The Opera Ain’t Over…
It ain’t over till it’s over – Yogi Berra
I stopped paying attention to the soap-opera headlines in the Persian Gulf once the cease-fire started. The talking heads are having a field day dissecting each word, threat, extension, and cancelled meeting. While it’s true that the Iranian leadership is stalling for time, so too is the US leadership but for different reasons.
The cure for higher prices is higher prices and the price of oil is far too high for the global economy. It’s doubly worse for China because they can no longer pay for illicit oil in yuan at a discount and it means that their small Shandong refineries that specialize in refining illicit oil are being starved.
For US consumers, higher oil prices have a similar impact that raising short-term interest rates have on variable-rate mortgages; household cash flow dries up. So why is Trump willing to take his time before finishing this military exercise?
Real Losers
The path of least resistance is the path of the loser – H.G. Wells
Western Europe and China are the biggest losers in this conflict. Germany is still paying over $9 per gallon for gasoline – it’s the same across Europe. The longer this continues, the worse things will get for the Pan-European economy. Banks will start booking losses on consumer and business loans and voters will get frustrated with the incumbents in Brussels.
I suspect, but don’t know, that Western European banks have been getting whiplashed in trading oil, levering long positions to drive prices higher to pressure the US to stop the insanity. Furthermore, I suspect the constant change of direction by the White House has caught too many traders levered in the wrong direction. Just a guess but I suspect the losses have been quite significant even though we may never learn of them.
The Chinese economy is already on death’s door. Ignore the nonsense of 5% GDP growth because it’s pure fiction; China is experiencing an economic depression. Foreign companies are pulling capital out as fast as possible leaving most Chinese people poor and hungry again. Executives and engineers are being barred from foreign travel; getting a passport to travel abroad is becoming impossible. I don’t know how they’re holding it together.
Roughly 48% of the world’s urea supply and 30% of the world’s ammonia supply pass through the Strait of Hormuz, both important sources of nitrogen. The jump in the price of oil is destroying the remaining economic vitality of the Middle Kingdom but the food situation may prove worse because Chinese agriculture is heavily dependent on fertilizer. Chinese farmers use 400% more chemical fertilizer than Western farms because 80 years of Communist agricultural policies has left the soil largely depleted and acidic. They also use 47% of the world’s total pesticide output on just 7% of the world’s arable land.
As an aside, Brazil is the world’s largest importer of fertilizer for their giant agribusiness sector, notably nitrogen, phosphate, and potash. The former rain forests are effectively devoid of nutrients and require heavy applications of fertilizer to grow corn and wheat.
Dollar
Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected – George Soros
Was Soros great at betting on the unexpected? Or was he so extraordinarily well-connected that he could bet on the unexpected knowing that it would soon be reality? Having close ties to global intelligence services does have its advantages.
Regardless of the truth of his prowess, money is made by taking the other side of an over-crowded trade. The short-dollar trade may be the biggest global trade of all-time. People talk about the collapse of the dollar like it’s a fact, not an opinion.
But what if the Iranian conflict is more than just eliminating nukes and destroying the mean old mullahs? What if it is a move to secure the US dollar as the primary reserve currency? What if the US Navy starts charging tolls in US dollars for passage through the Strait of Hormuz? What if the US takes Kharg Island and controls Iran’s export revenue? Demanding dollars for Iran’s oil?
Ships could pass through the Strait of Hormuz and pay a toll in US dollar stable coins for each passage, eliminating the necessity to pay Lloyd’s for shipping insurance. The City of London would HOWL over that prospect – perhaps it’s why the UK won’t help in the Persian Gulf. Perhaps they’re protecting their monopoly.
Control of Kharg Island would give the US control of Iran’s purse strings. Terrorists would stop getting funded and maybe, just maybe, capital could be invested in Iran for the benefit of Iranians.
The world would benefit because the risk premium that oscillates on Middle Eastern conflicts would be dramatically reduced. Furthermore, with the US controlling Iranian and Venezuelan oil, along with US output, the price of oil, perhaps the most important input cost of all, would stabilize. Just think of how beneficial it would be for the global economy if the price of oil became cheaper and less volatile.
Oil and Gas
It is hard to imagine a more stupid or more dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong – Thomas Sowell
The demand for oil and natural gas is falling thanks to its current high price – that’s just common sense. In the short run, gasoline has a low elasticity of demand but the same can’t be said for plastic. Chinese plastic extrusion companies are experiencing a sharp decline in orders thanks to the high price of oil and natural gas. Every day the Strait of Hormuz is closed is another day of demand destruction. For an over-levered global economy, demand destruction represents an existential crisis.
European leaders and Chinese leaders seem to have strong influence on Iranian leadership. This is especially true of the UK where Iranian leadership has heavily invested their personal assets. So why haven’t Keir Starmer, Xi Jinping, and others called for Iran to comply? The people of Europe and China are getting hammered by this conflict.
The answer is that Western Europe and China would lose significant power and wealth if Iran cedes to Trump’s demands. If China pays for oil with dollars, they will quickly burn through their currency reserves and the yuan would crater. Europe will become irrelevant. This is the real fight; Iran is just a proxy.
Trump has a window of time before he needs to produce results in front of the mid-term elections. I think the result is going to be a sharp drop in the price of oil and natural gas because I believe the US is going to succeed in the Persian Gulf.
Every day the blockade continues, inventories build on Kharg Island and the entire oil supply system in Iran backfills. They don’t have the benefit of time because they are running out of available inventory capacity. The next step will be the shut-in wells which means those wells will need to be re-drilled in the future. Without the export channel, Iran is drowning in its own oil.
Kharg Island
All the armies of Europe, Asia, and Africa combined, with all the treasure of earth (our own excepted) in their military chest, with a Bonaparte for a commander, could not by force, take a drink from the Ohio, or make a track on the Blue Ridge, in a trial of a thousand years – Abraham Lincoln
After a laundry fire and a brief rest in port, the USS Ford is back in the Red Sea. The Abraham Lincoln remains in the Arabian Sea and now the George Herbert Walker Bush is sailing north of Madagascar toward the Arabian Sea. Three supercarriers in one neighborhood is a scary development more so when you consider that roughly 500 US Air Force planes are in theater. In addition, the Bush is armed with a laser drone destroyer.
The USS Tripoli is an amphibious attack carrier with two amphibious transport docks in its task force. This task force carries somewhere around 5,000 US Marines trained for amphibious landings. At the same time, the USS Boxer is off the western coast of Palawan with another two amphibious transport docks carrying 5,000 Marines. I expect they will be used to secure Kharg Island and others in the Persian Gulf.
Before these ships can transit the Strait of Hormuz, the Strait must be cleared of mines and that’s taking place today. This is why the President has the luxury of time to keep the blockade in place even as Europe, China, and Australia struggle with dwindling reserves of oil and jet fuel. The US is building forces in the region while Iran suffers.
Pirate ships were built for stealth and invisibility. They filed no manifests with any agency or government. When they went missing or sunk, nobody went looking for them. They simply disappeared into the ether – Robert Kurson
The US has started boarding Iran’s “shadow fleet”, believed to be 500 ships, mostly tankers, that allow them to avoid sanctions and trade with China and others. In recent days, the US has boarded tankers off Sri Lanka, Malaysia, and Indonesia. These moves have the potential to be a game-changer in the conflict with Iran because it will prevent them from monetizing their oil while preventing Iran from importing weaponry.
On April 19th, the USS Spruance blew a hole in the engine room of the MV Touska, a giant cargo ship believed to be carrying primary chemicals from China for making rocket propellant. It may also have been carrying electronics that can be used for martial applications. It appears the US Navy caught China red-handed.
Further interdictions could prove highly embarrassing for China, risking massive tariffs in response, even restrictions on international banking transactions. China is in a bad place because Iran supplies 12% of their oil needs.
Iran and China have been ignoring US sanctions for years even as these restrictions have created opportunities for our so-called “friends” in Europe to extract rent from this illicit trade. You don’t move 500 ships around the world’s oceans, particularly through the Straits of Malacca, without everyone knowing it.
Laundering the cash flow of the shadow fleet has been a boon to banks around the world, especially banks in Turkey and Dubai, but no longer. The UAE is seeking US dollar swap lines with the US because the conflict has cut oil cash flows.
Without the revenue generated by the shadow fleet, Iran is helpless and the global banks siphoning off that revenue become insolvent thus the need for dollar swap lines. This isn’t 2008 where the Federal Reserve effectively bailed out the world with dollar swap lines with central banks. The Trump Administration is destroying the life-blood of the Western banking system. Power is moving from Dubai and Singapore to Houston, which is becoming the center of the global energy market.
Conclusion
Let us recollect that peace or war will not always be left to our option; that however moderate or unambitious we may be, we cannot count upon the moderation, or hope to extinguish the ambition of others – Alexander Hamilton
We only get to see the men behind the curtain when they attempt to reach too far and expose themselves. Once the enemy is known, we can look backwards and see their fingerprints on the events that brought us to the present. Such is the impact of the financial entities that have dominated Europe for centuries and whose reign appears to be at an end.
In their arrogance, they left themselves vulnerable to financial destruction in the Caribbean, Persian Gulf, China, and the cartels of South America. Once oil revenues are wrested from this cabal, Western Europe will face a massive social, financial, economic, and military restructuring that could last decades.
This will prove to be apocalyptic for the beneficiaries of the global central bank model of the past 125 years and opportunistic for people who can operate on a decentralized frontier. The pause in the Persian Gulf conflict is temporary until the conditions have been set for the last phase – control by the US Navy.
The crowd that believes in the dollar’s decline and rising inflation are going to be met with deflation and disinflation. The price of oil, natural gas, and food is going to fall – at least in the US. If it happens before the mid-terms, we can safely start discounting the return of the American System in 2027.
The financialization cycle is over after 125 years. The future is about re-building a destroyed industrial base, not about trading crypto and Mag 7 stocks. If you’re interested in learning more, visit us at https://geovestadvisors.com/ and drop us a line.
Philip M. Byrne, CFA