December 28, 2023 - 7:00am

When the Gaza war broke out in October, the contrast with the 1973 Yom Kippur War was stark. Whereas the earlier conflict sent inflation soaring in the West, triggered a global recession and heralded the end of the Keynesian era, this time around the breakout of fighting barely registered in world markets. 

Now, as the conflict enters its third month, that second proposition is starting to look dicey. Despite constant diplomatic efforts to prevent Iran or its various regional proxies from entering the conflict, their pace of activity has stepped up. Recently, Iran-aligned Houthi rebels have opted for a new tactic of attacking Red Sea container ships perceived as Israel-connected or Israel-bound. With 12% of global trade passing through this channel, the diversion of ships to the longer Cape route by some companies will start to raise shipping costs. Meanwhile, as volatility grows in the region, the price of oil — which had been declining all through the early weeks of the war — recently resumed rising.

Should this situation continue, inflationary pressures will once again begin building, even if they look manageable for now. While an uptick would complicate the job for central banks which are still trying to bring down inflation, provided matters don’t worsen, the effect on retail prices will remain muted. The US-led Combined Maritime Forces, originally formed to protect Red Sea traffic against Somali pirates, has now been repurposed to counter Houthi attacks, and the oil price remains well below the highs of recent years.

But what if matters do worsen, and Iran and the United States are drawn more directly into the war? For the time being, it appears that Iran would still prefer to avoid outright involvement. However, Washington claims that the Islamic Republic has been assisting the Houthi attacks, and Israel recently used that as a pretext to assassinate an Iranian Revolutionary Guards general. It seems likely that Iran will issue a response in due course.

It’s equally possible that Israel may have its own reasons to strike preemptively, most probably against Hezbollah. Because it is a closer ally to Iran than Hamas, Tehran would be less likely to stand by if its Lebanese partner became mired in combat. For their part, US forces are now stretched increasingly thinly across the region, which could embolden Iran and its allies.

Were Iran to directly enter the conflict, attacks on shipping would probably widen beyond the Red Sea to the Strait of Hormuz, which could dramatically affect oil prices. Given how much the world economy has changed in the last fifty years, inflation wouldn’t soar as it did then. But the current wave of celebration that inflation has supposedly been licked, and which is fuelling rallies in stock and bond markets, would probably come to a screeching halt. Central banks would dial down any optimism that rate cuts are on the way.

Tension is rising and American diplomacy has proven ineffectual at halting the spiral. It may be that recent diplomatic initiatives from within the region will suffice to cool tensions. Because if Iranian and American forces end up facing one another, all bets about the stability of the world economy can be called off.

John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a religion (Simon & Schuster, 2017).