There was a time when the outbreak of war in the Middle East would send oil prices soaring and threaten a global recession. Back in 1973, when Egypt and Syria launched a coordinated assault on Israel and Saudi Arabia cut oil shipments, the world price of oil shot up fourfold. As long queues formed outside petrol stations and bedtime stories were read by candlelight amid blackouts, Western economies suffered the double blow of rising prices and falling output. Ever since, the resulting cocktail of what came to be called stagnation has haunted policy makers, their memories darkened by those cold nights.
But what a difference a half-century makes. After Israel launched its attack on Iran last week, the oil price rose sharply, but only back to the level at which it spent most of the last three years, merely reclaiming recent lost ground. As for fears of a global recession, stocks briefly fell before regaining most of their ground too. At least initially, the world’s investors regarded this war as an irritant rather than a catastrophe.
It’s a bit surprising, not least because the war lands at a delicate time for the world economy. In the last couple of weeks, both the OECD and World Bank issued their updated economic forecasts for the world economy. Neither is optimistic: global growth is expected to stay below 3% this year. Leading the way downwards are the developed economies, all of which are growing slowly if at all.
So, despite the serene sense in markets amid a major war, the risks to the global economy remain high. The tenuous balance of the moment may not last. For now, the world’s major powers are standing by while Israel and Iran slug it out. When US President Donald Trump suddenly left this week’s G7 Summit and tweeted that Tehran should evacuate, speculation was rife that Americans were about to join Israel’s fight. But when the night passed without further incident and Trump subsequently said he was looking for a “real end” to the war, its future course remained as unclear as ever. While Israel enjoys the upper hand, having apparently established complete air dominance, the conventional wisdom is that it does not have the ordnance or air power needed to deliver a decisive blow. To completely destroy Iran’s nuclear facilities, Israel would therefore need the Americans to join their mission. But a rift has opened in the administration between those who want to back Israel’s war, like the US ambassador Mike Huckabee, and those who want to continue the pivot towards containment of China.
This raises the possibility that Israel will be left to continue this war alone and, unable to bring it to a resolution, will succeed mainly in motivating the Iranian leadership to double down on the creation of a nuclear bomb. It’s a safe bet that if the Iranians do that, the Saudis will move to do so quickly as well. The insecurity in the region will then only worsen.
Yet accurate predictions would require knowing the President’s mind, and it’s not clear if anyone does. Although American presidents have enjoyed a great deal of discretion in foreign affairs, there has always been a general predictability to the behaviour of American presidents. Trump’s predecessor Joe Biden, for instance, could be counted upon to grumble incessantly about Netanyahu but always give him what he wanted, in light of his ideological commitment to Zionism. But with Trump, it seems to come down largely to who he is listening to on any given day.
During his second presidency he has indicated quite unambiguously that the United States is tired of playing the role of hegemon in global affairs and will thus base its future decisions on its own priorities, as expressed by the President himself. He apparently believes that nimbleness allows him the freedom to do deals and rework the rules of international economics in a way that maximises American interests.
But if the renunciation of long-standing commitments and alliances gives the President the freedom of manoeuvre he apparently envies in leaders like Vladimir Putin and Xi Jinping, Trump’s approach differs in one crucial respect. Whereas Xi and Putin — and even North Korea’s Kim Jong Un for that matter — root their decisions in strategies and ideological visions that are identifiable and consistent, Trump’s America First vision remains inchoate and unclear. One day tariffs are on because they’ll restore American manufacturing, the next they’re off because they were only ever intended as bargaining chips in trade negotiations. One day mass deportations are on to protect American jobs, the next they’re off because they’re hurting American farmers and hoteliers. And on it goes.
Amid this uncertainty, long-term planning has become challenging. So far, most American business managers haven’t changed their investment plans for this year, although early signs of an increase in the number of firms aiming to scale back investment amid rising uncertainty are starting to emerge. But more tellingly, the evidence that foreigners are starting to lose faith in America, and are consequently pulling their money out, continues to accumulate.
In this light, the most significant development of this Middle East war is that a decades-old rule of the global economy — that in a geopolitical storm, everyone heads to the safe bastion of the US — appears now to be broken. In the past, amid increased tensions in the region, the oil price rose, the dollar strengthened and US bond yields fell, as global investors rushed to park their money in the safe haven of the US. This time around, the opposite has happened. The oil price has remained in its recent range, the dollar has continued sliding and bond yields haven’t fallen. In the meantime, gold continues its relentless upwards march as the world retreats from the dollar and returns to the ancient metal as a favoured reserve currency.
“A decades-old rule of the global economy appears now to be broken.”
What appears to be unfolding, therefore, is a global economy that resembles that of the period between the last century’s two world wars — a time when a declining empire, the UK, lost its hegemonic role but the rising power, the US, wasn’t ready to replace it. Britain had ceded its place as the world’s biggest economy to the US, but the Americans weren’t yet ready to build a military force to match their status as an economic superpower: on the eve of the Second World War, Douglas MacArthur lamented that the entire US army, which was smaller than Portugal’s, could have fit into Yankee stadium to watch a baseball game. Britain, meanwhile, was desperately trying to avoid conflict at all cost, and could not play the role of world policeman. Equally the pound sterling was gradually weakening, but the US dollar didn’t yet replace it as the world’s reserve currency. Amid that de-centred world economy, there followed an era of volatility — financial crises which were poorly managed, trade relations which worsened — and which climaxed in the Great Depression and the onset of war.
The world economy today may be moving into a similar interregnum. That would make it vulnerable to any kind of major economic shock, of the sort seen in the 2008 global financial crisis or again in the 2020 Covid crash. But those crises occurred at a time when there still existed a broad political consensus among G7 states about the global order, one based on open markets and relatively unhindered flows of money, goods and services. As a result, financial and political leaders were able to manage those crises swiftly and effectively with a high degree of coordination, involving such measures as central bank swap lines, and a widely shared consensus on the basic contours of policy: a blend of loose fiscal and monetary policies and a commitment to keeping global trade flowing.
Faced with a similar economic shock today, it’s possible such harmony will prove elusive. And while the Middle East war may not provide the shock, other tensions are building in the global financial system. Some see private equity headed for a moment of crisis, while the formal financial system’s recent embrace of crypto, despite still not being able to make a use-case for it, has strong late-bubble vibes to it — the sort of vibes which become contagious shortly before a fall.
Barring a dramatic escalation — say a mass casualty event that takes the war into an entirely new phase, the closure of oil shipping lanes, attacks on Western or other regional forces — this Middle East war may not pose a 1973-style shock to the world economy. But it has uncovered the looming problems in the Western economies, and highlighted the growing risks to future growth. The longer the war continues, the worse that will get, so the US — which will ultimately be decisive — will have an interest in bringing the conflict to a rapid conclusion. Whether or not Trump proves able to do that, though, will reveal how far the hegemon has fallen.
