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Wars cost money, and the people in the countries which get involved in them have to pay the bill. People can have different views about the wisdom or otherwise of Donald Trump in attacking Iran, but the economics are undeniable.
The longer this war continues the greater the cost to Americans, as well as to people in the rest of the world. The US President knows this, which is why this will not be a long war.
The bill comes in a string of different ways. First and most obvious is the impact on oil and gas prices, though it will take a while before the rise in the price of crude oil and wholesale gas that has already happened has its full impact on the price at the pumps and in household energy bills. But already the average price of gasoline in the US, at over $3.50 a gallon, is up 21 per cent on a month ago and the highest since the middle of 2024.
Some 20 per cent of the world’s oil and a similar proportion of its liquefied natural gas passes through the Strait of Hormuz, and the longer it stays shut the greater the pressure on prices. While it is for the military experts to assess whether the US forces can find a way of guaranteeing safe passage without ending the war, the practical question facing a shipowner right now is whether it is worth the risk. Since three ships have been attacked in the past 24 hours the answer is almost certainly no. So the strait is effectively shut.
The impact on energy prices is just the first of a series of effects. Natural gas is key to the production of ammonia-based fertilisers, so that pushes up the price of food. The airline industry is hit directly by the sharp reduction in flights though the Middle East, but also indirectly via the cost of fuel, which has risen by nearly 60 per cent. So the price of flights within the US has already started to climb.
Then beyond all that is the impact on financial markets. The cost of oil has gone up – that is obvious. Less obvious is the fact that the cost of money has gone up too. That is a reaction to the rise in inflation. Consumer prices in the US were up 2.4 per cent in February, the same as the month before, so already above the 2 per cent target. That was, of course, ahead of the war. It is pure guesswork to assess the impact of the conflict until we know how long it lasts, but economists are talking of inflation being pushed up to 3 per cent or even 4 per cent by year end if it continues for a few weeks.
An increase even to 3 per cent would make it very difficult for the Federal Reserve to cut interest rates. The markets also expect longer-term bond yields to climb slowly, and the effect of that would be to push up mortgage rates, which are already around 6 per cent for a 30-year loan.
So the bill for Americans goes way beyond the immediate impact at the fuel pumps and on airline fares. There is an impact through the housing market. Companies needing to borrow to fund investments will find they have to pay more than they otherwise would. Demand for goods and services will fall for the simple reason that more money spent on fuel and food is money that can’t go into buying other things.
There will be a drag on the job market as employers become more cautious about hiring. And while there will be some gainers, including the oil companies and defence industries, the overall impact will inevitably be that most Americans will be poorer.
That leads to the really big question: will this war push the US economy into recession?
Some economists think it will. For example David Rosenberg, a well-regarded commentator on the markets, argues that the war, on top of other features including the possible ending of tax credits after the midterms, will lead to a sharp fall in the stock market and a recession in 2027. Jim Paulsen, an experienced market strategist, claims that most of the economy already is in recession and is propped up only by the high-tech sector.
But the mainstream view is that the US is big enough to withstand the blow from higher energy prices provided these do not last too long.
That makes sense. The polls show that the war is deeply unpopular, with more than half the country opposing it. Clearly Trump and his advisers didn’t think through the likely reaction of Iran to the attack, and in particular that it would close the Strait of Hormuz.
Though they were a bit wobbly over the weekend, the financial markets have now made the assessment that this will be another case of Taco – Trump Always Chickens Out. I give it another couple of weeks before he folds.
Need to know
The US is a net exporter of oil and natural gas, whereas the UK (and Europe, bar Norway) are net importers. So on a narrow calculation of impact on GDP the effect of the oil shock on the US is less than that of other countries. The dollar has strengthened a bit on this, and US bond yields have risen by less than those elsewhere.
Nevertheless, all yields have risen, so their 10-year treasury notes are over 4.2 per cent and our gilts over 4.6 per cent – actually touching 4.66 per cent in afternoon trading on Wednesday. Not good for our Chancellor’s Budget arithmetic.
But I do think it is worth making the point that the world economy is resilient and that if this war does indeed end in the next couple of weeks, then while there will be a long drag on living standards everywhere, it won’t be the catastrophe that some believe. Whatever your politics, it is dreadful at a human level, and the damage to infrastructure will take time to repair. But I don’t think it inevitable that the US or the world will plunge into recession. Or, to put that point slightly differently, if there is a recession in 2027 it will be principally caused by other forces.
Think of it this way. What is happening now is much more limited than what has been happening in Ukraine. It is terrible that we have to use that war as a template to assess the economic impact of this one, but there is nothing better. The two Iraq wars were too long ago.
However, at a time like this you have to keep asking yourself the question: could I be wrong? The answer of course is always yes. The element that I am most concerned about here is that there might indeed be some sort of ceasefire, with Trump ending the US offensive, but there continuing to be terrorist attacks on Middle East infrastructure. In other words, there will be lasting damage to the stability of the entire region.
I don’t think it is helpful to try to forecast the detail. My point is simply that a Taco moment won’t end the hostilities, and that something worse will happen in the coming months.
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