Trump’s war is strangling the world

When Kevin Warsh explained why the US Federal Reserve Board had lifted its policy rate for the first time in three years last week, he studiously avoided any direct references to the war in the Middle East.

Three things had changed, he said, since the Fed’s July meeting, when the Fed left the federal funds rate (the equivalent of the Reserve Bank’s cash rate) unchanged: the US economy had strengthened, inflation hadn’t slowed and the “geopolitical landscape” was one of “shocks and uncertainty.”

With the US 10-year bond yield, the world’s risk-free benchmark for assets, trading around 5 per cent, Warsh said economic strength, a surge in artificial intelligence-related expenditures and “hot spots” around the world – particularly the differences between the spot prices of energy and the “so-called crack spreads” – were driving long-term yields.

While Warsh might add growth and AI investment to the influences on US inflation, that begs the question of why other developed economies with less growth and less AI investment – from Australia and Japan to the European Union – are also wrestling with persistently high inflation and their central banks are also raising their policy rates.

The answer lies within the Middle East. The war in the Middle East has driven up oil prices from around $US70 a barrel to over $US100 a barrel (it traded at almost $US110 a barrel on Friday) and, more particularly, has had a more dramatic impact on gasoline and diesel prices.

In the US, the average price of gasoline ahead of the attacks on Iran by the US and Israel in February was $US3.18 a gallon, with the average price of diesel $US3.70 a gallon. Today, the average gasoline price is $US4.47 a gallon and that of diesel $US6.50 a gallon – a record.

The same holds true around the world, with the price of diesel at record levels in Europe and Asia and likely to surge further during the northern hemisphere winter.

Crude oil supply out of the Middle East is still well below pre-war levels despite some oil now being shipped out of the Strait of Hormuz, a big lift in production outside the region and the world’s strategic oil reserves still being deployed.

Not only have crude supplies been diminished, but the refining infrastructure in the Middle East has been targeted and significantly damaged by Iran.