An Edgier International Situation Benefits Defense Spending and the U.S. Economy
Peace is not going to break out any time soon. And that’s great news for the U.S. economy.
The overall international situation is far tenser now than it was two months, or even two weeks, ago. Then again, did you really think President Donald Trump was going to win a Nobel Peace Prize?
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Peace does not work well for the U.S. economy. The system is dominated by defense stocks and large displacements of tax dollars to the military.
The Department of Defense (DoD) alone employs one percent of all Americans. (Source: “Department of Defense employs 1 percent of Americans,” The Washington Post, September 12, 2011.)
As it happens, the DoD is the biggest single employer anywhere in the world. Clearly, defense is not only vital to national security, it’s often essential for the U.S. economy.
The U.S. Economy Relies on a Large Military
Military bases in the United States are cities in their own right. They employ thousands of non-military support personnel and become hubs for a wide variety of commercial and social services.
More significantly perhaps, the priority that the military enjoys in the U.S. government has helped build a group of companies that gain when the United States decides to do something about a problem abroad.
The military-industrial complex always wins from rising international tensions. Political and diplomatic solutions might be desirable in the longer run, but it’s always better for Wall Street and the U.S. economy to protract the conclusion of peace treaties for as long as possible.
Debt, Shmebt
Setting aside the growing problem of U.S. national debt, given President Trump’s tax cuts, military demand will continue to play a leading role in the U.S. economy.
The Iran Deal and the potential for a ‘thaw’ in the Korean peninsula literally threatened peace. President Trump has taken care of the Iran “problem.” He has repealed the nuclear deal and has effectively turned Iran into public enemy No. 1 again.
When evidence of a thaw in South and North Korean relations and rumors of a Trump–Kim Jong-un meeting became reality, many defense stocks dropped.
The prospect of peace made it clear, if it wasn’t already, that tensions and the threats of wars are fuel for the U.S. economy.
There is a problem.
The DoD and the publicly traded corporations upon which so many Americans depend for weekly wages and quarterly dividends only have one customer: the U.S. government. And they only have one incentive: external danger.
Curtailing Defense Spending Could Hurt Investors
The real risk for shareholders is that—given the high level of U.S. debt and the associated pressure on budgets—the government might be forced to cut back on defense spending.
As an investor, it always pays more in the long run to be cautious than overly bold. Stocks cannot always go up.
Now, the stock prices of the likes of Raytheon Company (NYSE:RTN) and Lockheed Martin Corporation (NYSE:LMT) may have already gone too high. To justify the current prices, sales must rise.
For the time being, Trump is doing all the right things as far as these companies are concerned. He’s raising tensions and the risks of dangerous conflagrations in the Middle East.
Yet, peace in North Korea threatened to spoil the defense stock party and the U.S. economy with it.
Nevertheless, there is a glimmer of hope. As the date of a historic summit between North Korean leader Kim Jong-un and U.S. President Donald Trump approaches (June 12, for the record), many obstacles have also approached.
Pushing the “Libya Model” Is Bad for Peace But Great for Military Spending
The biggest obstacle goes by the name of John Bolton, Trump’s national security advisor. Bolton has offered North Korea the “Libya model.”
The Libya model implies that North Korea should disarm completely before the U.S. will make any concession.
Former Libyan leader Muammar Gaddafi did just that. He gave up his weapons programs and pursuit of nuclear capability in 2004. In 2011, Gaddafi was brutally murdered by U.S.-backed rebels and Libya became a mess.
North Korea, therefore, interprets the Libya Model as a warning.
Pyongyang’s pursuit of nuclear weapons was precisely a plan to lead the U.S. into negotiations. It cannot be expected to give up anything before the talks. To do so would amount to renouncing all deterrents against attempts to overthrow the regime from the outside.
Then There’s Iran
The North Koreans have not mentioned it specifically, but Trump’s decision to reject the Iran Deal—duly signed by a U.S. president, his allies, the UN, the EU, and Russia—has not played well in Pyongyang.
The North Koreans have decided that reaching a peace agreement with Washington might be more dangerous than the status quo. After all, Trump has shown that the U.S. president’s word is only good for the duration of a presidential term.
As if to prove Kim Jong-un’s suspicions right, the U.S. has participated in joint military exercises with South Korean forces, sending all the wrong signals. Washington even assembled the largest ever contingent of stealth “F-22” fighter jets for the occasion.
The U.S. may have sent the F-22 to send a message to China, which has been improving and increasing its military hardware. But, no matter, score one for the military-industrial sector (and defense stocks).
The summit in Singapore, should it even proceed at this point, risks turning into a diplomatic disaster. Perhaps it may even be better if it does not happen at all.
A likely breakdown of talks, given the bad omens, could overheat the tensions and blow the winds of war. Not holding talks would keep tensions at a more manageable level.
Even if North Korea Caves, There’s Always China
China’s own military technology ramp-up plays to the U.S. defense contractors’ benefit.
Indeed, defense stocks have significant room to grow. Tensions over Iran and the Middle East will sustain and boost the entire defense sector in 2018 and even more so in 2019.
Consider Trump the biggest gift that the defense sector has ever enjoyed. He’s the closest U.S. president to Major T. J. “King” Kong (a character in Stanley Kubrick’s 1964 movie Dr. Strangelove) since George W. Bush. The fires are going to keep on burning, and the rockets are going to keep flying off the shelves.
To be clear, there’s a growing possibility of an open conflict breaking out between Israel and Iran. And it will inevitably involve the United States.
China, which buys some 25% of its oil from Iran, feels threatened by Trump’s sanctions. These sanctions add another layer of friction between Beijing and Washington, considering the trade war climate that the White House has raised.
The sanctions on Iran also ensure that the U.S. economy will keep on trucking.
Like it or not, Trump’s repeal of the Iran Deal is the best possible gift he could have given the U.S. military-industrial complex.
Trump Likes His Rockets
For example, Raytheon, the maker of Trump’s “intelligent rockets,” gained some 2.5% just as Trump announced he would reinstate sanctions against Iran. (Source: “US weapons manufacturers’ stock price soars as Trump pulls out of Iran deal,” RT, May 9, 2018.)
President Trump is not pursuing aggressive international policies at random. He seems to have a plan, which is literally to boost demand for military equipment worldwide.
Accordingly, the White House is ready to introduce legislation that will reform U.S. weapons export policies to facilitate and accelerate sales to US allies.
Given the intense national security concerns surrounding the manufacturing of weapon systems, the military-industrial companies rely almost exclusively on U.S. industry and employees.
The defense contractors could not ask for more. They have a salesman president, who has a hand in determining the scale and type of geopolitical tension—for example, repealing the Iran Deal—and also takes an active role in selling weapons to governments affected by those very policies.
Trump sees this as part of his policy to create jobs, strengthen allies and partners, support defense contractors, and advance U.S. interests and security.
The U.S. economy, as it works now, can benefit significantly from this policy because many governments want what it makes: missiles, drones, and the means to control them.
And if there’s one thing we’ve learned about Trump, it’s that he likes his rockets.
In fact, he likes them even more than North Korean leader Kim Jong-un, given that the latter has shown a willingness to negotiate the dismantling of all the ones he has if the United States does the same.
