How the Conflict Between Israel and Iran Could Spark a Global Recession

Commentaries on economics and technology.
March 17 2012 7:03 AM

The Fear Premium

Oil supplies are up, and demand is down. But the conflict between Israel and Iran threatens to cause another global recession.

President Obama and Israeli Prime Minister Benjamin Netanyahu.
President Barack Obama met with Israeli Prime Minister Benjamin Netanyahu in early March to talk about the conflict with Iran

Saul Loeb/AFP/Getty Images.

Today’s fragile global economy faces many risks: the risk of another flare-up of the eurozone crisis, the risk of a worse-than-expected slowdown in China, and the risk that economic recovery in the United States will fizzle (yet again). But no risk is more serious than that posed by a further spike in oil prices.

The price of a barrel of Brent crude, which was well below $100 in 2011, recently peaked at $125. Gasoline prices in the United States are approaching $4 a gallon, a damaging threshold for consumer confidence, and will increase further during the high-demand summer season.

The reason is fear. Not only are oil supplies plentiful, but demand in the United States and Europe has been lower, owing to decreasing car use in the last few years and weak or negative GDP growth in the U.S. and the eurozone. Simply put, increasing worry about a military conflict between Israel and Iran has created a “fear premium.”

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The three most recent global recessions prior to 2008 were each caused by a geopolitical shock in the Middle East that led to a sharp spike in oil prices. The 1973 Yom Kippur war between Israel and the Arab states led to global stagflation (recession and inflation) in 1974-75. The Iranian revolution in 1979 led to global stagflation in 1980-82. And Iraq’s invasion of Kuwait in the summer of 1990 led to the global recession of 1990-91.

Even the recent global recession, though triggered by a financial crisis, was exacerbated by spiking oil prices in 2008. With the barrel price reaching $145 in July of that year, oil-importing advanced economies and emerging markets alike faced a recessionary tipping point.

The risk that Israel’s threat to attack Iran’s nuclear installations will, in fact, lead to an outright military conflict may still be low, but it is growing. Israeli Prime Minister Benjamin Netanyahu’s recent visit to the U.S. demonstrated that Israel’s fuse is much shorter than America’s. The current war of words is escalating, as is the covert war that Israel and the United States are allegedly engaging in with Iran (including killings of nuclear scientists and use of cyber-warfare to damage nuclear facilities).

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Iran, with its back to the wall as sanctions bite harder (especially the recent SWIFT and central bank restrictions, and Europe’s decision to stop importing Iranian oil), could react by increasing tensions in the Gulf. Eventually, it could easily sink a few ships to block the Strait of Hormuz, or unleash its proxies in the region, which include pro-Iranian Shiite forces in Iraq, Bahrain, Kuwait, and Saudi Arabia, Hezbollah in Lebanon, and Hamas and Islamic Jihad in Gaza.

Recent attacks on Israeli embassies around the world appear to signal Iran’s reaction to the covert war being waged against it, and to the tightened sanctions, which are aggravating the effects of the regime’s economic mismanagement. Likewise, the recent escalation in cross-border fighting between Israel and Gaza-based Palestinian militants could be a sign of things to come.

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