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The Iran War
As we know, Trump’s mind is parked in a parallel universe where Vladimir Zelensky is actually Vladimir Putin, Japan is actually Iran, the Iranians are actually begging to make a deal, and oil is actually gushing straight out of the Strait. Of late, though, dawn seems to have risen on Marble Head (ye olde New England expression). Here’s our Supreme Leader’s most recent salute to Iran’s leaders.
They’re scum. You know what scum is? They’re scum. They’re sick people. They’re led by sick people. And they’re vicious, violent people.
Since the infamous U.S.-Iran MOU was signed 22 days ago — the one heralding a ceasefire — Iran has attacked Gulf shipping, US bases, and our Gulf allies almost every day. Apparently, America’s unconditional surrender wasn’t enough for Trump’s short-lived latest beloved enemy. Iran decided that ceasefire meant fire away. As a result, its leaders have gone, inside three weeks, from “rational” and “reasonable” to “scum.”
A day is a long time in the Middle East. Yesterday morning senior Administration officials said they “expect Iran to issue a public statement in the coming days that the Strait of Hormuz is open and that commercial vessels attempting to transit the waterway won’t be attacked.”
Somewhere around 3 PM, Iran’s new, if likely dead, Supreme Leader, Mojtaba Khamenei, issued, if likely from his grave, this public statement.
“We pledge to avenge the blood of the martyred leader and all the martyrs of these two wars from the criminal and disgraced killers.” This blood oath follows on the images of millions of Iranians chanting “Death to America,” “Death to Israel,” and “Kill Trump” at Ali Khamenei’s, Mojtaba’s father’s funeral.
The “Kill Trump” part has gotten under our own Supreme Leader’s skin. Two nights back he posted,
“One thousand missiles are locked and loaded and aimed at Iran, should it act on its threat to assassinate, or attempt to assassinate, a sitting President of the United States, in this case me.”
Back up to yesterday (July 11th) at 10 PM EDT — still within 24 hours of the 1000-missiles warning. CNN’s instant news headline read: Hostilities resume after Iran fires on ship in Strait of Hormuz.
The Perfect Economic Storm
Let’s set aside Trump’s fantasy world. Iran’s regime, or at least the part with fingers on triggers, is dead set on obtaining a nuclear weapon. Indeed, Iran has already started repairing its nuclear facilities. Iran is also, as revealed by its ongoing attacks and repeated hostile official statements, dead set on controlling passage through the Strait of Hormuz, dominating the Gulf states, and eliminating Israel, either directly or by proxy. The US, Gulf states, and Israel are dead set that Iran neither obtain a nuclear weapon nor control the Strait let alone dominate/destroy its enemies.
This disconnect spells what we have been seeing, MOU or no MOU — ongoing war with no end in sight. This spells long-term closure of the Strait, which potentially spells $200 per barrel of oil.
Why potentially? Well, despite everything, the current price of oil — $73 a barrel — is right where it was before the war. This, by the way, is what economics’ basic model of exhaustible resources, the Hotelling Model, predicts.
Harold Hotelling’s seminal 1939 paper, The Economics of Exhaustible Resources, shows that, absent extraction costs, suppliers of an exhaustible resource like oil will be indifferent between selling their stash now or in the future. What makes them care less is the expected path of prices, which rise, in the Hotelling model, at the rate of interest.
Take oil producers. In Hotelling’s model, they can sell their oil now at the current price and invest the proceeds at interest. Or, they can sell their oil for a higher price in, say, five years — a price that equals the current price times the interest rate compounded for five years. Whether they sell now and save for five years or sell in five years, they’ll have the same proceeds, meaning they don’t care when they sell. So, we could simply be seeing Gulf states flipping from supplying oil in the present to supplying oil in the future with other oil producers flipping in the opposite direction. If this indifference didn’t hold, sellers would adjust the timing of their sales to ensure it did.
Hotelling’s prediction is clearly partly at play. American and other producers have increased their supply as Gulf shipments have dried up. Yet, extraction costs aren’t zero and a prolonged war would decimate trillions of dollars of petroleum-extraction infrastructure in both the Gulf states and Iran — infrastructure whose replacement would take years. Moreover, the International Energy Agency suggests non-Gulf suppliers can cover at most one quarter of the reduction in Gulf-state supply.
As for a prolonged Hormuz closure, oil-market experts suggest the price of crude could reach $200 a barrel. Add on our just-renewed sanctions on Russian oil shipments and Ukraine’s accelerating decimation of the Russian petroleum industry, and, well, maybe today’s oil market is smoking something.
The Perfect Economic Storm
Let’s assume oil’s price quickly rises to $200 a barrel. Let’s assume inflation hits 7 percent. Let’s assume a massive war-related increase in the already massive 6-percent-of-GDP federal deficit. Let’s assume that far higher inflation and a far higher deficit produce 10 percent interest rates. Let’s assume a massive stock market crash thanks to the higher interest rates and a bursting of the AI bubble (in line with my multiple demonstrations of AI’s authentic ignorance).
Let’s further assume what major interest rate increases produce — a massive crash in the bond market. Let’s assume the dollar drops by 15 percent, which would contribute to higher inflation (at least short term). Let’s assume that the Democrats win in a landslide making Trump not just a lame, but an impeachable and convictable duck, which means he can’t provide the tech industry more sweetheart deals, which means lower AI-company valuations.
Let’s assume the current run on private credit becomes a stampede, taking down, as discussed here, large parts of the life insurance industry. Let’s assume this triggers a run on trillions in cash surrender value policies. Let’s assume uninsured depositors get spooked and run on banks a la the run on Silicon Valley Bank. Let’s assume the Fed opens up the printing press to save the economy inciting yet more inflation and even higher interest rates.
Let’s assume all this spells bad times for yours truly — YOU.
Taking Shelter From the Storm
I’m not a financial advisor and I don’t give financial, let alone investment advice. But I can tell you what’s going through my mind. It’s Good Golly Miss Molly, the stock market is extremely high as valued by the Shiller price-earnings index. It’s Good Golly Miss Molly, the 30-year Treasury Inflation-Protected Securities (TIPS) — the safest long-term investment around — is yielding an historically very high 2.8 percent. It’s Good Golly Miss Molly, I’m glad I dumped my stocks and built a TIPS ladder. It’s Good Golly Miss Molly, the market thinks inflation will run at only 2.2 percent over the next five years when it’s running at twice that rate right now. It’s Good Golly Miss Molly, the nominal (non-TIPS) bond market will crash big time if the perfect economic storm hits. It’s Good Golly Miss Molly, vastly overhyped AI companies comprise 45 percent of the value of the S&P. It’s Good Golly Miss Molly, with so many US, let alone Chinese and other foreign AI companies competing against one another — to guess what is far too often the wrong answer or algorithm, how can AI companies make large enough profits to justify their market valuations? It’s Good Golly Miss Molly, if AI is threatening to end our jobs, why would anyone put themselves in a position to simultaneously lose their job and lose their shirt by investing in our highly AI-dominated equities market? It’s Good Golly Miss Molly, our fiscal system makes money from inflation because large parts of it are unindexed or under-indexed to inflation. So, we need to save more today in anticipation of higher real net taxes tomorrow — something no one’s doing. It’s Good Golly Miss Molly, I’m hearing lots of savvy investors tell me they’re out of the stock market.
How can you protect yourself from my terrible-case scenario? Clearly, adjusting your investments — taking leave of the general US stock and bond markets, buying individual US stocks that will weather a general crash, building a TIPS ladder, and holding US, Canadian, and other non-Gulf-based energy stocks — is one answer. Another is buying foreign stocks and bonds of fiscally sound countries like Canada, Australia, and New Zealand. Yet another is buying products now that are likely to rise in price. A third is purchasing durables and real estate that will likely retain their real value. A fourth is saving more and earning more (to the extent possible by, for example, looking for a higher-paying job or postponing retirement). And a fifth is to do actual financial planning, i.e., economics-based financial planning, to make sure you aren’t leaving money on the table by making the wrong spending, saving, insurance, career, job, retirement account contribution, housing, location, retirement, Roth conversion, retirement account-withdrawal, and other decisions.
Ability to select individual stocks that will weather a bad market seems questionable. And you might need to hold a dozen or more of them to diversify enough to reduce risk of being over concentrated and having some of them ho baf
This highlights that the Strait of Hormuz is more than a geopolitical issue; it serves as a conduit linking conflict to oil prices, inflation, interest rates, fiscal policy, and asset values.
The scenario is intentionally severe, which is valuable because investors often assess risks in isolation and overlook how these risks can compound.
I would not recommend exiting equities entirely, as resilient businesses can adapt and inflation may boost nominal revenues. However, it is prudent to stress-test portfolios, maintain inflation protection, and limit reliance on any single overvalued market segment.