War scenarios: Iran, oil embargo and the collapse of the world's financial system
by Maurizio d'Orlando
Fears are growing that the confrontation between Israel and Iran might escalate. An oil embargo might lead to the collapse of the world's financial system.

Milan (AsiaNews) – As the intensity of the war between Israel and Hezbollah grows, so does the number of victims on both sides. Syria and Iran are de facto in the conflict. The latter is under scrutiny for its nuclear programme so much so that various economic observers are wondering whether the Mideast conflict might not spread and lead to the destruction of Iran's nuclear plants.

Faced with pressures and criticism from the international community against its nuclear programme Iran has not hesitated from warning the world that if it is attacked it won't shy away from using oil as a weapon.

At first glance such threats appear unrealistic and with little deterrence value. Iran's share in oil exports is in fact relatively modest compared to total production and consumption in the world. Yet, if we take into consideration some issues that might cause mass mobilisation in the Islamic world there are risks that must be considered.

Oil at 200 dollars a barrel

If the Muhammad cartoons affair showed anything, it was the potential to mobilise Muslim masses on short notice. That controversy I think was probably a rehearsal, not unexpectedly carried out as the decision by the UN International Atomic Energy Agency to defer Iran's uranium enrichment programme to the UN Security Council got nearer.

Should the current Israel-Lebanon crisis involve others, there are people in Tehran who do not lack ideas and imagination to find some reason for mass mobilisation, especially in Muslim countries.

With strong internal public pressures, Muslim leaders are likely to be forced to join an eventual Iranian oil embargo. With the sudden loss of a third of all oil supplies, crude prices would probably jump by 3-400 per cent from the current long term average of US$ 60 a barrel.

Even at the historic heights of US$ 75-77, oil prices have so far remained within reasonable limits given today's political risks.

One reason may be that technical reasons have induced oil companies to trade in slightly lower prices and make money on the difference. But this small-scale trend might not survive serious jolts, i.e. Iran's use of oil as weapon. Should this happen, oil prices might shoot up to US$ 180-200 a barrel.

This would push up the prices of other raw materials, including food staples like grains. Agricultural prices could go through the roof, especially if people started to hoard ahead of a possible, even limited, nuclear confrontation. In turn this might result in harvests being affected by nuclear winter.

Financial system in crisis

The impact on the world's financial system would also be devastating. Rising prices for raw materials would inevitably generate inflation. The money supply or M3 (i.e. the quantity of money in the economy to purchase goods, services, and securities) levels are already at historic heights.

The US Federal Reserve has ceased publication of the US M3 monetary aggregate. The European central Bank is no longer paying attention to this parameter to prevent the US dollar from dropping too much vis-à-vis the euro. In Japan, the level of monetary supply has reached 260 per cent of GDP.

This suggests that the world economy might not be able to avoid Weimar-style hyperinflation or stratospheric interest rates that would snuff out the life of the real economy.

Manufacturing companies with listed shares might see their profitability drop like a stone as a result of the rapidly rising prices of raw material, pulling down stock values with them. The stability of the world's financial and monetary system would be jeopardised.

Several studies have already pointed to the structural weaknesses of the existing financial and monetary system. In the last few years we have witnessed the meltdown of the Russian, Asian and Argentine economies, the 'New Economy' bubble burst, and major corporations like Enron and Parmalat as well as smaller ones like Swissair go belly up.

In case of the Mideast confrontation escalating, what would happen to financial derivatives (described by some as the bubble of bubbles)? 'Derivates' are financial contracts whose value is derived from the performance of assets (such as commodities, shares or bonds), interest rates, exchange rates, or indices to hedge against extreme or long-term events.

Under normal circumstances, hedging against risks covered by derivatives carries little risk, so much so that some small Italian municipalities have invested in such atypical contracts. However, should the Mideast conflict widen, what is usually considered improbable by financial analysts might become real. The entire system might be put at risk if this happens, especially if we consider that according to the Basle-based Bank for International Settlements (or BIS), which operates as an international organisation of central banks, the total value of 'financial derivatives' is 50 times the world GDP.

A war against the West

Each war is different from the last one. Nowadays we need not think about nuclear war in terms of the adversary's total destruction as envisaged by cold war 'Doomsday' or 'Judgement Day' scenarios. A feasible war aim today might be undermining the financial and economic system of the West.

In the current crisis, the two contenders, Israel and Iran, seem certain that they are going to prevail over the other; Israel through US support, and Iran by mobilising Muslim public opinion as well harnessing support from  countries like Venezuela but also China and perhaps India which have reservations about the existing system or want to replace it with their own.

For this reason, Israel used the understandable indignation over the abduction of its two soldiers and then enemy rocket attacks, which are routine along the border, to carry out a pre-planned invasion.

For the same reason, Iran has taken advantage of every opportunity to provoke with its statements on the Holocaust and Israel's creation, or by financing the Iraqi insurgency and Hezbollah.

Both contenders seemingly want to precipitate things now. Israel knows that if it now loses the 'legitimacy' of its nuclear monopoly in the region, it would never regain it. Iran knows that only now it can wield the oil weapon and profit from the weakness of the financial system of the West. Above all, only now can Muslim masses be mobilised for nothing is certain about what the future has in store since Muslim countries are also changing.

Meanwhile oil traders are talking sotto voce about a hot confrontation between mid-September and early December, one that might even go nuclear. Let us hope that it is all barnyard chatter. Let us hope the world heeds the words of the pope. Let us hope, if nothing else, that the world will look out for its own self-interest.