2026 isn’t 1979: How the US could withstand another oil shock

Just when the U.S. economy appeared to have circumvented steep increases in tariffs, it now faces a new global shock amid the conflict with Iran. The price of oil fluctuated wildly this week between $120 a barrel and $90.

Some observers have compared it to the 1979-1980 oil shock, when prices quadrupled following the Iranian revolution. Iran’s oil production plummeted from 5.2 million barrels per day in late 1978 to 1.4 million barrels per day in 1980, effectively removing 6 percent of world oil production.

Gregory Brew of the Eurasia Group says the current disruption is the largest supply shock in history by a factor of two in an interview with Vox. This mainly stems from a blockade of the Strait of Hormuz through which 20 percent of world oil supplies pass. Oil facilities across the Gulf region are also under an attack that could affect supply even when the passage is reopened.

Daniel Yergin of S&P Global calls it the “nightmare scenario” for global energy. He points out that whereas Europe and the U.S. were the main markets for Gulf oil in the 1970s and 1980s, over 80 percent of the oil and 90 percent of liquefied natural gas went to Asia last year. This has added to pressures worldwide as Asian buyers have bid up prices.   

One factor that helps contain the fallout in the U.S. is that it is now the largest producer of oil. Two decades ago, it was the world’s largest importer of oil. The U.S. is also the world’s largest exporter of liquefied natural gas, whereas exports from the U.S. were negligible even 10 years ago.

The big unknown is how long the war with Iran will last. The Trump administration is banking on a short conflict, given the dominance of U.S-Israeli military capabilities. But there is uncertainty about what it will do to end the Gulf blockage. 

War has a way of producing unintended consequences. When Russia invaded Ukraine in February 2022, Vladimir Putin believed the conflict would end quickly. But as Ukraine put up stiff resistance, the oil price surged from $75 a barrel to a peak of over $120 per barrel. Prices then eased back as the Federal Reserve tightened monetary policy to combat inflation.  

One lesson from that period is that the U.S. economy proved to be resilient against the shocks. It overcame both the fallout from the COVID-19 pandemic in 2020-2021 and Fed rate hikes over the next two years, because it was well diversified and benefitted from government programs that produced a powerful recovery. The U.S. labor force also was highly adaptable as workers who were unemployed took gig jobs. 

In comparison, the economic picture today is in flux. Investors were upbeat about the economy’s prospects at the beginning of this year because uncertainty about tariffs had lessened, tax cuts in the so-called “One Big, Beautiful Bill” were in the works and the Fed was expected to ease monetary policy further.  

More recently, however, several factors have altered the equation. 

First, the Supreme Court’s ruling that Trump’s use of reciprocal tariffs was unlawful means that uncertainty about tariffs is back. Trump has declared he will use Section 122 of the Trade Act of 1974 to impose a temporary 15 percent tariff on trading partners of the U.S. The White House has also said it will use other statutes to impose additional tariffs later this year.

Second, the job market has weakened since tariffs were implemented last April. The labor market lost 92,000 jobs in February and the unemployment rate ticked up to 4.4 percent. While some of the weakness reflects temporary factors, establishment jobs have fallen five out of the last nine months. The latest estimate of the Census Bureau also shows the number of people in the labor force declined by 1 million in January, mainly owing to a decline in immigration.

Third, inflation is above the Fed’s 2 percent target, with the index for personal consumption expenditures that the Fed prefers reaching 2.9 percent in January, or half a percentage point higher than the Consumer Price Index. With gas prices at the pump up by about 50 cents since the Iranian conflict began, headline inflation is set to surge in March. 

So, how do these considerations alter the economic outlook? 

My take is that the resolution of the Iranian conflict is a wild card: Trump could end it at any time, considering Iran’s nuclear capability has been destroyed, but Iranian drones that threaten passage of oil shipments through the Gulf could prolong it.

Failure to end the conflict quickly could result in oil and gas prices staying elevated longer while growth slows. If so, the likelihood that the Fed will ease monetary policy will be diminished, and Federal Reserve chair nominee Kevin Warsh’s job will become more difficult. 

Nicholas Sargen, Ph.D., is an economic consultant and is affiliated with the Darden Business School. The second edition of his book “Global Shocks” is forthcoming. 

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