US withdrawal from the Iran deal could seriously escalate the developing trade war

The United States’s unilateral withdrawal from the Iran deal is a geopolitical disaster for the Middle East. But whilst most attention has, rightly and understandably, been focused on the potential for the deal’s unravelling to lead to actual war it also has the potential to seriously escalate the developing trade war. Indeed, from a strictly economic point of view, the timing looks catastrophic.

Back in March the Trump administration placed a 25 per cent tariff on imported steel and 10 per cent tariff on aluminium but granted a temporary exemption to Canada, Mexico, Brazil, the European Union, Australia, Argentina and South Korea. That exemption was due to expire in May but has since been extended to 1^st June.

If the EU exemption is allowed to lapse, Brussels has pledged to respond in kind with a package of measures hitting imports of iconic American goods such as Harley Davidsons, Levi jeans and bourbon whiskey. Whilst it might sound like the European Commission is aiming to hit those going through a midlife crisis, the measures are actually carefully targeted to cause maximum pain for the President ahead of November’s midterms—they would disproportionately hurt manufacturers based in swing states.

In the past few days most of the immediate economic analysis of the end of the Iran deal has focussed on the oil price. The price of crude has advanced to a three and half year high, above $71 a barrel, on fears of a reduced supply from the Islamic Republic and the potential for wider disruption to supplies across the Arabian peninsula. But the real economic pain will come if the division between the EU and the US over Iran spills over into the wider trade conflict.

Even after the end of US sanctions on Iran in 2015, US companies have (in general) been wary to do much business in the Islamic Republic. By contrast several large European companies have invested heavily, French oil giant Total has embarked on a multi-billion dollar project in the South Pars gas field, Renault and Volkswagen began exporting cars to Iran last year and Airbus struck a deal to sell 100 jets in the country. Last year European exports to Iran hit $11bn, a 66 per cent rise over 2016 and around one hundred times higher than US exports to Iran.

On Tuesday, the new US Ambassador to Germany (on the very same day he presented his credentials to the German President) tweeted that:

As @realDonaldTrump said, US sanctions will target critical sectors of Iran’s economy. German companies doing business in Iran should wind down operations immediately.

Before the deal the US operated secondary sanctions on Iran and those look set to return. Rather than just banning American companies from doing business in Iran, the administration effectively reserves the right to sanction any company doing business in the US if it transacts with Iran.

The EU therefore finds itself in a quandary—France, Germany and the UK are keen to preserve the deal. Foreign Secretary Boris Johnson has stated that, “we will cooperate with the other parties to ensure that while Iran continues to restrict its nuclear program, then its people will benefit from sanctions relief in accordance with the central bargain of the deal.” But whilst the EU can argue that it wants European companies to keep doing business with Iran, there is relatively little it can do to protect those companies from US counter measures.

The key sector here is banking—any bank with US operations or which clears its dollars through the US (in effect every major European bank) could find itself at risk if it finances any European involvement in the targeted sectors of the Iranian economy. The potential penalties are huge: in 2015 the French bank BNP Paribas was fined almost $9bn by US regulators after being found guilty of breaching US sanctions policy in Sudan, Iran and Cuba.

The EU and the US are already heading into a trade conflict, and any US attempt to punish European companies doing business with a country that their own government says they can operate in could seriously escalate that conflict.

In the short term, the likely economic winner is China. If European investment in Iran begins to dry up then there are plenty of Chinese companies and banks willing to step up to their place. In general Chinese companies have fewer ties to the US than European ones and, crucially, are far less reliant on dollar funding cleared in the US. Chinese oil major CNPC already has a 30 per cent stake in the South Pars field development and would no doubt scoop up the rest if Total was forced to withdraw.

In the longer term though, there are no real winners in a trade war—the results are slower growth, higher prices and more unemployment.