Shortly before the war with Iran began, I wrote that the seeming complacency among government officials and financial market participants was based on two assumptions which I argued were unlikely to turn out to be true: 1) President Donald Trump would make a last-minute deal with the Iranians and declare victory and 2) even if Trump didn’t make such a deal, the Iranians would not do all the things which they threatened to do if attacked.
Here we are three weeks into the conflict between the United States and Israel and Iran. There was, of course, no last-minute deal and the Iranians have done exactly what they threatened to do. Here is what I reported before the war were Iran’s threats:
Those threats include attacking U.S. bases in the region, attacking any country that assists the U.S. and Israeli war effort, attacking U.S. naval vessels, and, most important, closing the Strait of Hormuz through which passes 20 percent of the world’s exported oil and liquefied natural gas.
As I suggested, the complacency was likely to turn into panic in many capitals of the world. That has now happened. The governments and peoples of the Persian Gulf states allied with the United States have been directly attacked by Iran in response to attacks on it by Israel and the United States. Governments of countries dependent on the reliable delivery of Persian Gulf oil and liquefied natural gas (LNG) are desperately trying to find supplies elsewhere and adjust to the sudden shortage. Since most other oil and LNG is already delivered based on contracts, that has left countries scrambling for Russian oil and LNG on which U.S. sanctions have been lifted. But Russia’s exports were already skirting sanctions so the increase in supply is likely to be minimal.
Given all this, it is somewhat baffling then that in the financial markets—with the exception of the oil market—complacency continues to reign. Stock markets are down, but there has been no crash. The widely followed S&P 500 Index is down from 6,900 at the the beginning of the war to near 6,500 on Friday, a level at which the index closed as recently as November 20 of last year. Markets for agricultural products are reflecting higher input costs, but there is no extreme run-up of food prices—yet! Prices for gasoline and diesel have risen quickly, but the public has been told again and again that this is just temporary.
Here is why I believe the complacency in the financial markets is misplaced:
- The Iranians closed the Strait of Hormuz except to their own ships and those of friendly countries. But the ship traffic is now just a trickle of what it was before the war started. The Trump administration did not anticipate that the war would go on this long, nor did it believe that Iran would close the strait. That explains why there was no ready-to-execute plan to keep it open. The U.S. military is telegraphing that it may seize Kharg Island, Iran’s major oil port in order to pressure the Iranian government to allow ships to pass through through the strait. Now this is where as I said in a previous piece, logic is your friend. Kharg Island is nowhere near the Strait of Hormuz. There is no way a U.S. military presence could possibly affect directly anything along the strait, so it’s possible that the public discussion about seizing Kharg Island is just misdirection..
One thing you can be certain of: Unlike the Trump administration, the Iranian military has already carefully thought through how it would repel and defeat any force trying to take Kharg Island or landing far to the east on the Iranian side of the Strait of Hormuz, an area lined with caves and fortifications. Does it look like a small force could even survive such a mission? And how would such a force control the coastline anyway? So far no massive ground invasion is being contemplated, something that would take months to assemble. If the strait were to stay closed for several months, such a closure would almost certainly create a worldwide depression.It is important to understand that if the U.S. military does attempt to take Kharg Island, the battle might result in the destruction of the oil port. Iran has already struck some oil and gas infrastructure in other countries in the Gulf region in response to the destruction of its own gas infrastructure by Israeli attacks on the world’s largest natural gas field known as South Pars. There is every reason to believe that Iran would respond to the destruction of its own oil port in the same way. Persian Gulf oil infrastructure in other major oil and gas exporting countries could be damaged in a manner that could take years to repair or rebuild.
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One more thing: Iran doesn’t need to control its shoreline on the Persian Gulf to threaten gulf shipping. Iran has shown that it can target anything it wants with drones and missiles launched hundreds of miles away. Even if the U.S. military could control the entire Iranian Persian Gulf coast, that would not prevent Iran from threatening shipping anywhere in the gulf including the Strait of Hormuz.
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Yet one more thing: Does anyone remember the Houthis of Yemen, allies of Iran, who successfully closed the Red Sea to cargo traffic starting in 2023 in sympathy with Palestinians in Gaza during the war between Hamas and Israel? The Houthis stopped harassing U.S. shipping after the United States agreed to a cease-fire and withdrew. Right now some of Saudi Arabia’s oil has been diverted via pipeline to its Red Sea port. The Houthis could at any time open another front in the already complicated war with Iran. And the Houthis have drones and missiles and demonstrated the will and the ability to use them effectively.
- The Trump administration believed that heavy targeted bombing and assassination of top leaders would lead to a quick surrender of Iran. That hasn’t happened and so the administration kept bombing Iran thinking the regime would ultimately collapse, either through surrender or through an internal rebellion that overthrew the government. That still hasn’t happened and doesn’t look like it will. Any market participant who believes that it may still happen will likely have a long time to wait during which the world markets will adjust to the loss of energy, fertilizer and chemicals and the chaos unleashed in supply chains as a result.
- Many market participants believe with justification that a frustrated Trump will at some point simply declare victory and withdraw. It’s hard to see how he would do that given the strong influence on him of supporters of Israel in the United States and of the leader of Israel, Benjamin Netanyahu. Netanyahu wants Iran’s nuclear program dismantled, all its ballistic missiles capable of reaching Israel destroyed, and a pliant new regime installed in Iran. None of that would be accomplished if the United States withdraws prematurely.
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Let’s assume though that Trump does simply declare victory and withdraw. That only meets one of Iran’s conditions for peace: The U.S. military out of the Persian Gulf. But there are other conditions including the lifting of economic sanctions, security guarantees from major powers (presumably Russia and China) that Iran will not just be attacked again at a later date, and reparations for damage done to the country (which might take the form of tolls for ships carrying cargo for previous belligerents). It’s hard to see the Trump administration agreeing to any of these other demands or even considering them seriously.
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The bottom line: A U.S. withdrawal from the conflict with Iran will not automatically lead to the reopening of the Strait of Hormuz. The strait may remain closed until other conditions are met. And, of course, even if the United States withdraws from the conflict, that does not mean Israel will.
- [This section was added after I had finished writing and editing this post. It is difficult at this time to weigh the seriousness of President Trump’s rant on Truth Social discussed below.]Â President Trump announced Saturday night on Truth Social that if Iran does not open the Strait of Hormuz within 48 hours (which by my calculations means Monday night Eastern time), he will “obliterate” Iran’s electric power generation plants. It’s hard to know whether this is yet another Trump bluff and if it is not, how many power plants he would order destroyed, and whether the U.S. military would execute the order since to do so would clearly be an internationally recognized war crime.
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Beyond that it would be economic suicide for the global system including the United States. Here’s why: Such an attack would almost surely result in Iran attacking energy infrastructure throughout the gulf region and in Israel. That might mean major damage to critical oil and gas ports, pipelines and refineries far beyond what has already occured, damage that I indicated above would take years to repair. If Iran manages to do damage that is extensive enough, it would almost surely crash the world economy into an instant depression that would be difficult to emerge from. No amount of government spending or central bank money printing could make up for the lost physical energy supplies.
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Please understand what this will mean if both Trump’s threat and the expected Iranian response are successfully carried out to the fullest extent. Millions of people will perish within weeks in Iran as economic life comes to a halt. Millions more will flood out of the country in search of water, food and safety. If Iranian leaders believe the country is headed toward such a fate, those leaders may decide to target water desalination plants upon which Israel and several Persian Gulf nations depend for the bulk of their water. Extensive damage would essentially leave large swathes of the region immediately uninhabitable. That would in turn lead to an instant mass migration out of the countries affected. All this would almost certainly become the largest humanitarian disaster in history. The result for those outside the war zone would be something akin to a peak-oil-precipitated economic and societal crash beyond any previously contemplated or discussed on this blog.
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Will someone talk Trump off the ledge before the power plant bombing campaign begins?
The effects of the closure of the Strait of Hormuz on energy and other critical supplies are being discovered daily. There are the obvious effects: quick rises in gasoline prices and a shortage of gas used for cooking in many Asian countries. And there are the not-so-obvious effects: the sudden shortage of nitrogen fertilizer and the loss of an important source of helium. (Just in case you don’t know, helium is critical in the manufacture of semiconductors and there is no replacement.) These and other shortages will mount and the prices will rise as long as the strait is closed.
How long a closure will it take to finally put the world into a recession or even a depression? Some economists are saying the risk of a recession is rising. I believe that this conflict will continue for much longer, perhaps months for the reasons stated above. If that turns out to be the case, the very high price of oil and other key commodities could bring what looks like an already overindebted financial system to its knees.
Iran already knows this. That’s why it has chosen to use the closure of the Strait of Hormuz for leverage in this conflict. I don’t expect the Iranians to give away that leverage for anything short of almost complete capitulation to their demands.
P.S. It is important to understand that even if by some miracle the Strait of Hormuz were opened tomorrow, it would take months before the wells, refineries and oil and gas ports would return to pre-war levels of operations. What I’m telling you is that immense economic damage has already been baked into the world economy.
