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The Syrian conflict dominating news headlines is already gyrating markets and forcing onlookers to assess the financial impact of the evolving events.

Obama: Engagement is Inevitable

President Obama, during remarks to reporters in 2012, set a ‘red line’ with respect to the use of chemical weapons by the regime of Bashar al-Assad, assuring retaliation in the event such an attack takes place.

“I have been very clear to the Assad regime, but also to other players on the ground, that a red line for us is we start seeing a whole bunch of chemical weapons moving around or being utilized.”

The inevitability of an engagement then became reality when reports of chemical attacks, allegedly by the Assad regime, surfaced in June and late August. Obama made clear that the authority to engage Syria militarily lay solely at his discretion as Commander-in-Chief and the red line drawn would be credibly enforced. Nonetheless, in an effort garner public support, Obama sought the approval of Congress, thus igniting an open debate on the merits of a conflict. Proving Congressional approval to be little more than a gesture, Obama, during a news conference in Sweden and also by his administration later, affirmed the commitment to act unilaterally regardless of the outcome of a congressional vote.

Short Run Effects of War on Markets

Wars in the formal sense have not been declared since World War II, yet varying military conflicts since have evolved into what history commonly regards as war. The extent of military engagement, if any, to be used in Syria is yet to be determined but even the evolving prospects of some military conflict are rattling markets.

In the past, conflicts rarely result in consistent reactions by markets. Depending on the general trend of assets prior to military involvements and exigent circumstances, asset price prediction is complex.

In the present Syrian conflict, following the August 21 chemical attack, markets began to anticipate a conflict on the horizon which sent the dollar, gold and oil higher. As delays to military action arose, following Obama’s turning to Congress and furthering of diplomatic efforts, the upward trends in the dollar, gold and oil started to reverse.

Gold price reacts positively as the chances of war increase

Gold Price Graph Annotated with Syrian Conflict Timeline

(See full Syrian conflict timeline)

Long Term Effects of War on Markets

Aside from day traders, the long term effect of military conflicts on global markets is the primary concern to investors and those trying to simply protect their wealth. Wars tend to create noticeable and lasting impacts on the economy. Massive increases in government spending, indebtedness, money printing and changing global relationships are among the common consequences. These factors tend to weigh negatively on the US dollar in the long run, but over time prove positive for rare, liquid commodities like gold.

The negative long run effects on the dollar contrast the usual short term positive effect which is often misconstrued as investors flee to the safety of the US dollar. Rather, military conflicts create uncertainties for the investment environment which leads to deleveraging and cash building to buffer unexpected changes. As assets go up for sale and credit scales back, the US dollar, being the base currency, rises in value in the short run but serves to threaten the long run stability of the US economic system. The United States is the world’s largest debtor and a rising currency value makes debts relatively more difficult to service. The increase in demand for dollars also prompts the US Federal Reserve to supply more dollars via the printing press, which negatively weighs on the dollar in the long run as demands eventually subside while excess money supplied hangs over. The ongoing deleveraging serves to hamper growth which prevents job creation and the ability to garner credit.

The Syrian conflict in particular may have uniquely devastating long run effects on the dollar as geopolitical tides converge. Syria is pitting major economic players such as Russia and China against the United States, stirring an East versus West global divide that has not been seen since the cold war. Global currency wars could escalate from these tensions, as China moves to diversify away from its reliance on the US dollar, and Russia continues to stockpile gold perhaps to threaten the US dollar’s global currency reserve status.

How to Strategize in Case of War

Regardless of the outcome preparation is key. Few people cancel their insurance as the days go by without an insurable event occurring. The reality of military conflicts is that while the outcome is uncertain, the negative risks are pervasive – including large tail risks. A conservative strategy that insures against the array of mostly negative outcomes embodies much of gold’s general allure. Remaining cognizant of the risks and insuring against the negative outcomes is likely the most prudent course of action when trying to protect wealth and defend against deteriorating global support for the currency many people heavily rely on.