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JAN 01.27.2017
ECONOMICS: US PERSPECTIVES
NATIONAL DEFENSE: IS ANOTHER SPENDING
BOOM ON THE HORIZON?
+ Joseph G. Carson, US Economist and Director—Global Economic Research, joe.carson@abglobal.com
President Trump has promised to increase defense spending—and
there’s support from key members of Congress. If a large multiyear
plan is approved, it would represent a sharp reversal from what has
beentheweakesttrendindefensespendinginthepast50years.
And the timing and scale would have important implications for the
outlook on growth and inflation.
National Defense—The Trump Plan
President Trump has promised to deliver
an ambitious program to rebuild the US
military. It would include modernizing
US nuclear weapons systems, investing
more in cybersecurity, enlarging the navy’s
fleet and increasing the number of fighter
aircraft for the air force. Trump’s plan also
includes additional military personnel—well
over 100,000, according to some
estimates.
The details of Trump’s first Pentagon
budget will form part of the overall budget
he’ll submit to Congress in late February or
early March. The actual funding request for
the current fiscal year (which ends
September 30) must be completed by April
30—that’s when the current legislation
funding the military budget is set to expire.
More important, Trump’s blueprint for the
Pentagon budget could set the baseline
for defense spending for at least the next
four years. It’s also worth noting that
Trump’s military expenditures could be at
the low end of what some in Congress are
proposing.
For example, Senator John McCain, who
chairs the Senate Armed Services
Committee, recently released a white
paper on defense spending, Restoring
American Power. McCain argues that the
US has underinvested in the military for
several years, and that it is now vital for
the US to substantially increase funding for
the Pentagon. His plan calls for a $640
billion defense budget for fiscal year 2018,
which is $58 billion above the current
budget baseline. Moreover, the McCain
defense plan urges an additional $430
billion in military spending over the next
five fiscal years.
Defense Spending Patterns Are Unlike
Other Federal Programs
History shows that defense spending
programs are unusual in that they’re neither
cyclical nor countercyclical. Most often they
are based on military and political strategiesaswellasongoingreadinessto
respond to or engage in global encounters.
Based on historical gross domestic
product (GDP) data, there have been three
large defense-spending programs in the
past 50 years (Display 1). The first buildup
Display 1
Defense Spending Comes in Big Waves
YoY % Change
80
70
60
50
40
30
20
10
0
(10)
Nominal Defense Spending
Vietnam
War
Reagan
Buildup
Iraq
War
(20)
64 72 81 90 98 07 16
Trump?
Through September 30, 2016
Four-year moving average
Source: Bureau of Economic Analysis and Haver Analytics
occurred in the mid-1960s, during
President Lyndon Johnson’s term, and ran
for five years. That was tied to the military
engagement in Southeast Asia.
The second large defense-spending boom
occurred during the first four years of the
Reagan presidency. This buildup was part
of Reagan’s political and military strategy
to rebuild the military apparatus after what
he saw as years of neglect.
The third major increase started during the
first term of President George W. Bush.
This one was linked to events surrounding
9/11 and the following events in the
Middle East.
1
From a political and military standpoint, the
Trump defense plan parallels the goals and
objectives of President Reagan’s military
push. And with McCain’s more aggressive
plan aligned on the same premise of
modernizing and improving the readiness
of the US military, Trump will likely have the
backing of this influential member of the
Republican congressional leadership.
Today’s Economic Backdrop—
Similar to the 1960s
The economic and financial implications of
a large, multiyear defense-spending plan
must be weighed against the economic
environment at the time of implementation.
And from a historical context, today’s
conditions have more similarities to the
economic setting of the mid-1960s than
during the defense buildups of the early
1980s or early 2000s, which were either
in recession or the very early stages of
recovery.
Incontrast,theUSeconomyinthemid-
1960swasalreadyinitsfifthyearof
expansion, the jobless rate of 4.5% was
relatively low and inflation was tame
(roughly 1.5%). Nonetheless, the extra
defense spending boosted domestic
demand growth and added significant
pressure to labor costs, materials and
supplies, and product prices. So much so
that the acceleration in consumer price
inflation(from1%in1961tonear6%in
1970)fromthestarttotheendofthat
businesscyclewasoneofthelargestof
any economic growth cycle during the
postwar period.
Today’s economic backdrop looks similar in
many ways. The economy has been in
recovery for seven years, the jobless rate is
in the mid-4% range and inflation is stable
(at around 2%). While many domestic and
global factors are different now, we would
still expect a large multiyear defensespending
program to add to growth and
put upward pressure on labor costs and
inflation in the coming years. Keep in mind
that we’re coming off the weakest five-year
defense spending trend in the past 50
years, so Trump’s defense spending need
not match any of the prior three to have a
major impact.
Stay tuned for the unveiling of Trump’s
budget and pay close attention to the
defense spending request. A large
multi-year program would definitely lift
inflationary pressures. While we wouldn’t
expect an acceleration like that in the
1960s, a sustained rise of 100 to 200
basis points in general inflation would still
seem reasonable—and far above what the
Federal Reserve and financial markets are
currently expecting. n
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