The Economic Risks Of Escalation

On Wednesday, July 8, US President Donald Trump declared that the cease-fire with Iran was “over.” Apparently, ending the brief halt in the kinetic conflict. It’s an unfortunate turn of events that will inevitably result in further killing and destruction. Much will be reported on the specific destruction of military bases and civilian infrastructure. US Central Command has already begun announcing the specific targets it has ordered destroyed.

But while the current focus remains on the war's physical structures and strategic objectives, there is another economic effect that may, in the end, have a far-reaching impact not only on the Islamic Republic of Iran but also on the American Home Front.

Here are the three specific Economic Risks that we see in our future.

Risk #1: The Petro Dollar

The world began to see a schism between the US and its chief Middle East ally, Saudi Arabia, in May 2026. It was then that the Saudis denied the US forces access to the Prince Sultan Airbase in its attacks on Iran. President Trump had launched “Operation Freedom” in his continuing battle with Iran.

But Saudi Arabia would have none of it; previous attacks by Iran, ironically against that very airbase, had shown that the risk was too great. In a personal phone call between Crown Prince Mohammed bin Salman and Trump, the Prince made it clear that Saudi Arabia would not support the US war. It was a major break in the alliance. We can only imagine how the US President received the news.

Reinforcing the House of Saud’s new stance, it has remained on the sidelines in this week’s battles. The result has been that Iran is not attacking them.

It marks the end of 50 years of military support from the Saudis; it remains to be seen how this will affect the US-Saudi economic relationship. Likely, that’s over also. If so, this will be a major blow to the Petro Dollar, the most significant overseas depository of US currency that has been instrumental in propping up American sovereign debt — billions of dollars have been used globally in the “oil trade,” dollars that will now make way for another currency. While the outcome of the Iran War remains uncertain, it looks like the President may have risked the PetroDollar and lost.

Risk #2 Energy

It’s the multi-headed monster of the entire dispute: energy — so much comes from the price and availability of oil, gas, and derivative products. For Americans, the most apparent effect is the price at the gas pump. It’s a simple, straightforward measure of the pain in an average citizen’s wallet.

However, rising gas prices also reveal subtle forces at work in the economy.

For economists, rising gas prices indicate that discretionary consumer spending will be diverted to meet this higher expense. Additionally, logistics companies will incur higher operating costs for their trucks, planes, railroads, and ships. Add all this together, and economists have concluded that a $1 rise in the price of gasoline will result in a 1% decline in the Gross Domestic Product (GDP).

At the beginning of this year, the nationwide average of a gallon of regular gasoline was $2.81; today, that average price has risen to $3.85 -we’ve reached that $1 rise in gas. And just for reference, the GDP growth rate last quarter was only 2.1%; take away 1% GDP growth, and we’re dreadfully close to a recession.

Risk #3: The Strange Behavior of the World’s Largest Financial Market

Suppose there’s one thing that Stock Brokers and Investment Managers can rely on: the stability of the US Treasury Market. It’s the largest and most secure financial asset on earth.

As a result, when times get tough, financial advisors naturally look to “govis” as the safe and secure place to invest. It’s called the “flight to safety,” and it’s been that way for as long as I can remember. Amid wars, pandemics, and natural disasters, US T-bonds have rallied as people seek safe-haven investments.

But not now.

Since hitting a high in March, the first time the Iran struggle appeared to be ending, the 10-year US Treasury Note has declined by 5.5%. It’s a remarkable trend, one that I don’t ever remember seeing.

Here, we can speculate about the significance, but it doesn’t take much guesswork to see what’s probably happening. Investors are increasingly concerned about this Administration’s lack of fiscal discipline: foreign military incursions are happening one after another, at a rate we’ve never seen before. And each one of these interventions costs billions.

Rumors are swirling on Wall Street that the Pentagon is out of money and will have to come to Congress to request a supplemental allocation of funds. It’s on top of a record-setting $1.5 trillion budget, with supplemental requests already submitted. That’s just for the current cash expenditures, the cost of operation. What lurks in the future are the capital expenditures that will be needed to replace the munitions used, planes, and bases destroyed in fighting Iran. There’s a sneaking suspicion that we’re not being told the full extent of the capital losses ongoing in the Middle East.

If any of this turns out to be the case, it explains why, for the first time in memory, investors are reluctant to move to US Treasuries.

Of all the risks in the conflict with Iran, this is the most significant. As the nation that manages the largest sovereign debt portfolio, we cannot afford to lose our sterling reputation. Whether they like it or not, the Administration’s most important role is “bond salesman to the world.” The conflict with Iran and the President’s erratic behavior are threatening our reputation as a solid and reliable debtor.

And that’s “This Week’s Economy”

The preliminary report on Second Quarter GDP showed the economy growing at a middling 2.1%.

The Unemployment Rate notched down to 4.2%, the lowest level in a year.

Inflation continues climbing. For the third month in a row, inflation increased, rising to an annual rate of 4.2%. It’s principally a reflection of the mind-numbing rise in gasoline prices, up 40% this year, a direct result of the conflict with Iran. Futures markets now predict a better-than-50 % chance that the Federal Reserve will hike interest rates, with one respected market estimating the odds of a Rate Hike at 80%.

Finally, the Bureau of Economic Analysis reported that our Trade Balance fell to its lowest level in more than a year — driven primarily by a 3% decline in exports and a 3% rise in imports. Imports, as you may imagine, were driven higher by rising oil and pharmaceutical prices.