Getting Serious

Pinchas Landau, The Jerusalem Post:

There is good news and bad news about Iran. Starting with the bad news, this is that Iran is a large country with considerable and rapidly growing resources, run by a gang of religious fanatics, who may or may not be irrational, but who definitely intend to obtain nuclear capability; certainly intend to use this capability to further their aims; and may be prepared to actually use the weapons that this capability entails.

The really bad news is that the Iranian President is not merely a raving anti-Semite, but actually means what he raves.

The good news is that the rest of the world is now taking Iran seriously and intends to at least try to prevent the Iranian leadership from realizing its nuclear ambitions. This much is fairly clear to anyone who follows international news.

In the narrower sphere of the financial sector, there is also good news and bad news about Iran. READ MORE

This time we'll start with the good news, which is essentially the same as that relating to the world at large: Analysts are finally beginning to take seriously the Iranian issue and the threats it involves to the global financial and economic system.

The bad news is that these analyses tend to the view that the less desirable scenarios are the more likely outcomes. The really bad news is that the scenario seen as most likely is the one in which Iran is able to achieve its goals without being attacked or even pressured to desist from its nuclear program.

Now let's consider the way the financial analysts see the Iranian crisis develop. As noted, they deal in scenarios and probabilities: There are three main scenarios, each of which has to be assigned a probability. They are

• a) that Iran bluffs its way through to completing its program;
• b) that Iran is attacked (by the US, Israel or a US-led coalition);
• c) that Iran accepts a deal whereby it receives nuclear fuel from outside, presumably Russia, but does not seek to produce it itself.
  

Defining the scenarios is the easy part, the real issue is what weight or probability to give to each scenario. Once that is done, you can make derivative assumptions about various key economic and financial factors, primarily the price of oil. Then you have to make actual decisions about how to structure financial assets and liabilities so as to minimize the damage that will stem from a negative scenario being realized.

The good news about this process is that it is finally moving to center-stage, instead of being whispered about by fringe types or relegated to "end-of-the-world" scenarios. As it becomes embedded in the way financial and economic players think and act, the markets and the entire system undergo a process of adjustment to events that have not yet occurred - but are expected to. This is a very inexact procedure, because the unknowns are so great, but it involves the markets estimating risk premiums and factoring them in to the prices of all the shares, bonds, currencies, commodities and what-have-you that stand to be affected. The better this adjustment is executed, the less will be the degree of shock and disruption when the anticipated event actually occurs. The unspoken assumption of these analyses, is that the countries, commodities, etc. being discussed are just pieces on a chessboard. The analysis is surely more objective as a result, but whether that makes it more accurate is another matter. The need for economic and financial analysts and the companies and clients they serve to address the geo-political threats facing the global economy instead of sheltering in a make-believe world of mathematical models fed into a "black box," has been apparent for some years. Finally, this conceptual shift is taking place - but the methodology remains, perforce, that of economic analysis, which is to say of rational actors pursuing their goals by rational means.

In general, this approach works well, even when transferred from economics to international relations or other spheres. However, a problem arises when one player ceases to act rationally whilst the others assume that he will so act.

In the Iran game, there are two potentially irrational players, namely Iran itself - whose leaders may prefer to kill Jews than save their own people (Hitler and co. in the period 1943-45), and us.

For us, the possibility that they not only mean what they say but will do anything to achieve their goals is not conducive to strictly rational responses based on risk-weighted scenarios.

Do they realize that, and do they consider it good news or bad news?

landaup@netvision.net.il