Iran’s Threat to the World Economy

Iran and the United States are engaged in a dangerous game of chicken over the Strait of Hormuz. That game could lead to the collapse of the Iranian economy and to the precipitation of a US and world economic recession. Since the start of the US-Israel war with Iran at the end of February, Iran has exercised effective control over all sea-lane traffic in the strait. It has done so with the purpose of inflicting material damage on the US and world economies in order to strengthen its negotiating position in any eventual peace settlement with the United States. For its part, since the start of the ceasefire at the beginning of April, the United States has blockaded the strait. It has done so with the objective of preventing all of Iran’s oil exports from leaving that country and all imports from reaching Iran. The US hopes that this will cause a total collapse of the Iranian economy and bring on hyperinflation that will force Iran to give up its nuclear ambitions in any future peace settlement. There is a real risk now of a prolonged stalemate over the strait since both sides believe that they have the upper hand. Iran seems to believe that it can inflict real damage on both the US and the world’s economies and their financial markets. It also believes that Trump has very much less tolerance for economic pain than does the Iranian Revolutionary Guard. For its part, Trump seems to believe that a total collapse of the Iranian economy is not far off and that such a collapse will leave the Iranian government with little choice but to settle the war on US terms. It is difficult to overstate the danger to the world economy from a potential protracted closure of the strait. It is not simply that 20 percent of the world’s oil and liquefied natural gas production passes through that strait. It is also that 30 percent of seaborne international fertilizer trade passes through that strait, as does 30 percent of the world’s helium production and 10 percent of the world’s aluminum production. While much has been written about how this Iranian crisis constitutes the most serious energy supply shock on record, surprisingly little attention has been paid to helium’s crucial importance to the world economy. This is all the more surprising considering that helium is an irreplaceable, non-renewable resource used in critical industries like semiconductor manufacturing, the aerospace industry, and medical imaging. A prolonged shortage of helium could have an adverse impact on all industries based on computer chips, including most notably the automobile industry. Already, the Strait’s closure is laying the ground for a damaging world energy and food price shock. Over the past two months, the price of Brent oil has approximately doubled to its present level of almost $120 a barrel, while European natural gas prices have increased by some 70 percent. Meanwhile, fertilizer prices have increased by around 50 percent. That is bound to have a negative impact on world food production in the second half of the year. Further underlining the dangers of a prolonged closure of the strait to the world economy is the fact that a physical shortage of a number of oil-related products is already being experienced in a number of Asian countries. One way that the Strait of Hormuz crisis could negatively impact the US economy and its stock market is by causing an energy and food price shock. That could cause households to retrench on their spending, as underlined by the University of Michigan consumer confidence index, now dropping to its lowest level since 1978. With the US economy having grown by only two percent in the first quarter of the year, it would not seem to take much for the economy to succumb to recession. Another way that the Iran crisis could negatively impact the economy and stock market is by causing a rise in interest rates. Higher inflation may preclude the Fed from resuming its interest rate-cutting cycle anytime soon. Meanwhile, the need for increased defense spending in the wake of the Iran war makes an already worryingly high budget deficit. The risk of higher long-term interest rates ahead is underlined by the rise in the 10-year Treasury bond rate from less than four percent at the start of the war to its present level of around 4.4 percent. We have to hope that Iran blinks first and soon so that the strait can be reopened. If not, we should brace ourselves for some rough economic and financial market sledding in the second half of this year. The post Iran’s Threat to the World Economy appeared first on American Enterprise Institute - AEI .