The Iran war is dialing U.S. economic danger up to 11

President Trump’s extraordinary gamble in attacking Iran and risking a wider conflagration in the Middle East dials up the economic hazards facing the U.S. economy from "very high" to "extreme." The point is, this new stress compounds a series of other severe pressures already facing the economy, which is now even more unlikely to emerge unscathed.

The immediate 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 U.S. equities, the weight that the administration’s tariffs had already put on the economy’s back, a still-deteriorating fiscal outlook and a stubbornly persistent rate of inflation. Now let’s add the possibility of spiking energy prices, interrupted trade flows and global political turbulence.

Last week’s new inflation numbers were already 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 Federal Reserve’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.

New inflation due to surging energy prices would arrive on top of this already-troubling prospect. Energy prices rose as the strikes on Iran began, and analysts are contemplating oil at well 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 the arrival of a new government 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 infrastructure comes under sustained attack and the Strait of Hormuz is shut down, $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 U.S. is a now a net exporter of oil, so the domestic growth penalty would be less this time around. But the shock would still be global, the net effect on the U.S. would still be stagflationary, and it would compound existing inflationary pressures.

Such bad-case scenarios direct one’s attention to the fiscal-policy backstop. Whether the U.S. still has one is very much in question. Even before the Supreme Court overturned the administration’s so-called reciprocal tariffs, the outlook for public borrowing was testing limits. Budget deficits at 6% of gross domestic product, even with the economy at full employment and comfortably quiescent interest rates, mean that public debt (already near records) will continue to grow faster than the economy. That’s what "unsustainable" means.

The administration’s IEEPA setback will deprive the government of around $150 billion a year of expected revenue (a little more than it could raise by increasing all income-tax rates by one percentage point). In addition, the government might have to refund the 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 new "investigations" that could lead to new taxes under other authorities — actions that threaten to upend trade deals already made 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. Moreover, 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 U.S. has a big current-account deficit, financed by an equally big capital-account surplus, but no "balance-of-payments deficit" in the usual meaning of that term.) The other available authorities are legally questionable as well, because they mostly rely on some kind of urgent need to block trade, and there’s no such need.

Congress is 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 bogus emergency follows bogus emergency. But litigation and a skeptical Supreme Court have stepped up in Congress’s place. The IEEPA 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 maximum fiscal uncertainty will prevail. As a result, Washington will have little or no "fiscal space" to respond to a big economic setback with tax cuts and extra public spending.

In the end, uncertainty off the scale might be the hammer blow. At a certain point, confidence is tested once more and, all of a sudden, everything gives way. How much disruption can the U.S. economy, for all its amazing strengths, absorb? The Trump administration’s trade and budget policies were already gambling with financial disaster. Now, with the Iran strikes, the White House has just doubled down again.

This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. Clive Crook is a Bloomberg Opinion columnist and member of the editorial board covering economics. Previously, he was deputy editor of the Economist and chief Washington commentator for the Financial Times.