of such a scenario will be trade and investment flows from the US to the rest of the world. Given that we are the most open economy in the world and we have benefited enormously from the glorious age of globalisation since 1990, the economic ramifications of a Yankee defeat in Iraq would be disastrous.