America’s Bubble Economy - Profit When it Pops » 2007

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Archive for April, 2007

BOMBING IRAN COULD TRIGGER A BUBBLE POP

by James I. Wiedemer

After articles by Seymour Hersh last year, and a variety of other revelations, it seems clear that the U.S. is seriously considering bombing Iran’s nuclear installations. President Bush has refused to drop it as an option. Although there has been much debate about the wisdom of such attacks from the standpoint of effectiveness, such as whether they can really stop Iran’s nuclear program, or just delay it, and whether or not the Middle East’s public reaction will be apoplectic or merely disgruntled, there is a neglected issue: economics. It seems clear the U.S. is already headed for a “bubble pop” in the future, perhaps in as little as three years, under normal circumstances. But, an Iran bombing campaign may change all of that, radically. Iran has made it clear that if the U.S. bombs its nuclear installations, it may retaliate by attacking Persian Gulf oil supplies. Such attacks, particularly if they become effective in any way, could very well help precipitate a “bubble pop” with dramatic economic effects.

Any attack on Iran is likely to be used by speculators as an excuse to send oil prices sky high even though absolutely no damage is done to oil supplies, yet. Further, Iran itself, a significant oil producer, may be “off line” for anything but shipments through its northern frontier to Russia, which will put upward pressure on prices. OPEC may counter by increasing output, but if this is done by nations bordering the Persian Gulf, it is likely to be viewed as a hostile act by Iran.

Iran has several ways to inhibit the flow of oil: (1) attack shipments directly, either in the open Persian Gulf or at the narrow and vulnerable straits of Hormuz; (2) terrorist attacks on installations in Saudi Arabia, Kuwait, and the United Arab Emirates; and (3) demanding that Muslims everywhere pull together and fight U.S. bombing by means of the “oil weapon.” The “oil weapon” was used by Saudi Arabia in 1973 as part of the Yom Kippur War (or Ramadan war from the Arab side). It generated sharp oil prices increases and gasoline lines in the U.S. Not only Arabs, but Muslims in North Africa and Indonesia may find this approach appealing.

The U.S., of course, has powerful military forces that will move to protect oil shipments. The U.S. Navy has worked particularly hard on anti-mine capabilities in recent years, perhaps with a Persian Gulf contingency in mind. U.S. airpower can probably knock down Iran’s Air Force. It can sink Iran’s regular Navy. Precision guided munitions may knock out Iranian anti-ship missiles or artillery in the areas next to the Straits of Hormuz. Watchfulness may be able to deal with speedboat attacks or the sea going equivalent of IED’s. Convoying however, could be a necessity, with suitable U.S. escorts. U.S. government ship insurance will be needed. U.S. Navy or Merchant Marine crews may be needed to actually man the tankers if foreigners refuse to steam in a war zone. One only hopes that if the U.S. bombs, it has the plans and the manpower and equipment in place to deal with the consequences.

Sabotage strikes aimed at the Persian Gulf installations are also very possible. It may not be politically feasible in Saudi Arabia to have thousands of U.S. Navy Seals, Marines, and Army personnel patrolling the docks and harbor waters at Ras al Tanura or other critical oil shipping sites. If Saudi security has to be depended on, there is the sad fact that even if they are competent enough to deal with Iranian commandos, there may be Saudi sympathizers who hate what the U.S. is doing to the point where it is almost impossible for the Saudis to provide security. That, of course, assumes they agree with shipping oil to the U.S.

All of these disruptive activities could lead to tremendous price increases for oil which will have very adverse effects on the world economy. There will be no support for bombing Iran in the European Union. The Russians are strongly opposed to it. The Japanese won’t like it.

Unfortunately, these countries send massive amounts of investment to the U.S. If they don’t like the U.S., or see any hint of economic down turn due to high oil prices, they may send less money to the U.S. Arabs and Muslims may decide to get out of dollars and into Euros, not only for sound economic and business reasons, which they are already beginning to do, but for political reasons as well. Arab and Muslim friends of the U.S., Mubarak in Egypt, Musharreff in Pakistan, the King of Jordan, and the petro-Monarchs will be under huge political pressure caused by U.S. bombing, thus magnifying anti-U.S. sentiment world wide. This may cause further investment diversions or withdrawals of investment dollars. All these issues combined could cause a dollar crash.

How likely is the U.S. to attack? Surely a bit less so with the election of so many Democrats in November 2006. However, President Bush may decide he must act on his view of what is needed for U.S. security, regardless of whether a Democratic Congress agrees with him or not. President Bush may also choose to dispense with the sort of extensive diplomacy he engaged in prior to attacking Iraq. Colin Powell is no longer there. He may feel it won’t get anywhere and he’s just going to do what he feels is necessary for U.S. security, including a pre-emptive strike on Iran’s nuclear installations.

The Israelis may force the issue by essentially saying “if the U.S. doesn’t bomb, Israel will.” The Israelis seem very interested in such attacks, although there have been a few voices pointing out that it may be hard for Israel to knock out every target by itself - they would probably need help. Israel is concerned by statements by Iran’s leaders that Israel should be wiped off the map. After the Holocaust, no Israeli can dismiss such talk as idle rhetoric, even if it is. Tel Aviv is at risk. The Israelis may feel compelled to act, whatever the U.S. does. Bush is no doubt aware of this and may move to bomb as a result. Recently, President Bush himself traveled to Jordan, but he also met with the Israelis. An Iran bombing campaign was surely on the agenda for that meeting.

President Bush has never liked the Iranian Republic, they are part of his “Axis of Evil.” He may feel a showdown with Iran is inevitable, sooner or later, so it might as well be sooner, on our terms. He cannot abide with the idea of an Iranian nuclear power and has said as much publicly. He may view them as the source of much of our troubles in other parts of the Mideast, most natably and recently by supplying the Hezebollah in Lebanon. Iran may be critical in the level of violence in Iraq. The mere existence of Iran’s current regime, particularly with nuclear weapons, constitutes, in President Bush’s mind, an on-going threat to the petro-monarchies which he has supported. In his mind, they may need to be dealt with. In President Bush’s mind, a bombing campaign would at least eliminate the nukes, or severely delay them, along with causing enough economic pressure, perhaps, to topple the Iranian regime. While this may be exercise in fantasy, it is appealing to some. Bombing is more likely to destroy the opponents to Iran’s regime than the nukes they are targeting.

Overall, how likely is a bombing attack? The answer: it’s a very real possibility. Maybe even 50/50.

If so, when? What tell tale signs are there? Probably before next year, which is an election year. The probability highest in the Spring of 2007. Carriers are a sure clue. One carrier is not a worry. Two carriers in the Gulf, particularly when the deployment is announced as a move against Iran, is clearly cause for at least some concern. Three carriers makes no sense unless an attack is very near. Newsweek recently wrote that they have confirmed that a third carrier is moving into the Persian Gulf. Air Force rotations will bring on air rescue reservists by late Spring - an interesting set of units to call at that time. They are useless in Iraq. Excellent air units with top notch equipment will be available about then. The weather shouldn’t be so bad. Previous Mideast attacks have been in the late winter-early Spring. It will also be before the U.S. election season heats up.

Although some estimates suggest that Iran may be 5 years away from getting a bomb, much less a practical bomb deliverable by missiles, the Israelis and Americans are also suggesting that within a year the Iranians will have enough uranium to make a bomb inevitable and almost unstoppable. Hence, there would be another pressure for a strike in 2007. President Bush will be out of power in less than 2 years and there’s no telling who will replace him. If an Iran bombing strike is going to be done, 2007, appears to be the year to do it.

Bombing is appealing because it is so easy. U.S. ground forces need not be involved in a big way, making planning much, much easier. The plans are on file. The bombs are all but ready. The President can just pick up the phone and give the word. Planes will move directly from the U.S., Diego Garcia, and the carriers to hit targets in a highly organized attack.

Once an Iran bombing campaign begins, it may lead to a whole set of economic consequences that no one seems to be too concerned with at present. The Secretary of the Treasury is an expert at market panics. If we bomb, he’ll get to work overtime. Unfortunately, if the bombing triggers a bubble pop, it will be too late to reconsider the bombing decision. If bombing triggers the bubble pop, the interest of the U.S. public in cleaning up the Mideast may fall as fast as their 401(k)’s and their home prices. Ironically, these are the very things President Bush’ voters would expect him to preserve.

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Imports and Exports Have to Be Equal, Unless…

It’s amazing sometimes how often business journalists and economists, even very well regarded economists miss this point. When trading in dollars, imports and exports have to be equal. In a front page article in the Wall Street Journal, highly esteemed economist Alan Blinder missed this key point when he expressed concern that free trade would be harmful to the US because as many as 40 service jobs, not just manufacturing jobs, could be outsourced to low wage countries. This is simply wrong. For every dollar of goods we import, the other country has to import a dollar of goods. What will India or China buy from us in return? We can’t “export jobs” as long as we trade in dollars.

Of course, I did say unless. The unless refers to manipulation of exchange rates. If exchange rates are manipulated, exports and imports can be highly unequal. Or, if you pay for imports in gold, exports and imports can be highly unequal. But, if you pay in dollars, the only thing the payee can do with that dollar is to use it to purchase one dollar worth of US goods and services. Imagine a dollar as gift card redeemable at only one store, the United States. Of course, someone in another country might take that dollar first, but ultimately, the only place it can be redeemed is the United Sates.

This is why trade for so long was conducted in gold or gold equivalents. We only went to pure dollar trade in 1973 when the US was rapidly running out of gold. It was a good move that allowed imports and exports to explode and was key to creating the modern global economy.

However, it also opened the way to exchange rate manipulation. If central banks, foreign or domestic, manipulate exchange rates, we could export millions of jobs. But, why would we ever support that? Because the manipulation is created by massive foreign investment in our government and other debts as well as stocks and real estate. This foreign investment is critical to our current economy. Take it out, and interest rates will rise, stock and real estate prices will fall. The economy will be hammered.

This manipulation happens in two ways. Once is very blatant. Foreign central banks, such as China and Japan, buying up dollars to keep the price up. Just like good old penny stock manipulation. The other way is simply the effect of a bubble investment economy. When the US stock market started going up after the government began to massively borrow in the early 80’s, foreign money started to pour in to take advantage of booming stock markets and real estate markets. This also forced the value of the dollar up and more money kept coming in. Although there were some hiccups, this spiral or more money pouring into the US continued for years and constitutes a “mainp7ulaiton” of sorts in that the bubble economy has created an artificial demand by foreigners for dollars that could and will easily reverse when the returns go flat or decline for any length of time.

So, when Alan Blinder says we could lose 40 million jobs, that’s only because he assumes this foreign exchange rate manipulation would continue. And, of course, it can’t. Even if we wanted it to. Like any investment bubble, when the returns go from highly positive to flat or highly negative as they inevitably will at some point, the investment money flows out—very rapidly at times. That will greatly decrease the value of the dollar and the foreign exchange manipulation will, very harshly, be over.

In the long run, all that is happening is the “invisible hand” of Adam Smith is forcing foreign exchange markets into equilibrium by changing the relative prices of the foreign exchange (the dollar) . No manipulation and bubble market can last forever and in forcing the exchange rates to equilibrate, our economy will be crushed, as will the world economy. The good news is that once we came out of this wrenching change from manipulated bubble markets, we will never again manipulate foreign currencies and trade will always be equal. China and India will have massive service and manufacturing exports to the US, but they will also have equally massive imports. In fact, that will be one of the great challenges India and China will face in moving out of the Bubble Bust will be to configure their economy to accept massive imports. They will need to figure out what to buy as well as what to sell.

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Lack of Discussion of Deficit’s Key Stimulative Role

Even if you think the federal deficit is very bad, it is important to recognize that it can have a very positive stimulative effect on the economy. This is Economics 101.

It is a key factor in our economic growth, just as is consumer spending. Yet, we follow consumer spending closely and completely ignore deficit spending. If just the annual deficit were eliminated (not the cumulative deficit) Washington, DC would fall into a depression and the rest of the country would be in a recession. It is the same as cutting more than half the defense budget.

The economy is beginning to slow down now, but no one points out the role that declining deficit spending may be having in that slowdown. One can argue just how important deficit spending is to the economy, but it clearly is very important.

Yet none of the Wall Street economists or financial analysts who analyze the economy spend much, if any, time analyzing its impact on the economy. Many academic economists also ignore this key factor of economic growth. You have to wonder why.

One of the reasons our economy may be slowing down now is that our federal deficit is no longer growing. The most stimulative type of deficit is a rapidly growing deficit. Steady state or declining deficits are less stimualtive than rapidly growing deficits. Recently, we have moved from a period of explosive growth in our deficit to one of no growth or a decline. This clearly has a major effect on the economy, but no one talks about this key change as a key part of our economic outlook.

It is akin to the lack of discussion of the money supply when talking about inflation. We hear all sorts of inflation talk about interest rates, productivity per man hour, a Goldilocks economy—all sorts of issues regarding inflation, but almost never do you hear much discussion about the money supply. You could argue just how important the money supply is to creating inflation, but almost no one would argue it isn’t important. My feeling, as I wrote in my recent blog, it’s not just an important element in inflation, it is the only element important in inflation. Something that Nobel Prize winning economist Milton Friedman would very much agree with. Yet, you hear almost no discussion of it when talking about inflation

If you look at federal deficit spending, you will not only see how important they have been to our current economic recovery, but how important they have been to the last 25 years of fairly consistent growth and the boom in our asset prices (stocks and real estate). Maybe I’m wrong, but no one seems to discuss this positive impact very much. Why? People don’t like the idea of a bubble and they certainly don’t like the idea that deficits are a key to our current economic growth. But, that doesn’t mean it isn’t important. People seem to want to talk about what is comfortable and not necessarily what is most important. Maybe they know more than they say. Maybe what they don’t talk about speaks louder about their real economic fears than what they do talk about.

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