This time around, war in Israel shouldn’t upend the market

One of the most significant developments impacting the global economy was the Yom Kippur War in October 1973. When Egyptian and Syrian forces attacked Israel to regain territory lost in the Six-Day War in 1967, the U.S. government sided with Israel. Arab members of OPEC responded by imposing an oil embargo that curbed world oil supplies by 4 million barrels per day.  

During the First Oil Shock that ensued in 1973-74, oil prices quadrupled and contributed to a spike in global inflation and a significant tightening of monetary policies by industrial countries. The result was the most severe recession in the post-WWII era until then and a sell-off in world financial markets. The volatility during this period effectively ended any hopes that the Bretton Woods system of fixed exchange rates could be resurrected. 

By comparison, the response of financial markets following unprovoked attacks by Hamas on Israel has been modest thus far. Oil prices rose by 4 percent on the news, but they have subsequently eased, and both the U.S. stock and bond markets have rallied. Consequently, most observers believe the fallout from the conflict will be limited for the U.S. provided it does not escalate throughout the Middle East. 

One of the principal differences is that the U.S. economy is energy independent today, whereas the U.S. had become increasingly reliant on imported oil during the 1970s. The problem then was exacerbated by price controls on crude oil that were adopted in 1971 to combat inflation, but which contributed to declines in domestic oil production. When faced with fuel shortages and price hikes in 1973-74, stopgap measures were adopted to conserve energy including having gas stations ration supplies and homeowners use less electricity.   

The path to restoring U.S. energy self-sufficiency occurred over several decades. In 1975, Congress established fuel economy standards for new passenger cars to double the average fuel efficiency of new fleets by 1985. Thereafter, President Carter subsequently eliminated price controls on domestic crude oil in 1979. However, it was not until 2019 that the U.S. became a net energy exporter owing to increased production of shale oil, increased energy efficiency in the transport sector and a ramp-up in liquid natural gas and oil export projects.  

Energy self-sufficiency does not mean the U.S. is completely immune from oil supply shocks. But their impact has lessened over time. During the two U.S. conflicts with Iraq, for example, crude oil prices roughly doubled, but the Federal Reserve refrained from tightening monetary policy because inflation was under control. More recently, Russia’s invasion of Ukraine caused the price of West Texas Intermediate crude oil to surge by 50 percent initially to more than $120 per barrel. However, oil prices plummeted thereafter until Saudi Arabia and Russia agreed to cut back production to stabilize prices.  

Crude traders do not expect a massive price surge now, as there is no immediate threat to supply. Rather, the principal uncertainty is whether the conflict between Hamas and Israel will spread to other parts of the Middle East such as Iran, which could be complicit in assisting Hamas. 

Thomas Friedman conjectures that Hamas’s motive in attacking Israel may have been to prevent the normalization of relations between Saudi Arabia, Iran’s main rival, and Israel. Such a deal would benefit the moderate West Palestinian Authority by providing it with a huge infusion of cash from Saudi Arabia along with curbs on Israeli settlements in the West Bank and other advances to preserve a two-state solution. 

One concern is that a retaliatory strike by Israel against Iran would inflame concerns about the Strait of Hormuz, which Iran has previously threatened to shutter. To deter this possibility, President Biden left no doubt where the U.S. stands when he stated: “The United States has Israel’s back.” Biden pledged more military assistance to Israel and announced that the U.S. was sending an aircraft carrier to the area. 

A key development that lessens the risk of global supply disruption is that members of OPEC are not threatening to cut back production as they did 50 years ago. The minister of the United Arab Emirates, a key OPEC member, reportedly stated that the conflict would not affect the group’s decision-making: “We do not engage in politics; we govern by supply and demand and we do not consider what each country has done.” 

Finally, another consideration that mitigates the risk of an oil price spike is the strength of the U.S. dollar, which has appreciated by 10 percent on a trade-weighted basis over the past two years. Moreover, there currently is no viable alternative to challenge the status of the U.S. dollar as the world’s reserve currency. This is in marked contrast to what happened in the 1970s when the dollar was perennially weak as the United States became a high-inflation country. Consequently, OPEC members were motivated to raise the price of oil at that time to recoup some of the loss of their purchasing power resulting from oil being denominated in dollars.    

Weighing these considerations, there is a possibility that oil prices could test $100 per barrel if the conflict between Hamas and Israel were to broaden. But prices would have to rise well beyond that level to threaten the U.S. economy given its inherent resilience and status as being energy self-reliant. 

Nicholas Sargen, Ph.D. is an economic consultant with Fort Washington Investment Advisors and is affiliated with the University of Virginia’s Darden School of Business.  He has authored three books including Global Shocks: An Investment Guide for Turbulent Markets.