What are the possible economic and financial consequences of the War of Aggression by the US and Israel against Iran? Dillon Maxwell is a member of the Socio-economics Policy Analysis and Research Collective (SPARC) and a PhD Economics candidate at SOAS, University of London Photo: Screen Grab We know when wars start, but not when they will end. Everyone knows the infamous consensus at the onset of the First World War: “It’ll be over by Christmas.” It wasn’t. And the human and capital toll weakened the British empire to an extent from which it never recovered. The sun never set on the British empire, until of course it did. Something similar may be underway with the American empire. The Americans and Israelis have started a gratuitous war, the consequences of which are far reaching and uncertain. This article explores the potential economic consequences. The arguments are speculative but informed by theoretical and empirical analysis of the present. They are split in two: disruption to global supply chains; and shocks to international finance. Conclusions about state policy close. Supply Chains Modern production is organised through global production networks (GPNs), sprawling worldwide. These rely on advanced logistics to coordinate tight production and transportation schedules, reducing inventory costs and enhancing profitability. Covid exposed the lack of redundancy in this system. As economies went into lockdown, an enormous shock reverberated around the globe, sparking widespread supply chain disruption. What we see today is an eerily familiar. The Iranian military has effectively closed the strait of Hormuz, choking off the Persian Gulf, wherefrom flows 25% of the world’s seaborne oil and 20% of global LNG exports. But the current supply shock is different to Covid. Even if the war ends soon, supply has already been lost. Capacity has been taken offline due to inadequate storage, or it has been bombed. Bringing it back online is not as simple as turning a tap; it takes time, realistically weeks to months. And rebuilding destroyed infrastructure will take years.
The current oil supply shock is the largest on record. But are comparisons to the 1970s energy crises alarmist? The 1973 oil embargo lasted 5 months; the current disruption could be shorter or longer. Energy efficiency has improved over the last fifty years; oil dependence per unit output has generally declined. But this can be misleading: as manufacturing has globalised, fossil fuel products have become choke-points in pivotal GPNs. Gas and oil remain essential to many electricity systems, sometimes as balancing power sources, and to industrial heating; aviation and shipping fuels are irreplaceable inputs for the mass transportation of finished and intermediate goods; petrochemical feedstocks become plastics, which are ubiquitous; and other derivate products are essential ingredients for fertilizers, metal processing, and high-tech manufacturing. Table 1 quantifies the back-end of this argument. Table 1: Main non-energy materials and commodities exported from the Gulf
[Table]
Commodity | Gulf share of world production | Main regional exporters | Uses
Ammonia and urea | 35%–45% (urea), 30% (ammonia) (of world exports) | Bahrain, Iran, Kuwait, Oman, Qatar, Saudi Arabia, UAE | Fertilizer, basic chemical input
Helium | 38.8% | Qatar | Chip-making, medical imaging
Sulphur | 21.6% (45% of exports) | Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, UAE | Fertilizer, mining and metals processing, uranium extraction
Methanol | 32%–35% (of world exports) | Bahrain, Iran, Oman, Qatar, Saudi Arabia | Fuel, basic chemical input, biodiesel manufacturing
Polyethylene | 15% (capacity) | Iran, Kuwait, Qatar, Saudi Arabia, UAE | Packaging, pipes, bottles, electrical insulation
Polypropylene | 9% (capacity) | Iran, Oman, Qatar, Saudi Arabia, UAE | Packaging, automotive manufacture, consumer goods
Aluminium | 9% (22% of non-China supply) | Bahrain, Oman, Qatar, Saudi Arabia, UAE | Key industrial metal
Phosphate | 3.9% | Saudi Arabia | Fertilizer
[/Table]
In international transportation, jet fuel prices have doubled and war risk insurance premiums for tankers in West Asia have increased tenfold since the start of the war. By comparison, premiums for ships transiting the red sea tripled in one week in January 2024 following the Houthi blockade, and oil flows through the Bab al-Mandab Strait never recovered, despite the American-Houthi ceasefire. Since the Iranian military is far more sophisticated, we can posit that disruption to the strait of Hormuz will be more severe. Figure 1 Given globalisation, the current disruption implies more than demand destruction; we can expect production to be taken offline. It is not simply a case of reducing energy demand: of turning off the central heating or working from home and leaving the car parked outside. Aircraft without kerosene will not fly; farmers without sufficient fertilizer will cut back on crop yields; cargo ships stuck in the Persian Gulf or priced out by rising fuel and insurance costs will not transport goods; and plant and equipment short key inputs will be shutdown. Even where there is redundancy, surplus stocks can be stored far afield from demand, all while aviation and shipping is disrupted and dear. The world has seldom been more interconnected, nor production more dispersed; failure of a key node reverberates across the system.
Then there are the second order effects. Disruption across one GPN can spillover over to another, creating non-linear feedback dynamics that are impossible to accurately predict. Moreover, because turnover times vary markedly in different nodes and networks, disruption will likely be staggered across products. For example, households in many countries will feel the pinch with energy bills soon, whereas food inflation won’t appear until late this year or sometime in 2027. Picture stagflation as a cascading tsunami of supply disruptions, one price shock wave after another. International Finance A few days into the war, an advisor to the IRGC commander told Al Jazeera: The Americans have debts of hundreds of billions of dollars, and they are thirsty for the region’s oil. They will not get a single drop.
Beyond choking GCC oil flows, the Iranians are clearly trying to disrupt the flows of international finance. They want to hit the Americans where it hurts – their wallets. Reportedly, Iran is also negotiating with various countries to allow tankers through the strait of Hormuz, providing their oil is invoiced in Chinese Yuan. This has sparked debates on whether we are witnessing the end of the petrodollar, or even of the hegemonic status of the US currency. Iran has long suffered under the yoke of US sanctions and has little to lose from upending international finance. But can they do it?
Talk of the petrodollar typically refers to two relations: the invoicing of oil in US dollars; and the recycling of dollar surpluses from oil exporters into US securities. The architecture of the petrodollar system emerged in the 1970s, as the US and Saudi Arabia agreed to price and trade oil in US dollars. These relations have been resilient: despite upheavals in the world market, oil today remains predominantly dollar priced and traded. Whether current developments will undermine the dollar system in the long run is unclear. What is apparent is its resilience at present: despite falling US securities prices, the dollar has appreciated since the start of the war. Figure 2 The dollar strengthening during a crisis is nothing new, but that it’s appreciating while bonds and equities sell-off is peculiar. Clearly what we’re witnessing isn’t a flight to safety in classic sense of international capital flowing into dollar securities, pivoting on the dollar’s international store of value function. It could, however, be a dash for cash by global firms due to an interplay between the dollar’s role as means of account and means of payment in the world market. As fossil fuel commodities appreciate, the assets and liabilities of internationally operative firms reprice. Higher oil and gas prices raise transaction demand among firms around the world for dollars as a means of payment; internationally operative financial institutions anticipate liquidity pressure and dash for dollar cash; and the result is dollar appreciation. Evidence for this hypothesis is that asset managers have been pivoting to cash at the fasted rate since March 2020.
In this light, the selloff in US Treasuries is likely driven by central banks in energy-importing countries liquidating FX reserves to arrest their depreciating currencies. As oil and gas reprice, energy importers exchange more of their domestic currency for dollars, increasing the supply of domestic currency relative to demand in forex markets, and the demand for dollars relative to supply. The flip side of contemporary dollar appreciation is the tendency for the exchange rates of energy importers to depreciate absent state intervention. Figure 3 So the Americans have started a gratuitous war and international crisis, yet the dollar strengthens. Furthermore, far from US Treasury sell-offs indicating withdrawal from the dollar system, the current moment shows how imbricated the world market is within it. What dollar crisis?
How about petrodollar recycling? In the 1970s, this mechanism became a pillar of the American empire. Oil exporters would recycle vast dollar surpluses into Treasury bonds, supporting the US balance of payments given persistent current account deficits. Surprisingly, this mechanism diminished before the conflict. At pre-war oil prices, major Gulf exporters did not enjoy large current account surpluses. Indeed, the important trade surpluses originated in East Asia, particularly from China. These were far larger than the those from major oil exporting nations combined: Figure 4 Today, petrodollars matter less to the US balance of payments than surplus East Asian dollars. Surging energy prices are unlikely to change matters, since GCC producers have their main export route shutdown and their infrastructure is under fire. Russia could be a big winner, but it’s unlikely to generate many petrodollars. This is salient because East Asian countries are highly dependent on energy imports from the Persian Gulf. Table 2: Proportion of Oil and Gas imports from the Middle East: China, Japan, S. Korea [Table]
| China | Japan | South Korea
Oil imports from the Middle East | ~50% | ~95% | ~70%
LNG imports from the Middle East | ~33% | ~11% | ~20%
[/Table]
The longer the war persists, the greater the likelihood that energy import-dependent nations experience supply shocks, impacting their exports. A contraction of world trade and disruption to Eurodollar recycling is a greater threat to the US balance of payments than attacks on the petrodollar. An ameliorating factor is that such a contraction could improve the US current account by reducing imports. But this could easily be offset through another channel: the Trump administration is waging an expensive war and seeking to almost double military expenditure; it is difficult to see how this wouldn’t increase the need for foreign capital inflows at a time of increasing scarcity. To paraphrase IRGC advisor: “the Americans have debts of hundreds of billions of dollars, and they are thirsty for East Asian surpluses .”
Although centrifugal forces exist in the global dollar system, there are counterbalancing centripetal forces (the dollar is appreciating). It’s therefore too early to write obituaries for dollar hegemony. So what would pressure on the US balance of payments look like? – probably an uptick in domestic US interest rates, the main problem wherewith is that the US is likely at the tail end of a credit cycle: Figure 5 Figure 5 shows credit flows to the non-financial private sector as a share of GDP and the fed funds rate. Notice that credit downturns coincide with the emergence of major financial crises, and that these are typically preluded or paralleled by interest rate hikes. Upturns in the cycle involve expanding credit flows and overextending balance sheets. But higher rates raise refinancing costs; credit growth slows and eventually collapses, with lenders deleveraging. Today there are widespread concerns about overinflated asset markets, particularly relating to the AI investment boom. If the war precipitates higher interest rates in the US, financial stability risks will sharpen. Iranian missiles could burst the asset bubbles on Uncle Sam’s frothy face. Conclusion: Policy Constraints Policy responses to the Covid crisis in the Global North were not easy, but they were feasible: vaccinate the population and end lockdowns; refloat businesses and households with expansionary fiscal and monetary policy; and wait for supply chain bottlenecks to loosen. The inflationary shock did not hit immediately, so central banks initially cut rates and did enormous QE, although once they started raising rates, it didn’t take long financial system cracks to appear.
Responding to the current crisis could prove more challenging. Governments cannot print oil and gas. Whatever capacity is lost in the Persian Gulf will take a long time to reconstitute, with ripple effects across GPNs. Price shocks are likely to be staggered and non-linear, although they will hit many countries quickly. This is crucial because a protracted period of inflation will constrain monetary policy space, even in the US, especially if contracting global trade at a time of elevated military expenditure puts pressure on its balance of payments. The risks are manifold, particularly if one thinks American asset markets are overheated.
Another consideration is that many countries have enormous sovereign debts. Rising interest rates increase debt serving payments; the limits to how high these can go as a share of government revenues is unclear – but there are limits. What if governments in the Global North decide to cut rates and rollout QE? This would be a novel response to an inflationary crisis and could juice asset markets. But the ability of governments to do so would surely depend on their trade and fiscal balances, and the health of their financial systems. There are no easy solutions. States may find themselves stuck between a rock and hard place – between a Blackrock and a Hormuz strait.
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