US Strategy I: Roaring 2020s Vs Stagflating 1970s Redux. In last Tuesday’s QuickTakes, reacting to the latest Middle East war, we wrote: “We’ve been expecting a pullback due to excessive bullish sentiment, but now we expect a 10% correction from the high. It’s hard to imagine that the IRGC [the Islamic Revolutionary Guard Corps] won’t use drones and speed boats to maintain their effective blockade of the Strait [of Hormuz]. If they are successful in doing so, the correction could be closer to 15%.” The day before, a senior adviser to the IRGC’s commander-in-chief warned, “If anyone tries to pass … the navy will set those ships ablaze.”
Since then, the Iranian navy has been largely destroyed. However, as long as the IRGC can fly drones, the Strait will remain straitjacketed. President Donald Trump has authorized the US Navy to escort ships through the Strait, but that operation may take a while to implement and may not completely succeed at thwarting Iranian drone attacks. Meanwhile, on Saturday, the New York Post reported, “A commercial oil tanker was set ablaze in the Strait of Hormuz after it was struck by an Iranian suicide drone, the country’s Islamic Revolutionary Guard Corps said Saturday, with a US Navy mission to safeguard ships through the region possibly still weeks away.”
Military historians have debated whether air power alone can decisively win a war. Most have concluded that it is rarely sufficient on its own to achieve total victory and lasting political change. Air power is exceptional at destroying things—infrastructure, supply lines, and concentrated armor. However, it cannot “hold” a street corner, search a basement for insurgents, or administer a local government. It also can’t eliminate drones.
On Saturday, the President refused to rule out boots on the ground, though he did rule out using Kurdish forces as a proxy for a ground invasion of Tehran, calling the war “complicated enough” without them. He said that ground forces would only face an adversary “so decimated that they wouldn’t be able to fight at the ground level.”
Meanwhile, here on the home front, Friday’s employment report for February was much weaker than widely expected. Also on Friday, January’s retail sales report was weak. As a result, the Atlanta Fed’s GDPNow model lowered the projected Q1 real GDP growth rate to 2.1% (saar), down from 3.0%. The US economy and stock market are stuck between Iran and a hard place currently. So is the Fed. If the oil shock persists, the Fed’s dual mandate would be stuck between the increasing risk of higher inflation and rising unemployment.
Here are a few of the consequences of the war for our economic and financial market outlooks:
