In the most recent 1963Macro article, the distinction was drawn between one of two paths forward: escalate or leave. A few days later, the United States appears to have chosen the path of escalation. Whether that decision proves correct or successful remains to be tested against time. But, barring a repeat of April—which seems unlikely at this moment (see No Offramp)—or a highly unexpected Iranian capitulation under threat, aggressive U.S. strikes have been said to likely move forward imminently.
If strikes are imminent and move forward, we have reached the point of major escalation that potentially brings a suite of negative economic consequences the administration has sought to avoid. Examples of key economic risks associated with material U.S. escalation:
Sharp moves in crude and broader energy markets
Conflict that extends beyond the immediate theater
Renewed inflation pressure, primarily supply-driven
Damage to energy and water infrastructure
Currency stress and potential disorderly moves
Physical shortages of critical inputs
Sovereign debt and fiscal stress in vulnerable economies
Internal political or social unrest
Wider, uncontrolled regional war
This is not exhaustive, but is a representative list of the high-level pain points to weigh if the United States is going to pull the kinetic lever in a sustained or meaningfully more aggressive manner.
A bit over a month ago, in Molecules over MOUs: Japan’s Approaching Supply Stress, the case was made that eyes should become more aware of Japan. The country is notably import-dependent on crude from the Gulf, shoulders sizable inflation and currency problems, and sits at the center of the USDJPY carry trade that still matters for global markets. If Japan experiences serious internal stress (yen), the ripple effects may be challenging to contain should anything happen in a disorderly manner.
Today we received a useful signal on that front. Treasury Secretary Scott Bessent publicly addressed the yen, noted its extreme undervaluation, and indicated coordination and preparedness around yen-related transactions and potential intervention—coming shortly after South Korea’s own actions and Japan’s recent large-scale support operations. In practical terms, the U.S. Treasury seems alert to the types of risks outlined above and would logically inject this stability at a time that military operations may otherwise be destabilizing. Bessent and his team understand that Japan (and others) could, under sufficient pressure, sell Treasuries at scale. As Hank Paulson has warned in recent months, Treasuries can be weaponized; the Fed and Treasury need ready tools to manage that possibility. In this example, even if out of necessity with no intent of harm.
This ties back to the Camp David discussions today and the reported decisions surrounding strikes. It appears that the United States is laying what foundation it can to manage potential fallout if the economic cost of engagement proves as severe as some assessments suggest. The comments from Treasury are less about the yen or Japan in isolation and more about ensuring that systems with weak foundations have backstops so that other, less-fragile but still imperfect systems do not cascade. Additional Treasury and Fed actions seem possible if the engagement proceeds as currently signaled - which may be more severe than some observers anticipate.
An Iran conflict taken to the level necessary to actually remove the IRGC goes well beyond what was advertised at the outset of the campaign. There was legitimate hope in the early stages that sustained, high-tempo air power would force Tehran—or what remained of its decision-making structure—to the table in a lasting way. In some respects it did produce pauses. Those pauses, however, proved largely tactical.
Ultimately, the combination of an air campaign plus the threat of further attack was insufficient to disarm Iran’s nuclear capability and permanently secure free passage through the Strait. This publication has long been skeptical of the MOU path, not because a durable agreement would be undesirable—it would be highly beneficial for Iran, the GCC, and global energy markets—but because it was never the most likely outcome. President Trump has recently acknowledged this himself.
It is possible that something intervenes to postpone or avert the next phase of strikes and produces a more durable de-escalation. The probabilities, however, do not currently lean that way. Even if delayed, absent a legitimate diplomatic path that has so far remained elusive, the situation simply returns to the same decision point at a later point in time. The cycle has repeated enough times that further recycling appears less operationally useful.
This returns us to the risks listed above regarding military escalation in Iran. The potential negatives depart from zero and move toward probability values that require serious assessment if strikes proceed. Before examining those probabilities more closely, it is worth scaling the Gulf’s importance to the global economy:
The GCC accounts for roughly 2% of global GDP (nominal; somewhat higher on a PPP basis).
It produces 20–23% of global oil and holds some of the world’s lowest-cost reserves.
The Strait of Hormuz carries approximately 20% of global oil consumption and a comparable share of seaborne LNG trade.
GCC sovereign wealth funds collectively manage an estimated $4.8–6 trillion, with a substantial portion (commonly cited in the 30–40% range) invested globally.
Petrochemicals, fertilizers, and a range of industrial inputs remain heavily dependent on Gulf production and logistics.
The Gulf matters. The costs of sustained conflict in the region will therefore likely be shared, in some form, across the global system.
The question then becomes how much of the economic damage outlined earlier materializes, and who outside the Gulf absorbs it most directly. We already know the Strait is effectively closed for practical commercial purposes. Global energy inventories and logistics are and have been under pressure. GCC economies are registering the hit—Saudi Arabia’s economy contracted roughly 4–5% in the most recent reported quarter amid the disruptions. Globally exported, supply-driven inflation is no longer theoretical. The physical flows discussed throughout this series will eventually become a problem that cannot be papered over indefinitely. As argued in Iran Has the World by the Gas Tank, it is this physical constraint that Iran has been exporting, forcing markets into successive adjustments. Many of those adjustments have proven adequate for a time, with markets seemingly treating the conflict as a temporary Hormuz problem. That framing underweights the more consequential assumption: that GCC infrastructure will remain intact and ready to export at scale once shipping conditions improve.
The decisive variable likely becomes how Iran chooses to retaliate. Iran has openly threatened GCC energy and economic infrastructure on multiple occasions. The Houthis have already fired on ARAMCO facilities, and Iran retains a missile capability such that one or a small number of successful strikes causing disruptive damage to critical Gulf infrastructure is a credible concern.
The risk of damaged GCC energy infrastructure dots directly to Japan and the U.S. Treasury. Japan’s energy position becomes more critical if its primary suppliers are not merely constrained but physically degraded. The difference between “stymied” and “destroyed” carries a meaningfully higher probability of inflation spikes, particularly for energy-import-dependent economies. Japan, already operating with a cracked foundation on currency, inflation, and fiscal metrics, sits near ground zero for the transmission of several of the risks listed above. Yen support helps keep the dominos wobbling rather than falling in sequence, in theory.
Iran has been a major global event blending markets, geopolitics, energy, economics, history, and ideology into a single, high-stakes topic. More importantly, it possesses both the reach and a non-trivial probability of inflicting economic damage, absent clear surrender by one side or the other. The United States has not lifted pressure. Iran has not capitulated. Both sides have been damaged in places and emboldened in others. Both appear to view the conflict as being about more than today’s map of the Strait; it is about the future of a region that is consequential globally.
The base case from here is that the U.S. strikes that proceed in some form. How they are executed, and for how long, is no longer fully at the discretion of the United States aside from beginning the campaign. The Iranian response will likely be the key determinate for the economic cost of the engagement and how that cost resonates globally.
Time will tell.
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