Weekly Forecasts Special Issue

An economic worst-case scenario for the U.S. from the war with Iran

Contents:

1. Towards the collapse of the petrodollar trade.

2. Statistical scenario modeling of the effects of the shock of the closure of the Strait of Hormuz for the U.S. economy.

3. The economic worst-case scenario for the U.S. economy.

What naturally interests us all is how the economic shock that has started to emerge will be. In this Special Issue, we present both statistical and economic (theoretical) modeling to answer this question, concentrating on the U.S. economy.

What many fail to grasp is that the road we’re on implies the collapse of the U.S. financial and military hegemony. I understand that this is too far for many to grasp at this point, but I already explained some of it in my update to the Sword of Damocles and yesterday. We now want to open it up a bit more.

We also want to add some (statistical) “meat on the bones” on the shock that’s about to hit the world economy. We start the modeling of this shock, naturally, from the U.S., which is the biggest economy and holder of the global reserve currency. We construct a model based on our forecasting model for the U.S. GDP to model two scenarios: an oil shock and a supply chain shock. Naturally these two yield rather different outcomes, with the latter presenting something of an “apocalyptic” near-term trajectory for the U.S. economy.

We end with a worst-case scenario for the U.S. economy, which underlines the dire toll the war can take on the U.S. We are in the midst of major geopolitical and economic upheavals.

Tuomas

Towards the end of the petrodollar?

A major change slowly manifesting in the Middle East is the possible (likely) end of the petrodollar trade. U.S. dollars rose to dominate oil transactions after the collapse of the Bretton Woods system in 1974, when Saudi Arabia and the U.S. reached an agreement where the oil from the Saudis would be priced and sold in U.S. dollars. In return, the U.S. promised to provide security guarantees and access to American financial markets for the Kingdom of Saudi Arabia. Other countries of the OPEC (the Organization of the Petroleum Exporting Countries) quickly followed suit. Notably, the petrodollar is not based on any formally binding agreement, but it is more of a convention, based on mutual benefit.

In the Bretton Woods system, created in 1944, countries tied the value of their currencies to the USD, whose value was tied to gold. It created an exceptional role for the USD because it made it a global reserve currency. At its peak, some 120 countries were included in the system, which created a vast pool of demand for U.S. dollar liquidity, with the USD effectively backing up the global financial system.

When the Bretton Woods system collapsed due to the excess money creation to fund the war in Vietnam, another source of (global) demand for the USD needed to be created to absorb the money printing (credit creation) of the U.S. The petrodollar was erected to fulfill this need. The petrodollar system effectively became the source of the forever-wars of the U.S., because keeping it alive meant keeping U.S. ‘boots on the ground’ globally. To fund all the military bases, the U.S. needed to create a lot of credit (money). So, essentially, there was a never-ending loop, where the war machine required money to feed the global demand for the USD to provide the security to guarantee the reserve currency status of the U.S. dollar. Effectively: money for safety for money. Rinse and repeat.

Now, the question becomes, what will happen to the petrodollar system if the U.S. is forced to retreat from the Middle East? This is how Grok-4 answered this question (at noon on 10 October 2026):

Over time, the absence of U.S. forces could catalyze a paradigm shift, aligning with “petrodollar war theory” arguments that U.S. interventions have historically enforced dollar primacy.

Without boots on the ground, the system might unravel as follows:

• Geopolitical Realignment: Gulf nations could pivot toward China, Russia, or BRICS for security and economic partnerships, accelerating yuan-based oil deals and diminishing U.S. leverage over global energy flows. This mirrors recent sentiments where Saudi officials accused the U.S. of abandonment, potentially ending long-standing petrodollar pacts.

• Erosion of Dollar Reserve Status: A decline in petrodollar demand could force the U.S. to balance trade deficits more stringently, leading to austerity measures, reduced military spending abroad, and a vicious cycle of weakened global influence. At the extreme, this might result in higher U.S. inflation and borrowing costs, as foreign holdings of dollar assets drop.

• Counterarguments and Resilience: Not all views predict collapse; the dollar’s liquidity and institutional advantages could sustain it even without full military backing. A phased withdrawal with contingency plans might mitigate blowback, preserving some alliances and limiting immediate disruptions to oil trade.

Overall, while not an overnight death knell, a U.S. exit would likely hasten the petrodollar’s decline, reshaping global finance toward a more fragmented, multi-currency energy market and curbing American economic exceptionalism.

To fully address the effect, we need to emphasize the change occurring in the foundation of the petrodollar, i.e., security guarantees. Iran is currently completely demolishing these in the Middle East. While the liquidity provided by the USD would still be there (for a while longer at least) after the U.S. withdrawal from the Gulf, this would not weigh much standing against safe passage through the Strait of Hormuz. Iran has already asserted a policy line that it will control the Strait also in the future. If so, it could set the condition that all vessels using the Strait need to use Rial in their transactions. So many companies use and depend on access to the Strait that they would be forced to agree. Thus, if Iran wins this war and takes full control of the Strait, it will almost immediately rise as a major regional player pushing the U.S. out. This would, most likely, deliver a mortal blow to the petrodollar and the global U.S. hegemony.

The fall of an empire is never quick nor pretty. This is what we’re seeing to play out in the Gulf. Israeli PM Benjamin Netanyahu lured the U.S. into a battle it could very well lose, without the U.S. president Donald Trump probably understanding what would be at stake if their decapitation strikes and “revolution” would fail. This is exactly what has now occurred.

Yesterday, Tuomas presented a scenario on how the war would end, arising from market reactions. Here we just add that ending the war can come only through the capitulation of Israel and the U.S. If the U.S. capitulates and withdraws from the Middle East, it would deliver a blow that could turn lethal for the petrodollar and thus for the U.S. global hegemony. That said, Iranians are enraged, and the “blood vengeance” from the killing of Khamenei has united both religious and secular factions of Iranian society. We don’t think there can be a victory against such a nation, which has prepared for this conflict for decades.

So, we consider that economic repercussions are what will end this conflict. The problem with this is that, when they appear, there will be no quick fix to them. This implies that if the war does not end within the next seven days (or so), we need to start to expect a global economic depression.

How bad of an economic shock?

Statistical modeling is a good tool for analyzing different economy-wide scenarios if there are (more or less) matching scenarios to be found in recent history. More precisely, we can construct a statistical forecast on the effects of shocks if shocks of a similar kind can be found from a period when an economic variable under interest, like gross domestic product, has been measured. When we consider the effects of the closure of the Strait of Hormuz, from henceforth “the Strait,” two historical examples come to mind: the 1973-74 oil crisis and the first global Covid lockdown in the spring of 2020.

In early October 1973, the Yom Kippur War broke out between Israel and the coalition of Arab states led by Egypt and Syria. On October 19, President Richard Nixon requested a $2.2 billion emergency loan to Israel from U.S. Congress. Immediately after this, the Organization of Arab Petroleum Exporting Countries proclaimed an oil embargo against the U.S. and all Western countries supporting Israel. In six months, the price of oil rose by nearly 300% and even more in the U.S., which at that time was highly dependent on Middle Eastern oil.

In January 2020, the Covid-19 virus emerged from Wuhan, China. By the end of March, the whole world was in a lockdown (in the U.S., the lockdown started on 15 March). The economic hit was massive with the service sector shut down and financial markets collapsing (up to a point of a bailout by the Federal Reserve), while supply chains broke down. While it lasted for just a few months (basically for one quarter, Q2 2022), it is the closest historical example of the rupturing of global supply chains.

What we are going to do is to harvest information from these two drastic occurrences to build two statistical scenarios on the likely effects of the closing of the Strait. In the first, which we call the Oil crisis scenario, we extract data from the U.S. real gross domestic product (GDP) from quarters that saw the biggest declines between 1973 and 1975.¹ They are used to statistically model a scenario where the closing of the Strait lasts a maximum of three weeks (the week starting on the 23rd).² The foundation of this scenario is the view held by several analysts that until (approx.) the third week of the closure, resuming oil, gas, and commodities production will be relatively rapid (lasting from weeks to months). However, if the closure prolongs to a month, the shutdowns become semi-permanent, while the production of all kinds of oil-linked minerals, gas, fertilizers, and commodities will also start to shut down. This is what we warned about last week. We call this the Supply chain collapse scenario, and we harvest information from the second quarter of 2020 to model it.

To summarize, in the Oil crisis scenario, we expect the world to be hit by a severe raw energy shock (which is already on its way). In the Supply chain collapse scenario, we expect the global supply chains to begin to collapse, causing widespread shutdowns of industries and services (this is currently approaching).

We use our updated forecasting model for the U.S. gross domestic product (GDP) we unveiled last week as a basis for our estimations. We use the exact same setup, i.e., a vector error correction (VECM) model with three explanatory variables: U.S. Real Gross Private Domestic Investment (RGPDI), (seasonally adjusted) Real Gross Domestic Product (RGDP), and Loans and Leases in bank credit.³ As explained above, in the first model, we include a dummy variable that accounts for the quarters between 1973 and 1975,⁴ when the U.S. economy received the worst hits from the oil shock. Figure 1 presents the results of our forecasting model for this scenario.