President Joe Biden has requested a $100 billion aid package from the US Congress. This package encompasses aid to Israel and Ukraine, funding for border security, disaster relief, and support for the Indo-Pacific region. The request comes at a critical juncture as the world watches escalating conflicts in Ukraine and Palestine, which pose challenges and opportunities for the US economy.
Impact on Trade and Investment
War has always been a multifaceted factor when it comes to its effect on trade and investment. The disruption in the flow of goods, services, and capital across borders can greatly impact the supply and demand sides of the economy. However, it’s worth noting that wars can also create new trade and investment opportunities as nations aim to secure their strategic interests or explore new markets.
Drawing parallels from history, during World War II, the US economy benefited from its role as a major supplier of weapons and materials to its allies and gained access to new post-war markets in Europe and Asia. In contrast, during the more recent wars in Afghanistan and Iraq, the diversion of resources to military spending and regional instability hampered trade and investment.
Now, in 2023, the landscape has shifted. The US is no longer the world’s primary manufacturing hub. China, with its unparalleled manufacturing capability, stands to benefit, akin to the US during World War II.
According to Federal Reserve projections, the US GDP is expected to grow by 2.1%. Yet, the World Economic Forum’s Report on World Economy 2024, prior to the Israel-Palestine conflict, already predicted a weakening global economy, with 61% of chief economists surveyed anticipating further deterioration. Now, with these conflicts, those projections seem even more precarious about the economy.
Challenges and Opportunities in Ukraine and Palestine Conflicts
The war in Ukraine involves a standoff between NATO and Russia, significant trading partners of the US. Years of sanctions and counter-sanctions have considerably reduced trade between the US and Russia, impacting both economies. The situation also threatens Europe’s energy security, which is heavily dependent on Russian gas.
To mitigate this dependency, the US has been promoting alternative energy sources, like liquefied natural gas (LNG) and supporting Ukraine’s energy diversification efforts.
The war in Palestine, on the other hand, involves a long-standing conflict between Israel and the Palestinians, with broader regional implications involving Iran and Saudi Arabia. The US, a staunch ally of Israel, has been actively involved in the region, providing military and economic aid and seeking a peace deal based on a two-state solution.
However, recent escalations have cast shadows on the peace prospects, further intensifying the regional turmoil. These conflicts also have repercussions on the oil market, with supply disruptions causing Brent crude prices to surge from $75 per barrel in July 2023 to $95 per barrel in October 2023. This oil price spike will significantly impact inflation, putting pressure on the savings of individuals.
The US Economy: Inflation and Interest Rates
War’s impact on inflation and interest rates is undeniable. It can drive up inflation through increased demand for defence-related goods and services, supply disruptions, and government spending. In turn, this can prompt central banks to raise interest rates to combat inflation, negatively affecting economic growth and employment.
Past experiences offer insights: World War II led to double-digit inflation due to massive government spending, price controls, and rationing. The situation post-war moderated due to reconstruction and productivity growth, alongside Federal Reserve tightening.
In contrast, the wars in Afghanistan and Iraq saw relatively low inflation, largely due to low oil prices, globalization, technological innovation, and accommodative Federal Reserve policy. Recent inflation surges are linked to supply chain disruptions, rising commodity prices, fiscal stimulus, and pent-up demand.
The ongoing wars in Ukraine and Palestine could potentially impact inflation differently. If these conflicts escalate into a broader global war, they may lead to a severe supply shock, driving up oil prices and increasing defence spending. This, in turn, could force central banks, including the Federal Reserve, to raise interest rates aggressively, slowing down economic growth.
Conversely, if these conflicts are contained or peacefully resolved, they could have limited or even positive effects on inflation. For instance, a peaceful resolution of the Ukraine conflict could ease sanctions on Russia, improving trade relations. Similarly, peace in Palestine could stabilize the oil market, leading to lower inflation and enabling central banks to maintain low-interest rates to support economic recovery.
Impact on Exchange Rates
Exchange rates are not immune to the influence of war. War can affect exchange rates by changing the demand and supply of currencies, investor expectations, conditions of economy and confidence. Wars can also alter the relative performance of the economy and monetary policies of involved or affected countries.
In general, war tends to weaken the currency of the directly involved or affected country while strengthening the currency of perceived safe havens or beneficiaries of the conflict.
Historically, during World War II, the US dollar appreciated due to its role as a supplier and a safe haven. However, after the war, it depreciated due to the Bretton Woods system. The wars in Afghanistan and Iraq saw the US dollar depreciate due to deficits and loose monetary policy.
Also Read : South Africa Explores Visa Waiver for Indians and Chinese