The Seven Risks of the Iran War

The war in Iran is being treated by financial markets as a systemic event rather than a local conflict.

In this episode, Professor Harvey outlines a framework for understanding that distinction. He distinguishes between geographically contained wars and those that intersect with critical nodes of the global economy. Iran sits at the center of energy transit routes, regional trade networks, and broader strategic relationships, making the potential spillovers materially different from more isolated historical conflicts.

He identifies several layers of uncertainty shaping market behavior: renewed inflation risk from disrupted oil flows through the Strait of Hormuz, the economic interdependence of surrounding countries, questions about whether other major powers could alter their posture in response, the duration of the conflict, the stability of political transition, and the fiscal capacity of the United States to sustain prolonged engagement given elevated debt and deficits.

Transcript

SPEAKER_00 0:00

I'd like to welcome everyone back to another episode of Cam Harvey's Through the Noise. And let's just get right into it. This week, I think everyone has been paying attention to what is going on in Iran. Certainly the markets have been paying attention. They've been up, they've been down, down mostly. And yet we live in a world that has conflicts all over the place. And we've lived with a world with conflicts as far as I can remember. So why are we paying so much attention to the war in Iran? Well, obviously we're paying attention because we're at war.

SPEAKER_01 0:38

But I think it's really important to realize that every war is different, every crisis is different. And there are certain categories that we could use to try to think about the implications. And one useful way to categorize is just how local the conflict actually is. So think about the war in Afghanistan. That was local. It wasn't disrupting the world economy in any way. Maybe it disrupted poppy production. And contrast that with Iran, which is much more connected with the rest of the world. So we've got global implications. So I think that that is a key difference, and that's certainly why markets are taking this war much more seriously than, for example, what happened in Afghanistan.

SPEAKER_00 1:35

Okay. Do you have any examples of the kind of risks? Why, in particular, is Iran so well positioned to be a big player in the world economy?

SPEAKER_01 1:45

Yeah, so I I think of kind of a categorization of different uncertainties that exist here. So let me go through some ideas, some of which are obvious, as to why this is very important for the world economy and for financial markets. So number one, um one uncertainty is the risk that inflation is rekindled. So 20% of the world's oil goes through the Stratoharmoose. And that's stopped right now. That's the reason that the price of oil has spiked. And inflation is very important in terms of the economy. It's also very important politically. So higher inflation is bad news. So even though the U.S. is relatively self-sufficient in oil, that doesn't mean that the prices remain the same. It's a global commodity. So prices actually go up. And again, I contrast this with Afghanistan, which was local, even Vietnam, even though that was a long and painful war, it was relatively isolated, not a major player in terms of world trade. So just having a cluster of important countries in this area has negative implications. Number three, there's uncertainty about China. So China's not involved in this directly, but could they be indirectly? And in particular, does the U.S. operating in this theater in the Middle East create an opportunity for China to expand territorially, knowing that it would be very difficult for the U.S. to fight in two theaters. So number four, in terms of uncertainty, is the length of the war. So markets like short, surgical sort of strikes, a short war, the example of the 12-day strike previously on Iran is an exemplar for that. So any uncertainty about the length is really a big deal. So if the expectations move to a longer war, then that is negative news for the market. Number five uncertainty has to do with regime change. So the previous regime is gone, and there's uncertainty about the new regime. So it is possible that the new regime creates more problems than the previous regime. So that's yet another level of uncertainty. Number six is in the background, it's not well discussed, but I want to put it on the table. And that is is the US in a financial position to conduct a longer-term conflict. The US has a$38 trillion debt. The fiscal deficit is$1.9 trillion a year. That is not a position of strength, and we know that war is expensive. So a shorter-term war is much preferred because it's cheaper. But if this goes longer, that creates strain on the financial health of the U.S., which already is burdened with a very significant debt, more than the GDP of the U.S. And I guess the last piece of uncertainty is subtle but important. This is not the U.S.'s first expedition to the Middle East. And there are questions as to whether the U.S. has learned the lessons of previous engagements in the Middle East. And I think that also creates some risk.

SPEAKER_00 6:30

Okay, so this is like a nesting doll of risks. We just go layer by layer by layer by layer. And the markets are reacting. But how certain are people about these risks?

SPEAKER_01 6:44

Okay, I like this. So really what you're talking about is something I've thought deeply about. And this is the idea of the uncertainty of uncertainty. So let me unpack that just a little bit. So you might have uh a measure of risk, and it goes from zero to a hundred, uh, where zero is like no risk, nirvana, and a hundred is thermonuclear war. So you might have a measure, and let's say it's 65. And and you're pretty confident uh about that. So maybe it's 67, maybe it's 63, it's in it's in a narrow range. But in another scenario, you might be less certain about what the risks actually are. So maybe it's 65, but it could spike the 90. And I think this particular conflict is like that. So imagine how risk would explode if China uses this to their advantage. So there's a lot of uncertainty or ambiguity about the risk. And of course, financial markets do not like risk. So when risk spikes, that means that there's less investment. So companies hold off on major projects until the uncertainty is resolved. And investment is a driver of GDP growth. So that negatively impacts the cash flows of companies, and especially so if this is a longer-term conflict. And risk also affects the time value of money. So we value stocks and other assets in terms of the value today of those future cash flows. And if risk increases, then the risk premium will increase. People demand a higher rate of return. And the only way that they can get that is if asset prices drop. And if there is a spike in risk, that drop could be a plummet. So it's really important to take the risk into account, and as I also mentioned, just the uh the uncertainty about the uncertainty.

SPEAKER_00 9:11

Thank you so much for these uh these thoughts that are really pertinent today and also tie to um things you've been thinking about for a long time. Thank you very much. Thank you.