scary dog
Dear dog, this is how you do it. Photo by David Bachar
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Gregory: "Is there any other point to which you would wish to draw my attention?"

Holmes: "To the curious incident of the dog in the night-time."

Gregory: "The dog did nothing in the night-time."

Holmes: "That was the curious incident."

Two events went down last week that should be warning us all: our seven or eight years of peace and security – a relative term, of course, here in the Middle East – may very well be coming to a crashing halt.

The deadly attack on the Israeli tourists in Bulgaria told us that the war with Hezbollah and Iran is very real and involves a lot more than threatening remarks from Jerusalem and Tehran. The killing of three of Bashar Assad’s war council the same day sounded like the death knell of the regime we have come to regard as a permanent fixture of the region; with its demise comes a new and unpredictable source of instability.

The financial markets are supposed to be the great barometer of political and economic risk, incorporating all the informed and calculating opinions of the investor community. Of course, as barometers go the markets are not so terribly accurate, but when their short-term failures are usually on the side of panic. Yet, the Tel Aviv Stock Exchange’s TA-25 index rose 2% the day after. The shekel weakened, keeping above NIS 4 to the dollar, but that was a long time coming and had nothing to do with heightened political concerns. On Friday, it was back down below NIS 4.

The usual measures of risk were unaffected. The spread on credit default swaps actually fell for the week to 155 basis points, in line with other economies with credit profiles similar to Israel’s. In English, that means the markets didn't perceive Israel as being riskier. And if anything, the spread between 10-year Israeli and U.S. government bonds likewise narrowed to 2.55 percentage points from 2.7 points.

The hound at the stables failed to sound the alarm the night when the race horse Silver Blaze was stolen, prompting Sherlock Holmes to observe to the clueless Inspector Gregory that the hound must have known the thief.

Last week, the markets acted like the dog that saw no reason to bark. Terror attacks are all too familiar and Assad has been fighting the rebels more nearly a year and a half. The Syrian civil war is nothing new.

Or is it?

The last seven or eight years (depending on when you want to date the end of the second Intifada) have been such a pax Israelitica that its existence was barely acknowledged. Yes, rockets were falling on Sderot during much of that time, but Hamas & Co. presented no strategic threat to Israel. Operation Cast Lead wreaked destruction on Gaza but it caused Israel more PR damage than economic losses. Yes, we fought a real war with Hezbollah in 2006 but its impact economically and politically was negligible. The economy had one quarter of declining output and quickly regained its losses. Investor extraordinaire Warren Buffett went ahead and made his first purchase outside the U.S. in Israel, buying control of blades maker Iscar for $4 billion even though the company’s main operations were inside the range of Hezbollah’s rockets.

Israel has enjoyed a good run economically during the pax Israelitica. That was due to a large extent to business-friendly (if not exactly social-friendly) economic policies as well as to a burgeoning high tech industry.

But the contribution of political quiet should not be taken for granted. In the seven years, some $60 billion of foreign investment poured into the economy, more than double the amount in the previous 20 years. Defense spending as a percentage of gross domestic product fell to its lowest level since the 1960s, freeing resources for lower taxes and other budget items.

In fact, the Lebanon war was a defining moment for pax Israelitica: In the eyes of foreign investors and businesspeople, Israel was no longer a military and political risk. The New Middle East of dining on hummus in Damascus and mixing oil wealth with Israeli genius never arrived, but the Same Old Middle East didn’t seem particularly threatening.

After several years of pax Israelitica the public was at peace enough that it could starting thinking about the price of cottage cheese. The irony was that just as protest tents were being erected in the heart of Tel Aviv, pax Israelitica was becoming unraveled.

What will the new post-pax era look like?

Speculation like that is inevitably doomed to error. But it is a safe guess to say it will look a lot like the three decades before the pax, when Israel had to contend with chaos in Lebanon and two intifadas. This time the chaos will be in Syria, quite likely in Egypt and perhaps even in Jordan but thanks to an easily accessible of rockets, it will likely impinge on Israel’s home front far more than before. An attack on Iran would create economic havoc many times worse than this.

The new era of perpetual low-flame conflict and occasional hot wars will almost certainly take its toll on investor confidence and limit fiscal options as the army legitimately asks for more money. Israel may be less able to adjust to the new era. We are more linked than ever to the global economy through trade, investment and tourism. The offshore gas fields, Israel’s single biggest economic asset, are vulnerable to attack.  Having had a taste of something approaching European living standards, and relative peace, the average Israeli will not be happy about a retreat back to the old era.