Global economy is facing the prospect of another profound shock
Any event that extends the US-Iran conflict, or threatens sources of oil and gas, is likely to lift energy prices to levels that will sow inflation
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IN THE most hopeful scenario for the global economy, the latest war in the Middle East ends within a few weeks.
The region continues to produce oil and gas. Shipping resumes in the Strait of Hormuz, preventing a shock to the world’s energy supplies. Fear of inflation subsides.
But experts have cautioned against any hasty sense of reassurance. The American and Israeli bombing of Iran, and Iranian reprisals throughout the region, set dangers in motion that pose a substantial threat to global economic fortunes.
The most alarming fears centre on the possibility that the Iranian government – pushed to the brink of elimination – may unleash more aggressive retaliation.
It may accept the near-certainty of the intensified bombing of its own territory as the cost of fighting another day.
The Iranians will also presumably seek to damage the capacity to produce oil and gas in regional powers such as Qatar and Saudi Arabia.
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Any event that extends the conflict, or threatens sources of oil and gas, is likely to lift energy prices to levels that would sow inflation.
That can prompt central banks worldwide to raise interest rates, pushing up the costs of mortgages, car loans and other forms of borrowing.
And that will choke off consumer spending and business investment – a classic pathway to a downturn.
“We’re in a very precarious period,” said Kenneth Rogoff, a former chief economist at the International Monetary Fund and a Harvard University professor.
A chess grandmaster and a student of history, he was skeptical of the consensus that the conflict will be short-lived.
He cited the assassination of the presumptive heir to the throne of the Austro-Hungarian Empire more than a century ago – an episode that set off a global conflagration.
“It’s a little bit like asking, when the Archduke Ferdinand got killed, what the macroeconomic consequences would be, and having no idea what was next,” he said. “When World War I started, everyone thought it would end in a month.”
Big trouble for world’s largest importing nations
At the centre of concern for the moment is the fate of the energy produced in the Middle East – the source of 30 per cent of the world’s oil and 17 per cent of its natural gas.
Any disruption to that flow will almost certainly trigger trouble in the world’s largest importing nations – major economies in East Asia and Europe.
Whenever the world confronts fresh reasons to worry about the access to Middle Eastern oil, comparisons turn to the 1970s, when the Organization of the Petroleum Exporting Countries (Opec) delivered a series of shocks.
As it cut supply to lift prices, Americans had to submit to a previously unthinkable indignity; waiting in long lines at petrol pumps for rationed sales, and paying record prices to keep their enormous sedans on the road.
Back then, as it has now, attention was focused on the Strait of Hormuz, the narrow waterway that borders Iran and is a maritime conduit between the Persian Gulf and the Indian Ocean.
Roughly one-fifth of the world’s oil supply passes through the channel, much of it destined for Asia.
Pressure on transit through the strait was especially intense in 1979, the year the American-backed Shah of Iran was toppled by a revolution that installed its extremist government, which has ruled since.
Yet, the historical parallels diverge there. The cartel, now known as Opec+, has already pledged to increase production to compensate for any stocks imperiled by the war.
Due in part to steep increases in American production, the world’s supply of oil generally exceeds demand.
For many countries, the oil shocks of the 1970s, and the Persian Gulf conflict that followed, prompted the pursuit of greater energy self-sufficiency.
Recognition that oil and gas entail perpetual geopolitical risks – to say nothing of climate change – has also driven a shift from fossil fuels to renewable sources of energy.
China and Europe have led the way, investing heavily in wind and solar power.
But the crisis at hand underscores the stubborn reality that the world remains heavily dependent on fossil fuels. If passage through the Strait of Hormuz is impeded for more than a few weeks, and if Iranian missiles damage refineries, that will outweigh any immediate gains from cleaner sources of power.
And if refineries are taken out, that will eventually limit production of petrochemical products, including fertilisers. It can increase the cost of growing food, threatening malnutrition in sub-Saharan Africa and South Asia.
“Oil and gas are still extremely important,” said Kjersti Haugland, chief economist at DNB Carnegie, a Nordic investment bank based in Oslo. Whatever the merits of the green-energy transition, she added, “there is still a very long way to go”.
Oil prices spiked more than 10 per cent on Monday (Mar 2), a clear expression of concern about access to global energy supplies. But prices slid later in the day, an apparent recognition that the concern was limited to the ability to export oil and gas from the Middle East.
Dependence on imported energy
China, Japan, Germany, South Korea, Taiwan, Italy and Spain – all significant exporters of factory goods – are already contending with the trade war pursued by US President Donald Trump.
They are navigating tariffs and increased costs for raw materials such as steel. Now, they are staring at the possibility that the price of fuel may soar as well, if the war in the Middle East does not quickly yield to diplomacy.
“The most vulnerable parts of the world are Europe and East Asia, given that they are dependent on imported energy,” said Adnan Mazarei, a senior fellow at the Peterson Institute for International Economics in Washington.
A sense of the stakes emerged on Monday, when Qatar’s state-owned oil company announced that it was shutting down its production of liquefied natural gas (LNG), given the dangers of transporting its wares through the Strait of Hormuz. That sent the price of natural gas in Europe soaring by 50 per cent.
China appears especially susceptible, given its reliance on Iran for more than 13 per cent of its oil imports.
Its government is already contending with a disastrous slide in real-estate prices that has decimated savings for millions of households.
India confronts unique troubles. The Indian government promised Trump in February that it would reduce its purchases of oil from Russia as a way to gain relief from American tariffs.
It has sought to make up the difference by importing more oil from Persian Gulf suppliers such as Saudi Arabia and the United Arab Emirates. Now, the war threatens those supplies, too.
India’s economy also relies on so-called remittances – money sent home by migrant workers labouring in construction, retail and hospitality.
Some nine million Indian migrant workers are in the Persian Gulf, contributing 38 per cent of all remittances, said an analysis by Shumita Deveshwar at macroeconomic research and advisory company TS Lombard.
The US may appear more insulated, given its status as the world’s largest producer of crude oil and biggest exporter of LNG.
But while American fossil fuel companies are poised to profit from an extended increase in the price of oil and gas, American consumers will almost certainly wind up paying more for petrol. The price of fuel will filter through the rest of the economy, nudging prices higher.
This is the reality that prompts many experts to assume that Trump will seek to end the conflict – before higher energy prices have a chance to exacerbate rising costs for consumer goods.
He owes his office in part to the public unhappiness regarding the price of groceries. It could be politically perilous to head into November’s congressional elections amid higher petrol prices.
Yet, the long-term impact of the unfolding conflict will tend to increase inflation, Rogoff, the Harvard economist, said. The US will need to replenish its stock of weapons, adding to the national debt.
“We’re going to end up spending a lot more on the military, and it’s going to have implications for interest rates and inflation,” he said. “That’s baked in the cake.” NYTIMES
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