Will Trump cause a Greater Depression? Dollar swaps are a bad sign

Financial crises are never alike. What they all have in common is a proliferation of strange stories. The 1929 crash came with stories of shoeshine boys giving stock tips based on something they overheard. Investors thought in the early 2000s that complex financial instruments and modern methods of mathematical finance would make it safe for them to invest in dodgy mortgage products. The stupidity of these narratives was captured in a book, This Time is Different, written by Kenneth Rogoff and Carmen Reinhart. Financial euphoria usually arises from amnesia about financial history.

The shoeshine boy of our age is the US soldier who placed a $400,000 wager on Polymarket, a betting exchange, ahead of the January capture of Venezuela’s President Nicolás Maduro. But the strangest story of all is one that most people have easily missed for it is hidden deep inside the financial pages. America’s Treasury Secretary Scott Bessent said that several Gulf States, including the United Arab Emirates, have requested dollar swap lines with the US. In a swap two parties agree to exchange something — in this case, US dollars for the UAE’s own currency, the dirham. A swap line would be an arrangement where UAE can trigger a swap at a moment’s notice.

But why would they want to do this? The UAE is very wealthy. The amount of dollars it already holds is more than 10 times the size of the US administration’s Exchange Stabilization Fund, which would be the counterparty to the swap. Gita Gopinath, a former deputy director and chief economist of the IMF, says this may indicate that “the consequences of the Iran conflict are far greater than what we see priced in markets. Such explorations do not arise lightly, even behind closed doors.”

Brad Setser, a fellow at the Council on Foreign Relations, writes that there is something radically new happening here. To him, it looks like a dodgy off-balance sheet transaction “with the Emirates getting the upside”.

Manipulation of betting markets and dodgy swaps are plausible tell-tale signs of a coming financial crisis. I do not know how the Iran war will end, but the diplomacy is more difficult than President Donald Trump pretends; this was illustrated over the weekend when the US President called off the planned trip to Pakistan by his envoys Steve Witkoff and Jared Kushner. A full diplomatic solution will take time to prepare and agree. Once agreed, it will take more time to put into place. This will take months. Even then, oil and gas prices will not drop back to where they were before because the war has caused permanent damage to infrastructure such as pipelines and processing facilities. Shipping and insurance companies will take time to assess when it will be safe to resume travel through the Strait of Hormuz.

If Iran were to receive any revenues from traffic through the strait, as Trump has suggested, that would set a costly precedent for the world economy — a tax on international shipping. Inspired by the Revolutionary Guards, the Indonesian finance minister, Purbaya Yudhi Sadewa, said his country, too, was considering imposing a toll on ships passing through the Strait of Malacca. This strait is even more important to the global economy than Hormuz. Approximately 40% of global trade passes through it.

These measures would defy the United Nations Convention on the Law of the Sea, which establishes the principle that no state has sovereignty over the seas. If we gave up on this idea, it would be a leap back into the ages of pirates and gunboat diplomacy. We would not only be undoing the past 30 years of globalization but the last 200. Times would indeed be different if we went down that path.

We should not think for a moment that a quick and dirty peace deal, a US capitulation, would be the least bad outcome for the global economy. The biggest risk for the world economy is not a spike in oil prices, nor temporary shortages of urea and helium. Supply shocks are bad, but they are the kind of shocks for which you can prepare.

The bigger short-term risk would be a new global financial crisis, one that could be triggered not only by a long war, but also by a bad settlement. By that, I do not mean a collapse in stock markets as a primary driver of the crisis. If the blockade of the Strait of Hormuz were to lead to a global recession, it could unleash a whole sequence of crises in other parts of the financial sector, for sovereign private debt in particular. That’s why people like me, who follow global financial flows, are so spooked when they hear about the US/UAE conversations regarding a currency swap. If this were just a dodgy deal, that would probably be the most benign explanation. But it could also mean that they are preparing for a cardiac arrest in the global financial system. In this scenario, UAE banks might find it suddenly very difficult to borrow dollars; and in this case, a swap line would help keep the global financial system moving. But that system would be under extreme stress. And in this scenario, we would no longer be talking about the price of diesel or shortages of kerosene but about a Greater Depression. And, yes, stock prices would fall too. But that would be the least of our problems.

There is one big difference, though, between today and 2008. Back then, world leaders came together to fix the crisis. The Group of Twenty, until then a debating club of central bankers and finance ministers, held its first G20 summit at the level of heads of state and government in November 2008 in Washington. The Americans, the Russians, the Chinese and the Europeans were all sitting around a table, ready to set up new financial rules and agree a coordinated economic stimulus. For the first time, European leaders whose countries took part in the euro met as a distinct Eurozone. Our multilateral governance system was still intact then.

I have no nostalgia for those days. What the leaders decided back then worked in the short term but caused long-term damage to Western economies and democracies. Monetary quantitative easing and fiscal austerity were the most disastrous economic policy decisions anyone has taken this century. Both happened without democratic checks and balances. The reasons why the multilateralists got so upset about Brexit was that it was the first successful backlash against multilateralism.

So I am not mourning the passing of the age of multilateralism. But we have to understand the consequences of its passing. If the global economy went into a cardiac arrest, as it did in late 2008, we should not expect our politicians to come together as they did then and agree on a quick fix — or any fix. They will blame each other, as they do now. This new financial crisis will play out without proper intervention.

In such a world, one that has abandoned multilateralism, it will be more important than ever for the superpowers to exert strategic restraint. China looks superficially restrained politically, but its economic policies are beyond reckless. Indeed, China is by far the biggest contributor to global economic imbalances. And China may, at some unknown point in the future, launch a military attack on Taiwan.

Vladimir Putin is no man of restraint either, and nor is Trump. We know that Trump is, by nature, an impulsive gambler. There is no chance that anyone would confuse him with a strategic actor. He clearly miscalculated when he ordered the attack on Iran. It would be a triumph of hope over experience if Trump were to embrace the idea of strategic patience going forward. Trump and his secretary of war, Pete Hegseth, have surrounded themselves with yes-men. There is nobody in the administration left willing to speak truth to power. Hegseth fired critical generals together with senior officials, most recently John Phelan, the secretary of the Navy. Trump has no permanent national security adviser. Mario Rubio, the secretary of state, fills this role part-time. We know that JD Vance was a war skeptic, but he is not going to stand up to Trump either.

The current generation of Europeans leaders are rules-based creatures, none more so than Prime Minister Keir Starmer. They are mourning the passing of the multilateral age. Strategic, long-term thinking is alien to them.

Amid the gloom, there is, however, one big potential upside. AI remains the optimists’ most plausible story, a rational reason for market valuations being as high as they are today. AI is potentially the most significant innovation since electricity. It could change the way we work and live more than any other technological innovations we have experienced in our lifetimes.

But the age-old rules of investment still apply. This time can only ever be different to the extent that AI will affect economic productivity growth. The effects of AI have only just started to show up in some economic figures in the US. I myself believe that AI will be a life-transforming technology. But we won’t know for sure for some time yet.

This, in turn, means that the spoils of AI will almost surely not arrive in time to save us from the folly of this war, and the commercial and financial havoc it will unleash. In that sense, this time will indeed be different, but not in a good way.

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