Clive Crook: Just how resilient is the US economy? The Iran war could turn out to be a test

The near danger is a setback in financial markets that gets out of hand. In many ways, some such reversal was already overdue, given the apparent overvaluation of US equities, the weight placed by tariffs on the economy’s back, a still-deteriorating fiscal outlook and stubborn inflation. Add the risks of spiking energy prices, trade interruption and global political turbulence.

Inflation is a cause for concern. The core producer price index, which excludes food and energy, increased by 0.8% in January, markedly higher than expected. Its main components feed into the Fed’s preferred metric, core PCE inflation. That’s running at 3% in the year to December, still much higher than the Fed’s 2% target. On Monday the Institute for Supply Management supplied more such evidence: It said the price of manufacturing inputs is rising at the fastest rate since 2022.

Energy inflation would arrive on top of this already-troubling prospect. Energy prices rose as the strikes on Iran began and analysts are contemplating oil at over $100 a barrel, up from $65 before the offensive.

As always, there’s a reassuring best-case scenario: If all goes well, a quick campaign followed by a power shift in Tehran might lift the threat of future conflict and improve confidence in the global energy infrastructure, which could bring oil prices lower than they were before. But if the conflict continues and widens, energy facilities comes under sustained attack and the Strait of Hormuz stays shut, $100 a barrel might be decidedly optimistic.

Echoes of the 1970s: A lasting spike in oil prices would mean stagflation: higher inflation plus slower growth, a combination that the Fed is powerless to defeat. Granted, the US is a now a net exporter of oil, so the domestic growth penalty would be less this time. But the shock would still be global, the net effect on the US would still be stagflationary and it would compound existing inflationary pressures.

Look at America’s fiscal-policy backstop. Whether the US still has one is very much in question. Even before the Supreme Court overturned so-called reciprocal tariffs, the outlook for public borrowing was testing limits. Budget deficits at 6% of GDP, even with the economy at full employment and comfortably quiescent interest rates, mean that public debt will continue to grow faster than the economy. That’s what ‘unsustainable’ means.

The tariff setback will deprive the US government of around $150 billion a year of expected revenue. It might also have to refund tariffs already collected. To make good the shortfall, Trump has announced a new global tariff of 10% rising to 15% under Section 122 of the 1974 Trade Act; he also promised ‘investigations’ that could lead to new taxes under other authorities—actions that threaten to upend trade deals with numerous partners. In short, the court’s ruling guarantees two things: less revenue than previously expected, combined with even greater uncertainty about the future tariff regime.

Section 122 tariffs can only be imposed for 150 days without Congress’s approval. They are probably illegal because their rationale—the need to address “fundamental international payments problems” including “large and serious balance-of-payments deficits”—arguably doesn’t apply.

The US has a big current-account deficit, financed by an equally big capital-account surplus, but no BoP gap. Other tools are legally questionable as well, because they mostly rely on some kind of urgent need to block trade.

Congress seems remarkably unconcerned about this presidential abuse of its trade laws. Having gifted these supposedly limited delegations of power to the White House, it now just watches as one bogus emergency follows another. But litigation has stepped up.

The legal setback underlines the fragility of the broader tariff strategy. As long as import taxes can’t be relied on and until Congress is forced to take budget control seriously, the revenue shortfall will worsen and high fiscal uncertainty will prevail. As a result, Washington will have little or no fiscal space [for a real crisis].

Uncertainty off the scale might be the hammer blow. At a certain point, confidence tested again could mean everything suddenly gives way. How much disruption can the US economy, for all its strengths, absorb? US trade and budget policies were already gambling with financial disaster. With the Iran strikes, the White House has doubled down again. ©Bloomberg

The author is a Bloomberg Opinion columnist and member of the editorial board covering economics.