The March of Folly by Barbara Tuchman that was published in 1984 chronicled 30 centuries of governments taking actions against their self-interest, starting with how Trojan rulers dragged inside their walls an odd-looking wooden horse despite warnings of Greek tricks.
If the book was written today, it would surely include the decision by US President Donald Turmp to attack Iran because he was warned Tehran would weaponise the Strait of Hormuz and retaliate against its neighbours. No matter. With Israel, Trump attacked. Adding to the economic damage is Trump blockading the Strait to open a waterway that was open before the war began.
Trump’s problem is Tehran recognises the Strait is a ransom tool, by virtue that on any given day the waterway hosts 20% of the world’s exports of oil and natural gas, plus fertilisers needed for farming, plastics for household use, helium and more to make microchips, bitumen for roads, and materials such as aluminium for cars and sulphur for copper production.
The interruption to the shipping of these essentials is the war’s overarching assault on the world economy. The shortage-driven surge in the prices of these staples, which might only be starting, is boosting inflation – Australia’s has already surged to 4.6% while it’s reached 3.8% in the US – and interest rates, especially bond yields. Growth is threatened as people curb oil-driven consumption and struggle with higher rates. The combination warns of the re-emergence of the 1970s torment of stagflation, which is shorthand for high inflation during recessions.
A second harm from the war is damaged Gulf economies (including Iran’s smashed one). Iranian attacks on energy assets and the region’s hubs have jeopardised Gulf plans to create stable business, energy, cultural and tourist oases. Arab leaders are worried enough to have requested US emergency facilities (dollar swap lines) to protect against blocked energy exports and missing travellers.
The damage to the Arab world will limit the investment the West enjoys from Gulf sovereign wealth funds, which, holding about US$6 trillion in assets, are among the world’s biggest investors. Gulf authorities may even sell foreign assets, which could shake the West’s asset markets.
A third blow is how the war batters developing countries. Poorer countries must pay more for oil and fertilisers. Those that can’t face energy and food shortages, possibly famines. Their factories are short of inputs. Many countries are missing out on the estimated US$100 billion their expatriates remit each year from the Gulf. They confront higher interest repayments on their foreign debt. The danger is US rates climb enough to trigger a debt crisis.
A fourth repercussion of the war is the crumbling of global alliances, which, even with free-loading allies, are a cost-effective way to pay for protection. Indebted governments everywhere are spending more on arms. That is straining budgets and boosting government bond yields possibly to the point of crisis.
A fifth blow is the war re-highlights the risk of relying on global supply chains. Governments will intensify efforts to ‘reshore’ or ‘friendshore’ the production of necessities. They might subsidise renewable energy to reduce Gulf oil dependence while doubling down on relying on non-Gulf fossil fuels. This focus on security will override efficiency.
A sixth hit from the war is the breakdown of the ‘petrodollar accord’ of 1974 that helped propel the US dollar to reserve status when Saudi Arabia agreed to price oil in greenbacks in return for Washington’s protection.
China and India are paying for Gulf oil in yuan and ships have reportedly paid Iran in yuan and crypto to pass along its southern shore. This will speed the development of payments networks in euros and yuan that US foes are building to escape Washington’s financial sanctions gifted by dominance of the US dollar system. Multiple payments systems are a costlier, murkier and riskier way to operate global finance.
The war’s blows to the global economy are exacerbated by other Trump actions. One is the threat to the Federal Reserve’s credibility with Kevin Warsh as Fed chair. How will Trump react if Warsh fails to cut rates even though inflation has been above the Fed’s target of 2% for five years and is accelerating? How will investors react if Warsh cuts rates when inflation surges to double or even triple the Fed’s target?
Another covers Trump’s on-off tariffs that were imposed on nearly all US trading partners last year. Trump has lowered, postponed or made temporary these import charges due to lobbying, the granting of gifts and, above all, after adverse investor reaction. His tariffs imposed under the International Emergency Economic Powers Act of 1977 were ruled illegal by the Supreme Court, but Trump is seeking to reimpose these import taxes under other statutes. However done, tariffs boost costs thus inflation, upset business plans and create global political frictions.
The uncertainty surrounding US tariff policy feeds into the norm-breaking, policy shifts, treaty smashing and other uncertainties stemming from Trump’s administration that deepen political polarisation, deter business investment and labour hiring and sap at consumer spending.
These threats have burst on an indebted world economy that has feeble defences against recessions. Governments are too indebted to offer much fiscal stimulus to support economies. Faster inflation rules out monetary stimulus by central banks, highlighting how stagflation snookers policymakers. Geopolitical cleavages work against international cooperation. Other risks include that hopes for artificial intelligence have driven stock-market valuations to record highs and troubles surfacing in US private credit.
Given all this, the damage from the Iran war could prove impossible to contain and morph into another global financial crisis. This may not be evident yet. But it will be soon.
Sure, stocks at record highs argue against doom. But note that bond investors, all professional unlike stock peers, are gloomy. The United Arab Emirates’s exit from OPEC will boost oil flows. But only when the war is over. The US economy is spared the worst of the war’s blows. But that might harden Trump’s bargaining positioning and ultimately magnify the war’s damage. Record-low US consumer confidence, rising petrol prices and accelerating inflation warn of some damage already too for the US. Advanced economies overall, with their rule of law that underpins Adam Smith’s invisible hand and Joseph Schumpeter’s creative destruction, can survive much.
But perhaps not what the folly of launching the Iran war has foreseeably unleashed.
Michael Collins is a freelance writer and editor, economist, and investment specialist. Republished with permission from the author’s Substack newsletter @denouementwatch.