The ceiling of Church and Union Charleston, a South Carolina bar converted from an old church, with the text of Sun Tzu's The Art of War covering it. Photo by Martin Pelletier/Postmedia

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During my summer holidays in the southern United States, I visited a bar that had been converted from an old church. Covering the ceiling was the entirety of Sun Tzu’s The Art of War. Looking at the situation in Iran today, I can’t help but think they have read the same text.

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When investors think about the war involving Iran, they instinctively focus on oil. That’s understandable because every conflict in the Middle East immediately raises questions about crude supply, tanker routes and energy prices. What makes this episode different from past geopolitical crises is that the global economy is carrying record levels of sovereign debt and governments can no longer absorb inflation shocks the way they once could.

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Therefore, every dollar increase in the price of oil and refined products such as gasoline and diesel feeds inflation expectations, pushes bond yields higher and increases the cost of financing already massive fiscal deficits. While investors and commentators continue debating whether higher interest rates will solve the problem, the reality is that monetary policy cannot produce more oil or reopen disrupted supply chains. As long as the conflict continues, inflationary pressure remains embedded in the system and will continue to wreak havoc on both bond and equity markets.

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The Iranians understand this. In a world burdened by excessive debt, the critical battlefield is no longer confined to oil fields or shipping lanes. It extends directly into the U.S. Treasury market. If they have indeed studied The Art of War, they would know that Sun Tzu argued the highest form of generalship is to thwart an opponent’s strategy rather than confront its forces directly.

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While the United States possesses overwhelming military superiority, financial markets do not respond to military power alone. They respond to risk, uncertainty, inflation expectations, fiscal deficits and investor confidence. In today’s case, by refusing to capitulate to U.S. demands and prolonging the conflict, Iran may be exploiting the vulnerabilities of an already indebted global financial system, increasing pressure until it ultimately gains leverage at the negotiating table.

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We’re already seeing this in the relentless rise in Treasury yields at a time when the U.S. government is carrying record debt levels and facing enormous refinancing requirements. A market once considered the world’s ultimate safe haven has become a source of extraordinary volatility.

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What makes this dynamic particularly dangerous is its self-reinforcing nature. Modern markets are dominated by systematic investors, leveraged hedge funds, commodity trading advisors, volatility-targeting strategies and algorithms that respond almost instantly to price trends. Rising yields trigger risk reduction, risk reduction creates selling pressure, additional selling pressure pushes yields even higher. In effect, Iran is taking full advantage of these market participants to amplify the pressure throughout the entire financial system.

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We are, as a result, witnessing economic warfare in a modern form. You no longer need to confront an aircraft carrier directly when you can trigger reactions inside global capital markets that rapidly tighten financial conditions, pressure asset prices and increase borrowing costs.