There are at least four very bad and mutually reinforcing effects an “event” in Saudi Arabia, any of the Gulf states, or even Iran, would have on the United States’ macroeconomy:

1. The price of oil would jump, because of both the immediate supply disruption and an upping of the risk-premium owing to the fear that turmoil may spread to other oil producers.
2. The United States’ trade deficit would sharply increase, driven by the cost of oil.
3. Financing of the United States’ trade deficit would be reduced, as the recycling of oil funds into “petrodollars” is interrupted in the affected state or states. Increased petrodollar flow from other oil states due to high oil prices might or might not take up some of the slack.
4. The US would face immediate, expensive security options, likely requiring the Administration to request large emergency funding packages, as for Hurricane Katrina and Iraq War. These would worsen both the Unied States fiscal and trade deficits.

In short, aside from the ugly politics and warfare, the nationalism and unrest that any Gulf state crisis would provoke, it’s hard to imagine anything more perfectly tuned to turn America’s worrisome but so far benign deficits into a debt-financing and balance-of-payments crisis. If such a scenario were to occur, a lot would depend upon the willingness of other states to underwrite some of the security costs and to step up to the plate in replacing lost petrodollar purchases of US assets. If China, Russia, Japan, Western Europe, and other Gulf states support the US position, and want the US to take its traditional lead role in security interventions, they could collectively ease much of the financial pain. If there is not strong support for America’s position during the crisis, surplus countries could worsen the pain by slowing purchases of US securities. (That the economies of these other countries would also be rocked by any American financing shortfall might not matter in the context of a “hot” geopolitical event.)

Note that the above scenario would largely hold for an Iran-related crisis. Iran is not a “petrodollar” country — they don’t peg their currency to the dollar or spend their oil wealth directly on US securities. But it is likely that much of Iran’s current account surplus indirectly finds its way to purchasing US debt. In the end, money from countries that save more than they consume or invest flows to the countries that consume and invest more than they save, even if that flow is indirect and intermediated. An interruption in flows from any major surplus country would affect the ease with which United States meets its huge need for external finance.

This entry was posted on Thursday, March 16th, 2006 at 5:02 pm PST.
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