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War & Economy: Do they get along?

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The tense geopolitical atmosphere throughout 2017, has made its impact in the currency markets. When Donald Trump officially entered the White House in January, the global temperature rose by more than a few degrees – given the President’s populist rhetoric during his campaign. The dollar index, which measures the USD against a basket of other major currencies, has been dwindling, largely thanks to the ongoing tensions between the U.S. and North Korea. As a result, many forex traders have lost confidence in pairs like the USDJPY, writes FXTM Senior Staff Writer Nikola Grozdanovic.

Over the course of the year, Trump aired his infamous disdain on Twitter and in interviews at the likes of China, Syria, Russia, Canada, Mexico and North Korea. The most heated of which, is undoubtedly his current feud against North Korea’s Kim Jong Un, who ordered a sixth nuclear missile test in early September and is showing no signs of stopping the provocation. These increasing tensions are giving investors the jitters about the reality of military conflict, with some claiming that war may actually be a good boost for the stunted global economy.

Many economists have used the United States’ recovery after the Great Depression as a shining example of how war can revive a flailing economy. Studied in economics classes for decades, U.S. recovery post-WWII was demonstrated through declining unemployment rates, increased spending, and a remarkable re-balancing of supply and demand after the country underwent its worst ever economic period. Nonetheless, it’s good to remember the famous parable by French economist Frederic Bastiat whenever you want to shatter the myth of war being good for the economy. In the story that is today known as the ‘Broken Window Fallacy’, a vandal breaks a shopkeeper’s window and all the witnesses come to the conclusion that it’s actually a good thing. Now the shopkeeper will pay the glassmaker for repairs, and the glassmaker will, in turn, spend the money he made on something else. This cycle will ultimately bolster the economy for the entire community.

Bastiat breaks this theory down as a fallacy by explaining that the broken window incurs a maintenance cost, not consumption of a new product, and that all other industries outside the window-making business actually lose out in this scenario. The onlookers do not factor in these ‘invisible’ third party merchants, and that’s what economists and investors who argue that war is good for the economy also fail to do. War would be a short-term fix for certain industries, while others would fall behind, and what’s more, the destruction of war would lead to even more costs in the long run.

We can easily apply Bastiat’s example to our times today. Independent researchers Capital Economics conducted a study on how a potential war between the U.S. and North Korea could affect global economy. Gareth Leather and Krystal Tan use past examples, after the Second World War, to prove that wars more often than not lead to big GDP drops. As a primary example, the war in Syria caused that country’s GDP to fall by 60%. Going further back, South Korean GDP fell by a tremendous 80% during the Korean War in the 50s.

If a new war breaks out, the Korean Peninsula would take the biggest hit, and the side-effects would trickle out to the larger world economy because South Korea compromises 2% of the world’s GDP. Home to the world’s three biggest shipbuilding corporations, South Korea is also the world’s largest producer of LCD screens and semiconductors, and vital to the global car manufacturing industry. If the country gets ravaged by war, multiple supply chains and trading routes around the world would be severed and damaged.

The U.S. economy would most probably feel negative repercussions as well; the Iraq War in the early 2000s cost the country an estimated $1 trillion. If a North Korean-U.S. war gets dragged out, federal debt hikes would be devastating for national debt, which is already estimated to reach a whopping $65 trillion by the end of the year and that’s without war.

Tensions between the U.S. and North Korea only appear to be intensifying, with North Korea’s Foreign Minister Ri Yong Ho recently accusing Donald Trump of declaring war when the U.S. president said Kim Jong Un “won’t be around much longer”. The White House is denying any such declarations, but that’s not stopping commodity investors and forex traders from gearing their strategies for wartime. Since he entered office, Trump’s rhetoric has been failing to move the needle in the currency markets, with the Canadian dollar gaining 21%, and the Mexican peso 8%, against the greenback since January. Despite a bounce-back on 11 September after the damage of Hurricane Irma caused less damage than expected, the dollar index has been on a steady 6-month decline since Trump’s inauguration. Add all this negative sentiment to the destruction and long-term effects that an actualised military conflict would incur, and we’d be looking at a devastating turn of economic events.

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