As if anything else couldn’t go wrong.
North Korea proclaims it has the hydrogen bomb.
China’s stock market falls back into the abyss, taking the U.S. with it, prompting Beijing to devalue the yuan to forestall the deflation of asset prices and even engage in wholesale purchases of stocks.
The rationale for devaluation is because China cannot create more foreign reserves. To do quantitative easing in China, where the yuan is pegged to the dollar, it needs more dollars — but it cannot print those. So, all that can be done internally is to increase the number of yuan for every dollar to create more internal liquidity. This is to combat asset price depreciation, but those price drops are already happening anyway. The question is of magnitude.
International trade is grinding to a halt with the Baltic Dry Index falling and other manufacturing surveys going negative, as well as an overall decline in both U.S. exports and imports in 2015, an extremely bearish indicator.
Oil keeps getting hammered, approaching $32 a barrel amid weak global demand.
Add to that hot mess now fresh tensions between majority Sunni Arab Saudi Arabia and Iran, a majority of which is Shia Persian. Besides the obvious sectarian clash between the two sects of Islam are even wider geopolitical implications.
It began with the execution of the Shia cleric Nimr al Nimr on charges of disobeying the government, firing on security forces and inciting sectarian strife. Next thing you know, Iranians are sacking the Saudi embassy in Tehran, diplomatic ties between the nations are severed, and the situation escalates dramatically with the Saudi airstrike at or near the Iranian embassy in Yemen.
Yikes. And it’s not even February yet.
Fortunately, the Saudi defense minister has thrown some cold water on the prospect of a direct armed conflict between Iran and Saudi Arabia, telling the Economist on Jan. 6, “[War] is something that we do not foresee at all, and whoever is pushing towards that is somebody who is not in their right mind. Because a war between Saudi Arabia and Iran is the beginning of a major catastrophe in the region, and it will reflect very strongly on the rest of the world. For sure we will not allow any such thing.”
So, cooler minds may prevail in the end. Still, it reminds the world of just how fragile the situation in the Middle East is, and just how scary war between Iran and Saudi Arabia could really be.
For starters, Saudi Arabia is a U.S. ally. Iran on the other hand is a satellite of China and Russia. Critically, China depends in part on Iran for oil.
Add to the mix, for 40 years, the petrodollar — that is, Saudi Arabia’s commitment to trade oil in dollars — has underpinned demand for U.S. treasuries and other dollar-denominated assets worldwide.
To help resolve to the 1973 oil shock, Richard Nixon convinced Saudi Arabia to only accept dollars for payment of oil in return for protecting their oil fields and a guaranteed return on investments in U.S. treasuries. The petrodollar was born.
This was the move that solidified the dollar’s reserve currency status, since surplus dollars were required by nations on hand in order to purchase the most important commodity in the global economy.
It is also may be one thing that has helped to push down U.S. interest rates overall for the past 30 years, and been the basis for the world’s current credit-driven financial system.
But, take away the mechanism for settling international trade in U.S. dollars, and suddenly, the relative economic stability currently afforded by the petrodollar evaporates. The anchor that helps keeps U.S. treasuries yields so low might suddenly no longer there, too.
Defending Saudi oil fields from invasion in that context, then, is not merely about propping up the monarchy there but to protect one of the very vital currents of U.S. financial dominance and the global economy more broadly.
Instability in that region, particular to the government of Saudi Arabia being under threat by Tehran, therefore is something to be avoided like the plague.
But it gets worse.
What if the U.S. commitment to Saudi Arabia is actually in question?
Take the Iran nuclear deal, which risks prompting a nuclear arms race in the region. The day it was announced Saudi diplomats were already saying that the deal green lights initiating their own nuclear programs as a counter balance to Tehran.
It is into this already volatile mix that now White House Press Secretary Josh Earnest blasted the Saudis for the execution of the Shia cleric. “This is a concern that we raised with the Saudis in advance, and unfortunately, the concerns that we expressed to the Saudis have precipitated the kinds of consequences that we were concerned about,” said Earnest.
Right off the bat, the U.S. position was to assert blame for what could be war on the U.S. ally in Riyadh.
Raising the obvious question, who would Obama back in Saudi-Iranian War? Longer history suggests the U.S. would back Saudi Arabia without question, but the shorter history, with Obama and his new nuclear agreement with Iran, which directly challenges Saudi Arabia, plus the shunning of other traditional U.S. allies like Israel over the same issue, could demonstrate that a new if only temporary paradigm has emerged.
In the meantime, you have a situation where Russian warplanes are apparently flying into NATO airspace, prompting strikes by Turkey. Ukraine is another powder keg, with the U.S. and Russia backing opposite sides of what has already been a very bloody civil war.
This is a pretty bad situation. And much of it has happened or escalated in the past month alone while you were all distracted by the holidays and football games.
Time to wake up.
We could be on the cusp of another catastrophe akin to 1914. The backdrop is profound economic weakness and financial collapse in some quarters, and entangling alliances akin to those that brought the Triple Entente and the Central Powers to arms a century ago.
Many of the forces as of this writing are operating in very close proximity around the ongoing wars in Syria, Iraq and Yemen. And then across the world China is in full correction and now its oil supply in Iran may be threatened by war.
This is potentially a very dangerous situation. The economy is very weak and at the same exact time, if the powers that be cannot pull growth out of the current situation, they might end up pulling something else out entirely.
This is a guest post by Robert Romano senior editor of Americans for Limited Government.