Mounting energy shortages and geopolitical deadlock around the Strait of Hormuz are creating financial stresses that markets have yet to fully recognize, raising the risk of a sharp global correction.
I believe the global financial markets are now in what I would call a Wile E. Coyote moment, frequently depicted in the old Warner Bros. animated series called 'The Road Runner Show.
' In this cartoon series, a coyote, while pursuing a roadrunner, would inevitably end up running off a cliff and be suspended in mid-air until he looked down and hurtled to the bottom. I say this because, in case you didn't notice, last week we had the first public admission that fear is starting to grip monetary officials as a result of the Iran conflict.
The United Arab Emirates UAE asked the United States government for a currency swap line, essentially a loan in dollars collateralized by the UAE's own currency. I believe this event could be the leading edge of a financial panic that will ripple through the global financial system in the coming weeks, one that will bring various markets back into alignment with physical reality.
That physical reality consists of an ongoing serious energy shortage and badly broken supply chains, which are only getting worse as Iran continues to prevent critical energy and chemical supplies from exiting the Strait of Hormuz except for its own. The UAE government insists that the need to swap its dirhams for dollars is not a sign of financial stress. The move is just a precaution, the government says.
In fact, it is a sign that the stress is real and probably metastasizing in other Persian Gulf countries out of public view for the moment. The UAE government and its businesses are, after all, taking in many fewer dollars these days as the war with Iran has prevented the export of most oil and scared away tourist dollars and expatriots.
And yet there are debts to be paid and expenditures to be made, many of which must still be paid in dollars. The same financial pressures must be bearing down on the other Persian Gulf nations, even if they haven't yet cleared their throats to ask for help. We are told often by President Donald Trump that the Iran conflict is going to be wrapped up any day now. The days, however, have turned into weeks and now months.
For a detailed explanation of why this conflict is unlikely to be resolved anytime soon, I recommend this piece. The short version is that we are faced with a kind of geopolitical three-body problem where all parties have irreconcilable demands, ones for which there is no practical way to split the difference.
The three main parties, the United States, Israel, and Iran, are far from any agreement, and the United States and Israel, who are ostensibly on the same side, disagree among themselves. Then there are the other Persian Gulf states and the other major powers of Russia and China. The three-body problem in physics is unsolvable. This N-body problem in geopolitics seems likewise utterly intractable.
As long as there is no agreement, Iran will almost certainly continue its stranglehold on the Strait of Hormuz, severely limiting energy and other resources that leave the Persian Gulf. Participants in financial markets around the world are in deep denial about this. They should take the UAE's request for a currency swap line as a warning.
In fact, some people are calling the swap line a bailout because, given the fast deteriorating economy of the UAE, it is not certain that the dirhams that the United States will get as collateral for its dollars will be worth as much when it comes time to reverse the swap as is normally done after an agreed period of time. Governments have the power to create money and to assist one another when there is an imbalance in the types of money distributed around the world.
But businesses must get their money from customers, and when what they are trying to sell for instance, oil and gas cannot be delivered, they do not get paid. As readers probably already know, beyond energy, a wide range of critical products come from the Persian Gulf states, including vast quantities of fertilizer, petrochemicals, and helium. Helium is essential in the production of semiconductors and the operation of MRI machines in hospitals.
And, I have calculated that current reductions of oil and natural gas supplies amount to a loss of 4.5 percent of the world's total energy, which, given the economy's direct dependency on energy for everything, likely means a loss of about 4 percent of world economic activity. For comparison, the economy of the United States shrank 4.3 percent from the beginning of the Great Recession to its bottom.
But major disruptions of the supply of energy and critical chemicals imply negative effects ramifying across the entire world supply chain and the morphing of high prices into actual shortages. This would suggest that economic activity will take and is taking a bigger hit than the current loss of energy supplies suggests, one even greater than the Great Recession.
Unless the geopolitical three-body problem I described above gets resolved, I expect that in the coming weeks markets will move far more radically than they have so far done, oil way up and stock markets way down as the fear the central bank in the UAE is feeling now finally reaches investors. All this will be an unwelcome outcome if it occurs. But it will only align financial values with the physical realities of supply now unfolding.
I suppose the parties to the Iran conflict could soon come to their collective senses, resolve every sticking point, and reopen the Strait of Hormuz to all traffic. In fact, the financial media is now full of stories about investors 'looking past' this little dust-up in the Persian Gulf region.
My guess is that few of the latest crop of financial journalists have ever seen any Road Runner cartoons, and so it doesn't occur to them that what investors are 'looking past' is a cliff. P.S. If the Strait of Hormuz remains closed and stock markets remain aloft indefinitely, this will convince me that financial markets are now completely and permanently decoupled from physical reality. Does that seem like a plausible scenario By Kurt Cobb via Resource Insights
Strait Of Hormuz Financial Markets Iran Conflict Supply Chains Global Economy Currency Swap Oil Prices Geopolitical Risk Recession
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