The world has never been in an oil crisis under such high debt levels! Economists: The United States is especially vulnerable

Caixin April 7th News (Editor: Xiao Xiang)
Renowned economist and Rockefeller Capital Management’s global investment strategy division, Rockefeller International Chairman Ruchir Sharma, wrote over the weekend that the outcome of the U.S.-Iran war remains uncertain, but the oil shock triggered by it has exposed a new type of vulnerability in the global economy: the world has never before been caught in a crisis while carrying such heavy debt burdens, making the United States, despite being the world’s largest oil producer, particularly vulnerable.

In a commentary published on Sunday, he warned that this lack of fiscal space leaves heavily indebted governments almost powerless to respond to the energy shock caused by Trump’s war on Iran.

Sharma pointed out that the first post-WWII oil crisis occurred in the 1970s, marking the beginning of a new era: government fiscal deficits shifted from “occasional” to “persistent.” At that time, the typical deficits in the U.S. and other major countries were about 2% of GDP. Today, the average deficit has more than doubled, and the average government debt level of the G7 has risen from 20% of GDP to over 100%.

Last year, global debt grew at the fastest pace since the COVID-19 pandemic began, reaching a record $348 trillion, more than three times the global GDP.

Sharma stated that with one-fifth of the world’s oil and liquefied natural gas trapped in the Persian Gulf, governments are rushing to implement price controls, rationing plans, and subsidies. However, many governments lack fiscal resources, and bond investors are ready to punish any over-spending attempts.

“Long-term inflation expectations remain stable, but markets worry that the Iran oil shock will lead to further spending increases, combined with rapidly expanding deficits and debt, which is causing bond term premiums to rise,” Sharma wrote.

This shock has already manifested in the U.S.: recent demand for U.S. Treasury auctions has been weak, pushing yields higher than expected, highlighting investor concerns about the impact of the Iran war on deficits and debt.

Meanwhile, central banks around the world are also struggling in their efforts to lower inflation — the Federal Reserve has failed to bring U.S. inflation down to the 2% target for five consecutive years, affecting the prospects of offsetting the economic slowdown caused by the oil shock through rate cuts.

“The most vulnerable countries are those with the highest government debt and deficits, and central banks that have failed to meet inflation targets: among developed countries, the most prominent are the U.S. and the UK; among emerging economies, the greatest risks are led by Brazil, Egypt, and Indonesia,” Sharma said.

He added that although the U.S. is the world’s largest oil producer, its nearly 6% annual budget deficit last year makes it the top among developed nations, and it cannot escape the long-term effects of war.

Last weekend, the Trump administration planned to increase annual defense spending by 50% to $1.5 trillion, which could worsen the U.S. debt outlook, as interest payments on all borrowing have already exceeded $1 trillion annually. Sharma estimates that, combined with recent tax cuts, this year’s fiscal deficit could reach 7% of GDP.

Trump previously stated he expected the Iran war to last four to six weeks. But now, the conflict has entered its sixth week, with little sign of a quick end.

In fact, all signs point to further escalation: thousands of U.S. soldiers are heading to the region; a third aircraft carrier is en route; the Pentagon is moving nearly all of its JASSM-ER stealth cruise missile stockpiles to the Middle East.

All of this will be costly. Reports indicate that after exhausting most of their most expensive munitions and Iran’s attacks damaging or destroying U.S. aircraft, radar systems, and bases, the U.S. Department of Defense is seeking $200 billion in war funding from Congress.

Joseph Brusuelas, Chief Economist at RSM, noted in a report at the end of last month: “Funding the war will increase U.S. debt, triggering bond market sell-offs, as investors will require additional compensation to cover potential losses. Long-term rates like the 30-year mortgage rate are partly dependent on the performance of the benchmark 10-year U.S. Treasury yield.”

Sharma summarized that any sustained rise in oil prices could be amplified because governments’ policy tools to respond to shocks are nearly exhausted. This new vulnerability not only exposes the global economy to the consequences of the Iran war but also to every foreseeable future shock.