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Biden Opens a Can of Worms


Biden has had enough. 


He finally gave the green light for military strikes against the Houthis in Yemen to teach them not to mess with the mighty United States. 


But what defines success and failure?  


What chain reaction will this decision set off in the Middle East and in the rest of the world? 


What is the great leverage that Iran is holding over Biden and the US? 


Will the US sacrifice Israel to prevent a second term for Trump? 


Is the economic soft landing that the global financial market is pricing consistent with increasing geopolitical risks in 2024 ? 


Why it is that to get the 2024 macro right, it is crucial to get oil right? 




Are elephants afraid of mice? 


 Pliny the Elder, the Roman naturalist, thought so. 


The popular notion that elephants fear mice has yet to be proven scientifically, but this was what came to my mind when I saw the news of another attack by the Houthis earlier this week. 


On January 9, that is, Tuesday of this week, Houthis militants, after a brief pause that lasted less than a week, launched its 26th attack on ships in the Red Sea since November 19. 


What made this attack both interesting and important was not that it was the biggest of these attacks to date, but that it was supposedly carried out against a US ship that according to the Houthis military spokesperson was “providing support” to Israel. 


Which US ship could he possibly be referring to? 


Could he have meant a US war ship currently in the Red Sea, such as the USS Eisenhower that the US navy calls its finest 5-star aircraft carrier?


In case you find my suggestion preposterous, the British foreign secretary admitted that the Royal Navy ship HMS Diamond was specifically targeted in the attack, along with US war ships. 


Have the Houthis completely lost their minds? 


Do they really think they stand any chance against the combined military might of the US and British navy?


Even with the eighteen drones, two cruise missiles and one ballistic missile which they launched in this attack? They were, of course, all shot down. 


Yemen has a population of only 32 million people with a GDP per capita of less than $700 a year


It is one of the poorest countries in the world


Yet, it is difficult not to see in this latest attack by the Houthis a declaration of war against the United States, the most powerful country in the world. 


Are these Houthis suicidal? 


Or are they really smart? 




Game theory is the analysis of strategic interaction of multiple players.  


What I love about game theory is that it does not see the world in terms of good guys versus bad guys. 


In game theory, there are only good players and bad players


Game theory only concerns itself with what people or countries decide to do to win. 


From a game theory perspective, the Houthis seem to be playing pretty smart, at least until yesterday


Until yesterday, they succeeded in disrupting 30% the global container traffic, largely with impunity 


Impunity because until yesterday, the US and its allies had restricted their response to the Houthi attacks to pure defensive actions. 


Meaning, not going beyond shooting down their missiles, rockets, and drones. 


But all this defensive action did was to further embolden the Houthis. 


Indeed, the January 9th attack by the Houthis came just a day after the US had issued a final warning. 


This left Biden with no choice but to act. 


And This is why, finally, the US went on the offensive last night. 




On Thursday night, U.S. and British forces struck more than 60 targets in 16 locations in Yemen with 100 precision guided munitions. 


They hit Houthi air defenses, munition depots, launching sites and radar.


The aim, according to US defense secretary, was “to disrupt and degrade the Houthis’ capabilities.


Was this objective achieved? 


It is too early to know for sure. 


There are conflicting reports about the results of the US-British attack


But success and failure of this operation are easy to define. 


Will the operation succeed in stopping further attacks by the Houthis? 


Or will it set off a regional war that brings the US into direct conflict with the Houthis’ backer Iran? 




So will the latest US-British attack put an end to the Houthi attacks in the Red Sea? 


I am not a military expert but I am a little skeptical. 


Skeptical only because of what I have learned from following Yemen’s civil war from afar. 


Let’s remember that a Saudi led coalition of the Sunni Arab states has been fighting the Houthis in Yemen, on and off, for the past 8 years. 


Let’s remember that the Saudis, armed with advanced American weapons, failed to achieve a decisive victory against the Houthis. 


This after 350,000 people had been killed in the war, many of which civilians. 


The Houthis’ success lies in the fact that it was able to force the powerful Sunni coalition into a military stalemate by fighting the war on its own terms. 


The Houthis are experts at using low tech weapons to neutralize high tech weapons of their enemies. 


And, like Hamas in Gaza, they have learned to use civilians as human shield to great effect. 


The massive Saudi air campaigns, backed by the US and the UK during most of the war, did little to weaken the Houthis. 


But they did earn the Saudis the accusation of committing genocide, not unlike what Israel is facing right now. 


Call me a party popper if you want, but I don’t know what the US and the UK can achieve in couple hours of bombing that the Saudi led coalition could not achieve against the Houthis in 8 years.


I think it is safe to assume that the Houthis have been preparing for the US attack. 


I think it is safe to assume that, like Hamas in Gaza, the Houthis have placed their missile and rocket launchers in heavily populated areas, in schools and in hospitals. 


Unless Biden is prepared to send troops into Yemen, or that he is willing to take the risk of being accused of committing genocide too, my feeling is that we have not seen the end of the Houthi attacks in the Red Sea


All else equal, this is bullish for oil price. 




What about the prospect of a regional war that brings the US directly into conflict with Iran? 


On January 1, Iran sent a naval destroyer into the Red Sea, a day after US helicopters killed 10 Houthi militants trying to board a tanker by force. 


It does not mean that Iran is prepared to go to war with the US, but it is a clear signal that Iran stands united with the Houthis. 


Iran is no match for the US in a direct military conflict but the regime in Tehran knows that they are holding a powerful card, a card that gives them great leverage over Biden. 


They know that Biden is trailing Trump in the polls. 


They know that Biden is facing growing pressure from within his own party to either improve his standing in the polls or step aside for another Democrat to run against Trump. 


They know that the only chance for Biden to make the 2024 election a competitive race is if the US economy achieves a soft landing


But they also know that for the US economy to achieve a soft landing, the Federal Reserve has to start cutting interest rates soon


And for the Fed to starting cutting interest rates, inflation has to get below 3% soon 

The only way this can happen without a sharp slowdown of the US economy is a decline in oil price


Put simply, Iran knows that the last thing Biden wants to see is a higher oil price 


And a direct conflict between the US and Iran will no doubt push oil price higher, possibly much higher. 


The great irony is that it was Biden himself who has handed over to the Iranians this great leverage. 


Thanks to Biden’s decision to not enforce existing sanctions on Iranian oil exports, Iranian oil exports have surged. 


In just a little over a year, Iranian oil exports have increased from 200 thousand barrels a day to now 1.2 million barrels a day. 


Any direct conflict between the US and Iran would force Biden to stop Iranian oil exports. 


A sudden disappearance of 1 mln barrels per day of Iranian oil will send oil price sharply higher. 


This is why Iran seems so confident: they think they have Biden exactly where they want him. 


Whether Biden will let Iran dictate US foreign policy, especially with respect to Israel’s unfinished campaign in Gaza, I don’t know. 


What is clear, however, is that from a game theory perspective, Biden is running out of options. 


This should be viewed also as bullish for oil price. 


What will come next? 


I don’t have a crystal ball, but I can imagine the following scenario:


After regrouping, the Houthis resume their attacks in the Red Sea. 


This prompts more US strikes on Yemen. 


Soon images of destruction and dead civilians start to stream on Al Jazeera, the pro-Iran channel in Qatar. 


The unity of the 10 member coalition the US managed to assemble to protect the Red Sea begins to fracture. 


Sunak’s approval rating in the UK falls further. 


Washington increases pressure on Israel to stop its operation in Gaza. 


As disagreement between the US and Israel deepens over what to do next, the Hezbollah in Lebanon decides to intensify its attack on Israel’s northern border.


I don’t want to go on, but you get my point. 


It can get really ugly and the global economy will be just one of the many victims of the escalation. 


This is certainly not the only potential outcome but I do think the probability of this scenario is pretty high 


High enough for me to think that it is at odds with the soft landing scenario that financial markets are currently pricing for the global economy in 2024. 

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As always, thank you for your analysis. Can you estimate how much game theory factors in historically in the macro-economic world?

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Maybe 10-20% of the time. Game theory is about strategic interaction. In the world of macroeconomics, game theory can help us understand decision making when multiple players are involved. In the US, game theory is especially useful when we have a split Congress (like right now) and when we have conflicts with foreign countries.


Hi David, A very interesting analysis of a complex situation. Thanks!

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Glad you like it


Would this be bullish for LMT and bearish for GLD?

Replying to

I think rather the opposite if anything. LMT depends on the fiscal largesse/constraint. The GOP is determined to cap fiscal spending in 2024. Gold and oil are positively correlated for obvious reasons


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