U.S. President Donald Trump is likely to escalate the war with Iran, risking "1970s stagflation" if it does not go as planned, renowned economist and investor Nouriel Roubini told CNBC. Speaking to CNBC's Carolin Roth at the Ambrosetti Forum in Cernobbio, Italy on Friday, Roubini — best known for predicting the 2008 Global Financial Crisis — rejected the view that Trump was "looking desperately for an off-ramp" to end the war. Markets have appeared optimistic in recent days about a potential resolution to the conflict. "People make the argument that … his polls are down, he wants this war to be over because there'll be damage for the economy, growth, inflation and the mid-term elections," he said, referring to congressional elections in November. "But if you think about it, the damage has already been done. If there is a ceasefire on conditions that are Iranian style, he's going to look like a loser — his credibility's weaker, he's going to lose the election for sure." "My argument is that, counterintuitively, he's going to decide to escalate," Roubini said of Trump. "He's going to escalate by taking over Kharg Island , continuing to bomb, with Israel, the leadership of Iran and the military structures." He outlined a scenario where "everything goes well, maybe the war lasts a little bit longer because of this escalation, but then you could have regime collapse." This could mean Oil prices might be higher in the short term, but a regime change — which Trump has called for in Iran — could deliver "a situation that is better for the world in terms of geopolitical stability," Roubini said. But he warned of another scenario where, after Trump escalates, "the Iranians are able to continue to block Hormuz or attack the oil facilities of the Gulf, then you end up in 1970s stagflation." "I think at this point he's going to escalate. From his point of view, it's worth taking that risk, given the option value of winning the war," he said. On Thursday evening, Trump said he would extend a pause on energy facility attacks for a further 10 days to allow for talks on a peace deal. The suspension will now expire on April 6, Trump said, adding that "talks are ongoing and … they are going very well." The update came as the U.S. deployed thousands more troops to the Middle East. While Roubini said Friday that his baseline scenario was not stagflation or a recession, but a slowdown of economic growth, he told CNBC that markets were being too sanguine about Trump's desire to end the war swiftly. "If it doesn't end soon, and you have escalation, you have a binary situation: you escalate, you win, and then that's better for the world and for the market long term," he said. "But if you escalate and you don't win, you end up with 1970s stagflation. So the question is whether the market is pricing in the tail risk of ending up with a long war, with a shock like the 1970s and then with a stagflationary consequence for the world. It's not my baseline, but it probably is a tail risk that the markets currently have not fully priced in." No TACO this time? Roubini noted that the Nasdaq Composite was trading around correction territory, while bond yields across the globe were rising rapidly. But while market pressure had forced Trump "to essentially back down, to chicken out" in the past, Roubini argued the current situation might be different. "The problem is that if he chickens out right now, he loses credibility. He lost the war. The current regime is in power. He's [then] going to lose... the election," he told CNBC. "So I think that at this point, the only option he has is to escalate. Because if he escalates, there is a state of the world with some meaningful likelihood that … [Iran's] leadership collapses, and he's not doing as poorly in the midterm election. "If it stops now, then he loses for sure. So in that sense, the market discipline is less of a pressure for him, because he has to make all the bets on a tail risk."
