Israel-Hamas war risks further deglobalization and inflation

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A version of this story first appeared in CNN Business’ Before the Bell newsletter. Not a subscriber? You can sign up right here. You can listen to an audio version of the newsletter by clicking the same link.

The global economy is facing tremendous uncertainty from the war between Hamas and Israel in the Middle East, on top of the ongoing war between Russia and Ukraine. Those conflicts don’t just threaten the regions where they’re unfolding; they may also fray the weakening interconnectedness that remains among the world’s largest economies.

The global economy has become more integrated over the past century. International supply chains have grown and technology has exponentially advanced, boosting the free flow of trade, capital and information globally.

That interconnectedness is known as globalization. It ramped up in the latter half of the 20th century following Germany’s reunification after WWII and grew even more as China became an international trade juggernaut.

However, since the 2008 global financial crisis many say those ties have begun to weaken. Seeking to stabilize their economies, many nations have begun to establish protectionist policies that attempt to shield their domestic industries from foreign competition, according to a recent analysis from Wells Fargo.

The dismantling of those economic ties is called deglobalization.

Some economists say that globalization has simply stalled, while others argue that it is reversing outright, with the Trump administration’s tariff war with China, the Covid-19 pandemic and Russia’s invasion of Ukraine as catalysts.

Wells Fargo economists have recently taken a bearish stance. According to them, the era of globalization has ended. On top of the rise in “harmful” trade restrictions, they point to a sharp decline in foreign direct investment flows around the world.

They say Israel’s declaration of war against Hamas could be yet another catalyst for deglobalization, though the extent of that is still up in the air.

Before the Bell spoke with Brendan McKenna, an international economist at Wells Fargo, on how the Israel-Gaza conflict could hasten deglobalization.

(This interview has been lightly edited for length and clarity.)

Before the Bell: What role could the Israel-Gaza conflict play in deglobalization?

Brendan McKenna: We did have geopolitical relations start to improve in the Middle East, but because of what’s going on in Israel and Gaza, it seems like we backtracked on a lot of that positive momentum.

And when you have this geopolitical fracturing, that just leads to reduced trade cooperation between countries, less information sharing, less technology sharing, and less financial-market linkages.

At the end of the day it is a deglobalization force.

What will determine how much of an impact the conflict has on deglobalization?

If the situation in the Middle East does escalate, that’s probably going to lead to a bigger fracturing in the Middle East and then possibly between some other major economic actors.

When you think about the United States, the country has very strong support of Israel, and if you see other countries such as China either take the other side or not explicitly support Israel, or choose to abstain, I think there’s a possibility that some of the trade linkages between the United States and those countries may sour.

If deglobalization does get exacerbated, what would that mean for inflation and monetary policy, globally?

With deglobalization, you get a global economic environment that’s less competitive, and when there’s less competition, that is ultimately inflationary, causing prices to rise.

If we do continue to get this economic fracturing led by geopolitics, that’s ultimately going to be something that’s inflationary, which can lead to higher interest rates, not just from the Fed, but also from other major central banks around the world.

And not only are you going to get pretty scary forces that would reduce global GDP growth and act as a restraint on global economic activity, but you can also get tighter monetary policy as a result which could kind of compound those effects as well.

How could deglobalization potentially be a good thing?

If there is another type of major economic shock, like from the pandemic, the US would not be reliant on China to provide raw materials. Production nearshoring can save a lot of time if there is a shock and can also save on a lot of costs.

Over the Covid era, China shut down production, disrupting the global supply chain, so deglobalization would bring some production back within US borders. It can also improve relations with Mexico and other countries.

Obviously, the US-Mexico relationship under the Trump administration was somewhat tense. If the US shows that it is committed to the trade relationship and building infrastructure and putting investment on the ground in Mexico, that can actually be something that could improve and enhance geopolitical relations between the US and Mexico.

So there’s not only a possible economic benefit, but there’s also maybe the political capital that can also be built up as a result of it.

Israel’s vast tech sector has seen its fair share of crises, from financial downturns and the Covid-19 pandemic to periodic flare-ups in the Israeli-Palestinian conflict, my colleague Hanna Ziady reports.

Each time, the industry has bounced back, demonstrating why the country of just 9 million people is known as the world’s “startup nation.”

But the war sparked by the Hamas assault last weekend that killed more than 1,300 people in Israel has upended daily life in a way that presents a unique challenge to the country’s most important industry.

Schools have been ordered to close, once-bustling streets in Tel Aviv, the center of business, have virtually emptied and many businesses remain shut. Some are closed for security reasons, but many simply cannot operate because their employees have been called up to military service.

“This is different than anything we’ve faced before,” said Avi Hasson, the CEO of Start-Up Nation Central (SNC), a non-profit that promotes Israel’s tech industry globally.

Monday: Philadelphia Fed President Patrick Harker delivers remarks.

Tuesday: Earnings from United. Canada’s statistics agency releases September inflation data. The US Commerce Department releases September figures on retail sales. The Federal Reserve releases September data on industrial production. The National Association of Home Builders releases its Housing Market Index for October. Fed officials John Williams, Tom Barkin and Michelle Bowman deliver remarks. China’s National Bureau of Statistics releases September data on industrial production, retail sales and fixed-asset investment along with third-quarter gross domestic product.

Wednesday: Earnings from Procter & Gamble and Tesla. The United Kingdom’s Office for National Statistics releases September inflation data. The US Commerce Department releases September figures on housing starts and building permits. Fed officials Christopher Waller, John Williams, Michelle Bowman, Lisa Cook and Patrick Harker deliver remarks.

Thursday: Earnings from American Airlines. The US Labor Department reports the number of worker filings for jobless benefits in the week ended October 14. Federal Reserve Chair Jerome Powell participates in a discussion in New York. Fed officials Austan Goolsbee, Michael Barr, Raphael Bostic and Patrick Harker deliver remarks. Japan’s statistics agency releases September inflation data.

Friday: Fed officials Patrick Harker and Loretta Mester deliver remarks.

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