The Economic Consequences Of An Israel-Iran War

The Economic Repercussions Of An Israel-Iran War

An Israeli invasion of Iran could provoke a spiralling in oil prices with catastrophic consequences for the world economy, as well as unpredictable political repercussions throughout the Middle East. Yet, Israel continues its dangerous game of brinkmanship.

An Israel-Iran war has the potential to be even more disastrous for the global economy than any previous conflict in the Middle East, says Professor James Hamilton, an expert in energy economics at the University of California, San Diego.

According to Professor Hamilton, while all previous conflicts involving oil producers have caused serious oil price spikes, this time, the price rises would be unprecedented.

“You can go all the way back to the Suez Crisis in 1956-57, then the Arab Oil Embargo in 1973-1974, the Iranian Revolution in 1978-79, the Iran-Iraq war of 1980 and the first Persian Gulf War in 1990. Each conflict saw about a 7 percent drop in world oil production and each one was followed by economic recession in the US,” he said.

“But a war between Israel and Iran has the potential to be three times as serious because of the strategic importance to the world economy of the Strait of Hormuz off the Southern coastline of Iran.”

About 14 tankers carrying 17 million barrels of crude oil pass daily through the Strait of Hormuz, which is 39km wide at its narrowest. This total represents 35 percent of the world’s seaborne oil shipments and 20 percent of oil traded worldwide.  

 “Iran is saying that if Israel attacks they will close down the strait and shut down the whole Persian Gulf. It may be bluster, but these are scary and dangerous threats,” said Professor Hamilton.

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Can Iran Really Close The Strait Of Hormuz?

Whether Iran would be able to close the Strait of Hormuz is one of the many intangibles of the whole affair. Opinions differ, but the US Defense Intelligence Agency says Iran has strengthened its military capacity in recent years.  

In the past few years, Iran has bought thousands of sea mines and wake-homing torpedoes, as well as hundreds of advanced cruise missiles. These have been tactically deployed along Strait of Hormuz, alongside hundreds of small fast-attack craft and fast inshore-attack craft.  

Saudi Arabia and the United Arab Emirates (UAE) have taken Iran’s threats to disrupt the passage seriously. Both countries have opened new pipelines which bypass the Strait of Hormuz. The UAE has built a 370km pipeline linking the oilfields near Abu Dhabi with the port of Fujairah in the Indian Ocean. It has a capacity of 1.5 million barrels a day, accounting for 65 percent of the country’s exports.

Meanwhile, the Saudis have re-opened the Iraqi Pipeline in Saudi Arabia (IPSA), which was built in the 1980s to bypass Gulf shipping lanes after oil tankers were attacked during the Iran-Iraq war. It could supply about 16 percent of Saudi exports. 

Related: UAE Launches Oil Pipeline To Bypass Strait of Hormuz

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Dr Kristian Coates Ulrichsen, Director of the Kuwait Program at the London School of Economics, said: “Past events suggest the Iranians could not close the Strait completely, but they would make it difficult to navigate by attacking tankers. Another factor is that insurance premiums would rocket, which also has a big bearing on oil prices.”

The result would be an inevitable spiralling of oil prices.

“With the global economy in such a parlous financial state, it can’t afford a spike in oil prices. After 2001, prices are high anyway and the world economy is not ready for a US$150-dollar barrels of oil. It would shake confidence to the bone in financial markets because the Gulf and the Strait of Hormuz are the keys to the global economy.”

Dr Ulrichsen however believes that Israel is presently engaged in a game of brinkmanship; and an attack, thus, is unlikely to happen soon. Dr Ulrichsen warns though that games of bluff and counter-bluff on the international stage could have unforeseen consequences, especially when the rhetoric on both sides have been so provocative.

The Israeli Defence Minister Ehud Barak, has claimed that Iran is approaching a ‘zone of immunity’ beyond which it could not be stopped from developing the capacity to build nuclear weapons. Barak recently issued the threat: “The Israeli front is as prepared as it has ever been” to attack Iranian nuclear facilities.

In response, Iranian President Mahmoud Ahmadinejad has described Israel as a “cancerous tumour” that would soon disappear from the map. He also said that the “Zionists” were usurpers of Arab territory. 

With temperatures running high, the situation is inherently unstable.

 “With any game of brinkmanship, it’s not easy to predict what’s going to happen. We none of us have any idea, but a conflict would be in no one’s best interests,” said Dr Ulrichsen.

He added: “My fear is that if the US increases sanctions to the point at which Iran is really hurting and they still refuse to comply, the Israelis will feel there is little else to do short of military action. That would increase the likelihood of conflict exponentially.”

Fragile Politics: Israel, Iran & The U.S.

In the US, the Obama administration is anxious to avoid an Israel-Iran war because of the dangers of undermining the fragile American economic recovery. President Obama has pursued an aggressive line of sanctions to deprive the Iranian economy of revenue from its huge oil and gas exports. 

The US has persuaded South Korea and Japan to cut Iranian oil imports, while India and China have been forcing Iran to sell discounted oil. The 27-member European Union (EU) has also banned Iranian oil imports and withdrawn shipping insurance from Iranian vessels.

Meanwhile, the US has engaged the support of major Arab oil-producing countries, such as Saudi Arabia and the UAE, to supplant any shortfalls from Iran.

The sanctions are having a crippling effect on Iran’s economy. Oil exports have fallen 40 percent in 2012, according to the International Energy Agency, costing the country nearly US$32 billion and the value of the Iranian rial falling by 40 percent since last year. Inflation is rampant, unemployment is soaring and bankruptcies are proliferating.

Related: Iran Feels the Pinch as Oil Export Loss Reaches $10bn

Related: Iran’s Oil Production Reaches 20-Year Low

In addition, Iranian banks have been banned from sending and receiving money from foreign banks by the Society for Worldwide Interbank Financial Telecommunication (SWIFT). Soon, Iranian businesses may be unable to trade at all on the world stage. 

The US has also been waging cyber war under the codename “Olympic Games”. The Stuxnet virus shut down a large part of Iran’s nuclear programme and the US is thought to be responsible for the Flame virus, a spyware program which eavesdrops on conversations near infected computers.

The US would like to see Iran comply before its economy collapses. But, if the regime stubbornly resists, President Obama hopes the regime becomes a victim of its failures and crumbles from within. 

“The Iranian elections are next year and the US will be hoping for a more cooperative leader than President Ahmadinejad,” said Ulrichsen. “But the situation is complicated by Iran’s dual power structure. Supreme Leader Ali Khamenei vets the presidential election candidates. In the last election, liberal candidates were barred and it’s likely that there will only be hardliners in the race again this time.”

In the US, the political ramifications of the Israel-Iran stand-off could intrude on the presidential elections on November 6.

If Israel attacks, which candidate in their right mind would not offer support to the Israelis? Failure to stand by them would be political suicide and a sure-fire election loser. Obama could not afford to be characterised as weak by his Republican opponents,” said Ulrichsen.

Obama is taking great pains to dissuade the Israelis from aggressive acts, but ironically a conflict could prove to be an election clincher for the President in a close race, according to Professor Hamilton.

 “Wars have traditionally been vote-winners for the incumbent US presidents as the American people tend to rally round,” he said. “The problem for Obama would come in the aftermath when he would have to deal with an even weaker economic situation.”

Professor Edward Haley, a political scientist from Claremont McKenna College, argues that both President Obama and his Republican rival Mitt Romney have backed themselves into a dangerous corner over Iran.

“Obama has been very emphatic about not tolerating Iranian nuclear weapons. So, if he wins the election and they continue to enrich the uranium, his words could come back to haunt him. Romney has left himself even less wiggle room.”

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Economic Fallout

The Israeli Government, on their part, has downplayed the seriousness of potential strikes, claiming that targeted attacks on nuclear facilities would last about five days. In their tightly scripted scenario, they would carry out a few bombing raids on the four major uranium-enrichment facilities at Natanz, Fordow, Esfahan and Arak. Then the Iranians would retaliate with rockets from Hezbollah forces in Lebanon, but the Jewish state would only have to absorb 500 casualties.

Few experts take this optimistic view seriously.

“We’ve heard those types of facile predictions a lot over the years. But wars are not always clean things. They don’t get resolved nicely and neatly in short periods of time,” said Professor Hamilton.

A number of major political and military leaders in Israel have also warned Prime Minister Benjamin Netanyahu about the dangers of invasion. Some have even questioned his mental stability. Powerful dissenting voices include the former President Shimon Peres, two former chiefs of the Israeli army, Shaul Mofaz and Amnon Lipkin-Shahak, and the former head of spy agency Mossad, Meir Dagan.  

The Israeli people, too, have an intimate understanding of the uncertainties of war. In 1982, they were told that the Lebanon War would last a few days, but invasion led to 18 years of armed conflict. The Israelis also remember Americans claims that the US war in Iraq would be an uncomplicated matter, but it has cost thousands of lives over a nine-year period.

“Even after conflict is over, the ramifications are much longer-lived than people expect,” said Hamilton. “The Iranian revolution of 1978 is still affecting modern Iran. A lot of their expertise in the oil industry left the country and they had a hard time rebuilding. Iraq has never recovered from the first Gulf War in 1990.”

The economic burden for Israel would be considerable. According to a study by the research group BDI-Coface, a conflict with Iran could cost the Israeli economy €41.6 billion, nearly 20 percent of GDP. Short-term damage would be about €18 billion, but long-term losses would be greater still.  

Related: War With Iran Could Cost Israel’s Economy $42 Billion: Study

The ripple effects of conflict in the wider Middle East are a further element of the complex picture.

“The whole Middle East is a very volatile place. You open a bottle and who knows what will come out? People study it and have grand plans, but it’s so hard to know,” said Professor Hamilton. “The fallout from a war would have repercussions throughout the Middle East, where sectarian tensions have escalated sharply. Bahrain, Saudi Arabia and Kuwait could all be affected.” 

Even if Israel strikes were successful, they would only be delaying the inevitable, according to Professor Haley.

“It’s already too late to control Iran’s nuclear proliferation and all the strikes would do is allow the world to adjust to Iran owning nuclear weapons,” he said.

In the long-run however, some believe that Iranian nuclear weapons might actually turn out to be a good thing. 

“The US political scientist Kenneth Waltz has argued that more nuclear weapons is a good thing because they act as a deterrent. When you ask yourself ‘what would happen to my country if I used nuclear weapons against another power which has them? Ah, yes. It’s going to disappear’. 

“In the Cuban Missile Crisis the US had 3,000 nuclear to Russia’s 50, but the US was deterred. So, I think Waltz’s argument is empirically true, but no government is going to take the chance. The Western powers will always do all they can to keep the number of nuclear powers to a minimum.”  

By David Smith,

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See also: MAD For Oil: Will US Sanctions On Iran Lead To Mutually Assured Economic Destruction?See also: A Global Perfect Storm – Why The World Faces An Economic Crisis In 2013: Nouriel Roubini