Pricing the Iran War's Future — Are Markets Right?

20:47Ed Elson:And, you know, to the extent that markets do spook Donald Trump, and, you know, as Justin was saying, you know, some of the US indices are some of the least affected by this, so it's possibly not the best way to read it. The oil price was deeply problematic for Trump and his administration. So we saw the oil price Brent shot to about$120 a barrel as the market opened on Monday, right before the FT reported that G7 authorities were looking to release strategic oil reserves to try and hose the price down a little bit. But all of a sudden, U.S. gasoline prices are up 16 % in a week. You're looking at$3.48 average for a gallon of gasoline in the States.

21:29Ed Elson:You know, you guys don't need me to tell you that the U.S. consumers, U.S. voters are hyper-focused on the gasoline price. And there did come a point where it looked like this is something that hadn't been baked into the calculations of what the authorities would, of what the US and Iran were doing, US and Israel were doing in Iran. How they haven't borne that into account, I don't know. But yes, if you effectively block off a pretty thin strip of sea that is used to transport 20 % of the world's oil, you've got a problem, you know, pretty obviously. And that came to bite the administration. And I think it was around that point that the oil really got into nosebleed territory.

22:11Ed Elson:That was where the administration thought we're going to have to soften our language here. And as Ed was saying, the language is either softer or harder, depending on whether you're listening to Trump or Hegseth. But the market has decided, and you can tell this judging from the decline in the oil price, the market has decided that the worst of this conflict has passed. Rightly or wrongly, I don't know.

22:30Katie Martin:Stay tuned for more of this panel after the break. And for even more markets insights, you can subscribe to my weekly newsletter, Simply Put, at simplyput.profgmedia.com.

22:52Katie Martin:As a chef, I know flavor doesn't begin in the kitchen. It begins on the land. And West Home's nature-led Australian Wagyu is a story written in the landscape of northern Australia.

23:05Justin Wolfers:Cooking is storytelling, and West Home Wagyu carries a story of northern Australia itself. Raw, powerful, and deeply authentic It's a testament to the passion and care

23:15Katie Martin:Raised in the rhythm of Northern Australia I'm Chef Maylin from ADA Club in Los Angeles And I invite you to visit Westhome.com slash Maylin to learn more And taste a story only Westhome Nature-led Australian Wagyu can tell That's W-E-S-T-H-O-L-M-E dot com Slash M-E-I-L-I-N Spring is here And there's a whole new way to chai at Starbucks that's made perfect for you. Choose your sweetness, dial it up, or keep things light. Add a touch of pistachio, a hint of strawberry, or vanilla, or make it a spring classic with lavender. Because this season, there's endless ways to chai at Starbucks. Thought sweet green was just salads?

24:00Katie Martin:Think again. There's a new way to do sweet green. Wrapped and ready, these handheld wraps pack bold flavor and 40 plus grams of protein into something hearty, satisfying, and built for life on the go. From craveable sauces to satisfying textures, they're designed to keep you going without slowing you down. So put that fork down. Try the new wraps today in app or at order.sweetgreen.com. Available at participating locations only.

24:33Katie Martin:we're back with our panelists to go back to justin's point of what the markets are doing for us they are our best attempt at understanding the future and so here we are trying to understand what do the markets think because maybe the markets know better than we do or at least that's the idea the trouble is when i look at what's happened with the markets this is a market that appears to be entirely reactive and not at all proactive. I mean, the way that prices seem to be spiking up and down, and even in my conversations with investors, I spoke with Steve Eisman, who's the legend of the big short, and I asked him, how does this change your investment strategy?

25:12Katie Martin:Does this change things for you? He said, it doesn't change my strategy by a single dollar. And that seems to be the consensus among many investors. And perhaps there's an argument that the US is insulated, this is going to affect other countries, it's not going to be a problem for us. I then look at, say, the oil price, and then I read about how much does the oil price affect the gasoline prices at the pump? What does that do to inflation? Could inflation go out of control? Does that mean stagflation? Does that mean we raise rates? Does that mean a recession? I'm going a little bit crazy thinking about the downstream effects, and I'm thinking this seems a lot more dangerous than a lot of investors and than that markets seem to think.

25:54Katie Martin:And now I've got a problem because I disagree with the markets who are supposed to be the smartest people in the room. So Justin, what do you make of this seeming message from the markets, which is it's not going to be a huge problem for America? Anytime any of us thinks we're smarter

26:15Justin Wolfers:and the big group of people with billions of dollars on the line. It's not impossible. We just want to be humble. Secondly, the fact that market prices are going up and down like crazy might sound like irrationality, and it would if we knew a lot about what was happening and the underlying state of play was stable. Yeah. So you knew when George W. Bush was president and he wanted to invade Iraq that news was changing. It might change his mind a little bit. We might go in earlier, later, longer, shorter. But we sort of knew what was happening. That's not where we – and so we had a baseline expectation and we're getting mildly interesting signals.

26:58Justin Wolfers:The thing about this president is, you know, the market rallied yesterday because they thought he had suddenly declared victory and was going to pack up and go home. Right. Which is unlike world leaders we've ever had before. I think it's actually possible he could do that. given that if you hear a rumor that he's about to declare success you probably should change your mind so i don't think the market in reacting in terms of large swings is being at all irrational and then so the ups and downs aren't irrational but i think ed your question was why isn't it down more yeah and here i want to tell you two stories that i think speak to that that i think are exactly on point.

27:39Justin Wolfers:So I was a young economist during the run-up to the Iraq war. The great thing about the Iraq war was it played out slowly. Powell would go to the UN, we'd get new information, Saddam would say boo, like all of that. And we were able to track, because there was prediction markets on whether the US would go to war, one of the very early prediction markets. We were able to track, I wrote this study back in real time back then, in a day or a week in which it became 10 % more likely the US would go to war in Iraq, the US stock market fell one and a half percentage points. And so from that, if you're one-tenth of a probability of a war moves the market one and a half points, that says the entire, the difference between going to war and not will be 10 times larger.

28:23Justin Wolfers:I think our conclusion was it would wipe 10 to 15%. The market was acting as if the market believed it would knock 10 to 15 % off the value of US stocks. Right. We weren't entirely energy independent back then, but we were well and truly on our way. So one thing to do is a case study here, which is the case study suggests the market seems less concerned about Iran than it was about Iraq by an entire order of magnitude. Mm-hmm. And I'm not sure I see the reason to be confident of that. Right. Second big lesson from Iraq is you remember Rumsfeld early on says this could take six days, maybe six weeks.

29:06Justin Wolfers:I doubt six months. And it took longer than six years. What that says is that early forecasts can be wronged by a factor of more than 365. So when Katie calls her friends on Wall Street and they say, here's what I think is going to happen, I think a rational thing to do is take their best guess and multiply by 365 and say, you know, this could happen too. Right. And I'm doing YouTube now, Ed, and tomorrow or maybe today, I don't know, I have to get around to making it. I've written a script. I have a piece coming out that looks at the history of wars. And it's almost always the case that when we go in, we go in thinking it'll be short, sharp and easy.

29:48Justin Wolfers:Yes. And it never is. and just as a question of economic theory, if two countries are going to war, given there'll eventually be some outcome and it would be more efficient for them just to go to that outcome and not kill young men and women on both sides first, that tells you that one of them must be overconfident. Yes. At least one. And so you should always be thinking, is it us? and if people are not thinking that, whether it's in Washington DC or Wall Street, then they should be. And that puts me a little bit in your camp, Ed. Yeah, maybe the central scenario is that things aren't so bad, but gee, I don't know.

30:31Justin Wolfers:There's lots of times we thought stuff would be easy and it turns out not to be. Exactly.

30:35Ed Elson:I mean, to be fair, everyone I've spoken to, whether they are, you know, bankers or investors or anyone in between, they have all had a good dose of humility around what's going on here. We don't know how this is going to pan out. And so various, you know, people have been sketching out various scenarios to me. One of them is that the oil price stays somewhere around the$80,$90 kind of mark where we are now. And that's probably something that the global economy can absorb without too many shocks. It complicates monetary policy rights. It makes life difficult for central bankers. It possibly does on the margins, keep inflation more elevated than it would otherwise be, but it's probably, you know, consumable.

31:12Ed Elson:We can cram this one down. What people say is not so easily consumable is if the oil price shoots to$150,$200 a barrel, particularly if that happens in a straight line. And we have quite poor visibility around how and whether that might happen, partly because I personally cannot discern what the president of the US is trying to achieve here. So it's a little bit difficult to kind of read what he would do and how far he would push this. Secondly, you know, one of the things that people have been saying around this apparent step back from the president over the past few days is, see, the oil price got higher, gasoline got more expensive, and taco, right?

31:53Ed Elson:Trump always chickens out. And he has kind of reeled back some of this language. The problem with that is Iran has agency here. And Iran is politically very unstable at the moment. It has a new leader. It's got, you know, presumably competing groups and competing interests. Any one of them can keep the Strait of Hormuz shut or virtually shut pretty much indefinitely. You know, it's not as if you pull up a shutter or put a sign across the Strait of Hormuz saying closed. You keep that straight closed by buzzing drones over it day and night. And Iran has got plenty of drones that it can do that with.

32:33Ed Elson:So regardless of what Trump wants to happen, he's not fully in control of this situation. You know, there are organizations in Iran that could keep that strait under pressure for a really long time. Just before I left the office to come home and do this here, there was a headline kicking around from an Iranian minister saying, no, this strait is closed and we will keep it closed and we've got the drones to keep it closed. So I think there is still a large amount of uncertainty around whether that strait is open for business. You might get the odd ship through, but we could end up with supply disruption here for a really long time.

33:10Ed Elson:So the nightmare scenario for central bankers, for finance ministers around the world, and honestly for investors, is that we do get$150 oil and it stays there. That's a different matter. That's a different situation to what we're in today. And it's difficult for investors to price in that possibility before it's actually happened. So I guess we should cut investors a little bit of slack. They can't price in completely fanciful situations. But it's not beyond the realms of possibility that we could get there, I think. Right.

33:40Katie Martin:And we can use our imagination about the downsides just as the markets decided to do when Citrini releases an article about what happens if AI, when we can play this game. So let's play this game. Justin, what if oil hits$150 a barrel, perhaps even$200 a barrel? What if this war isn't contained? What if it does continue along? What then?

34:04Justin Wolfers:So I think the other way of describing the point you just made is make a list of things that could go right, better than current expectations. Make a list of things that could go wrong, worse than current expectations. And it could be that I haven't taken Prozac in a while, but my list of things that could go wrong is much, much larger than my list of things that could go right. And Ed, one of the things I want to commend you on in your question, you led with oil, but oil's not the only pathway by which things go wrong. Right. I'm just spitballing here, but I have a feeling that having your hometown bombed to smithereens or having a local elementary school bombed could radicalize people.

34:44Justin Wolfers:I have a sense I've got I'm talking to two folks with accents so you guys can help me with this. In fact, I think the three of us should be called Accents Anonymous. We can take the show on the road. But my sense is folks in Europe are starting to rethink the idea that they're in a serious security pact with the United States. Yeah. I don't know how true that is. I'm not a foreign relations guy. But if that's true, that ups military spending in Europe and it has to up military spending in the United States as we have to provide the protection for ourselves that our European friends once gave us.

35:20Justin Wolfers:If you look at the big movements in public debt in any industrialized country, they all coincide with wars. So this could be a huge shock to public debt. It could be a shock to defense spending. You think about, you know, if we end up with troops on the ground, if people come home injured, maimed, killed. Those are, and I want to be clear here, expensive in every sense. Expensive in a human sense, but economics recognizes humanity. Also expensive in a fiscal sense, that Veterans Affairs looks after them for the rest of their lives. It could be that this is the next step in the Trump isolation dance, and America finds itself now one big step closer to autarky, which is a fancy dinner party word for cut off from everyone else, which would mean that the United States and North Korea were the world's two great isolated nations.

36:15Justin Wolfers:there's just so many things that could play out here and again most of them come off the the naughty list not the nice list that um you know and and they don't all run through oil and that's where i would be very nervous betting my family's future in financial markets given that

36:35Ed Elson:the counterpoint to that is you know just the past six years i have had some moments of serious trauma in financial markets. You know, we had COVID. We had the Liberation Day tariffs, which, you know, it's not even a year ago now. And it took like 20 % off US stocks. You know, it was a really violent move. They bounce back. They always bounce back. Markets are so much more resilient than we give them credit for. I think because the system has got safer since the financial crisis, because banks are safer beasts than they used to be, there are just a lot more safety nets kicking around in the system.

37:11Ed Elson:And we know what we've learned over the past six years and longer is that central banks are really good at putting out fires. They've absolutely got this licked. They know how to stop banks falling over. They know how to support bond markets. They know how to support economies. So whether that's complacency or not, I don't know. But you absolutely have to take your hat off to how resilient markets are. And I think there's a certain element of that coming through now where the calculation by investors is, yes, this situation is bad. Is it worse than shutting down the entire global trading network overnight like we did with COVID?

37:46Ed Elson:Probably not. All things equal. The other thing, you know, as Justin was saying, there is definitely a conversation in Europe about can we rely on the American security umbrella? That definitely means much more defence spending across Europe. And we're starting to see some of that kicking in, you know, from Germany and the UK and elsewhere. But one of the interesting things that a number of investors have brought up with me over the course of this week is that if you ever needed a big advert for the reason why spending on green technology makes sense and green energy, it is this. For some reason, we failed to do this at scale after Russia's full-scale invasion of Ukraine in 2022.

38:27Ed Elson:But this is just another thing bashing us over the head, saying we've got to be less reliant on fossil fuels. You know, if we ran the country on solar and we ran the country on wind, we simply wouldn't have this kind of vulnerability to anywhere near the same extent. So I do think this will be a shot in the arm for that. And on that front, Europe, you know, OK, some of the regulation may have been pulled back, you know, encouraging green technology, and that is problematic. But for a lot of investors, it never went away. No one utters the letters ESG anymore. No one talks about green and sustainable funds.

39:04Ed Elson:But in reality, that's what a lot of investors here are still doing. And it's about energy security. And I do think that when we come out of the other side of this mess, which I hope we do soon for a number of reasons, that I hope this is one of the things that we take away from it is that green technology is not a nice to have. It is a geostrategic imperative. serve.

39:26Justin Wolfers:Can I come as close to disagreeing with Katie as I will all day? Not about the second stuff. The second point you made there is about green technology. I agree. You said markets are resilient and we should expect that, it implied we should expect that to continue. Now, I think really what it is, is economies are resilient and markets are betting on the future of an economy. And so if we're thinking about regular economic shocks, even irregular ones, financial crises, COVID wars, I agree with you. Here's a different thought experiment. The question is, what are we learning in the current moment?

40:01Justin Wolfers:One thing we might be learning about is the president's determination in Iran. Another might be what's going on with world oil markets. But a far deeper one is, how far will the president go? How much of an autocrat is he? Is he willing to start a war because he feels like it, start a trade war based on a misunderstanding of his undergraduate days, take on central bank independence, destroy the federal bureaucracy. Are we going to see elections? Look, I understand how much of a nut job I sound like saying that. So I talk to very serious people. I say, is this a question that now belongs in polite society?

40:41Justin Wolfers:And the answer I get is yes. And so the question is, is he a big personality, but in the tradition of American presence? Or do we put him next to Orban? And do we put him next to Putin? Do we put him next to Turkey? Do we put him next to Argentina? Because if what we're learning about is how serious he is about the autocrat project, the autocrat project undoes the resilience of the economy. and here I just want to you know Turkey is a shadow of what it could be Hungary is a shadow of what it could be a hundred years ago Argentina was one of the richest handfuls of countries in the world the autocrat project came up they destroyed institutions and it struggled for a century since and I do think there's there may be a very real sense that what we're reacting to right now is not Iran as Iran but Iran is this is to oversimplify the case a mental health check a run as how far is the White House willing to go?

41:45Justin Wolfers:Because if we're willing to start a trade war and a war war, then, hey, Jingo, what are you forecasting for 27 and 28? Yeah, I do think I run hot and cold on this idea

41:56Ed Elson:that markets are a controlling factor on the president. You know, when we had the Liberation Day tariffs, the moment when he pulled back was when there was a slightly weak auction of relatively short-term U.S. government bonds. I have a hard time believing that he's keeping a very close eye on government bond auctions on a day-to-day basis. I have an easier time believing that he's keeping a close eye on oil prices and on the price of gasoline, with the midterms coming up in November. So I think he's playing with fire, and I think there's a genuine possibility that this runs away from his control and that he hasn't mentally accounted for what the retaliation from Iran could look like over the long term.

42:36Ed Elson:that there really is a genuine scenario potentially where oil goes to$150,$200 a barrow. But we're not there now. And I do think that one of the reasons we are not there right now is that he has taken a look at the price of gasoline and thought, this is a political liability for me. So in a way, it's the oil price that might save us from disaster here or from further disaster here. You know, maybe it will keep a bit of a check on him. But it is an incredibly dangerous situation. and investors currently are not positioned for disaster. They've taken a little bit of risk off the table and they've been a little bit cautious for 10 days or so.

43:14Ed Elson:They are not positioned for that hellscape where things do absolutely run out of control and we should be alive to that risk, but aware that it hasn't happened yet and the markets are very good at withstanding shocks.

43:27Katie Martin:Could I just ask you, Katie, before we end here, these investors who are less concerned about this and you brought up the point of market resilience, are they not concerned because markets have been historically resilient throughout the history of difficult experiences, difficult times, crises? Or is it that they believe that this war will be quick and dirty and over and Trump said it's basically complete and so it's over and so we don't have as much of a reason to worry anymore? The first one seems I can kind of get my head around. I still have a little bit of an issue with it. The second one, I don't believe at all.

44:07Ed Elson:I think it is a little bit of both. And I think the midterms are a very big controlling factor here. I think if we didn't have midterm elections coming up in November, then I do think we would potentially be in a different space. So, you know, look, I share your concerns that this could very easily run out of control and that the US and Israel have lit a fire that they cannot douse down. Very aware of that as a possibility. Right now, you know, today, the betting is that that won't happen. And we should hope that that remains the case. You know, investors, you know, the clues in the name, right, they are paid to be invested in markets, they are paid to take risks, they're not paid to be big scaredy cats and get out of everything that looks potentially risky, you know, at the first sign of trouble.

44:57Ed Elson:So it is a calculation for them, there is a very genuine risk that this gets out of hand, you know, for central bankers and investors and for, you know, real humans in developed economies and emerging economies. We're not at the worst case scenario yet. Doesn't mean we can't get there.

45:11Katie Martin:Okay. Justin Wolfers, Katie Martin, thank you both so much.

45:15Ed Elson:Pleasure.

45:16Katie Martin:Okay. That's it for today. We appreciate you joining us for another Profit Markets panel. If you have a guest you think we should speak to on this topic or any other topic, please drop us a line in the comments or email our producer Claire at markets at profgmedia.com we hope to hear from you that's it for today this episode was produced by Claire Miller and Alison Weiss edited by Joel Patterson and engineered by Benjamin Spencer our video editor is Brad Williams our research team is Dan Chalon Isabella Kinsel Chris Nodonoghue and Mia Silverio and our social producer is Jake McPherson thank you for listening to ProfG Markets from Prof G Media.

45:54Katie Martin:If you liked what you heard, give us a follow. I'm Ed Elson. I will see you tomorrow.