FINANCIALMARKETS’ IRAN DELUSION
is little risk of central banks hiking interest rates following an oil-price shock. Both assumptions are clearly flawed. Even if the risk of a full-scale war may seem low, there is no reason to believe that U.S.-Iranian relations will return to the status quo ante. The idea that a zero-casualty strike on two Iraqi bases has satisfied Iran’s need to retaliate is simply naive. Those Iranian rockets were merely the first salvo in a response that will build up as November’s U.S. presidential election approaches. The conflict will continue to feature aggression by regional proxies (including attacks against Israel), direct military confrontations that fall short of all-out war, efforts to sabotage Saudi and other Gulf oil facilities, impeded Gulf navigation, international terrorism, cyber attacks, nuclear proliferation, and more. Any of these could lead to an unintentional escalation of the conflict. Moreover, the Iranian regime’s survival – its leaders’ top priority – is more threatened by an internal revolution than by a full-scale war. Because an invasion of Iran is unlikely, the regime could survive a war (despite a very damaging aerial bombing campaign) – and even benefit as Iranians rally around the regime, as they briefly did in response to the killing of Soleimani. Conversely, a full-scale war and the ensuing spike in oil prices and global recession would lead to regime change in the U.S., which Iran badly desires. So, Iran not only can afford to escalate, but it has all the incentives to do so, initially through
Conversely, a full-scale war and the ensuing spike in oil prices and global recession would lead to regime change in the U.S., which Iran badly desires. to more than $150 per barrel, setting the stage for a severe global recession. And even a more limited disruption – such as a one- month blockade – could push the price up to $80 per barrel. proxies and asymmetric warfare, to avoid provoking an immediate U.S. reaction. The assumption about what a conflict would mean for markets is equally mistaken. Though the U.S. is less dependent on foreign oil than in the past, even a modest price spike could trigger a broader downturn or recession, as happened in 1990. While an oil-price shock would boost U.S. energy producers’ profits, the benefits would be outweighed by the costs to U.S. oil consumers (both households and firms). Overall, U.S. private spending and growth would slow, as would growth in all of the major net-oil-importing economies, including Japan, China, India, South Korea, Turkey, and most European countries. Finally, although central banks would not hike interest rates following an oil-price shock, nor do they have much space left to loosen monetary policies further. According to an estimate by JPMorgan, a conflict that blocks the Strait of Hormuz for six months could drive up oil prices by 126%,
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February 2020
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