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As the two-week war in Iran extends into its third month, the coverage of this issue, at least so far as the economics go, has been primarily focused on the impact this is having on the rest of the world. Global oil prices, global trade, the impact on supply chains, food production, energy security in Europe, the military budget of the USA, the future of regional hubs like Dubai that sold themselves on being the safest cities in the world, and the future of the petro dollar underpinning global finances. But there is another variable that has been largely overlooked, and that is the economic resilience of Iran itself and how long it can truly afford to keep this fired up. There is the common talking point that Iran is
holding the global economy hostage with drones that cost $20,000 but require half million dollar interceptors to shoot down. And as far as economic trade-offs go, that should clearly be in their favor. These little anecdotes also play into the wider assumption about how this conflict is playing out, which is that it's hurting all of the parties involved. But so long as Iran can cost the world more than its adversaries can cost it, well then they hold all the cards at the negotiating table. But one potential flaw in that assumption is Iran was not and is not a healthy economy. Even before this conflict started, it was facing extremely high levels of inflation, widespread poverty, frequent power outages, endemic
corruption in business and government, youth unemployment of over 20%, stagnant economic growth, capital flight, and brain drain. All fueled by a misallocation of resources towards a large military, and an overdependence on fossil fuels. In one of the most oil- richch countries in the world, more than a third of the population lives on less than $9 a day, even after adjustments for purchasing power parody. And more than half of the population is now considered malnourished. And that's according to their own Ministry of Social Welfare. Even with all of that fossil fuel energy, they were struggling to reliably keep the lights on in their capital city. The one silver lining is
that Iran is a pro state that has somehow avoided Dutch disease, but it only did that because it has been so heavily sanctioned. All of this is to say that if this conflict really does boil down to the global geopolitical equivalent of punch for a punch, then Iran might have its hands around the world's windpipe. But it is still ultimately an anemic and malnourished combatant. Even before the direct and indirect cost born by this war, Iran and its people were struggling, which might reasonably suggest that they are ultimately on a timer before their already stressed institutions collapse completely. And this is before even mentioning the breakdown of OPEC and what it may mean for the country's one financial lifeline. But unfortunately, another variable that should be
considered is that the economic systems that support the people of Iran and the economic systems that support the military of Iran don't have nearly as much overlap as they do in most other economies. So, what was going wrong in Iran's economy before the war? How has Iran's economy been affected by the war? And finally, how much does this all impact the potential longevity of this conflict? Trying to make a non-politically charged video about Iran can be very difficult in today's media landscape. It can be almost impossible to separate facts from fantastic wording designed to get clicks, especially with all the recent
events that have taken place. That's where Ground News, today's video sponsor, comes in. Ground News is an independent subscriber-f funed website and app on a mission to give readers a data-driven objective way to read the news. Their platform, gathers articles from all over the internet and ranks them on a spectrum from left to right, giving the user an immediate understanding of what basis on which the article is written. Look at this story for example. A right-leaning article talks about a new sanction placed on Iran as a way to avoid a crisis. But when you click on the bias comparison tab, you can see the left framing it as a strategic move to help a potential ceasefire. But not only do they point
out the differences, but they give a full breakdown of bias distribution, factuality ratings, and ownership information for all the sources covering the same story, letting you see exactly where the information is coming from. These are the kinds of examples that can reshape how you see the information. Without Ground News, these kinds of differences would be really hard to spot. In an environment driven by clicks and audience retention, keeping a balanced opinion is more important than ever. Go to ground.news/explained to save 40% on the same unlimited access vantage plan I use to get my news on the economy and the world. Supporting Ground News not only supports my work, it
supports an independent news platform, giving us agency over the information we consume. So before we get into things, it's time for the big disclaimer that this video will be as much as possible focusing exclusively on the economics of this situation and avoiding becoming an armchair general getting too into the weeds about specific military tactics and capabilities because there are certainly more qualified people out there to discern these factors and we will just be referencing them when required. The other thing is that as one of the most heavily sanctioned and isolated economies in the world, hard economic data produced to the same standard as most other countries is slightly harder to find for Iran. Okay,
so with all of that out of the way, even before the bomb started dropping, Iran's economy was not only struggling to provide good living standards for its people, it was struggling to keep itself together. Now, to be fair, a lot of this was the result of heavy sanctions from the international community. And of course, there is an argument to be made about Iran taking steps like shutting down its nuclear program to alleviate those sanctions, but that rabbit hole is an endless back and forth. And the reality is that in one form or another, Iran has for the last 40 years been one of, if not the most heavily sanctioned countries in the world. Trading places back and forth with Russia and North
Korea. These sanctions limit their ability to sell their oil internationally, which means that despite all of their resource wealth and their OPEC membership, they still struggle to actually move a lot of crude, at least compared to their regional peers. Sanctions also restrict imports, which leads to higher domestic prices for a lot of imported goods and limited supply of the industrial components needed for things like their own oil rigs. Because of this, they have struggled to maintain the very machinery that extracts the oil in the first place, which is a fairly bleak loop for an economy that depends on hydrocarbons for the bulk of its government revenue.
Over time, China has become the one real lifeline. China does not officially sanction Iran and is a major buyer of its oil to fuel a famously energy-hungry economy. In return, it supplies Iran with manufactured goods from its immense industrial base. In theory, it's a match made in heaven. But even still, there are some limitations. While China doesn't sanction Iran and has actually publicly renounced the Western sanctions, Chinese companies still can't openly do business with Iran if they want to do business with the USA. And ultimately, for most companies, the consumer market and financial system of the USA is a lot more enticing than some slightly discounted oil from Iran and a consumer base where more than a third of
people live on $9 a day. So, even with China in their corner, these sanctions have been absolutely crippling to long-term development. But beyond sanctions, it's not like Iran isn't making plenty of its own mistakes. Corruption in Iran is rampant, but in its own unique way. The state is highly extractive, which means it pushes out any real business growth, all to fund some fairly questionable objectives. The country's market is dominated by these strange institutions called boneyards. We have actually made an entire video on these. So, as always, we don't want to repeat too much here. But the brief explanation is that bonads are something like a mix between private businesses,
religious organizations, state companies, and a government department allinone. This weird hybrid status gives them a lot of advantages like not paying taxes, not being subject to the same regulations as ordinary firms, and having much more funding available to them than a normal competitor could ever access. which means that other businesses that might want to compete in their particular market simply get pushed out, leaving only these strange, inefficient, anti-competitive organizations behind, funneling whatever profit they do make back into the hands of the political elite. This is something of an economic theme for Iran.
It has a lot of resources. It just uses them in really dumb ways. Despite being one of the most energy abundant countries in the world, it has been suffering from an ongoing energy crisis. The grid is old, underinvested, and patched together with whatever components have managed to slip through the sanctions net. Power stations run on natural gas that the country also tries to export. So in winter, when domestic heating demand spikes, exports get cut and the lights go out. Anyway, has had rolling blackouts for years now, even in the middle of summer. Even though the country is sitting on the second largest natural gas reserves on the planet,
water is the same kind of paradox. Iran is not a particularly dry country by Middle Eastern standards, but decades of poor agricultural policy, inefficient irrigation, and overextraction from aquifers have produced a genuine water crisis. Major rivers and lakes have been visibly drying up. Farmland is being abandoned, and several of Iran's biggest cities are now dealing with serious shortages on top of the power cuts. Broadly speaking, this is what happens when an economy stops investing in basic infrastructure. Extractive corruption gets even more direct than that. The former Supreme Leader, for instance, sat on top of an organization called Satard,
that according to a six-month Reuters investigation, controlled assets worth around $95 billion, made up of roughly 52 billion in real estate, and 43 billion in corporate holdings. Much of it built by seizing the properties of ordinary Iranians, religious minorities, immigrants, and political opponents over decades. That figure is particularly impressive or depressing when you remember that Iran is not exactly the home of highpriced real estate. It's not like Australia where $95 billion worth of property gets you a two-bedroom duplex with a fixer up a bathroom. In Iran, these seizures had to be pretty vast to add up to that. Now, these resources weren't just seized to fund a
lavish lifestyle for senior leadership, although that may have been preferable. A lot of the money is redirected towards shadow funding a very large military for an economy of this size, as well as the famously controversial nuclear program that the rest of the world does not want them to have. The official line is that this is for domestic energy production, but even from a purely economic perspective, that doesn't really hold up. Iran is one of the most energy-rich countries in the world anyway. And even if they did finish a nuclear power plant, their grid is already falling apart, leading to those frequent blackouts. So, the only other logical explanation is that they are big-time environmentalists, really trying to cut
down on their carbon emissions. Military spending is officially only around 2% of GDP. But again, this is where opaque economic metrics become a real problem. In reality, their total military spending is far higher than this, with some estimates reaching as high as 10% of GDP. That money is routed through both the regular military and the much better funded Revolutionary Guard, all to say nothing of the money they spend on other people's militaries. A lot of Iran's money is used not only to fund its own military development, but also to bankroll the military operations of foreign groups across the region. Iran has financed several conflicts around the Gulf and pays a significant share of
Hezbollah's costs. Reports indicate that the average soldier in Hezbollah is paid more than 10 times as much as the average soldier in the regular Lebanese army. These payments to fund foreign conflicts have made Iran even more of a pariah on the world stage. On top of taking funding away from people at home who desperately need it. And on top of all of that, food security and water security have been deteriorating for years with the state spending more and more on weapons and proxies while the basics get harder to come by. So that was Iran on the eve of the war. Sanctioned, mismanaged, energy rich and energy short at the same time with a population already running out of patience. And then the fighting started
in late February of this year. After months of escalating tension and another round of nuclear inspections breaking down, the USA and Israel carried out targeted strikes on a number of Iran's underground nuclear facilities. That kicked off the conflict that we are now in the third month of despite it being widely advertised as a twoe or two-day affair depending on who was being asked and when. Almost immediately, sanctions were tightened even further with secondary measures aimed at making it nearly impossible for any non-Chinese buyer to keep purchasing Iranian crude. Retaliatory strikes went back and forth from there with infrastructure on both sides taking damage. But the Iranian
side absorbing the bulk of the hits to refineries, power stations, and government buildings. The financial response was about what you would expect. The Iranian realale, which had been sliding for years, collapsed almost completely. As of late April, it is trading at around 1.6 million realale to the US dollar on the free market, which by most measures makes it the single least valuable currency on the planet. To put that in perspective, when the current central bank governor took office in late 2022, the real was trading at around 430,000 to the dollar. So, it has lost roughly 3/4 of its value in just over 3 years. A currency that is collapsing on this scale doesn't just look bad on a chart. It kicks off
extreme inflation for regular people on the ground. Official annual inflation was already running at around 44% earlier in the year, and point-to-point inflation through the first weeks of the conflict ran above 60%. Which means the prices of imported goods, fuel, and basic staples have been rising not by the year, but by the week. That kind of price acceleration is what economists call inflation expectations becoming unanchored, which is a polite way of saying that nobody trusts the currency to hold its value long enough to even bother saving in it. This, in turn, has produced a second round of mass protests. These were initially motivated by the same living conditions that had
been getting worse for years, made suddenly intolerable by the fact that the state was visibly spending what little hard currency it had on domestic and foreign military operations rather than food, water, or fuel. Without straying too far from the economics, these demonstrations have been suppressed to a frankly horrifying degree, which was a major part of the justification used by the USA and Israel for the latest round of strikes. As the conflict drags on, more infrastructure has been destroyed, more sanctions have been layered on, and Iran's neighbors are getting visibly fed up with the situation. Nobody in the Gulf can reliably get their oil out through the straight of Hormuz right now, which is
undermining the livelihoods of several much larger players, as well as wrecking their longerterm attempts to diversify their economies through tourism and international business. We've already covered the Dubai and Saudi diversification strategy in some detail in another video. This is also a big part, although not the only part of why the United Arab Emirates announced this month, that it is leaving OPEC effective May 1st. Officially, the UAE has been wanting more freedom to expand production for years with an explicit goal of hitting 5 million barrels per day of capacity by 2027. And OPEC quotas had been getting in the way of that ambition. But the timing is not subtle.
The exit comes after weeks of Iranian missile and drone attacks on UAE territory. And after months of OPEC's golf members watching their tanker traffic get stuck behind a straight, that one fellow OPEC member has effectively shut down. Which means OPEC, the organization that has held the global oil price together for half a century, is now openly fragmenting because of a war fought by one of its own founding members. For Iran, that matters in a very specific way. OPEC was the one major international organization Iran was actually still part of in any meaningful sense. And even within OPEC, Iran had spent the last decade or so as the awkward sanctioned cousin that nobody quite wanted to coordinate with.
Anyway, watching the cartel fall apart removes one of the few remaining mechanisms that gave Iran any leverage over global energy markets. So, what comes next? This is the awkward question. Iran is making some money by acting as a toll collector through the Straight of Hormuz, which it has now closed off to most commercial traffic. That income, at least in theory, could be used to fund the kind of asymmetric conflict it has built its entire military doctrine around. Cheap drones, cheap missiles, mining vessels, and the implicit threat of doing more of the same. All other things being equal, this is a fight that should suit Iran's balance sheet much better than it suits the balance sheets of the countries
trying to keep shipping lanes open. They also have large stockpiles of military equipment that they can keep drawing on. But stockpiles are by definition finite and most of the production capacity to replace them is sitting in the same heavily sanctioned sporadically electrified industrial base that has been struggling for years. The real problem is that the economic systems that support the Iranian people and the economic systems that support the Iranian military are not the same system. Which means that even if the military can keep finding the resources to keep firing drones for another year or two, the civilian economy is going to run out of food, water, fuel, and patience long before that point. This is
the unfortunate result of an economy that puts a disproportionate amount of its limited resources into its military. It is much more likely to run out of the basics for ordinary people before it runs out of drones to lob it ships trying to make a run through the straight. So, while on a pure balance sheet basis, Iran might be able to keep the fight up and cost the world more than the world is costing it. Even from a fairly cold-hearted economist's perspective, it would be a real stretch to call this any kind of victory. The currency is the weakest in the world. Inflation is running at rates that wipe out savings inside of a year. The grid is unreliable. The water table is
dropping. Half the population, by their own government's measure, is malnourished. And the regional cartel that gave the country its one form of global economic relevance is now actively breaking up around them. In that kind of state, a regime can probably keep launching drones for a while longer. The harder problem is that it also has to keep feeding, watering, and supplying electricity to the population, doing the launching, and the room to do both of those things at once is shrinking by the month, which is the real reason this conflict is on a timer. and the timer is not running on the side of the Islamic Republic. Now, we have already made an entire video on the boniads and how these strange quasi
religious, quasi state, quasi private institutions came to dominate the Iranian economy. So, we didn't want to repeat too much here, but if you're interested, you should be able to click to that on your screen now. Thanks for watching, mate. Bye.
