When Hezbollah militants launched a murderous incursion into Israel last week, they began what might become the biggest war in the Middle East in a generation. Most chilling is the apparent coordination with Hamas and the clear ties between these groups and the Iranian and Syrian governments.

Resident Scholar Kevin A. Hassett

Much of the cause for concern is that the rhetoric out of Iran has been so bellicose in the last year, with President Mahmoud Ahmadinejad calling for Israel to be "wiped off the map." Now, Iran's proxies have brought the conflict to a new level. In a worst-case scenario, Israel will be drawn into a war with Syria and Iran, with the U.S. likely along for the ride.

The economic consequences of last week's actions were negative, though not overwhelmingly so. Yet what would happen to the world economy if a wider war ignited? If history is a guide, the fallout could be significant.

Sadly, there have been enough military confrontations in the region--five major engagements between Israel and regional Arab powers since World War II--for us to gauge the impact of another conflict.

The first was the Arab-Israeli War of 1948, which followed almost immediately after the state of Israel was created. The next big event was the Suez Crisis of 1956, precipitated by Egypt's nationalization of the canal, which prompted an Israeli invasion.

Six-Day War

Then came the Six-Day War of 1967, during which Israel captured Gaza, the West Bank, the Sinai Peninsula and the Golan Heights. In 1973, Egypt and Syria launched an attack on Israel's holdings in the Sinai and the Golan Heights, marking the beginning of the Yom Kippur War. Despite making initial gains, Arab forces were ultimately repulsed. Israel was again at war in 1982, when it invaded Lebanon with the objective of driving Palestine Liberation Organization forces out of the region.

What should we look for if the unthinkable happens again?

The most significant movement this time, as history suggests, would likely be in the price of oil. If Iran were drawn into a conflict with Israel, the country would likely attempt to disrupt oil transportation through the Strait of Hormuz, and might stop supplying its own oil to the world.

Energy analyst Peter Beutel suggested in an interview last week that such a move might push the price of oil higher than $100 a barrel, if combined with a disruptive hurricane in the U.S.

That possibility helps explain why prices climbed above $78 a barrel last week when the Israeli response began. A 37 percent move up from $78, pushing even past $100, is certainly possible given past oil-price responses to war in the Middle East. During the 1948 Arab-Israeli War, oil prices increased by exactly that percentage during the course of the fighting.

Drag on Economy

High oil prices put a drag on the economy for a number of reasons. First, consumers spend more at the pump, leaving less money to spend on other things. Second, big-ticket purchases of energy-consuming machinery tend to get put on hold. Folks purchase fewer cars when gasoline prices shoot up, in part because they want to wait and see if prices will head back down before they commit to the Hummer.

Businesses go through the same type of thinking, and capital spending tends to slow down when there are energy shocks. Given that there are many signs the U.S. economy has already been slowing, such a surge in oil prices might well be enough to push the economy into a recession.

There is significant historical precedent. The 1956 war in Egypt shut the Suez Canal to oil tankers. Oil producers cut output by 1.7 million barrels a day, roughly a 10 percent decrease in world oil production. Prices surged, and by August 1957, we were formally in a recession.

'Flight to Safety'

The outbreak of the Iran-Iraq war in 1980 caused world oil production to drop 7.2 percent. By July 1981, there was a recession. Iraq invaded Kuwait in 1990, and the same pattern held.

With that likelihood, expect the normal "flight-to-safety" assets to rally if full-scale war erupts. Gold prices would head way up, interest rates on government securities way down. During the 1982 Lebanon War, the 10-year Treasury bill rate dropped 12 percent in the 11 weeks from just before war began in early June to Aug. 24, 1982, the day after the PLO agreed to withdraw its forces.

The stock market would also take a big hit, history shows. During the course of the Suez Crisis in 1956, the Standard & Poor's 500 Index dropped 5 percent.

While this scenario is sobering, it remains unlikely, at least based on the economics. Oil accounts for about 10 percent of Iran's gross domestic product and comprises 80 percent of that country's exports. Take away the oil revenue in war time, and the economy would almost grind to a halt and certainly be unable to sustain a prolonged conflict. Only suicidal leaders would allow themselves to fight with Israel under such circumstances.

However bad it might get in the world economy because of a wider conflict, in Iran it would be worse. That realization might be the only thought between us and a recession.

Kevin A. Hassett is a resident scholar and director of economic policy studies at AEI.