View / Past oil shocks may teach us the wrong lesson about the Iran war

US President Donald Trump showed in recent days that he cares about the oil market much more than he had initially let on.

In less than 24 hours, he shifted from calling oil above $100 a barrel a “very small price to pay” for defeating Iran to declaring the war could end “very soon” and vowing to keep energy prices down. Brent crude, which at one point neared $120 a barrel, pulled back significantly to around $90.

For all the talk of how resilient the US economy has become to energy shocks, betting that it can absorb weeks of costlier oil is fraught with risks for Trump, and even more so for US allies.

Understanding past oil shocks is important, but relying on them too heavily can encourage the wrong conclusion — that we are either headed for a 1979-style crisis or that the economic consequences will be negligible.

To be sure, there is ample evidence that the US and the world have become far less reliant on oil: American GDP, for example, has quadrupled in real terms in the past 50 years, yet the country burns only slightly more oil today than it did then. The US has shifted from being the world’s biggest crude importer to a net exporter of energy. The global economy overall relies on a more diverse mix of energy sources such as solar, wind, and nuclear power. Daniel Yergin, one of the world’s foremost energy experts, notes how China has become resilient in a different way, by pouring oil into storage for a rainy day. When it comes to inflation, the starting point for this war is also much lower than the 2022 shock following Russia’s invasion of Ukraine.

But stripping out the geoeconomic nuance risks creating a false sense of security.

First, while the US economy was in better shape than most advanced nations on the eve of the conflict, it was showing visible signs of strain. Inflation has remained stubbornly above the Federal Reserve’s 2% target. Employers unexpectedly cut jobs in February, adding to concerns that the labor market is wobbling.

Other major economies, mostly long-term US allies, are even more vulnerable. In the UK, anemic growth makes the risk of stagflation more pronounced. Japan still gets about 95% of its crude imports from the Middle East, helping explain why its stock markets reacted so sharply to the risk of a prolonged disruption in the Strait of Hormuz.

The Gulf’s pain is different, but real. Governments may see higher hydrocarbon revenue if the disruption is short and energy infrastructure is largely left intact. But attacks will hurt sectors such as tourism, aviation, and logistics. The reality of geography also means their recovery may take longer.

Second, central banks can afford to treat an oil spike as noise only if they are confident the shock will ease quickly and not feed into broader inflation expectations. Lessons from their delayed action in response to COVID-era price increases will likely make them more cautious. One European Central Bank policymaker cautioned against rushing to action, but nevertheless said that the probability of the next move in interest rates being an increase rather than a cut had gone up, Bloomberg reported. The Bank of England, which had been expected to cut borrowing costs this year, is now seen staying put. In the US, recent increases in inflation gauges such as the producer price index may also prove short-lived. But how many temporary bumps can pile up before the Fed concludes it has to keep rates higher for longer — and what impact might those price rises have on the US midterm elections?

None of the above necessarily triggers a global recession or a devastating financial crisis. But it doesn’t have to be the 1973 Arab oil embargo all over again for it to hurt.

Alaa Shahine Salha is a senior executive at Saudi Research & Media Group and an economics contributor for Asharq Business with Bloomberg. He previously served as Bloomberg News managing editor for the Middle East and managing editor for economics in Europe.