Trump’s Iran mess festers, and the world economy slouches toward crisis

Open this photo in gallery:

John Rapley is a contributing columnist for The Globe and Mail. He is an author and academic whose books include Why Empires Fall and Twilight of the Money Gods.

You have to admire the faith of traders and investors, who sent stocks soaring and oil prices plunging on news this week that Iran was considering a U.S. peace proposal – news broken by a U.S. media outlet, which, as one wag put it, had already predicted seven of the past zero deals between Iran and the U.S.

Throughout this two-month (and counting) war, the Trump administration has skilfully managed the U.S. media to repeatedly reassure markets that peace is imminent, often planting stories in compliant outlets. That has prevented oil prices from rising too sharply and kept stock markets buoyant. If we really are on the cusp of peace, this will be remembered as a brilliant strategy that bought the U.S. time and kept the economy stable until a satisfactory resolution was found.

But if the peace agreement doesn’t come soon, this strategy may instead be remembered as a dangerous drug that lulled investors to sleep as they headed for the waterfall. Because regardless of the news reports, the world economy has now sailed into the amber zone: not yet in full-blown crisis, but on warning that one could come soon.

Doug Saunders: The Iran war has shown why Canada shouldn’t just take the world as it is

For all the hopeful talk, the Strait of Hormuz remains all but closed. None of U.S. President Donald Trump’s various attempts to force it open – threats to obliterate a civilization, a blockade to put pressure on the Iranian regime economically, an abortive attempt at providing some form of escort operation to get ships out, and now, news of an imminent peace deal – have persuaded insurers it’s safe to navigate the channel. With insurance and risks prohibitive, ship owners are staying away, and the flow of oil and other products out of the Gulf has nearly stopped.

You wouldn’t necessarily know it on this side of the world, but a full-blown energy crisis has already broken out in much of Asia, where gas is being rationed and plastic supplies are running out. Here, large buffer stocks and local supply have so far kept the impact mainly to higher prices on gas, which, while painful are at least manageable.

However, those buffer stocks are running down, not least because American companies are responding to the global shortage by boosting exports. Estimates vary as to how long remaining stocks can continue to plug the gap, with some placing zero day in about four weeks and others giving it until the end of the summer. If that threshold is crossed, the steady rise in oil prices will then speed up quickly, with a barrel costing US$150 or more.

Opinion: The Iran war, the Saudis’ bold bet and why Canada needs a new pipeline

As tempered as the reaction has so far been in North American energy and stock markets, signs of stress have nonetheless begun appearing. While stock markets have rallied, bond markets have slumped, driving interest rates on government debt higher than before the war – nearly a third of a per cent in the U.S. Gasoline prices keep rising and some demand destruction has already begun: Airlines are cutting flights and higher pump prices are leading people to cut back on driving, where possible.

If the standoff continues for long and oil prices shoot up, the damage will get much worse. Inflation will rise further than it’s already done and could get locked in. That will drive interest rates yet higher. Higher interest rates will likely cause a repricing of stocks, which could become violent if the current euphoria gives way to gloom.

So, we really must hope these peace talks bear fruit. There’s reason for both optimism and caution. Optimism because there does appear to be a genuine desire on both the Iranian and American sides to bring about a truce, with momentum building around this particular initiative. And at this week’s meeting in Beijing of the Chinese and Iranian foreign ministers, it’s likely that China pressed its Iranian partners to speed things up, both to minimize the economic damage to its own economy and also to manage its relations with other Gulf states.

Tony Keller: The weapon that can reopen the Strait of Hormuz? It’s the economy, stupid

But caution, because for now the deal being considered is essentially an agreement to keep talking. Significant gaps between the two sides remain on key issues, not least of which is Iran’s nuclear program. The best-case scenario will probably involve weeks of talks before traffic can begin to resume in the Strait of Hormuz; the worst could drag things out much longer.

The world economy doesn’t have the luxury of time, though. Each side in this negotiation will have to make some compromise if a deal is to be reached. And in what amounts to a game of chicken, the defining question will be which side caves first. Mr. Trump may have no option but to accept a deal that will look suspiciously like a surrender – an option that, given his allergy to being labelled a loser, we can’t assume he’ll take.