An anti-missile system operates as missiles are launched from Iran, as seen from Tel Aviv on June 18.Violeta Santos Moura/Reuters
Kevin Yin is a contributing columnist for The Globe and Mail and an economics doctoral student at the University of California, Berkeley
For those of us who grew up in the decades after the Gulf War, certain shocks to the global economy seemed more an artifact of economics textbooks than reality.
Our formative macroeconomic experiences were not supply side shocks such as the 1973 OPEC embargo or Saddam’s invasion of Kuwait, which drove up the price of oil and thus the costs of production. We were far more acquainted with drops in demand from repeated stock market bubbles and financial crises. For us, and the leaders of G7 nations in Kananaskis this week, the conflict between Israel and Iran is a reminder that old threats from the supply side are making a comeback.
In the almost 30 years between the end of Operation Desert Storm in 1991 and the start of the COVID-19 pandemic, the global business cycle was more or less defined by demand. As both the U.S.-led global order and market liberalization were ascendant, it was not supply chain disruptions and oil prices that posed the greatest threat to people’s livelihoods, but the interrelated challenges of asset bubbles, currency crises and sovereign defaults, all of which are primarily demand-side risks.
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It is rather astonishing how stark this pattern was in that period. From domestic crises such as the housing crash of 2008 and the dot-com bubble in 2000, to events from abroad such as the Asian financial crisis in 1997 or the Argentine sovereign default in 2000, most macroeconomic shocks for nearly three decades were financial in nature. What these events had in common was that, in each case, an asset value collapsed, and the loss of wealth induced people and businesses to cut back their purchases, slowing economic activity. Unlike supply side shocks, demand shocks are not inflationary (prices do not rise if no one wants to buy things), and thus pose a far simpler challenge for central banks and finance ministries looking to get the economy back on track.
If the leaders at the G7 summit this week were under any illusions that this was still the world we lived in, Israel’s unprecedented strikes on Iranian nuclear facilities and key military officials last week should have jolted them out of it.
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Because oil, and energy more broadly, is a critical input to all production of goods and services, large oil price increases are the quintessential supply shock. The Israeli attack itself does not threaten oil supplies, but the most drastic of potential Iranian responses would. If Supreme Leader Ayatollah Ali Khamenei chooses to bomb oil assets in the Gulf states or, worse, block the Strait of Hormuz, the key shipping lane for around 20 per cent of global oil supplies, companies around the world will be forced to cut production, and consumers will see the cost of living rise again. Experts do not see these events as likely yet, but U.S. President Donald Trump’s increasing willingness to get his country involved militarily is forcing Iran into a corner with fewer and fewer options.
The Israel-Iran conflict is part of a broader trend of countries emboldened to seek regional hegemony as the global influence of the U.S. wanes. But as geopolitical tension rises, so does its twin problem – the elevated risk of supply side shocks.
This was somewhat common before the nineties, as repeated wars and political crises in the Middle East put crude supplies at perpetual risk. But modern day Europeans are also familiar with this problem, since shipments of Russian gas halted from when Russia invaded Ukraine, sending European energy prices skyrocketing in 2022. Even Canada considered halting oil shipments in its trade war with the U.S. When international relations sour, energy supplies are among the first to go.
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But energy is not the only resource bottleneck at the whims of foreign affairs. China controls well over half the world’s supply of rare earth metals, which serve as crucial inputs for everything from cars to computer chips, and around 85 per cent of processing capacity. The country has already exercised this leverage in retaliatory export controls in response to Mr. Trump’s tariffs. Semiconductor chips are the key component in nearly all modern electronics, and more than 60 per cent of all semiconductors are manufactured in Taiwan, most by a single company. A war over, or blockade of, Taiwan could easily send prices soaring and grind production of many dependent goods and services to a halt. These threats would have been unthinkable 20 years ago, hence the West’s willingness to allow these dependencies to grow unsupervised until now.
The economy is not even close to the most important victim of war. But in lessons from the past and present, even the most cynical Goldman Sachs analyst can see that peace pays. That we have returned to an era of politically driven supply side risks only adds increased urgency for our global leaders to work toward a more stable foreign-policy framework.