00:00:00.000Hello and welcome to another episode of RealPolitik. I am your host Firas Maudad and I'm joined today
00:00:18.780by Dan and we're going to be talking a little bit about the economic impact of the war. I know
00:00:25.720you've done some great work about this shall we start with a brief recap as to yes please
00:00:31.240i'd like the i'd like the update as well yes okay so uh the first thing that i want us to look at
00:00:37.840is the iranian rate of missile fire and drone fire and it seems to have stabilized they seem
00:00:47.160to be able to fire as many missiles as they want to they've moved from the very high intensity
00:00:53.520phase in the first couple of days of the war to a sort of sustained engagement rate and so you see
00:01:00.240some days it drops to 50 other days it goes to 63 but this is the moving three-day average and you
00:01:06.740see some stability there you know they're doing enough to keep the united states busy
00:01:13.000and to deplete missile interceptors and so on can i ask a question on behalf of the audience on that
00:01:19.000one yes i mean i i appreciate that it's quite high at the beginning and presumably that's because
00:01:24.060you have those targets that you really want to hit yes on day one and then everything else is
00:01:29.340by definition a lower a lower tier target because you otherwise you would have hit it on day one
00:01:33.300yes but is is the rate that they're doing now presumably the rate that they think they can
00:01:38.120sustain over the long term which could be many many months owing to the fact that they got an
00:01:43.820open supply line to Russia and Kazakhstan and therefore they feel confident that they can just
00:01:49.180maintain this consistently. Yes and but there's another element to it which is that if you looked
00:01:55.220at the Houthi war versus Saudi Arabia 2015 to 2022-23 the Houthis kicked off with a huge number
00:02:03.820of or with a decent number of ballistic missiles then these tapered off and were replaced with
00:02:08.560cruise missiles so they can diversify their firing depending on need because the cruise missiles
00:02:16.120are actually harder to detect intercept etc so they could fire more of those so you could see
00:02:23.760a similar shift in the iranian approach right okay and trump is threatening to blow up everything
00:02:31.000important in iran and the iranians are threatening to do the same uh basically blow up everything in
00:02:37.620the region uh relating to oil and gas and desalination and things like that uh the
00:02:44.140interception rate of missile strikes is falling and so the israelis are able to intercept less
00:02:52.660of iran's missiles even though they're firing a much smaller number and that's so i'm saying
00:02:59.500that right so they started off being able to intercept 95 it fell to 75 now it's about half
00:03:05.500they're intercepting yes well that doesn't sound good for them no no and so the iranian strategy
00:03:12.080is to sort of wear down the interceptors and then maybe they escalate maybe they fire new
00:03:17.760kinds of ordinance etc well the story that i had heard early on and i don't know if this is just
00:03:23.160a story or what but that they were using up the old stock of missiles initially and the newer
00:03:30.000stuff hasn't been touched so i don't know whether that is just psychological warfare on the iranians
00:03:34.880behalf or whether they're holding back this newer stuff if it exists to fire the americans at the
00:03:40.860point where they try and land troops so they are using some of the newer stuff now and in some
00:03:46.760videos you see the missile sort of accelerating as the interceptors come towards it because it's
00:03:53.220equipped with a second engine that gives it a boost so this is where the first engine gets you
00:03:58.320into the hyperbolic arc and then as you come down the second stage fires it's got two engines
00:04:03.260and that one is to is to outfox the yes the interceptors yes okay yes and so you need to
00:04:11.260fire fewer of those to have an impact well and you need to fire more interceptors if you want
00:04:16.340to take it down they need to fire more interceptors at it and what they're doing is sort of wearing
00:04:20.860down the interceptors and what we've seen is that the iranians have obviously threatened to blow up
00:04:27.060everything important in the gulf like desalination and power and things like that they're also
00:04:32.020hitting some of the energy in a more sustained way. That's a different story here. But what we
00:04:40.540are seeing is that they're hitting the pipeline in the UAE that goes from, that bypasses the
00:04:49.400Strait of Hormuz, that goes from Abu Dhabi to Fujairah, meaning that they can do the same to
00:04:54.640the Saudi pipeline, which the world is increasingly relying on because now it's operating at full
00:04:59.920capacity seven million barrels of oil per day okay and the other one that down the one that
00:05:05.940just cuts out the straight that's like three one one and a half million okay one and a half okay
00:05:10.780so that's a fairly minor one and they've already hit it and they've already hit it and in the past
00:05:15.100in 2019 the houthi hit that other saudi one meaning that they could easily do it and now
00:05:21.280they've joined the war but they haven't yet shut down hormuz uh sorry babel mandab the red sea
00:05:26.900And so we're in the situation now where if the Americans exit the war tomorrow, it means that the Iranians control the Strait of Hormuz and the Houthi control Bab al-Mandab, meaning that the United States is no longer the guarantor of the security of global trade, meaning that there is no reason to use the American dollar as a result of that.
00:05:54.420so they guarantee open shipping lanes yeah they make everyone use the dollar that relationship
00:06:00.280breaks down one way it breaks down the other yeah i mean i'd push back to a small extent because
00:06:05.020i mean certainly the reason we started using the dollar globally in the first place was was because
00:06:08.940of shipping lanes and then it became entrenched through the um petrodollar by saying to the house
00:06:14.900we keep you in power forever if you sell um energy in in dollars i mean it has evolved to an extent
00:06:22.160because now there is such a depth of liquidity in the dollar market
00:06:25.820that that is probably the primary reason why you use it.
00:06:32.880However, just because it's grown to that point
00:06:35.300and it has that depth of liquidity and it's a sort of trusted market
00:06:38.240and all the rails have been built around it,
00:06:40.300if you go around removing the underlying cause for it in the first place,
00:06:45.380there's nothing to stop a new currency coming along
00:07:23.100Which was just, I mean, it was just the Americans before.
00:07:26.060So the whole purpose of American policy in the Middle East outside of Israel was to make sure that no singular player controlled all of that energy.
00:07:36.760And so if the Iranians control both passageways, both waterways, they are de facto that energy hegemon.
00:07:45.180And that means that between them and Russia, they set the oil price for the world as part of OPEC+.
00:07:51.120And all of the other Arab players from Iraq all the way through Kuwait, Saudi, UAE, Oman, they have to listen to what Russia and Iran decide, essentially.
00:08:08.860So this has shifted the objectives of the war fundamentally and made its impact a lot bigger.
00:08:19.400I mean I wasn't entirely clear what the objectives were at the beginning but best I can tell the
00:08:25.120objectives now are to avert us to back where we were the day before the war yes yes and now they're
00:08:35.160going to send in ground troops and after they send in a small number of ground troops it's going to
00:08:39.660grow and then it grows and then it becomes who knows I mean the Iranians as you said uh the
00:08:48.160iranians don't have to win a single battle to actually win the war well this is the thing some
00:08:53.400of our american friends sometimes forget it's it's not that we're saying that we like the irgc of
00:08:57.480course we don't obviously and it's not that we're denying the fact that america has the strongest
00:09:02.560military but america had a significantly stronger military than the vietnamese and the americans in
00:09:07.820the vietnamese war uh won every single battle even during things like the tet offensive which
00:09:13.640were a massive coordinated strike really put pressure on the americans the americans still
00:09:18.580won every single battle vietnam won yes because the wind conditions were asymmetric and it was
00:09:25.640the same in afghanistan it was the same in iraq it was the same in algeria between the algerians
00:09:31.700and the french the wind conditions are different from who blows up most things and kills most
00:09:39.100people um and so this is the the new reality but sort of going to the economics of it all
00:09:47.980uh expectations of hikes across all central banks from germany united states bank of england and
00:10:01.540Japan. And it seems that as per the episode that you did on the economic impact of the war and
00:10:09.700brokonomics, we are getting to a stage where the interest rates are reaching an unsustainable
00:10:19.480position for countries like Britain, Japan, United States, and probably the EU. Could you
00:10:29.460yeah help us think about this a little bit better yeah i mean absolutely so look essentially that
00:10:36.420as these yields go up the cost of the government borrowing money goes up yes um of course these
00:10:44.180all of these i mean all of these governments here what have we got uk japan us and germany all of
00:10:48.780them have considerable borrowing yes um the the us uh i believe largest in absolute terms with the
00:10:54.640japanese uh relative to their economy um there was low expectation that any of this debt will
00:11:01.220ever be paid back but the core thing is rolling it yes whenever it comes up so depending on the
00:11:07.380the general blend of debt that you've got um you might be rolling it every five to five to ten years
00:11:13.500um bear in mind the last time that a lot of this stuff a lot of this debt was taken on would have
00:11:19.940been the covid crisis yes where um rates were fairly low and actually the the largest stock
00:11:26.480of it would have built up um in the in the post 2008 period when again rates were pushed to
00:11:31.860basically nothing yes so it made it very affordable for governments to have large debts because
00:11:37.040it doesn't matter how much debt you've got if you're paying zero percent on it it's it's not
00:11:41.840really your concern i mean you are you or i could have a trillion in debt if we're paying a zero
00:11:45.640zero percent rate on it um the problem is is when that rate starts to tick up from zero to you know
00:11:51.880one two three four and you keep going up now the the numbers that i sort of put on this is that
00:11:57.440the for example the us 10 year um they started below four percent um on this period um then
00:12:06.180they're now up they're just about to touch four and a half percent um why is that significant
00:12:13.380One, like I say, the U.S. need to spend considerably more money rolling over their debt, which means they have a lot less money to spend on everything else.
00:12:22.180It's now bigger than the Pentagon's budget.
00:14:23.260it's written into law um congress has passed bills saying that you will spend this much money
00:14:28.100on medicare for example or medicaid um and whole bunch of stuff in fact i think one of the few
00:14:33.100areas that they don't have written into law is the military spending yes which is the bit
00:14:36.940discretionary yes which is a bit they actually need now so um as as you as you push up on this
00:14:45.300you're necessarily constrained on doing everything else that they do so basically for every investment
00:14:50.980project that you consider it has to have a much higher rate of return yes every financial
00:14:56.800instrument that you want to buy every structure have a higher every other return yes all of the
00:15:02.560world the rest of the world's bonds have to have a higher return than the american treasury yield
00:15:08.920yes otherwise why would you take the risk and you would stay with the american bonds and how
00:15:15.040how do you make those how do you make those returns higher on something like a stock if if i
00:15:20.920was selling my stock and it had you know my discounted cash flow model suggested that you
00:15:25.240get a six percent return on this going into the future and my stock was valued at a thousand
00:15:29.900dollars per share and the rate was zero well now the rate's gone to five percent um there's only a
00:15:37.200one and a one point five percent risk premium so my stock has to go from a thousand down to a little
00:15:42.280over 500 yes in order that the rate of return on that stock is now getting back to that higher level
00:15:47.960yes um and so it drives by definition a stock market crash which drives a stock market crash
00:15:54.740yes and the second point i was making there is that because um uh because because these yields
00:16:01.740are being um compressed on the um on on on the government side um they they can't sell the notion
00:16:11.740but they're going to grow their way out of their debt pile because you know growth in um you know
00:16:18.700nominal growth you're gonna it's extremely hard to argue it's over five percent yes i mean i would
00:16:24.220argue it's a lot lower than that but you could at least make the argument that it's okay it's it's
00:16:28.380in the four to five percent range once you take inflation into account um once you go over five
00:16:33.660percent of the cost of debt there is no possible argument that you're growing your economy out of
00:16:39.420this debt trap you are quite clearly in a debt trap the debt is going to rise because the debt
00:16:45.020is rising at the coupon rate the rate the the demand on the bond yes and your economy is growing
00:16:50.680at whatever it's growing when one is clearly higher than the other well all that's telling
00:16:54.800you is is that in the future this debt number is going to go ever upwards meaning it's going to
00:17:00.880crowd out everything else you are in a debt trap that you can't get out of so the five percent in
00:17:04.980the u.s really does matter and of the 30 year they're already at it and on the 10 year where
00:17:09.740most of the borrowing lives you're four and a half right and so at the same time you have the
00:17:16.360japanese yields touching two percent and yields for britain touching nearing six percent and so
00:17:24.700this is a story that's repeated globally yes it isn't in fact just an american story it's a global
00:17:31.440story and you see the expectations there that okay you're going to have to raise interest rates now
00:17:37.080and that tanks all growth as a result but at the same time you're doing this while facing a
00:17:47.220um you're you're doing this while facing well obviously the rise in borrowing costs that we're
00:17:53.260talking about but a pretty much an explosion in natural gas prices yes obviously oil prices
00:18:03.180obviously uh fertilizer is shutting down because of the gas shortage and so you see india and
00:18:12.300bangladesh their fertilizer plants are either shutting down or partially shutting down
00:18:17.860and you are seeing that combination of food inflation and fuel inflation that also drags
00:18:27.420down growth and so raising interest rates now to control inflation
00:18:32.140sticks you in the debt trap at a time when people are facing real energy and food shortages
00:18:40.760yeah so so what i did in that previous that brokonomics episode um which actually i i filmed
00:18:45.880it a week ago but it's coming out tomorrow so people are actually watching this today before
00:18:49.100it comes out yeah um but you know i i picked 12 numbers which are kind of crucial for the system
00:18:54.340the um the u.s treasury 10-year um the uk 10-year the japanese bond now the interestingly the
00:19:02.160japanese have got a lower sensitivity at two percent there's reasons for that it's because
00:19:05.620they buy back their own debt yes and the uk is a little higher because we're used to slightly
00:19:09.200higher rates we don't get quite the privilege that the u.s gets um but then i went on to talk
00:19:13.660about um brent brent oil and and really the the benchmark there for when things start breaking is
00:19:19.960120 and the reason is is because up to 120 you kind of just absorb the price because it's within
00:19:27.340the normal range i mean maybe if you're sri lanka or something you're going to you're going to be in
00:19:31.660trouble but for most of the first world economy you're not you're not going to be in trouble at
00:19:34.640120 you're just going to have to compress your margins or whatever it is to get get there when
00:19:40.040you get over 120 you the the mechanism that's used in order to ration the the stock is going to be
00:19:47.680demand destruction yes and the higher you go over that so so the system will equalize there probably
00:19:53.560will be um for this foreseeable future for you know western countries there will be enough oil
00:19:59.120but it gets there by rendering so many things uneconomical that you have to you basically have
00:20:06.120to stop doing them that's what demand destruction means is is that the the ability to produce things
00:20:10.320you you simply turn them off because they're no longer viable basically if you have a chemicals
00:20:13.900plant or a car factory or whatever it is uh you can figure out a way when oil is in the 100 to
00:20:22.720120 uh dollar range but beyond that actually you're better off shutting down that chemicals
00:20:30.820plant or shutting down yeah it's a broad rule of thumb because of course every business will be
00:20:35.220different but but yeah certainly you're comfortable under 100 um you start to get uncomfortable over
00:20:40.360100 and 120 yeah you what you are you are just going ahead and shutting things down right um
00:20:45.720if you go much higher than that if you get into because i i hear that the british government from
00:20:50.460leaks that i've heard they're planning for a number of scenarios and the mid-range is that if
00:20:55.920this carries on much longer the oil is going to hit 150 and that is still the mid-range it could
00:21:01.260go as high as 200 yes now at that level um they're almost certainly going to have to step in
00:21:06.960yes and it's going to be things like four-day work weeks three-day work weeks yes um
00:21:12.740in fact we're already seeing it with some countries so
00:21:16.580i think pakistan egypt um pakistan thailand the philippines and now south korea is talking about
00:21:25.800doing some kind of lockdown and limiting people's ability to drive and things like that
00:21:31.040Yeah. So you're seeing the beginning of this kind of locking down people in place. But then what that also does is that, especially in the West, it places more people on benefits and it reduces the government's tax revenues, meaning that the debt trap actually accelerates.
00:21:50.340Because when you shut down a factory or when you announce some kind of energy lockdown and you're only going to be allowed to work if you're in an essential service, whatever that's defined as, well, what does that do?
00:22:04.820That means that a lot more people become unemployed.
00:22:07.900And so the government has to spend more on unemployment benefits.