Pentagon Suffers Death by a Trillion Cuts

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"Fire in the hole!"

He didn't come right out and shout it, but Defense Secretary Robert Gates probably should have given investors a warning of this sort earlier this month, when he announced plans to slash the defense budget by $100 billion. Across the length and breadth of the military-industrial complex, defense contractors are hunkering down, and preparing for the worst.

It's not exactly as if Gates has been shy about acting on past threats, after all. Last year we described a whole series of cuts implemented at his behest; one after another, multi-billion dollar efforts to develop Future Combat Systems, build F-22 Raptor fighter jets, and test an Airborne Laser fell to the budgetary axe.

What's next on Gates' chopping block? The secretary hasn't exactly kept it secret. In recent weeks, he has criticized:

  • General Electric's (NYSE: GE  ) proposed alternate engine for the Lockheed Martin (NYSE: LMT  ) F-35 fighter, which "probably does not meet the performance standards that are required." (For the record, GE disputes the characterization, arguing its engine is "exceeding all of its performance goals" -- but admits it will need at least $1 billion to complete development.)
  • Boeing's (NYSE: BA  ) C-17 transport aircraft, lumped in with the GE engine under the category "unneeded programs."
  • General Dynamics' (NYSE: GD  ) $13.2 billion amphibious landing craft. Neither "necessary [n]or sensible," says Gates.
  • And Northrop Grumman's (NYSE: NOC  ) aircraft carriers? "Do we really need 11 carrier strike groups …when no other country has more than one?"

But if all of that isn't enough to shake defense investors' confidence, there's a new report out that suggests Gates' wide-ranging axe-wielding is only the beginning.

Remember the Lorax
So far, Gates has been waging a one-man logging expedition in the defense industry thicket. He's quick with an axe, but to really do some damage, you need a Lorax-style chopping machine -- and wouldn't you know it? One just appeared.

A couple weeks back, the "Sustainable Defense Task Force" -- a group comprising policy experts and spending activists, backed by Reps. Barney Frank on the left and Ron Paul on the right -- published a report proposing to take Gates' $100 billion, five-year defense cuts and expand them five to 10 times. Over the course of a decade, the SDTF argues we should cut defense spending by nearly $1 trillion (all the cool analysts these days use the "T" word. "Billions" are so last millennium).

Now, the report stretches to 40 pages in length, so I won't bore you with the details. But here are the highlights: For starters, SDTF takes every program that Gates wants to cut and stamps it "Approved." But that's just the beginning.

SDTF would also cancel Textron's (NYSE: TXT  ) V-22 Osprey tilt-rotor aircraft, further postpone implementation of the KC-X Tanker Program, and slash the U.S. Navy 20% in size, retiring two aircraft carrier battle groups and cutting the fleet to 230 ships. Also retired from service: Thousands of nuclear missiles, 50,000 ground troops in Europe and Asia, and the entire F-35 fighter jet program (which was just getting warmed up).

Clearly, these proposals will spark controversy. Naturally, I've got my own opinions of 'em … but I'm not getting into a policy debate here. (However, if you want to debate the wisdom of the military rollback, and the necessity of curbing deficit spending, feel free to do so in the comments section below.) Rather, I want to highlight two crucial points investors need to consider in light of the SDTF's proposals.

Death by a trillion cuts
First, we're no longer talking about a "$100 billion scenario." When Gates suggested cutting spending by $100 billion over five years, the logical assumption was that presidential-congressional horse trading would ensue, resulting ultimately in Pentagon spending cuts somewhere above $0, but below $100 billion. That scenario is now out the window. Now we're more likely talking cuts of somewhere between $100 billion and $1 trillion over the next decade.

This is not good news for investors in defense companies. Revenues will drop, valuations will fall, and industry consolidation is likely as the defense majors scramble to shore up their revenue streams. (On the plus side, they'll probably do this by buying up smaller players like UAV-specialist AeroVironment (Nasdaq: AVAV  ) , so keep your eyes peeled for M&A activity. Acquisition premiums are in the offing.)

As the world turns, the pendulum swings
A second investment opportunity may open in Europe. Here's why: Few would argue that the U.S. needs to spend $500 billion a year and more to "defend" itself. We've got, what? Canada to our north, Mexico to our south, and what on our flanks? The Maginot Line's got nuthin' on the U.S. Simply put, America is not a nation surrounded by enemies. We spend $500 billion a year not to defend ourselves, but to defend our interests, and our allies, around the globe: Protecting international shipping lanes. Dissuading Somali pirates. Combating international terrorism.

Whatever your opinion of how much we spend on the efforts, you cannot deny that the tasks need doing -- and if the U.S. rolls back its spending on these fronts, chances are, someone else is going to have to step in and fill the gap. Will it be booming industrialist China that picks up the slack? A re-emergent Japan? Or will Europe find its way out of its economic hole and increase its historic underinvestment in defense?

Foolish takeaway
Whoever the "somebody else" turns out to be, it's likely we'll see their defense companies grow in revenues and earn more profits going forward. As U.S. defense spending shrinks, the world is turning multipolar again. Invest accordingly.

General Dynamics is a Motley Fool Inside Value recommendation. AeroVironment is a Motley Fool Rule Breakers selection, and Fool contributor Rich Smith owns shares of it as well. The Motley Fool has a disclosure policy.

Read/Post Comments (20) | Recommend This Article (21)

Comments from our Foolish Readers

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  • Report this Comment On June 23, 2010, at 3:44 PM, michnow wrote:

    Do you really think cutting defense will mean less spending by these morons. It just give them more money to spend on pork and buy votes back home.

  • Report this Comment On June 23, 2010, at 6:02 PM, valuwarrior wrote:

    Congressmen Barney Frank and Ron Paul give advice to the Defense Dept on what programs to kill (without hurting National Defense of course) and NOBODY listens. Hmmm. How is this news?

  • Report this Comment On June 23, 2010, at 9:40 PM, xetn wrote:

    The DOD has a budget of over $700 Billion, not counting the money for Iraq and Afghanistan. Do you feel safer?

    We have bases in about 140 countries. We are fighting a 10 year war in Afghanistan which we cannot win (shades of Viet Nam).

  • Report this Comment On June 23, 2010, at 10:16 PM, escs wrote:

    Re: xetn.... Sorry, but 'no', the $700+ does NOT make me feel any safer. And I believe that military bases in 140 countries is totally inappropriate... diplomatic missions..yes..military bases NO.

  • Report this Comment On June 24, 2010, at 2:42 AM, desertrat65 wrote:

    A powerful Navy guarantees access to shipping lanes and ports. A powerful Army and Navy guarantees protection of American interests abroad. Perhaps a more strategic deployment US of forces is required and a cost benefit analysis of current defense systems (aka Toys). The military doesn't just keep you physical safety, it guarantees your economic and political safety at home and abroad.

  • Report this Comment On June 24, 2010, at 2:49 AM, jomueller1 wrote:

    Please take a look at history: There were few wars on North American soil. Once the US were founded war activity was mainly directed to someone else's territory. Yet, no country fought as many wars as the US did. And for what? Economic world domination!

    Now that other countries have increasingly important roles on the world stage the US needs to revise her position and Mr. Gates may be on to something. On the other hand, savings of 100 billion may sound like much but over ten years it is peanuts and even one trillion does not make much of a difference.

    I propose not to dilly dally around with the pirates who cost enourmous amounts of money but get rid of them with the support of the UN and then convince the rest of the world of the obvious: There are no winners in any war! Except some financiers.

    The muslim countries are the best example of how wars do not produce "winners". Especially the terrorists should reflect on their actions. They destroy but do not accomplish anything beneficial. But as everyone wants to be politically correct nothing gets done. Sorry state of the world!

  • Report this Comment On June 24, 2010, at 7:42 AM, desertrat65 wrote:

    Funny, jomueller. Thanks.

  • Report this Comment On June 24, 2010, at 10:10 AM, 782gear wrote:

    I cheered at Sec. Gates speech a few weeks back. Four federal programs take the lion's share of federal spending: Health and Human Services, Defense, Social Security, and Interest on the Public Debt. Of the four, the Defense Department is most out of control.

    According to Gates, 40% of the budget is allocated to "overhead." He says there are 17 levels of management between him and tactical units. There are 35+ four star flag officers, each with large staffs, leading the 1.5 miilion man force. In 1943 during WW2, with 12 million under arms, the army and army air corps had five -- Marshall, Ike, Mac, Stiullwell, and Arnold.

    The military is much too dispersed around the globe, too top heavy, and too demanding on our national resources. We are paying the guard dogs more than the farmers.

    Of course, the congress and the administration must reduce the mission of the troops, perhaps taking on fewer wars, or at least taking on wars in which they can a least define the mission more clearly.

  • Report this Comment On June 24, 2010, at 10:11 AM, miteycasey wrote:

    Can we add welfare reform to the list as well???

  • Report this Comment On June 24, 2010, at 10:14 AM, jlssmith wrote:

    The F-35 program is overkill for Somali Pirates. As is an additional carrier group. As are most of the advanced warfighter programs.

    What are the real threats we face as a nation, and what percentage of our resources should be allocated to address those possibilities?

    We spend more on our defense than the rest of the world combined, but then do not utilize those capabilities to their fullest because we lack the will to power as a populace. Not a good investment.

    In my view, we need just enough to secure our borders. Anything more is just proping up the military-industrial complex Eisenhower warned us about in order to protect interests the George Washington warned against 200 years ago.

  • Report this Comment On June 24, 2010, at 11:24 AM, TMFDitty wrote:

    This being the Comments section, and not the article proper, I'll chip in a few thoughts.

    First, great comments up above. One caveat to keep in mind, though: As we scale down the military, we're going to also have to scale back our ambitions of preventing "bad things happening to good people." This will mean no more complaining that we're not "doing something" to help Darfur or Rwanda. It means when the PRC annexes Taiwan, when Russian tanks roll into Georgia, Kyrgyzia, Ukraine, we have to keep mum. Iran probably gets to go nuclear, and with fewer ships to interdict smuggling, N. Korea will be more able to export nuclear technology as well.

    There's a benefit to saving money, yes. But we need to acknowledge and be willing to accept the costs as well.


  • Report this Comment On June 24, 2010, at 12:55 PM, joroi wrote:

    In my opinion the cuts are absolutely necessary. We don't need aircraft carrier battlegroups to deal with Somali pirates or protect shipping lanes. For christ sake, the guys are in speedboats armed with machine guns! A coast-guard speed boat will be much better and MANY times cheaper for that.

    As for fighting terrorism ... well, even with a $700+ billion dollar budget we still get our ass handed to us. How are our nuclear subs helping us? Or all the carrier groups? Clearly it is not about HOW MUCH you spend as it is ON WHAT you spend it.

    Finally, exhausting our financial reserves on trinkets -- many of whom are totally unnecessary -- only means that we will have to cut necessary spending tomorrow! Slash it hard Mr. Paul!

  • Report this Comment On June 24, 2010, at 1:10 PM, AnotherNavyFool wrote:

    I come to the Motley Fool to learn about economics because it is not something I have devoted as much time of my life studying as I would have liked, but now you are stepping into an area that I not only study for enjoyment and hold a degree in, but also make my living and take deadly seriously.

    I can understand that Rich is looking at this from an economic point of view and agree with much of what he is saying. I would like to address a few points and then deal with a few of the comments that just made blood shoot out of my eyes...

    The cuts proposed by Gates have mostly been made with something rare in Washington - common sense. The proposal of Franks and Paul on the other hand really adds to the case for mandatory drug testing of Congressmen.

    The C-17 is a great aircraft, but the Air Force has not asked for any for a few years now. Know why they keep building them? Because CONGRESS keeps adding it back into the budget and makes the AF take aicraft it did not ask for. The extra engine for the F-35? Same deal. And the military gets the hit for it - kind of like the $600 toilet seat crap that resulted from Congress imposing purchasing guidelines and contracting guidelines that favor pork-barrel spending when real soldiers and sailors know you can get stuff cheaper at Walmart and Lowe's (where we get a military discount - 'cause we need every penny). No one in the military buys outrageously expensive stuff because we are stupid. We have budgets, too, but restrictions you cannot fathom that we have to follow or LOSE OUR JOBS for breaking federal law. As far as 11 down to 10 carriers, I am not happy about it (EVERY crisis that pops, the first thing asked is "where are the carriers?"), but for the sake of saving, we can do it with ten.

    Remember what happened with the Lorax cutting machine - it led to ruin, quickly. Following Franks' and Paul's suggestions is asinine. The V-22 is combat proven and in theater now, doing a great job. Yanking it would be stupid - like selling stock low because you are upset you bought it high. Maybe we can postpone the tankers, but I see them take off every day with crews younger than the airframes. Get rid of two carriers and go down to 230 ships? Hey, Franks and Paul, ever hear of a book by a guy named Mahan? Wait, that would mean reading something other than polls...

    I agree with Rich's comment about curbing deficit spending - but ALL departments of the government need to cut, not just the military, who does NOT spend the biggest portion of the budget. Make it proportional, make it fair, make it make sense.

    I will have to disagree about Europe stepping up and spending more for their defense. While I may not totally agree about what we spend that they get the defense beneft of, I have worked with too many Europeans to think they are have what it takes to take up the slack (except for England, maybe). That and they are dealing with their own economic issues. Same with Japan. They are still gunshy from military rule in WWII - as are many Asian countries who are not anxious to see them with a large military. China will definitely expand - they are doing it now, quickly. Look at their investments in Africa and Asia. Billions for Gwadar port in Pakistan (which sits on the oil supply routes China needs to maintain its economic growth and would protect with its growing navy. Hmmm...) Feel warm and fuzzy about them filling the vacuum we would leave?

    If you wonder why we haven't been attacked by a traditional army in a while, its because you usually don't go starting fights with someone who can stomp you. A strong military is the best deterent to aggression, not diplomacy, kind words, and hope. You use those to be better humans after the military gives you the security to do so.

    The military does more than just defend our soil. We do protect the shipping lanes, battle pirates, stop terrorists, etc. All you Fools who enjoy making money must also know the vital role freedom of the seas plays in getting us the oil we need to run our machines, power our economy, and ship those products from one place to the next. Do you think a rival (economic, ideologic, religious) nation who has a military as strong or stronger will just let you do that unmolested? Anyone forget Iran in 1988? Where was Europe, China, Japan, ANYONE else besides US who had the guts to escort the tankers through for the benefit of everyone?

    Our military also does something else that no other countries rarely do - we help others in need. Ever hear of the USNS Mercy and Comfort? Just because those hospital ships have a big ol' red cross on the side doesn't mean they belong to the Red Cross. BTW, the Chinese have built one now, too. Still think we ought to cut and slash that budget?

    @michnow, miteycasey - Too true.

    @xetn - Yes, I DO feel safer, because I know what threats there are out there, especially the ones that don't make it to the American news each day. And we do not have bases in 140 countries. We might interact in that many, at the request of the country for training or mutual protection. And I vehemently disagree - Afghanistan can be won, if we do it RIGHT and have the political will to follow through. It is not Viet Nam - not even close; read a few books and quit getting all your information from MSNBC.

    Diplomacy alone cannot do the job, and to paraphrase, war is diplomacy with higher stakes; however anyone can talk (just look at the UN). Backing it up with force when needed is a different matter - one I don't want to see us on the losing side of. When you rely on just diplomacy, you end up with things like the Iranian Embassy in '79, Chamberlain with Hitler, or the subject state of a much larger country rolling over you.

    @ jomueller1 - You tell us to look at history, I say you first! Once the US was founded, we still had wars: the French-Indian War, the Revolution, War of 1812, the Civil War, World War II (yes, it was fought partly in North America. Don't tell me the bodies washing ashore from ships sunk by U-boats or that the fight with the Japanese in Alaska doesn't count; soldiers and sailors died - it counts), and 9/11 (yep, it's a war and in NA. Don't think so? Ask a New Yorker or my friends at the Pentagon...).

    But your assertion that we fight wars for economic world domination shows a poor grasp not only of history, but what America is truly all about. We fought in wars when we were econmically weak or that did not expand our economic reach. We also honored alliances we made; it's called keeping our word. Of course wars involve economics and alliances help economic partnerships. I am tired of people talking like international relations could exist in vacuums with war, economics, trade, immigration, religion, ideology, etc. not being affected by each other. It leads to stupid slogans like "No blood for oil." Grow up and look at the world through something less rose-colored!

    Supoprt of the UN for piracy? Seriously? Does the UN have a navy now - and if it did, do you think they would shoot pirates in the head with SEAL snipers who seized a US ship? Maybe they would give them smurf blue life jackets and ask them about their childhood and how can they help...

    Convince the world there are no winners in war...let me know how THAT works out for you. I would think if you asked the Germans and the Japanese who the "winner" was of WWII, you'd get a pretty consistent answer. Or, if you could, ask the Cartheginians about the Romans, or the Persians about the Macedonians, or anybody about the Huns... no winners in war, how naive.

    And your example of "muslim" nations as an example of how there are no winners is just false. The muslim countries' problems stem far more from despotic rulers, repressive theocracies, and poorly run economies than war. If anything, war brought them up by making oil an important commodity. Before that, no one cared about their parts of the world. Now, some of the richest (and poorest) come from muslim nations.

    "Terrorists should reflect on their actions." Wow - I have never seen a more touchy-feely piece of tripe in my life. I am sure a terrorist reflects on what he has done - and is glad! He has already gone past the point of feeling remorse for actions he may take that could kill - THAT IS WHY HE IS A TERRORIST! Well, maybe he won't get a chance to reflect. Kind of hard to do when you have blown you brains through the roof of an explosive packed car you just detonated in a market full of mostly women and children of the same (almost) religion as you. I would rather kill the terrorist before he has time to reflect on anything - like better ways to hurt my family, friends, and country - yes, including you.

    @782gear - I agree more efficiency is the key to a better military and we are too top heavy, but we are well past the heirachy of 1943. Our fight is now more dimensional in ways they couldn't imagine. We have nuclear commands, space commands, cyber commands, etc. that are all legitimate battelfields in a future conflict. We also need smarter warriors than in 1943. Twelve million mostly draftees are very different than 1.5 million mostly tech-savvy and highly trained (and many college educated) soldiers and sailors (and zoomies). Not sure I agree with the "taking on fewer wars" comment. It's not like we asked for the War on Terror; that was kind of thrust on us. And for anyone who thinks just because we have been fighting for a long time that the threat is diminished, I will say it has not - and the INTENT of those who want to harm is is just as strong as ever (the ones still alive, anyway).

    @jlssmith - Real threats? How about a few countries that would love to launch nukes at us (if they weren't afraid of what would happen if they did), other countires starting a nuclear exchange that could escalate (PAK-IND, ISR-IRAN), religious extremists, both state-sponsored and non-, our allies under threat (on whom we depend for the trade that makes our stocks worth anything), etc. I agree we should have the political will to use all of our weapons to the fullest of their capabilties - diplomacy, military, economy - but you have to HAVE them ready to go to use them.

    We cannot rely soley on a happy geographical accident (the Pacific and Atlantic Oceans) to always protect us. The world is dangerous place and we are a big player in it - and it comes to visit. The answer is not to become isolationist (read history - the world's problems will eventually drag us in) - we rely on too many strategic materials and trade for our way of life. The reason the threat has (for some time) not seemed "real" to some people is because we confront our enemies on THEIR home turf instead of OURS. I would like to keep it that way. If you would not, then move someplace like Lebanon or Afghanistan or Pakistan or Congo and let me know how you like living in a place where the threat is among you instead of "somewhere else." I don't want to live there and am not willing to let our military suffer to the point it happens in our country.

  • Report this Comment On June 24, 2010, at 3:28 PM, BobTC wrote:

    Cutting carriers is a big target and looks good but what do we do when we don't have landing rights in a conflict area and we need to get a military force into the area fast? This is just more of the same political BS that I witnessed during my 25 years in the military. Cut, lose the industrial capacity and then pay through the nose later to get it back when it is all but impossible to rebuild. There are a lot of people out there who would like to bring us down and some of them are right here in our Government. It is pathetic that we have such a large conglomeration of CLOWNS running our government. This is the first time in my life that I have been afraid of our Government and the consequences of their poor and politicized decisions .

  • Report this Comment On June 24, 2010, at 5:54 PM, bozomonkey wrote:

    Hmmmm no one mentioned that the wars in Iraq and Afghanistan were complete shams in the first place. Remember "they have weapons of mass destruction"? They didn't when we came to town. They may have had them and got rid of them because they were afraid of us stomping them. So as corrupt and tyrannical as Sadam was, the people who we liberated (Shite Muslims) hate us more, so what did that solve? Oh right, we are still there.

    Well I guess our bombs were about to expire so we had to use them up.

    We had a war vice president (Cheney-Halliburton), and we were ra-ra'd into having a few wars. To think that isn't connected is naive.

    So our illegitmate wars are costing us trillions which could be better spent elsewhere, and are stretching our military resources quite thin. There are other threats out there, China and maybe Russia again. It wasn't that long ago when our country was colonizing and exploiting the rest of the world as fast as it could, just because we don't doesn't mean other countries have given up that ambition.

    I am all for having a potent, capable, cutting edge military but we shouldnt have to spend so darn much.

  • Report this Comment On June 24, 2010, at 10:10 PM, MICROBIOBOB wrote:

    Did you Fools know that the DOD just stopped two ladies, who had been charging upwards of $200,000 dollars in shipping charges to send under $10 worth of nuts and bolts to Iraq and had been doing this same thing for eight years! I understand that there not really sure if there computers can catch this sort of thing, even now. Waste and fraud are rampant in the DOD and HHS and everywhere else in both Federal and State governments. Unfortunately, we as a people want the largess, but, not the cost of providing it and, therefore, we keep electing the same representatives, over and over again, because they are providing this largess nationally as well as locally. Our representatives, like the Byrd from West Va, build monuments to themselves, use millions of dollars to promote themselves and their accoutrements. I bet 80% of those who vote in National and State elections do not know who they are voting for, other than their name. Some of this is because the information is not available (Project Vote Smart is a great site for help in this matter) and the politician only tells us what we want to hear and we do not demand accountability. This is tragically demonstrated by the re-election of politicians under felony indictments and even in at least two incidents, while they were in jail! Our housing fiasco started with Congressional mandates to Freddie Mac and Fannie Mae to get everyone into a home without regard to income. The whole idea of holding the DOD budget and many others sacrosanct is absurd and some backbone in our politicians would be welcome.

  • Report this Comment On June 28, 2010, at 6:41 PM, dzdiver wrote:

    Massively cutting of defense spending is very feasible. Hawks maintain that the budget should be a fixed percentage of the budget (4% or so as I recall) however this approach fails to take into consideration what the rest of the world spends on their defense. Gates IS looking comparatively and that is why he sees many areas to cut. The reality of the current defense spending is that the US spends more on its defense that the COMBINED TOTAL of all other nations that each spend a billion or more annually on their military. Another way to put it, if you list the top fifteen countries that spend the most on their defense budgets, the US is #1 and it spends more than #2 through #15 combined. This level of spending is excessive beyond all reason.

  • Report this Comment On June 28, 2010, at 7:10 PM, chukarlady wrote:

    I would much rather see free lunch for schoolchildren than free lunch for Boeing and Northrop Grumman. Go Mr. Gates!

  • Report this Comment On June 30, 2010, at 4:44 PM, TMFDitty wrote:

    @dzdiver: On a similar note, I recall reading recently that the U.S. Air Force has the most fighter jets of any military organization in the world. The No. 2 organization in that lineup is... the U.S. Navy.


  • Report this Comment On December 22, 2010, at 9:40 PM, SuffolkGuy wrote:

    There is a bit of game playing in the statement "USA's military budget is larger than the rest of the world's budgets combined." Consider China, the #2 military spender and that US spending is more than six times China's. [1] Surprise! this is because Americans who staff the US military or supply and support them are paid many times their Chinese counterparts . That is, the American machinists, engineers, accountants, technicians, welders, planners, etc. that are required to design, manufacture, support, maimtain and operate US aircraft are paid 5-10 times (my estimate) similar Chinese staff.

    As for military manpower, China's active military staff is 2,285,000, USA's is 1,580,255 per Wikipedia [2]. However the financial cost to China is much less due to the wage and price of benefits gap.

    The statistic is intended to make it seem that US military EFFORT exceeds China's when it only means that Americans are paid many times what Chinese are paid.



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