Trump’s war is starting to strangle the world

Even before the full effects of the impact of the war in Iran on energy costs flow through the global economy it is showing signs of the stresses of the global energy shock it precipitated.

In the US, already lukewarm economic growth numbers for the first quarter of the year – containing only the first month of the spike in oil and gas prices – were revised down late last week, while, in April, the inflation number the US Federal Reserve Board regards as its key indicator rose.

In France, inflation hit a two-year high of 2.8 per cent last month even as the economy is contracting. Italy and Spain are also experiencing rising inflation rates, with the European Central Bank expected to raise its policy rate at least once before the end of the year.

In China, manufacturing activity slowed last month and consumer spending, already weak, decelerated to its lowest levels in four years. Industrial output and investment are still falling, according to data released over the weekend.

While oil prices have fallen back from their post-attack highs as the talks about a deal to end the war drag on, the full effect of the war on oil, gasoline and diesel prices have yet to be reflected in the data.

Even if the war were to end this week, there has been massive depletion of global oil inventories. It will take months to restore stocks to their former levels and, in the meantime, the elevated cost of transport fuels will continue to trickle through supply chains and into end prices and inflation rates.

The average price for gasoline in the US, for instance, is now about 37.5 per cent higher than a year ago, and the average diesel price 55 per cent higher.

Consumer prices in the US and elsewhere were, even before the war, edging up because of Donald Trump’s tariffs on everyone and almost everything.

The US inflation rate was 2.4 per cent in February, but jumped to 3.3 per cent in March and then to 3.8 per cent in April.

The personal consumption expenditures index favoured by the Fed showed headline inflation rising from 3.5 per cent in March to 3.8 per cent in April. Excluding volatile energy and foods prices the rate rose from 3.2 per cent to 3.3 per cent.

Trump’s newly-installed Fed chairman Kevin Warsh is going to struggle to make the case that US interest rates should be cut when, having been above the Fed’s target of 2 per cent for five years, the inflation rate continues to rise and is becoming embedded in US supply chains and in inflation expectations, which have also risen sharply.

Before Trump’s tariffs and war, inflation rates around the world were subsidising from their post-pandemic highs and interest rates were falling. Economic growth, while moderate, was picking up.

Now inflation rates are surging, interest rates are rising and growth is faltering.

Asia, most dependent on the 20 per cent of the world’s oil that used to flow through the Strait of Hormuz, has been hardest hit, although China has been sheltered by the massive oil stockpiles it had accumulated in the lead up to the war, subsidies for its transport sector and its continuing electrification of transport.

Europe and Japan and other energy import-dependent economies, like Australia, are also suffering from the higher prices, either through higher prices for consumers, the cost of government subsidies or both.

The US, as the world’s largest oil exporter, benefits from the higher oil and gas rices and the blockage of Middle Eastern supply, but bits exposure to the global prices means it isn’t shielded from the price effects.

Its consumers, already hit by Trump’s tariffs, which are estimated to have contributed about 0.8 of a percentage point to the pre-war US inflation rate, are running down their savings as their real incomes fall.

The US savings rate, which has averaged around 7.5 per cent to 8 per cent this century, fell to a post-pandemic low of 2.6 per cent in April, according to data released last week.

While the US National Economic Council director, Kevin Hassett highlighted real (after inflation) wages at the weekend to claim that positive news about the economy was being ignored and assert that “on balance, real incomes, real wages are going up,” the April data shows that, at 3.6 per cent, the increase in wages was below the inflation rate.

The US data also showed that first quarter growth in the US, previously estimated at 2 per cent by the Bureau of Economic Analysis, had been revised down to 1.6 per cent. The US economy grew 2.2 per cent last year – Trump’s first back in the White House – after 2.8 per cent growth in 2024.

Given that consumer spending accounts for about 70 per cent of US GDP, the combination of a shrinking savings rates and plummeting consumer and business confidence (a Conference Board index of chief executive confidence dived from 59 to 47 last month) doesn’t augur well for what is, with China, a key pillar of the global economy.

The underlying weakness in the broader economy is also being masked by the extraordinary investment going into artificial intelligence.

Last year the US “hyperscalers” – the biggest of the technology companies with AI ambitions – plunged about $US375 billion ($522 billion) into investment in the sector. This year they expect to spend about $US750 billion and next year more than $US1 trillion.

While a lot of this spending is on imported components, and therefore detracts from GDP, there are unprecedented sums being spent within the US on data centres and their energy and water infrastructure and computing power.

Within the April inflation data, computer software and accessories prices rose 5 per cent. In the GDP data, business spending on equipment soared 17.2 per cent, much of which is presumably related to the explosion in spending on AI.

The Federal Reserve Bank of St Louis has estimated that about 0.9 percentage points of the GDP growth in the first three quarters of last year came from AI investment.

It would not be surprising if it were contributing significantly more, given the dramatic increase in AI spending and activity, which means the US economy is particularly vulnerable to any setbacks in the sector.

While oil prices have fallen back from their post-attack highs as the talks about a deal to end the war drag on, the full effect of the war on oil, gasoline and diesel prices have yet to be reflected in the data.

The underlying US economic picture is not dissimilar to that of Europe, the UK or, indeed, much of the rest of the world, where the wars – the trade war and the war in the Middle East – have lowered growth rates while raising inflation rates.

Stagflation – shrinking growth and rising unemployment even as inflation rates increase – is being discussed more frequently by economists around the world, with whether the prospect is more or less likely dependent on when and how the war in the Middle East ends.

The current economic context will make it difficult for Warsh to deliver what Trump expects – lower US interest rates.

Indeed, should he even try, he would risk starting his tenure as Fed chair with a humiliating defeat by a majority of the other 10 voting members of the Federal Open Market Committee that decides US monetary policy.

Until the war in the Middle East ends, and energy prices and inflation rates eventually start to drift down, the prospect is for higher central bank policy rates or, at best, rates that are unchanged, not the rate cuts Trump has consistently demanded or that households around the world – and their overly-indebted governments – desperately want.

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