Brent crude was in the low $70s a barrel at the beginning of July. Four weeks later, amid open talk in the US of a “massive attack” on Iran, it soared past $100, up more than 35%. The dollar strengthened and Treasury bonds maintained their role as the world’s safe haven. While this appears to showcase US economic primacy, a closer look reveals a disconcerting reality: the developed world’s diminishing capacity to absorb shocks.
Unlike the oil crises of 1973, 1990 and 2003, the 2026 Hormuz crisis has hit a world grappling with record public debt, persistent budget deficits, high real interest rates and an ageing population. The approach of easing monetary policy while also running large deficits is staring at its limit.
This crisis marks not just a geopolitical event, but also a stress test for the developed-market economic order, with consequences likely to echo long after any ceasefire.
What’s crucial is the compounding of shocks. The magnitude of the initial shock is less significant than the feedback effects it generates. Rising energy prices are driving inflation, forcing some central banks to maintain high interest rates or even tighten despite a slowing economy.
In the US, each new geopolitical commitment increases its defence budget (and often deficit), which leads to more bond issuances. If demand for bonds falls short, this cycle further elevates interest rates, crowding out necessary funding for infrastructure and future growth.
The US might be winning its military battles, but it could be losing the broader economic war.
America’s fiscal reckoning—a new economic battlefield: Washington entered this conflict with gross federal debt exceeding $40 trillion, nearly 125% of GDP—including intragovernment debt. Its federal deficit stands at about 6% of GDP, with net interest costs surpassing defence spending in the federal budget.
The 10-year treasury yield is at 4.7%, its highest since January 2025, while the 30-year yield is above 5%, the highest since the year before the 2008 crisis.
This mounting burden may partly explain its GDP growth slowing to 1.5% in the second quarter of 2026 from 2.1% in the first as government spending, investment and exports weakened. While inflation eased from 4.2% in May to 3.5% in June, it remains above the Federal Reserve’s 2% target.
Recently, the Fed left interest rates unchanged at 3.50-3.75% for the fifth consecutive meeting. Chair Kevin Warsh emphasized that there’s no “magic wand” to control inflation as energy prices climb amid the conflict.
What sets 2026 apart is the fiscal arithmetic underpinning the crisis. Every additional basis-point increase in bond yields carries a much higher budgetary cost compared to a decade ago, given America’s debt enlargement.
Only robust global demand for US Treasuries can sustain this. Historically, geopolitical crises have driven Treasury yields down as investors seek safety. This time, however, its debt overload and persistent market liquidity have offset that downward pressure.
The conflict between tight monetary policy and abundant liquidity helps explain why inflation remains more persistent than conventional models predict. This situation also highlights the limitations of Washington’s policy flexibility, despite the dollar’s apparent strength.
On top of these economic concerns, political dynamics add another layer of complexity. The conflict in West Asia has not yielded the decisive results the US administration hoped for.
As the country approaches mid-term polls, President Donald Trump’s net approval rating has dropped to around minus 25 points, the lowest of his term. This poses a risk of turbulence driven more by electoral than economic factors, even as markets hope for de-escalation.
Further, the conflict is not isolated. Iran is supporting Russia in Ukraine, and Ukraine is targeting Iranian-linked assets, hinting of an emerging axis of Russia, Iran, North Korea and China.
A wider war is not inevitable, but the overlap of these conflicts is enough to keep oil prices and risk premiums elevated during quieter periods. As America grapples with the harsh reality that strength comes at a price, its European partners are also feeling the impact of this evolving geopolitical landscape.
The economics of power—a new global divide: For decades, investors felt being ‘developed’ was synonymous with ‘safe.’ This crisis has dismantled that view. Advanced economies have accumulated excessive debt and left themselves with little policy flexibility, so any sustained geopolitical shock can threaten their fiscal stability, monetary independence and long-term growth.
Wars are now fought on government balance sheets, bond markets and in central-bank meeting rooms. While military superiority can win a conflict, it may not repeal the arithmetic of debt, inflation and rising borrowing costs— even, beyond a point, for an economy privileged by its control of the global reserve currency.
The defining divide of the next decade may well be between countries with the fiscal resilience to absorb repeated shocks and those whose ambitions have outpaced their balance sheets. And economic power tends to underpin geopolitical power, as it determines how much of the latter a country can sustainably afford.
These are the authors’ personal views.
The authors are, respectively, a senior economist, and assistant professor, Faculty of Management Studies.