A little Econ 101 vis a vis Iraq

By AUSTAN GOOLSBEE
The New York Times
PRESIDENT BUSH’S surge of troops in Iraq has done little to resolve the political debate over the Iraq war. But global financial markets have been monitoring the war for months, and with remarkable consistency, they have concluded that the long-term prospects for a stable Iraq are very bleak.

That is the picture that emerges from a study by Michael Greenstone, an economics professor at the Massachusetts Institute of Technology, titled, “Is the ‘Surge’ Working? Some New Facts,” which has been circulating as a working paper in academic circles.

Professor Greenstone started by reviewing basic statistics on the Iraqi economy and on the battle for security within Iraq since February. This data provided a murky view, at best.

He found that civilian deaths in Iraq had fallen substantially in recent months. At the same time, though, he found little change in the rate of American and Iraqi military fatalities, while the recruitment of members of the new Iraqi security forces declined sharply. On the industrial side, crude oil production fell as much as 20 percent, but there was evidence of a slight improvement in the availability of electricity.

Sifting through these facts was time-consuming, but it provided little real guidance on the state of affairs in Iraq.

It wasn’t until Professor Greenstone began examining the financial markets’ pricing of Iraqi government debt that he had his eureka moment. It was immediately clear that the bond market — which, historically, has often been an early indicator of the demise of a political system — was pessimistic about the Iraqi government’s chances for survival.

First, some background on the Iraqi bonds. After the United States helped Iraq renegotiate its leftover debt from the Saddam Hussein era, the Iraqi government issued about $3 billion of new bonds in January 2006. These dollar-denominated bonds pay 2.9 percent twice a year and mature in 2028, paying the face value of $100.

To say the least, the market for these bonds is not robust: as of last week, a bond with a face value of $100 was trading at around $60. Professor Greenstone calculated that, from the markets’ standpoint, the implied default risk over the life of the bond was about 80 percent.

The important point is that anyone who owns one of these Iraqi bonds has to decide each day whether the Iraqi government is likely to be functional enough to make its debt payments, or will default along the way. All else being equal, if the surge policy is effective, it ought to be raising the market price of these bonds.

Bondholders “aren’t politically motivated,” Professor Greenstone said. “They don’t have to rationalize their previous statements or justify their votes from years past. All they care about is whether there will be a functioning Iraq in the future such that they will receive their payments.” At a certain price, most securities will find a buyer, and there are still buyers for Iraqi bonds. But the price they are willing to pay is very low.

Full article: http://www.nytimes.com/2007/11/11/business/worldbusiness/11view.html?_r=1&ref=business&oref=slogin

 

Interesting. Thanks for the post.

 

This was a most interesting look at a subject I've often thought about. The emphasis of my (finance) degree was bond trading, more specifically, pricing, and I certainly agree with the writer's assessment of the implied risk assumed by those purchasing Iraqi paper. I do not, however, agree with his connection of the "surge" to the pricing. He made a convincing argument, but I'll argue that the falling prices were a function of investor weariness over the war, as it has dragged on, now, and the government's failiure to get on its feet thus far. I think his work, mostly done before the drop in overall violence (thankss in part to al-sadr's cease-fire) has unsuccesfully linked the action with a market that prices EVERYTHING and not just military action.

 

Does this topic not interest anyone else?

When I saw it, I thought it'd be a good discussion.


Meh. Guess not.

 

Are people really expecting Iraq to be long-term viable?

In addition, 2.9% bonds are pretty low-paying, and they are dollar denominated as well. All things which would give a substantial discount to the face price of the bonds.

 

Maybe if we come at the economics of Iraq from a different angle....$1.6 trillion by 2009.

http://www.cnn.com/2007/POLITICS/11/13/hidden.war.costs/index.html

 

Put it on the Diner's Club card and call it a day. $1.6 trillion is not our problem, it's our kids and grandkids' problem.

Don't look to hear anything about it in the next 12 months. Our aspiring presidential candidates will be much too busy debating evolution or Hillary's lesbianism, or brainstorms like the government giving $5,000 for every baby born in the US.

 

Which is why, when I have a child, they'll be enrolled in Spanish and Mandarin Chinese language classes ASAP.

 

Nice thought. In our district (which is considered pretty good) you don't get language until 9th grade. And it's Spanish or French or nothing. Thanks, Prop 13!

 

$20,900 per family of four from 2002 until now. It's even more astonishing when the costs are broken down like that.

 

Glad to see we're on topic.