Ceasefire Sort-Of Holding?

The world economy remains hostage to the war in the Middle East. Although the news flow remains extremely erratic, direct combat between Iran and the United States has been muted (although fighting was happening in Lebanon with Iranian proxies).

As I believe I noted before, one of my “hobbies” in university was reading up on international relations theory and diplomatic history. The current situation appears somewhat bizarre from the perspective of that theory. The usual story from the Realist perspective was that diplomacy since the Peace of Westphalia was determined by national interests. Since nations’ interests are determined by material facts, we do not need to enquire too deeply into the inner workings of countries to understand their international behaviour. We have reverted to an earlier mode of affairs, as many key governments are acting as neo-Royalist entities, where the interests of the ruling clique determine national policy. (Neo-Royalism has been the term recently floated by a few academics to explain the dynamics of the Trump administration.)

From the traditional perspective, the American intervention in Iran has been an unmitigated disaster for the American national interest. However, from the neo-Royalist perspective, the direct impact on President Trump and his colleagues has been muted so far.

The neo-Royalist perspective offers an explanation of how the United States can extricate itself from the war — since the national interest does not matter, walking away and leaving Iran in control of the Strait of Hormuz is not a concern. There are a few snags to the “chickening out” scenario.

1. The leadership of the Israeli government (as well as some Arab states) feels that it is in their interest to drag the United States into a wider war against Iran.

2. President Trump appears to be locked into his views from the 1980s, and has a strong fear of nuclear weapons. Ending Iran’s nuclear programme is therefore a personal concern.

3. He also first floated the idea of seizing Kharg Island in the 1980s, and the idea remains stuck in his head. Fighting wars to “take oil” represents the peak of his geopolitical thinking.

4. He dislikes the political ridicule associated with losing a war.

The common thread is that all of the analysis revolves around the personal situation of President Trump and his compatriots. Despite these negative factors, it appears that he understands that the conflict is disastrous for his Presidency, and therefore wants to get out. So long as American troops are not in direct contact with Iranians on the ground, the exit door is open and inviting. However, anything that leaves American troops in range of Iranian drones and missiles (which includes occupying the gulf islands) risks turning into a quagmire as troop casualties drive the logic of escalation.

(One possibility is that all the peace talks are just cover to give time for American troops to arrive in the theatre of operations. I believe that exit is still possible, but if the conflict expands, there will be an attempt to paint the situation as following a political plan that probably does not exist.)

The problem that the rest of the world faces is that there does not appear to be a mechanism to force a fast resolution. American energy markets remain orderly, so domestic pressure on the White House is limited. Problems in Asia and Africa with commodity prices are not a factor in their decision-making. The saving grace is that there are reports that ship traffic is starting to flow through Hormuz.

It will take months for the inflationary shock to work its way into economic data. We are going to see parts of logistical chains fail due to inadequate inputs, and they will then work their way downstream. Although neoclassical theory suggests that “expectations” should short-circuit the physical lags, the problem is that very few people know what to expect. To the extent that inflation can be driven by expectations, it needs to be a broad-based economic shock, like a collapse in the exchange rate.

It is also too early to have much insight into the reaction of central banks. It is very easy for central bankers to give tough rhetoric about not allowing inflationary psychology to sink in, actually hiking rates when an economy is imploding is harder to do.