The Iran Crisis Comes With Serious Risks for America's Economy

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Round 1 of the U.S. vs. Iran seems to be over, and the effects on the world economy seem to be negligible. Relieved at what looks like Iran's and President Donald Trump's intentions not to escalate the conflict, world markets rallied. The Dow Jones Industrial Average, which began the day after Iran's missile attacks on U.S. bases at 28,556, crept up to 28,637 just before the president's remarks then shot up to 28,768 after he finished speaking. Both the S&P 500 and Nasdaq closed the day at record highs.

That means markets believe that the Iranian situation will not have a major negative effect on the world economy. At least for now. But whether markets stay blasé depends on what happens next. Most experts do not expect a full-on war, but neither do they think this is over. Sina Toossi, of the National Iranian American Council, says the missile attack "was the overt public retaliation, which was necessary for public consumption at home. But there is likely to be covert retaliation as well in the coming months." Expect traders and investors to keep a close eye on oil prices, the canary in the economic coal mine.

Toossi believes that Iran has no choice. "There's no diplomatic off ramp. Trump and Pompeo haven't said what they want, but Iran has nowhere to go. Nothing left to give. The sanctions imposed as part of the U.S.'s 'maximum pressure' campaign have put the Iranian economy under a great deal of hardship." No one knows what Iran's move or moves will be, or when they will occur. According to Professor Nicholas Bloom of Stanford, who tracks uncertainty for the International Monetary Fund, "It depends on whether the Iranians feel they must retaliate against America or against Trump. If it's Trump, then any response may well be timed to affect the 2020 elections."

President Donald Trump
U.S. President Donald Trump concludes his remarks after speaking from the White House on January 08, 2020 in Washington, DC. During his remarks, Trump addressed the Iranian missile attacks that took place last night in Iraq and said, “As long as I am president of the United States, Iran will never be allowed to have a nuclear weapon.” Win McNamee/Getty

Peter Singer, of the New America Foundation, predicts an increase in cyber-attacks. "Iran put a lot of resources into building its capabilities. They're nowhere near the US but they're a real threat. So far, they've conducted a series of cyber-attacks that are really more about showing off their capabilities than doing real damage... We'll probably see those resume and go after soft targets, like municipal water systems."

Mark Finley, who's a fellow in energy and global oil at Rice University's Baker Institute, says, "Iran's been practicing asymmetric warfare for forty years. I wouldn't be surprised to see attacks on tankers and processing facilities, and perhaps pipelines." Toossi meanwhile says we may see bombings and assassinations by proxy groups, like Hezbollah.

Any of those could cause disruption in the oil market. Sectors like travel, manufacturing and agriculture are highly sensitive to oil prices. However, the effect on the global economy will likely not be as great as that caused by oil shocks of the 1970s. Economies are increasingly less sensitive to oil prices. Thanks to shale oil, the U.S. is almost self-sufficient in petroleum. That doesn't mean the U.S. wouldn't be affected because oil is globally traded and the U.S. is both a significant exporter and importer. It does mean the effects would be uneven and localized. While many regions would suffer, particularly rural and less affluent areas, oil-producing states like Texas and Alaska would actually experience an economic boom.

Any price jump that does occur is unlikely to last for very long. Kevin Book, who leads ClearView Energy Partners, a firm which forecasts oil prices, says, "Geo-political spikes come and go, and they tend not to be that long-lasting. There are a lot of brakes built into the system to handle short-term events. The Saudis can ramp up production or the president can tap strategic reserves." Book is telling his clients to expect Brent prices to level out around $60 per barrel. That's roughly where oil prices have been for the last year or so.

A full-on war, however, could result in more prolonged disruptions in supply and $100/barrel oil, which according to Singer, would trigger a "global economic slowdown and massive effects which would last for a generation." It could be triggered by further attacks by Iran or Iraq that create a spiral of escalation. Or the U.S. could decide to act preemptively because it believes retaliation is imminent or it senses an opportunity to create additional pressure on Iran. There remain very powerful voices in the administration pushing for nothing less than regime change.

Book notes, "It would be a mistake to think of [the killing of Soleimani] as a sudden, unstudied decision by the administration. There are hawks in the administration who've been lobbying for this for a while." Toossi agrees, "I'm afraid there are some very hard-line voices in the administration, we'll end up with war, and it will be the most costly war for America since Vietnam." A physical war could involve air strikes and U.S. ground troops, and could also spill over into other countries in the region.

The markets believe that scenario is unlikely. Everyone involved seems to be looking for a way out, despite continuing tough talk by Iran and the U.S. Iran's missile attack appeared to be designed not to inflict casualties. Trump's response to the attack was seen as muted and conciliatory. He described the damage caused as "minimal" and said, "Iran appears to be standing down, which is a good thing for all parties concerned and a very good thing for the world." Israel and Saudi Arabia may also be working behind the scenes to defuse the confrontation. Toossi says, "Israel and Saudi Arabia have been urging the U.S. to bomb Iran for over a decade. But they're only interested in a war where the U.S. bears the costs. Saudi doesn't want to see tens of thousands of Iranian missiles raining down on its oil production facilities. Now both countries are trying to talk the U.S. down and de-escalate the situation."

But even under a limited war scenario, increased uncertainty could trigger a recession in a global economy that is already beginning to show cracks. Finley says, "If consumer confidence drops, then people get worried and stop spending, and that could affect the economy. The president is very sensitive to prices at the pump." However, Lynn Franco, senior director of economic indicators at the Conference Board says, "We track consumer confidence and if we look back historically at 'shock events,' they tend to only have a temporary effect. They only last if it translates into job losses."

But she says, "It's very early in the game. We don't know how it will unfold." Professor Bloom says, "Trump is an unpredictable actor. Iran is an unpredictable actor. The Iraqi government is as well. It's a toxic mix."

Canaries in the Coalmine

If there is significant economic fallout from the conflict between the US and Iran, where will it show up first? There are literally dozens of metrics to predict economic trends--each with its own strengths and weaknesses.

Dr. Ataman Ozyildirim, Senior Director, Economics and Global Research Chair at The Conference Board, says some indicators are very noisy, with so much movement it can be hard to distinguish a trend from a blip. Others can be affected by isolated events and can jump because of short-term supply disruptions. None are foolproof. Ozyildirim recommends using a dashboard of several metrics and tailoring that dashboard for the needs of the user and the specific situation. For example, for the Iranian situation, it makes sense to look at oil prices. And if you're an investor, it makes sense to follow the markets. He also recommends looking at measures that cover different time frames. Here are five he'd be watching as the Iranian situation unfolds:

  • Brent Crude. Brent Crude is a composite price based on oil produced in the North Sea. It's used in 2/3 of all international oil trading. In general, UP is bad for the global economy and DOWN is good.
  • S&P 500. The expectations of traders and investors about the future are 'priced into' the prices of large stocks. While many people are more familiar with the Dow Jones Industrial Average, most pros use the S&P. In general, UP is regarded as good, DOWN as bad.
  • Interest Rates. Although a bit tarnished due to a recent scandal around manipulation by British banks, LIBOR (the London Inter-bank Offered Rate) remains the standard and most commonly followed measure of interest rates. UP means banks think financial risk is rising; DOWN means they think it's decreasing.
  • Consumer Confidence. Based on surveys that ask consumers how optimistic they are about the outlook going forward, both for the overall economy and themselves. One of the oldest is the CCI, or Consumer Confidence Index, produced monthly by non-profit The Conference Board. UP means consumers are feeling good, DOWN means they aren't.
  • Leading Economic Index. A composite index of ten different indicators produced by The Conference Board. Ozyildirim says, "I'm biased of course, but this one's been going since the 1930's and it's empirically proven. It's simple and transparent—there's not a lot of assumptions or calculations in it." UP means it looks like the economy is growing; DOWN means a contraction.
The Iran Crisis Comes With Serious Risks for America's Economy