Afghanistan and the Economy: The Impact

The Obama administration’s plan to add 30,000 more troops to the military operation in Afghanistan by this summer is designed to bring stability to the region, but it could also have an impact on American financial interests at home.

The conventional wisdom, of course, is that war is good for business, and a wartime boom would certainly represent a bright silver lining, particularly in the midst of a fledgling economic recovery.

But there are other considerations when weighing the effect of a mass troop deployment (and its associated outlays) on the American economy and an already-strained global financial system. For example, heavy spending could leave the dollar weaker (the U.S. has already spent as much as $227 billion in Afghanistan over the last eight years, according to one government estimate). And dramatic media reports and greater demand for oil could create fleeting stock plays but also ripples in energy costs.

Here’s a look at how the accelerated surge could affect several investment vehicles and key economic indicators.

Defense Contractors

In the near term, companies that solve the government’s immediate needs are in the limelight.

KBR (KBR), one of the first names that comes to mind in government contracts, barely budged Tuesday. But aerospace and defense stocks were on the rise, with Precision Castparts (PCP), Boeing (BA) and Honeywell (HON) gaining 2% to 3% each.

“There is going to be a higher level of spending than six months ago, because the U.S. has committed to solving this problem,” says Jeffries analyst Howard Rubel.

Beneficiaries could include companies like Alliant Techsystems (ATK), which has a contract for providing non-standard ammunition to the Afghan army; Northrop Grumman (NOC), which builds airborne communications platforms; and General Dynamics (GD), which provides communications, armored vehicles, and ammunition, Rubel says. “Those are just three examples of how it will work,” he says. “Some will happen as a result and others over time, because some of the funds are there already and some will be supplied in the future – Congress will have to vote on that.”

Of the contracts that already exist, L-3 Communications (LLL) is looking to renew an agreement to support special operations forces that’s worth $500 million a year, Rubel says.

The surprise market might be intelligence, surveillance and reconnaissance. Take Boeing, for instance. “They’ve got a laser system they’ve matted on top of a light armored vehicle, and they’re using it to destroy improvised explosive devices from safe distances,” Rubel says.

The Dollar

War is not cheap. And that carries implications for the U.S. deficit – and, by extension, the dollar.

The total estimate for U.S. military spending in Afghanistan during the current military operation is $227 billion, or about $30 billion a year, according to Congressional Research Service, a division of the Library of Congress. There are about 50,000 troops there, according to CRS, so an additional 30,000 could cost around $20 billion a year, says Kenneth Mayer, professor in the Department of Political Science at University of Wisconsin, Madison.

“Obviously there are specific costs associated with keeping troops there,” Mayer says. The question is whether the surge will lift the bill.

“I really don’t think that the increase in appropriations for operations and maintenance and additional contracts for weapons and ordinance will have a significant impact on overall government spending or the overall impact on the macro economy,” Mayer says. “Those kinds of procurement decisions are made on a much longer cycle, and are not usually part of a specific operation.”

Although the specific additional costs from this decision are not likely to be large enough to have much of an effect on the macro economy, perception can make a difference in currency markets.

“Obviously, expansion of troops always is going to mean somewhere along the line more money for the military, so certainly that can impact fears of an already growing deficit [rising] to even higher limits,” says Peter Cardillo, chief market economist at Avalon Partners.

Will more spending further pressure the dollar? “Potentially, if the market gets it into its head that this is a deficit-raising event,” says Phil Flynn, senior market analyst at PFGBEST research in Chicago. “But let’s face it, the dollar is under so many pressures – the Dubai crisis passing, the carry trade, rising geopolitical risk -- is it really going to make a difference? We know it’s another event that plays into the same scenario.”