Tensions across the Middle East are mounting as a war between Saudi Arabia and Iran looms as a powerful undercurrent in what is currently a proxy war. The battlefield is not only laced with Iranian supplied rockets firing into the Saudi capital of Riyadh, but it is also a financial war with Lebanon’s dollar Peg among the potential economic casulaties. As if to benchmark a moment in history, Capital Economics, which successfully analyzed the against the consensus Brexit trade, also notes a historical benchmark in the wider Arab conflict.

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Lebanon's Dollar peg

Saudis consider war with Iran after missile launch

Israeli security analysts are likely watching the brewing Iranian / Saudi conflict with both apprehension and relief. On one hand, like the price of oil, the Israelis are concerned about a wider regional conflict with nuclear potential. Iran, after all, is a nation that has publicly stated its goal is to wipe the Jewish people off the map. On the other hand, for the first? time in modern history, Israel can watch as it is not at the center of a regional firestorm with apoplectic consequences.

Currently, the once simmering war is now playing out more violently among proxies. When a ballistic missile was fired from Yemen directly at the Saudi capital, the nation’s crown prince, Mohammed bin Salman, quickly pointed a finger at Iran, blaming them for arming Houthi rebels with the offensive weapons.

Condemnation for the action was swift, with UK foreign secretary Boris Johnson reportedly saying the move “may be considered an act of war against the kingdom.”

But war has many definitions in a region perhaps best known for its multi-directional communication channels: what is said on the surface is often not as meaningful as what occurs behind the scenes.

A financial war in Lebanon could ramp up under the surface and force  Lebanon's dollar Peg to fail

The war of proxies could be heating up, as the sophisticated battlefield of 2017 is looking very different than wars previous.

Capital Economics notes that as tensions have flared, Lebanon’s dollar peg providing currency stability is in question. Lebanon is generally considered an ally of Iran and is known to house Hizbollah, a paramilitary force that frequently attacks Israel.

“The deterioration in relations between Lebanon and Saudi Arabia in recent days has raised fresh concerns over the sustainability of Lebanon’s dollar peg,” Jason Tuvey wrote. “While the country has substantial FX reserves, these would be quickly eroded in the event of severe crisis, forcing the authorities to devalue the pound. This could ultimately create problems for the government in servicing its large foreign currency debt.”

Calling Lebanon’s regionally dependent balance sheet “alarming,” Tuvey notes that a weakness that a military strategist might spot as well. After Lebanese Prime Minister Saad Hariri resigned over the weekend, a political vacuum sparked concerns over the once cosmopolitan region being thrown into a ramshackle state again.

“Even if Lebanon avoids becoming embroiled in a regional conflict, any restrictions imposed by the Gulf countries on Lebanon or Lebanese nationals could force the central bank to burn through its foreign exchange reserves – which cover slightly less than three times the gross external financing requirement,” he wrote.

The battlefield in Lebanon, with its capital Beirut once considered the “Paris of the Mediterranean,” could get financial if controlling gulf states tighten the noose.  “A more severe outcome, including the threat of a military confrontation in the country, would obviously have dire social and humanitarian consequences,” he wrote, while pointing to the subtler battleground. “A period of capital flight would quickly erode the country’s FX reserves and force the authorities to abandon Lebanon's dollar peg.”

If this happens, Lebanon sovereignty would be challenged financially just as it needs financial might to quell conflict inside its borders.