Doubling Down
We agree with President Trump that the Iranians have been troublemakers for the better part of 50 years, and that allowing them to obtain a nuclear weapon would be a serious mistake. We have also watched them lie and hide what they were doing contrary to prior agreements and therefore are not to be trusted.
However, we do think the President has significantly underestimated both the difficulty of securing the 800-1,000 pounds of 60% enriched uranium as well as the degree to which the Iranians have developed their own missile strike force – and the cost of eliminating it.
Since 1973 when the OPEC cartel first raised the oil price, we have often felt that the US has struggled to fully understand the complexities of the Middle East. That appears to be the case again. The President’s decision to go to war appears impulsive, made with little forethought or consultation with our allies, and without a clear exit strategy other than to think that if we blow everything sky high, we can expect surrender. The President thought the war would be over in a matter of weeks and did not bother to gain the support of his countrymen. He seems not to understand the hold the Iranian government has on its people, nor the incalculable damage he is doing to the reputation of the US as a reliable partner.
This war of sudden choice depends on the judgment that Iran presents a credible threat to not just its neighbors, but to the US. His objectives have been twofold: 1) Remove Iran as a credible threat to the US, Israel, and perhaps Europe by eradicating Iran’s ability to make and fire missiles; and 2) Locate and remove its store of some 800-1,000 pounds of 60% enriched uranium, enough to make 10+ nuclear bombs. To achieve the latter, the President is going to have to follow a scorched earth policy against not only military sites, but civilian ones as well – and to put boots on the ground to find and remove the uranium.
We want to be clear: we are sympathetic with President Trump’s objectives, but not his methodology as we have said so many times before.
Iran probably understands that economic pressure (“affordability”) is the key issue confronting the American people and that their strategy of blocking the Strait of Hormuz, if continued, is likely to be very painful for the rest of the world (except Russia, an ally, and Iran itself). While the US may be somewhat insulated relative to other regions, prolonged disruption will be painful, nonetheless, the longer the Strait is closed.
President Trump has told us the Iranians are begging the US for a deal. We think he “doth protest too much!” On the contrary, we think he, himself, wants a deal so bad he can taste it. Because of the affordability issue, he would like an off ramp, and soon. As a result, he is increasing the pressure on Iran by sending some 1,500 82nd Airborne troops and two Marine Expeditionary Force units of 2,500 men each. In addition, he is sending another 10,000 men for a total of 16,500 pairs of boots potentially on the ground. Of course, the US has combat units in various relatively close locations.
We forget that the Mullahs and the Islamic Revolutionary Guard Corps as well as the army are not going to put down their arms just because President Trump says so, and they are perhaps more inured to hardship than the US military. Ultimately, the US will probably win, but not without more troops than currently planned, and a scorched earth policy that would appall many of our citizens and allies. The US could win the military war but lose the political battle.
We suspect the strategy of Iran’s forces must be to make the war continue for as long as possible and to make the US and Israel pay as high a price – economically and in body bags – as possible. They know a ground war involving US forces may only delay the inevitable, but if Iran can withstand it long enough, it may win the political fight.
President Trump has a history of doubling down on his positions, and we expect he will do so again – along with the attendant consequences. Like him, we believe that Iran’s longstanding opposition to the US and Israel makes it difficult to trust its commitments. As a result, steps such as removing enriched uranium may prompt further escalation that might ultimately strengthen his political position.
Another benefit of taking control of Iran and its oil would be the leverage the US might gain over China. China gets most of its oil from Iran and were the US to gain control over Iranian exports, it might make the Chinese more dependent on Russian oil which is under sanctions. No doubt the President would try to use this lever against the Chinese to maintain flows of valuable rare earths. But it does give President Trump another significant reason to take the political risks.
We have written many times that we expect interest rates to remain higher for longer than most have expected. Now, we think that the oil price will be higher for longer as well.
The Cost of Doubling Down?
Higher global inflation
A larger US deficit
A contraction in US stocks and bonds
A greater decline in the President’s current political standing, or
An increase in his political standing!
The severity of these outcomes will depend largely on how long the war continues and the Strait of Hormuz remains blocked. We expect that it will be longer than another two to three weeks, especially if the President wants to remove the uranium from Iran’s control.
Having said this, the risk in our scenario is that the President completely walks away from the idea of capturing the enriched uranium. But he has no problem pursuing a scorched earth policy – regardless of whether it effects citizens or the military. If somehow, he can get the Iranians to give up their uranium voluntarily and to cease attacking ships in the Strait, then we might well see a reversal of the costs of doubling down above.
What to Do?
If the President does double down by putting boots on the ground before any surrender by the Iranians, it is advisable to have at least some cash or money market funds already in your portfolio to soften the impact of any market decline. In our case, whether we take the opportunity to add to clients’ equity holdings (because stocks will be on sale) depends on our assessment of the situation both at home and abroad. We might well lighten up on our oil holdings, taking profit before buying them back later after a substantial price decline.
If nothing else, the President is unpredictable – which is the way he likes it – and is powerfully motivated to survive the midterm elections. This may produce some other very surprising events. For the moment, we shall maintain our cash position but might (in a very few cases) increase our cash positions for safety. Stay tuned.
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