Bank of Israel Governor Stanley Fischer .
(photo credit: Ariel Jerozolimksi)
Bank of Israel Governor Stanley Fischer has a
problem. For the last 17 months straight, the BOI has been buying up
dollars in the foreign exchange market to stop the free fall of the
greenback against the local shekel.
This fall threatened to destroy the crucial
export sector, which accounts for almost 30 percent of the nation's
GDP. The BOI's purchases have brought Israel's foreign reserves to a
record of almost $50 billion.
At first, officials in the central bank insisted that this
policy had nothing to do with aspirations to artificially regulate the
exchange rate, but was meant to strengthen Israel's foreign reserves.
No one really bought this argument at the time, but now, when
these reserves can cover imports for almost 10 months, a depreciation
of the shekel has become an official stance.
At first, Fischer's moves were very successful. The
shekel, which had reached 3.2 against the dollar, turned around and
fell to a low of 4.2 at the beginning of April after the governor of
the central bank convinced local dealers he was serious, increasing the
level of the daily dollar dose to 100 million.
But in the last four months, the trend has reversed. The
dollar, which had weakened across the world, started recovering to its
current 3.75 level, despite the continuing purchases by the BOI.
is a limit to Fischer's ability to continue his support of the American
currency. When we say that the BOI buys $100m. a day, we actually mean
that our central bank is printing about NIS 400m. for the purchaser of
This is a classic inflationary activity. The BOI can offset
money-printing by increasing the issuing of its own bonds (the famous
Makam) to the public, but it hasn't done this so far, so the
inflationary effect still remains. Fischer believes that in the current
economic atmosphere of recession, deflation is a far more serious
danger than inflation, so he can keep pumping shekels to the money
So far, this belief has proved to be correct. But now, as we
can learn from the latest read of the consumer price index and from the
inflation expectations derived from bond market prices, things have
changed. Let us not forget that the prime responsibility of our central
bank, as clearly stated in the BOI Law, is to maintain price stability.
Printing so much money is the opposite of that.
A first sign of the growing concern of such an effect on prices
was the BOI announcement last week that it would stop buying government
bonds in the free market. This was another measure Fischer implemented
in the stormy months of late 2008, when he poured money into the bond
market to improve the institutional investor's (pension and provident
funds and insurance companies) liquidity.
But the bonds repurchase is small potatoes compared to the
challenges Fischer faces in the forex market. It is clear to everyone
that if the Israeli currency were to skyrocket again toward a rate of
NIS 3 to the dollar, many industrial companies could collapse, and
others - including in the prominent hi-tech sector - would suffer heavy
losses that would force them to lay off tens of thousands of workers.
In the current fragile economic environment, this would be a national
The task of supporting the dollar is getting even more
difficult if you consider two other important factors. The first is the
global trend against the dollar in the world's forex markets. This
trend is likely to continue due to the monstrous deficit in US trade
and the budget, which is growing bigger by the day.
Among the factors that have an extremely negative influence on
the value of the dollar are massive money injections by the Federal
Reserve, huge liabilities taken by the federal government from the car
and the mortgage market, ambitious health-care plans and
supporting the crippling state budgets.
The second factor is the relative strength of the Israeli
economy, which, together with the growing appetite for risk in the
world's financial system, will probably tempt more and more foreign
investors to divert money toward the Holy Land.
Indeed, this is something that has been going on for a few
months now, and it is a primary reason for the current appreciation of
No wonder that in the last few weeks we have witnessed a wave
of "macro studies" from prominent foreign banks that predict a further
appreciation of the shekel in the coming months. These banks usually
open their financial positions and then flood the market with so-called
"professional" studies in order to support their investments, trying to
tempt the masses to flow in the desired direction.
As we can see, Fischer's dilemma isn't simple. His ability to
buy more dollars is reaching its end, and the mighty forces of the
foreign exchange markets are threatening to ruin his achievement of
saving exporters from a disaster so far.
But the answer, in my view, is surprisingly simple. There is an
alternative to direct intervention in the forex market. Instead of
printing billions of shekels, Fischer should adopt a method that is a
common practice in places such as China and Thailand
, which also rely
heavily on exports and apply a 35% tax on short-term (12 months is a
reasonable limit) foreign investment.
Under this regulation, a foreign investor who withdraws his
money in less than a year will leave 35% of it in the government's
hands. Since a huge part of the dollar inflow nowadays comes from
foreign speculators who convert billions of dollars to shekels, if they
are invested in short-term local bonds, the new tax is likely to be
very effective in driving "hot" dollars away.
The argument that this step would be a regression to a
government-controlled market is ridiculous. First of all, direct
purchases by the BOI are themselves a means of control, so there is no
regression here. Moreover, short-term speculations like the ones
foreign banks conduct from their mother bases in London
have nothing do
with the real economy. They are merely financial raids made by sharks
who usually use shady practices such as those that destroyed the
financial system just a year ago.
The central government's duty to protect its
population from this kind of financial terror is the same as in the
case of physical terror. The notion that these steps will scare real
foreign investors away has proven to be wrong in the Asian countries
that have tried them out. It will only scare away the hyenas who have
no idea how to make money by actually creating something real.
the idea of fining short-term capital movements is not a guarantee to a
weaker shekel. A global collapse of the dollar will eventually take its
toll here as well, and there is no way to completely control a foreign
exchange market without returning to a fixed rate and a black market on
back streets such as Lilienblum in Tel Aviv
But it would certainly soften the punch, and more importantly,
it would not make us pay an extremely high price on the inflation front.