14 Mar

The Economics of War – Part 1

“It’s about energy.” – The Lonely Realist

Today’s TLR is a brief follow-up to this past Thursday’s “The Iran War”:

One month ago, writing about whether the US Dollar might surrender its reserve currency status, TLR noted that America and China are in a competition for global energy dominance (among many other competitions)…, and that the winner will see its currency strengthen and the loser will see its currency weaken. President Trump has promoted oil, gas and coal, all of which can be found in abundance in America. China, lacking oil and gas reserves, has chosen green and nuclear alternatives and today dominates those energy sources. The Iran War is reframing energy decisions for other countries that lack oil, gas and green alternatives, particularly those in Europe (e.g., Germany) and Asia (e.g., Japan, India and South Korea). While those countries may have overlooked their energy vulnerabilities, the Iran War now is forcing a refocus. China has been sensitive to potential energy disruptions and has taken out “insurance,” first by pursuing green and nuclear alternatives and second by stockpiling ~1.3 billion barrels of crude oil which covers ~4-6 months of its import needs. America’s former allies in Europe and Asia are in more challenging positions…, and they will not soon forget it.

The closing of the Strait of Hormuz sets the stage for a reconsideration of energy choices. If the U.S. fails to re-open the Strait within the next ~3 months, the impact on the global economy will be severe. An inability to use its military dominance to re-open the Strait will be perceived as an American defeat, both in the Iran War and in America’s energy and other competitions with China. If the U.S. can open the Strait within the next few months, oil prices will quickly return to pre-War levels and America will be deemed the winner…, on many levels. The fact is that, until now, the world did not fully comprehend the strategic vulnerability of the Strait. The share of seaborne commodities that flow through the Strait constitutes ~34% of the world’s oil, ~22% of the world’s minerals, ~16% of world’s fertilizer [ED NOTE: The U.S. gets 51% of its nitrogen fertilizer from the Middle East and India gets 89%, which means the closing of the Strait will have a meaningful impact on global food prices], plus jet fuel, aluminum, and chemicals. Few appreciated how easy it would be for any country, particularly Iran, to shut off that flow, and the impact doing so would have. Vulnerable countries now DO understand and, unless the U.S. can demonstrate that the Strait cannot be shut down for long, that America’s military can force a re-opening, they will adopt energy policies from an entirely new perspective.

To be continued….

TLR notes that the Iran War has disrupted the global economic calculus on multiple levels. Economic growth projections are being lowered…, and some analysts are waving stagflation, inflation or recession warning flags. We await further developments.

Finally (from a good friend)