The War's Impact on the Economy

One thing that I've been trying to stress in my posts about the United States-Israel war against Iran is that it was a terrible mistake by our cognitively challenged president. Cult leader, convicted felon, and failed President Donald Trump's brain is mush and, lacking the intellectual wherewithal to know better, he was convinced that Iran would be a repeat of the U.S. military operation in Venezuela. The reality has turned out to be much different. While the U.S. military has performed nearly flawlessly — though we should never forget the bombing of the Minab elementary school that killed over 150 school girls — strategically, the U.S. has lost the war. The most important damage resulting from the war, other than the lost lives, is economic. Trump's war is threatening a global recession. It is likely already too late to recover from significant economic damage and, as the war continues, things will only get worse.

Trump has repeatedly tried to suggest that the war would be short-lived and that recovery would be almost immediate. He once said that the war would be over in less than 4 weeks. Later he settled on a 4-6 week timeframe. We are currently in the 7th week. Yesterday, Trump extended the deadline he had set for Iran to agree to a deal until April 27. That would be the ninth week of the war. Chances are that the war won't be over by then. Economic damage from the conflict is directly tied to its length and, for the moment, nobody is sure when it will end.

Yesterday, the International Monetary Fund released a warning of the threat presented by the war to the world's economy. As the New York Times reported:

War in the Middle East has upended the world economy, the International Monetary Fund said on Tuesday, warning in a report that disruptions to oil markets could slow growth, fuel inflation and raise the possibility of a global recession.

The Times article went on to report:

The I.M.F. said that even if the war is short-lived, the damage to the global economy has been done. In that best-case scenario, the fund expects global growth to fall to 3.1 percent this year from 3.4 percent in 2025. That is down from the 3.3 percent that the fund projected in January. It is also lower than the 3.4 percent growth that it was prepared to project before the war broke out and oil shipments through the Strait of Hormuz were halted.

Moreover, while the United States is unlikely to suffer as much as several other countries, it will not be immune to the consequences:

The I.M.F. now projects U.S. output to rise to 2.3 percent in 2026. That is an increase from 2.1 percent growth in 2025, but slower than the 2.4 percent growth that the fund projected in January.

The White House projected 3.5 percent gross domestic product growth in 2026 in its latest budget forecasts.

In the United States, the most apparent economic vulnerability appears to be the hit that consumers are feeling from higher gas prices. The national average for a gallon of gas was $4.11 as of Tuesday.

The website oilprice.com has a report today that includes remarks by HSBC group chairman Brendan Nelson. He is quoted as saying, "The longer the disruption continues, the more the indirect effects from higher energy costs will lift inflation and depress growth." He also cast doubt on current estimates of economic growth because of the uncertainties resulting from the Iran war. Current estimates should be "approached with considerable caution," he said. The global research firm Wood Mackenzie was quoted as saying that:

Even if the Strait of Hormuz opened today without any restrictions and risks, oil and gas supply from the Middle East faces recovery of several months well into the late summer.

But that late summer estimate is extremely optimistic compared to analysis by International Energy Agency Executive Director Fatih Birol who reported as saying:

Current oil prices do not reflect the severity of the supply crisis caused by the war in the Middle East, warning that restoring lost capacity could take up to two years.

The longer the war lasts, the more dismal these predictions will become. As the Gulf states run out of storage capacity as a result of not being able to ship the oil they are producing, they have to shut down wells. Once a well is turned off, some of the oil within it is contaminated and can no longer be used. That oil is simply lost. Moreover, restarting the wells takes time and cannot be done quickly. The situation that we are currently in is bad and getting worse. But, it will soon turn catastrophic.

Much of the damage is already baked into the economy. As the New York Times report about the IMF says:

Even a more optimistic case, in which the war concludes expeditiously and the Strait of Hormuz reopens, will leave behind economic carnage. The I.M.F. estimates that oil prices will increase by 21.4 percent this year and that energy commodity prices, which the fund had said would decline in 2026, will instead rise by 19 percent this year.

Those higher commodity prices will flow through the economy, the I.M.F. warned. That would raise costs of energy-intensive goods such as steel and cement, erode the purchasing power of consumers and most likely require central banks to raise interest rates.

Meanwhile, Trump administration officials are sticking with a rosy scenario and trying to convince us that the war will end soon and everything will immediately return to normal. Trump's Director of the National Economic Council, Kevin Hassett, was on television this morning arguing in favor of an interest rate cut, the last thing you normally want during a period of high inflation. According to him:

If I were a Fed governor, I would be saying that an increase in the oil price that's related to disruption in the Middle East is something that we've seen over and over again, and it doesn't cause an increase in inflation.

Every other economic analysis is showing that higher oil prices increase inflation, but Hasset's job depends on denying reality. Hasset is clearly delusional. As I wrote above, Trump once suggested that the war would last less than four weeks. Now it will go at least nine weeks and likely longer. However, Hasset is still banking on Trump's predictions, saying:

The President is confident that it can be resolved and, when it is resolved, those prices will go right back down to where they were before.

Imagine if oil prices start going back down because the situation resolves itself somehow, then you could be looking at inflation close to zero.

Let's all bookmark this and check back at the end of the year to see if inflation is zero. Asked about the IMF report and its expectations regarding inflation, Hasset said:

I think that I disagree with the forecast for America. The fact is that our economy is really running on all cylinders...The U.S. is insured against a significant downside because we produce so much oil.

This is an argument that Trump frequently makes, and it is simply not based on reality. It is true that the U.S. is producing a lot of oil. However, oil is bought and sold on a global market. U.S. buyers have to pay the same prices that international buyers are willing to pay. That is why West Texas Intermediate crude has been over $100 a barrel lately, nearly double what it was selling for before the war. What's more, there has been a huge price delta between oil futures and the price of physical oil that is on a ship and ready to be delivered. According to oilprice.com:

Brent futures may have sunk below $100 per barrel, but constraints are intensifying amid the supply shock, with the physical price of a key North Sea blend, Forties, surging last week to a record high of as much as $147 per barrel.

The huge $50 a barrel premium of the physical crude over the futures prices signals that the real oil supply shock is enormous, even if the sentiment on the futures market is tentatively hopeful that there is still a way to resolve the Middle East crisis soon.

As a result, the real shock of oil prices is even worse than we might expect based on futures pricing. I expect that at some point, oil traders are going to internalize that the war is not going to be over soon, and there will be absolute panic on the market.

One irony is that while Trump demands that his underlings stay on message, a message that is often disconnected from reality, he himself is completely unable to do the same. As a result, while Hasset has been out telling everyone that gas prices will soon recover, Trump told Maria Bartiromo that oil and gas prices will "be the same or maybe a little bit higher" at the time of the midterm elections. That's probably the most accurate prediction I've heard yet from anyone in this administration. However, that means at least 7 more months of $4 a gallon or more gas. That's going to do wonders for Republican midterm results.