THE STAGE IS SET FOR WAR WITH IRAN

James Rickards is a hedge fund manager in New York City and the author of Currency Wars: The Making of the Next Global Crisis from Portfolio/Penguin.

WHY WAR WITH IRAN IS LIKELY
By James Rickards

U.S. News
March 20, 2012

War with Iran hangs over global markets like the sword of Damocles. Markets are already fragile as a result of body blows suffered in 2007 to 2009 from the housing bubble, the Madoff fraud, the Lehman and AIG collapses, and the severity of the depression. Uncertainty reigns because of doubts about the sustainability of the recovery without continual doses of more zero-cost money from the Federal Reserve. The last thing capital markets need is an exogenous shock in the form of war in a critical part of the world, but that is exactly what is coming.

While many wars are well-planned acts of aggression, some of the most deadly are the result of miscalculations of the intentions of others. One example is the U.S. Civil War in which the South thought the North would not respond aggressively to provocations, and the North thought the South would not sustain its efforts for long. Both sides were tragically wrong. Likewise, World War I was expected to be over in a matter of months without serious escalation but was fought for four years with 30 million combatants killed, wounded, or permanently disabled.

In the case of the current confrontation between the United States and Iran on the subject of nuclear weapons development, the world is again hostage to the probability of a war among parties whose calculations are driven by misreadings of the intentions of their opponents. This analysis begins with some known factors and moves by inference into things far less well understood.

There is little doubt that Iran will be able to build and detonate a nuclear device in 2013 or sooner. There is no doubt that Israel will not tolerate such a device in the hands of the current Iranian regime because it poses an existential threat—the equivalent of a second Holocaust. It is also clear that both the United States and Israel have the military capability to disrupt and delay the development of the Iranian bomb for at least several years.

Given Iranian efforts to harden their nuclear facilities against attack, it is better to launch an attack sooner than later, subject to the readiness of the attack force and other logistical and weather related variables. Finally, the United States has repeatedly expressed a preference for a diplomatic solution to this impasse or, failing that, regime change in Tehran, which could cause Iran to halt its weapons development efforts. For a murky situation, this is a relatively long list of knowns from which one can begin to plumb the unknowns.

The first unknown is how long the United States will wait for diplomacy or regime change to work before deciding that military action is required. Until recently, there was some reason to believe that the cumulative shock effect of Iran's ejection from the global financial payments systems and the resulting currency collapse, sky-high interest rates, and surging inflation along with shortages of certain goods and an oil embargo would either destabilize the country or force them to the bargaining table. However, Iran seems to have weathered these disruptions well and its return to negotiations seems just another in a long list of delaying tactics.

The second unknown is how long Israel will wait for the United States to decide that military action is required. Israel would much prefer that the United States take the lead in any attack provided it is done in a timely way. However, Israel will act if the United States does not and the United States knows this. At the bottom of the Israeli relationship with the United States is distrust based on a fear that the United States is prepared to tolerate a nuclear Iran and is just talking tough to stay Israel's hand long enough for Iran to achieve a fait accompli.

The most important unknown is whether Iran itself is indifferent to being attacked and perhaps even welcomes it. Consider the following: Iran is explicit about its desire to destroy Israel. Iran has been consistently provocative in promoting Shia unrest against Sunni rulers in Saudi Arabia, Bahrain, and the United Arab Emirates. Iran has powerful proxy assets it can unleash against Israel and the Sunnis, and has terrorist sleeper cells from Paraguay to Minnesota and Manhattan.

Ancient Persia invented chess. Skillful chess players will sacrifice a high-ranking piece such as a bishop in order to capture a queen. The modern day equivalent would be for Iran to sacrifice its conventional navy, air force, and nuclear program in order to pose as the aggrieved party while it destabilizes the Gulf, assaults Israel, and terrorizes America. No one seriously proposes a full-scale invasion of Iran; therefore the regime will survive. Taken in full, Iran has much to lose but much more to gain. It is this version of an Iranian deep game that makes the war all but certain.

So the stage is set. Iran underestimates American resolve in the face of its nuclear ambitions. The United States underestimates Israeli impatience with American diplomacy. The United States and Israel both underestimate the fact that Iran's goal of Shia supremacy outranks its nuclear program in importance. It is Iran's own confidence in its asymmetric warfare capability including proxy wars and global terror that make it indifferent to attack.

The market impact of such a war is predictable—higher oil and gold prices, a stronger dollar, and higher stock prices as the Fed eases to offset the impact of higher oil. Markets have begun to price in some of these outcomes but only in a tentative way. The potential for enormous gains and losses as the market moves from partial to full realization that a tragic series of events is about to unfold will be the most important investment story of 2012.