By Pulling Away From Iran Deal, Trump Has Unleashed Greater Debt Risk
The bailout of the “too big to fail” banks merely resolved the problem for Wall Street. It did not fix the debt afflicting the ordinary people and businesses that make up the real economy. It merely swept it under the carpet.
Near-zero interest rates and low oil prices helped contain inflation, making debt more manageable. The low interest rate debt also encouraged high-risk investment. The equity market outpaced all others.
Now, inflation, higher interest rates, and an oil price spike are coming together to create a perfect financial storm.
The Oil, Debt, and U.S. Dollar Storm
Two interrelated elements of the storm, as far as the average consumer is concerned, are debt and the dollar.
Sanctions will virtually eliminate about three million barrels of oil per day from the world supply.
The oil price will suddenly splatter to unsustainable levels. It will be like the period between 2006 and 2008. At $100.00 per barrel, oil will seem cheap.
If student loan, housing, auto, and credit card debt weren’t already a problem, canceling the Joint Comprehensive Plan of Action (JCPOA), also known as the Iran Deal, will not bring any relief to Americans.
There are no advantages. Oil prices were already rising on their own, making North American resources more competitive.
The “tax cut for the rich”-induced, artificial bull market cannot last in the next oil bubble. The problem of debt that triggered the 2008 financial crisis was never resolved.
Since the United States and other Security Council members signed the Iran Deal in late 2015, lifting sanctions, Iran has increased oil production significantly.
It’s the third-strongest oil producer in the Organization of the Petroleum Exporting Countries (OPEC) and the fourth top oil producer in the world.
Two General Effects Are Possible
President Donald Trump’s decision to pull the United States away from the JCPOA could have one of two general effects. None of them benefit the United States, and both will increase U.S. debt.
The first outcome, and the one that the White House would prefer, is that the primary (direct) and secondary (those that penalize foreign companies for doing business with Iran) sanctions will kill Iranian oil exports. Oil prices will increase sharply.
The second outcome would see the European Union, China, and Russia finding ways to circumvent the United States’ secondary sanctions.
They would continue to import Iranian oil and conduct business with Tehran. They have little choice.
At present, conservative estimates suggest that the European Union makes some $25.0 billion in exports to Iran. The figure would be far larger if it weren’t for the fact that the United States has failed to honor its end of the JCPOA.
Trump May Just Have Found a Way to Unite Europeans
Trump’s decision to pull the U.S. out of the Iran Deal has discouraged investments and has kept many European Union banks that were willing to lend to Tehran in limbo.
The European Union has also lost some $100.0 billion of export revenue because of U.S.-led sanctions against Russia.
The anger at Trump’s reversal of the Iran deal could trigger an unexpected show of pride and unity from the Europeans.
They could resolve to defy Washington on both Iran and Russia. They could even start to pull away from NATO to develop a more independent defense policy.
It would not be unprecedented. French President Charles De Gaulle pulled France away from the NATO military alliance in 1966. The motives, related to differences over the Vietnam War and perceptions of Washington overreaching, are surprisingly similar today.
Europe has not yet recovered from the 2008 financial crisis. Therefore, the European Central Bank (ECB) has not followed the example of its American equivalent, the Federal Reserve, in lifting interest rates. Far from it.
That’s why Europe cannot allow high oil prices and more lost markets (Iran) to interfere with its slow and vital economic recovery. Recall that, unlike the United States, Europe has endured direct effects from the so-called Arab Spring in the form of an unprecedented flow of refugees.
Apart from the security risks, the influx of migrants has weakened the socioeconomic and political fibers of the European Union. Ironically, Trump’s sanctions against Iran could prove to be the glue that Europe was previously unable to find to restore a degree of faith or hope in the European unity project.
If Europe acts, using precedents (for example, the same legal instruments it used to circumvent U.S. sanctions against Cuba), Americans will feel the impact of higher debt. In other words, Trump’s Iran strategy could backfire.
Enter the Petro-Yuan
China has not only become the world’s largest oil consumer, it happens to shop for most of its oil needs in Iran. Evidently, cutting off the biggest sources of oil to the most populous and fastest-growing economy in the world will have deep repercussions.
In response to Trump’s unilateral exit from the JCPOA, China will retaliate. It must do so in order to survive because it’s not just the oil price that is moving higher. So is the dollar.
Normally, there’s an inverse relationship between oil and the dollar. Oil is quoted in dollars—thanks to the petrodollar.
When oil prices rise, the dollar drops, because more greenbacks are needed to buy a barrel. When oil prices go down, the dollar goes up, because fewer dollars are needed.
The fact that both the dollar and oil prices are moving higher in unison now indicates a curious anomaly. The fact that the dollar is moving higher because the Fed has decided it must raise interest rates is the anomaly.
There’s no need to raise interest rates, other than to please the banks. Inflation is being driven by higher oil and commodity prices. And the higher oil price prospects, meanwhile, are a direct result of political tensions, which Trump has raised for one reason or another.
Therefore, the Europeans and Chinese will resist the U.S. plans for the Iran Deal.
As for the United States, which has decided to break early with quantitative easing, the higher cost of everything will raise debt as the highest concern of Americans for the next few years.
Disruptive Effect of Oil Cannot Be Stressed Enough
Trump’s politics have exacerbated the effects of declining oil reserves in the world’s largest economies. OPEC and Russia have gradually cut back on oil production, while Venezuela has experienced more dramatic production problems (and U.S. sanctions) than anyone expected.
This has left an over-sensitive market. Any drop in supply now will trigger a disproportionate price increase in the price per barrel.
Imagine, then, if Iran’s production were suddenly cut off. The largest importers of Iranian oil are China, India, and Turkey. Other producers might be able to compensate for some Iranian exports. But, if Iran is cut off—in a mechanism deeply related to Saudi interests—it will retaliate.
The Iranian navy can block tankers in the Strait of Hormuz, slow supplies, and affect industrial activity in China, India, and Europe. In a sense, the affected countries will have to evade U.S. sanctions to avoid a conflict.
Markets and World Economy Will Be Hectic for a While
China, for starters, will not only get around Trump’s Iran restrictions, it will inflict heavy damage on the dollar. China will increasingly demand to pay oil contracts in yuan and no longer in dollars. It will adopt the petro-yuan.
The launch of the petro-yuan could represent a veritable blow to the dollar as a currency. And to the dollar as an instrument of geopolitical power.
The petro-yuan threatens the U.S. dollar because yuan-based oil futures contracts will be convertible into gold.
No more need to convert gold in dollars first. And what’s good for gold holds for all other essential commodities. Russia or Iran could avoid U.S. sanctions using gold-backed yuan. Iran could sell directly on the Chinese market, bypassing any “dollar zones.”
Moscow and Beijing have already avoided the dollar for their growing bilateral trade. If pushed, Europe could adopt similar approaches. And that’s terrible for U.S. debt. Without the need for U.S. dollars, there will be fewer incentives to buy U.S. debt in the form of Treasuries.
It is the petrodollar that allows the U.S. to overstretch its defense dollar despite the now $21.0-trillion deficit.
The petro-yuan represents the most credible alternative to the dollar.
And Trump, by pulling out of the Iran Deal (and fueling other Middle Eastern conflicts with ideologically motivated steps designed to please a narrow electoral base) is undermining the pillars of U.S. power.