The escalating conflict involving the United States and Iran has ignited a firestorm of criticism, with opponents citing a litany of dire consequences. Beyond the immediate human cost, concerns are mounting over the economic fallout, including soaring gas prices and a heightened risk of terrorist attacks on American soil. Furthermore, the ripple effects of the military actions are dragging numerous Middle Eastern nations into the fray, as Iran retaliates with strikes against U.S. installations in key locations like Saudi Arabia, Bahrain, Qatar, and the United Arab Emirates.
One particularly alarming consequence, highlighted by researcher Logan McMillen, is the potential for a significant credit downgrade for the United States. McMillen paints a stark picture of the nation’s fiscal precariousness, noting that the U.S. government is facing a projected deficit of $1.9 trillion for the current fiscal year, with the national debt already eclipsing $39 trillion.
Economic Storm Clouds Gathering
McMillen elaborates on the dire economic landscape:
“Let’s set the scene,” McMillen explains in an article. “The U.S. government is staring down a projected $1.9 trillion deficit for this fiscal year, with the total national debt now pushing $39 trillion. Simultaneously, the expanding war in Iran and the subsequent crisis in the Strait of Hormuz have fractured global energy supply chains, driving Brent crude to $119 a barrel and sparking a massive inflationary shock. By any standard metric of sovereign risk, a state that is rapidly accelerating its debt issuance while engaging in a war of choice that is throttling the worldwide supply of oil should be facing the possibility of having its bonds repriced.”
He argues that the long-held perception of U.S. treasuries as the ultimate risk-free asset is becoming increasingly untenable.
The Erosion of Trust in U.S. Treasuries
McMillen contends that the “pristine rating” of U.S. debt no longer accurately reflects reality.
“This pristine rating is no longer a reflection of reality,” McMillen warns. “Many countries are beginning to explore alternatives to the petrodollar. And the physical infrastructure and foreign policy that underpin its value are in tatters, replaced by a series of ad hoc military strikes in the Persian Gulf and temporary waivers to ‘protect’ American consumers from the resulting inflation…. Simultaneously, Trump is calling on the U.S. to borrow trillions of dollars to finance the military, while signaling that the U.S. may withdraw from policing the Strait of Hormuz altogether.”
This precarious situation, McMillen suggests, indicates that the “full faith and credit” of the U.S. government is approaching a critical limit.
The Geopolitical Bargain Unraveling
The researcher posits that the U.S. government’s ability to sustain perpetual deficits has historically been underpinned by a crucial geopolitical bargain.
“The U.S. could run perpetual deficits because its military secured global trade, keeping the commodity inputs for industrialization at the periphery cheap and plentiful,” McMillen notes. “This arrangement allowed the U.S. to export its inflation and import the world’s surpluses at massive discounts, passing the savings along to domestic consumers as their wages began to stagnate in the late 1970s. But now, the clocks are running out, and the bills are coming due…. The Federal Reserve will soon be confronted with an inflationary shock that monetary policy is ill equipped to fix…. . There are only two exits, and both are likely to diminish the value of U.S. treasuries. Path 1 is monetization.”
Two Paths to Economic Peril
McMillen outlines two potential, yet problematic, avenues for the Federal Reserve to navigate the looming economic crisis:
Path 1: Monetization
To sustain the war effort and prevent the federal budget from collapsing, the Federal Reserve could opt to absorb the escalating wartime deficits. This essentially involves printing money to cover the government’s expenses, a move that typically devalues currency and fuels inflation.Path 2: Hiking Interest Rates
Alternatively, the Federal Reserve could attempt to combat inflation by significantly increasing interest rates. However, this approach is fraught with peril given the staggering $39 trillion national debt. The U.S. government is already allocating over $1 trillion annually solely to service its existing debt. Further rate hikes would dramatically inflate these servicing costs, consuming a larger portion of the federal budget and pushing the United States closer to functional insolvency.
Both of these paths, McMillen warns, are likely to result in a devaluation of U.S. treasuries, impacting investors and the global financial system. The current geopolitical climate and the economic realities facing the United States suggest a period of significant uncertainty and potential instability.
