No surprises to find that this month’s Letter from Lincoln is all about the economics of war, spreading out like an oil slick to pollute every other corner of the globe.
War is bad for business. Unless you’re producing weapons. But for everyone else war means disruption to supply lines, and higher energy prices, which all translates into increased costs, lower sales and unhappy customers as well as upsetting the fine calculations in how to compete with other suppliers. At the geo-economics level, this means the risk of inflation returning, and of higher interest rates and lower economic growth.
The Americans undoubtedly have military superiority but there is clearly a gap in their strategic thinking capability. They are fighting the wrong war – again – having failed to learn the lessons from the wars they lost in Vietnam and Afghanistan. They missed the memo from recent conflicts on the effectiveness of substituting cheap missiles and drones for conventional weapons. Nor did the Americans foresee the threat that Iran could bring to global logistics by effectively shutting down the gulf, and the geo-economic pressure that this would bring.
So far the Iranian strategy to spread the war as far as possible in the hope of causing global economic shocks to pressure the Americans has been remarkably successful. Oil prices have risen sharply, as has the price for gas, with warnings that this will push up inflation for many economies. Earlier this month Qatar’s energy minister Saad al-Kaabi told the Financial Times that all oil and gas production in the region could come to a halt, noting: “If this war continues for a few weeks, GDP growth around the world will be impacted.” He added: “Everybody’s energy price is going to go higher. There will be shortages of some products and there will be a chain reaction of factories that can’t supply.”
For now everyone is talking about oil, but there are other critical supplies such as fertiliser and helium that have been affected. Helium, for example, is used to produce semi-conductors, so a prolonged conflict will eventually hit the global chip supply.
There is no obvious end in sight. The American president Donald Trump has become used to his semi-literate social media postings causing foreign governments and market prices to change course. But this conflict with its real bombs and real deaths has revealed the emptiness at the heart of the Trump approach. The markets no longer jump as he expects, and his former allies have ignored his calls for help, exhausted by the economic tariff war and the gunboat diplomacy in Venezuela and Greenland.
Trump has offered various, barely credible reasons for starting this war but with no goals and no way to benchmark any success. His demands have fluctuated from total surrender to just letting him choose the next dictator. He has claimed the war is already won, but he’s going to carry on anyway or might just attack Cuba for the hell of it. However, it is not up to him. Both the Iranians and the Israelis may continue to fight, and the separate conflict in Lebanon is likely to continue. And although Trump may walk away and claim victory, in reality if the Iranian regime survives then its leaders will continue to pose a threat to both the Iranian people and to other nations.
Already, Trump has had to relax sanctions on both Iranian and Russian oil to ease the pressure on prices. And of course, the increased oil prices also mean more income for Russia, helping to alleviate the effect of sanctions on its economy and generally paying for its war against Ukraine.
Meanwhile other economies are suffering, particularly those with less resilence to energy shocks such as Pakistan which has implemented a four-day working week for government employees. In Europe, Slovenia became the first EU country to introduce fuel rationing earlier this month. The Irish government has cut its excise duties on fuel, knocking 20 cent off a litre of diesel and 15 cent off a litre of petrol. The International Energy Agency has suggested that people should work more from home and drive at slower speeds.
The latest UK figures show that inflation remained at 3 percent for January and February, largely helped by relatively low oil prices but offset in February by rising clothing and footwear costs. However, petrol prices averaged 131p per litre in February and have now risen to 149p per litre, with inflation predicted to hit 3.5 percent this summer.
The former Conservative chancellor Jeremy Hunt noted that the Treasury’s assumption was that “a 20 percent increase in energy prices meant 1 percent more on inflation and 0.5 percent less on growth.” Not surprisingly, the Bank of England opted to hold the base rate at 3.75 percent this month despite the previous expectation of a rate cut. Most analysts think that further interest rate cuts this year are unlikely, with some including Catherine Mann, who sits on the Bank’s monetary policy committee, saying there could be a rise in the base rate before the end of the year. Naturally, mortgage rates have already started rising.
The shadow chancellor Mel Stride accused the government of having left Britain exposed to such energy price rises but in reality decisions made by the previous Conservative government have not helped. The only way for any nation to sidestep the volatility of the energy market is to invest in renewable energy to have more control over its own power supplies. Changes made to planning law under the last government made it harder to install new renewables, particularly on-shore wind farms.
The war in the Middle East has also exposed the chronic underfunding of Britain’s armed forces, despite the government’s efforts to funnel more money into defence. This necessity is another gift from the US, with Trump having repeatedly questioned whether or not America would honour its NATO commitments, effectively leaving Europe defenceless. Despite recent increases in spending, Britain is not re-arming but simply slowing the pace of the disarmament that automatically results from not maintaining the existing weapons systems.
Nowhere is this more obvious than the six Type 45 destroyers that carry the UK’s primary anti-drone and anti-missile systems. Three of these are meant to be available for duty and three in maintenance. But in reality all six were stuck in varying degrees of maintenance at the beginning of the month due to budget cuts. The Navy accelerated the re-fit for HMS Dragon in order to provide anti-missile defence for Cyprus. Meanwhile, another Type 45, HMS Duncan, which will be tasked with defence of the realm, is still to complete its maintenance. So it follows that actual rearmament will require much greater spending, and over a longer period of time than has so far been budgeted for.
If the strait of Hormuz opens relatively soon and the oil prices and supply lines stabilise within a few months, then this gap in defence spending may turn out to be the biggest long term issue. And if the disruption to gulf shipping persists for a longer period, the need to plug that defence gap will become even more urgent, placing a further burden on the UK economy.
Nessan Cleary 
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