TOKYO — Whether US President Donald Trump cries “uncle” on the Iran war tomorrow or it drags on, the economic damage is already done on several fronts.
For the globe’s top economic powers, the idea of returning to some semblance of normalcy is easier said than done. The ever-festering risk of Iranian retaliation will now become a semi-permanent feature of geopolitical risk analyses. Yet damage to economic confidence could be a more enduring side effect.
In less than 14 months, the Trump 2.0 administration has moved the “Overton window” of what shocks are possible from Washington. Going forward, investors will be factoring in which “Black Swan” event might be announced on Trump’s social media feed.
These threats, as well as the “unknown unknowns” risks that Trump World might create over the next 1,046 days, will complicate financial decisions and trading strategies as long as he’s in office.
It will be incredibly difficult, in other words, to walk back or live down a 56-day period when a US president’s men spirited the leader of Venezuela to a New York jail cell and took out the Iranian leadership with Congress shrugging. And this is on top of the confusion and still-seething anger over Trump’s tariff turmoil.
And that’s just the damage Trump is doing abroad. At home, the coming fallout from the Iran war reminds us that “this administration is a sequence of supply shocks,” Tim Mahedy, a former Federal Reserve Bank of San Francisco economist, tells The New York Times. “This is coming on top of two other very significant supply shocks, tariffs and immigration policy.”
If the Iran conflict drags on for months, says economist Kathy Bostjancic at Nationwide Financial, it could shoulder-check business confidence, prompting households and companies to spend and invest less. “When there is an injection of new uncertainty into the business environment … that’s a hit to confidence,” she notes.
What, meanwhile, are the odds that Mojtaba Khamenei, Iran’s new supreme leader, accepts a Trump U-turn, reopens the Strait of Hormuz and just moves on? The successor to his father, Ayatollah Ali Khamenei, who was killed on the first day of the war with the US-Israel tandem and Iran, might not be in the forgiving mood that Trump World seems to think. The attacks, after all, reportedly killed Khamenei’s mother, wife and a son as well as several top Iranian defense officials
Yet the real shock in the long run could be a sudden and irreversible loss of faith in the dollar and US Treasury securities. The leader of a Group of Seven economy actively courting rogue-nation status is a new one for the world.
The same goes for a financial superpower that’s long called the shots in global circles, so defiantly burning the “exorbitant privilege” that enables it, even now, to sell 10-year US debt at 4.1% yields.
As the war in Iran threatens to trigger a 1970s-level inflation surge, Trump has been weakening the institutions charged with maintaining price stability. Case in point: Trump’s unrelenting push to morph the Fed into the US equivalent of the People’s Bank of China.
Through Trump put the moves on the Fed during his initial 2017-2021 presidency, the Trump 2.0 gang has really turned up the heat.
First, by trying to fire — or indict — Fed Chair Jerome Powell. Next, by trying to remove Fed Governor Lisa Cook. Then by adding Trump loyalists to the Fed board, including Trump’s White House economist Stephen Miran.
A MAGA-fied Fed could be a nightmare for the global financial system, despite efforts to replace the dollar and US Treasuries as the linchpin of the global economy. The risk is that Trump’s policies spook officials in Tokyo and Beijing, overseeing a combined US$1.9 trillion in US government debt.
In January, Deutsche Bank angered US Treasury Secretary Scott Bessent after one of its strategists warned foreign investors could leverage US holdings against Trump’s threats against Greenland, or to retaliate against his reciprocal tariffs.
In the first year of his second term in office, Trump has indeed busily set out to trash trust in the dollar. He has pushed the national debt above $38 trillion, attacked the Fed, imposed heavy tariffs on friends and foes alike, and shook up the globe with geopolitical adventurism run amok.
These policies and others have the dollar and US Treasury yields in electrocardiogram mode. Officials in Beijing — particularly at the PBOC — worry about the safety of the combined $950 billion in US Treasuries held by Beijing and Hong Kong.
UBS economist Paul Donovan noted that even if China isn’t threatening to dump official holdings of US dollars, “the idea that international investors may be less inclined to buy US Treasuries in the future (without dumping existing holdings) is getting attention in markets.”
That could change as Iran war fallout complicates Trump’s designs on a weaker dollar, catalyzing a bigger standoff with the Fed. So far, in spite of Trump’s fiscal exploits at home, the dollar is still playing its traditional role as safe haven, keeping the US exchange rate stronger than Trump would prefer. Especially now that US employment is weakening in real time.
In February, US payrolls dropped a surprising 92,000 and the unemployment rate ticked up to 4.4%. As Trump’s Iran “excursion,” as he calls it, propels inflation higher, the latest employment “numbers may have put the Fed between a rock and a hard place,” notes Ellen Zentner, strategist at Morgan Stanley Wealth Management.
Powell’s term ends in mid-May. Trump had been hoping that his pick to replace him, Kevin Warsh, would push for big rate cuts right out of the gate. That’s now very much in question.
Trump’s preference rate, closer to 1%, may face strong pushback. The minutes of the January Federal Open Market Committee indicated that “several” members thought rate hikes might be needed. The hawks are gaining power as the fallout of the Iran war on the inflation outlook mounts.
It’s not clear, though, that Trump will be patient. In January, he proposed that government-sponsored enterprises Fannie Mae and Freddie Mac purchase $200 billion in mortgage-backed securities.
It’s the sort of financing role the Fed would perform in times of credit market distress. Trump’s proposal, which appeared to be an attempt to end-run around the Fed to weaken the dollar, struck many as a way to revive quantitative easing. Economist Mohamed El-Erian at Allianz calls it the “people’s QE.”
Trump’s campaign for a weaker dollar also suggests he knows little about how Japan’s now-decades-long weak yen policy is backfiring on Asia’s No. 2 economy. Part of the problem is Trump’s 1985 mindset. Back then, the top industrialized nations could agree in a New York Plaza Hotel ballroom to weaken the dollar.
Forty years later, his desire for a “Mar-a-Lago Accord” seeks to recreate a global trade dynamic that no longer exists. Not when so much of the global wealth needed to command markets is in the broader BRICS (Brazil, Russia, India, China, South Africa) universe, including oil-rich states such as Saudi Arabia and the United Arab Emirates.
Even so, Trump’s top economic officials, including Bessent, clearly haven’t schooled him on why the exorbitant privilege that Washington enjoys, including the ability to issue debt at markedly low yields, is such a plus for America.
Might all this come to a head in 2026? Even the May decision by Moody’s Investors Service to revoke Washington’s last AAA rating caused little more than a ripple in debt markets. The reaction was that the dollar, for better or worse, remains the global system’s primary currency, despite intensifying efforts to find alternatives. For now, at least.
Xi Jinping’s China, meanwhile, sees an opportunity to position Asia’s biggest economy as a more reliable and pro-trade superpower. More and more, Team Xi Jinping probably can’t believe its lucky stars as Trump sabotages the globe’s biggest economy and a currency China aims to replace.
With Trump losing virtually every ally America ever made, accelerating the rise of US debt toward the US$40 trillion mark and undermining trust in the dollar, this is China’s moment to step up and make the yuan great again.
Granted, China faces daunting challenges. They include a giant property crisis that’s fueling deflation, weak domestic demand, runaway local government debt and high youth unemployment.
And a decade into Xi’s yuan internationalization push, the yuan accounts for just 2% of foreign-exchange reserves compared with 57% for the dollar and roughly 20% for the euro. Xi’s safe-haven dreams are belied by the tight controls on moving money in and out of China.
Yet Trump doesn’t have to make it so easy for China. Last year, Trump was irate over reports that the BRICS are angling to create a dollar alternative. Enough to threaten 100% tariffs if the BRICS and the broader Global South went ahead with the idea.
Diana Choyleva, chief economist at Enodo Economics, notes that most market commentary these days still treats economics, geopolitics, military risk, politics and technology as separate domains, to be consulted sequentially. In calmer times, that habit was merely incomplete. In today’s environment, it is increasingly dangerous.
“Consider the present conflict,” Choyleva says. “The immediate market response has been familiar: oil prices, shipping risk in the Gulf, inflation expectations and central-bank reaction functions. All of that matters, but it is only the first layer.”
Yet, Choyleva adds, the more consequential effects sit one step further out. “The [Iran] conflict,” she says, “is altering the strategic balance between the United States and China, strengthening the Iran-China-Russia alignment, reshaping energy leverage, and forcing countries from Saudi Arabia to Taiwan to reconsider their positions. Those shifts will matter far more for markets over the coming year than the first spike in oil.”
So will the extent to which Trump’s exploits over the last 56 days have the globe pivoting away from the US and US assets in a big way.
Follow William Pesek on X at @WilliamPesek
