Last update - 03:10 06/10/2006
5 reasons why the dollar dropped
By Hagai Amit
So what is happening to the dollar? It has plunged 2.5 percent in the last three weeks, which now makes a 5 percent drop in two and a half months. This has left many, in what we here in Israel often call the 51st state, rather surprised.
Yesterday, the dollar closed at a representative rate of NIS 4.25.
After the economy ended two months of uncertainty because of the war, politics and the budget, we expected Israeli investors to flee to their traditional haven: the dollar.
But even reports that the governor of the Bank of Israel might lower interest rates were not enough to stop the stampede driving the American currency downward.
So what are the real reasons for this surprising turn of events?
1. Investment managers are afraid to move money overseas
The drop in the dollar in the last two months is only part of the 9 percent drop in the last half year. There are those who claim that this is actually a sign of the growing maturity of Israeli investors as a result of the surging local investment markets in recent years.
"This is the culmination of a process whereby the Israeli public has internalized the fact that the dollar is not a shelter, or a safe investment," explained Eli Zahor, the CEO of the Barometer investment house.
On the other hand, the "immaturity" of institutional investors may explain why the drop in the dollar has stopped. "Institutionals love to advise all the time to send money overseas, but in practice for many of them this is just talk, and in reality not a lot of money is leaving. Even the big time managers act like the smallest investors, and are afraid to buy dollars when the exchange rates are low," said another market player.
2. Low inflation and high real interest rates
Interest rates of 5.5 percent, as in Israel, are not low in comparison to other countries around the world. When inflation is low, as here in Israel, real interest rates are in the 4 percent range.
It is not easy to find such interest levels, unless you are not scared to invest in developing - and risky - economies such as Brazil. These countries are riskier than Israel, which makes it an attractive destination for foreign investors who think it is worthwhile buying shekels with their dollars.
This touches on an important trait of Stanley Fischer, the Governor of the Bank of Israel. In spite of the exchange rate, Fischer continues to believe that the central bank does not need to intervene in the market, and has - for now - left it alone.
In a world where countries such as Japan and China struggle to keep their currencies undervalued in order to protect their exporters, Israel is quite an attraction because Fischer seems unperturbed by the situation - at least for now.
Take for example an economy of a completely different magnitude, China. The Chinese yuan is not rising, and the they are very carefully protecting their low exchange rates.
3. Foreigners are searching for investments
The world is awash with a huge amount of cash searching for investment opportunities. This is made clear by the fact that dollars are being converted to shekels for investment purposes, and because of an occasional big deal that appears in the news. The purchases of Iscar, the Psagot Ofek mutual funds, and other local high tech firms keep up a flow of dollars into Israel. Such purchases, which are real and not financial investments, have the biggest influence on local forex markets. But the real investments bring along financial investors and speculators in their wake - those who are willing to bet on the strength of the shekel.
"We are seeing the evolution of the shekel exchange rates as a result of an open foreign currency market, and because of international market forces," explained Shmuel Berger, the head of the Marvichim investment house.
"Today, as opposed to two or three years ago, the major players who set the agenda for the shekel are foreign institutions. It is like a bull in a china shop. Up until two years ago, the local business sector and currency traders set the tone," added Berger.
4. A strong economy and the treasury
"The strengthening of the shekel reflects the faith of foreigners in the Israeli economy, and their appraisal that the exchange rate is too low," said Berger. "The war actually showed the strength of the Israeli economy, since it came exactly at the time of Israel's greatest strength since the state was founded. Global analysts who set the credit ratings for Israel do not relate to the same things that worry Israelis, such as faith in the government or political instability," he added.
"Even this instability is not too bad, since even as governments have changed, the power of civil service officials has grown, and the ministry with the most powerful officialdom is the treasury," said Berger.
5. The Bank of Israel has not lowered interest rates
The real story behind the dollar's exchange rate plunge is the Bank of Israel. A drop in the dollar means a drop in inflation - and that is the flagship of the central banks' monetary policy, said Zahor.
Therefore, a drop in the dollar should encourage the bank to lower rates. On the other hand, since we are used to the central bank not meeting its inflation targets for the last decade, it is highly unlikely that it will lower rates quickly.
"Fischer does not have the courage to lower rates under 5.25 percent, and equality with U.S. rates is extremely respectable, too," a number of foreign currency traders estimated yesterday. The feeling is that only a series of interest rate drops will stop the dollar's fall, though a number of public statements by Fischer about a "correct exchange rate" could have an effect.
Another player is Israeli exporters. Their competitive position is being eroded by the rise of the shekel, and industry is wide open to the vicissitudes of the fluctuating dollar.
Finally, estimates as to where the dollar might stop are spread out from the present NIS 4.25, through NIS 4.21 and all the way down to the 4 shekel range.