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The strange relationship between war and money

Denver Business JournalOn the Money
From the April 4, 2003 print edition

At first glance it might seem that the marriage of war and money is nonsensical. However, war does seem to improve economic conditions. In fact, commerce and military conflict have been linked together for many centuries. In 1828 Webster defined war as: "A contest between nations or states, carried on by force, either for defense, or for revenging insults and redressing wrongs, for the extension of commerce or acquisition of territory . . ."

Without commenting at all on the political, ethical, emotional or moral issues surrounding war, there are economic relationships that often lead to an improved fiscal climate. Of course using statistics alone may not reveal factors such as: perceived uncertainty, expectations and the propensity to spend, or willingness to invest. 

Nevertheless, it is worth exploring both the obvious and not so obvious relationships that make the process of war economically stimulating.

Classic economic fiscal policy theory tells us government spending stimulates the economy because it puts more funds into circulation. 

Add to that the multiplier effect– that is, one new dollar (less what each person saves) passing from person to person has an influence of $10 or possibly more. It’s the government that pays for war.

Some of the expenditures are obvious. It’s easy to see the benefit for manufacturers of wartime equipment and supplies. The campaign requires vehicles, food, transportation, communications, ammunition, clothing, gasoline, etc. 

However, some of the fiscally stimulating expenditures are less obvious. 

Members of the military assigned to or deployed to a combat zone receive additional "combat pay" (officially called "imminent danger pay") which also carries a tax advantage. Congress and/or the President can designate combat zones as "Tax Exempt" areas. 
Earnings received while in these combats zone are excluded from taxable income. Bonuses and "special pays" are also excluded from taxable income if earned in the same month while in a combat zone. 

In addition, members of the military in a combat zone are authorized to deposit up to $10,000 (per year) of their pay and allowances into a special savings account that pays a guaranteed 10 percent interest per year. 

This program was established during the Vietnam era, and then phased out at the end of the Vietnam War. It was revived in 1991 during the Gulf War and still exists today.

This means that the government spends more for its military labor in times of war while simultaneously employing the additional fiscal policy tool of tax reduction and preferential return.           These policies increase available money to be placed into the economic structure.

However, one set of parameters does not represent the entire model. Fiscal, monetary and psychological issues mix together in a highly intricate and multifaceted way. Though government spending supposedly stimulates the economy, governments have no real income other than through taxation.

Robert Shapiro of MSNBC reminds us that since democratic governments are reluctant to ask their citizens to pay much higher taxes while they’re also placing their people in mortal peril, most large wars also involve changes in monetary arrangements to finance the conflict. 
America’s first national currency and modern bond operation grew out of the Union’s financing schemes for the Civil War. World War I funding demands transformed the infant Federal Reserve from a lender of last resort in bank panics into a modern central bank. The deficit financing of the Vietnam War (and monetary policies to accommodate it) helped launch the inflation of the 1970s.

To try to quantify the magnitude of the war relative to the entire economy, consider the following relationships.

President Bush has requested $74.7 billion from congress to finance the first installment of the war which is $20 billion more than the $54 billion AOL Time Warner lost in the 1st Quarter of 2002. Some have estimated the cost of the war will be more than $300 billion.
According to the U.S. department of Commerce, Gross Domestic Product (the output of goods and services produced by labor and property located in the United States) was $10,586 billion at the end of 2002.

That means the estimated expense of the war is approximately 3 percent of GDP.

Money and war-strange but inextricably bound bedfellows. The etymology of the word "war" comes from the Old High German werran to "confuse." At war’s end, maybe clarity will return.

© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.