Taking Stock / Mark to market
Steve Roach, the chief economist at Morgan Stanley, has become quite a hit on the lecture circuit.
Sure he has: Roach has been growling black prophecies regarding the U.S. economy and Wall Street for two years now, and pessimism is in. Five years ago, arch-bull Abby Joseph Cohen was the toast of the town; but the market reversal sent her star into a tailspin.
Roach is deeply concerned about the American economy, the credit bubble, the real estate bubble and excessive share prices. He does not agree that the U.S. economy can quickly recover from the Wall Street bubble.
A few weeks ago, when we asked Roach if he had anything optimistic to say about the American marketplace, he didn't miss a beat. "Yes, what's good about the American economy is that it's a mark-to-market economy," he said - meaning, valuations are customarily adjusted to reflect current market values.
What Roach meant is that America's business sector - companies, managers, investors - don't dawdle about adapting their behavior to changes in the marketplace. Companies slash spending, and lenders cut off financing to bad deals.
In short, all the players in the economic arena adapt to change in circumstance.
Recognizing changes in the market and taking action are the infrastructure of economic recovery. Inability to acknowledge that times have changed and attempts to sweep the problems under the rug render recovery impossible. The most obvious example is Japan, where the recession has lasted more than 10 years because of a general refusal to face up to and acknowledge the facts.
Two years ago, the combination of the Palestinian uprising and the bursting of the technology bubble created new conditions in Israel. The business sector's instinctive reaction was to ram its head into the sand and hope that better times would come, and soon.
Yet, in the last year, recognition of reality has begun to seep through the sector. Companies are streamlining, saving, changing direction, slashing their spending structures and abandoning concepts and norms that suited better times, when the economy was growing by 3-4 percent a year and capital was flowing in from abroad.
In the last three weeks, the process has shown up in corporate books, after major firms that had lived in denial up till now finally wrote down the value of their assets.
The growing wave of write-offs is infectious. What Bank Hapoalim did last week will force the other banks to toe the line. What IDB Holding Corporation did to its empire of companies will ultimately leave Israel's other huge corporations no choice.
In parallel, a macroeconomic phenomenon of equal importance is discernible - a gradual withdrawal from the "Dutch disease" of depending on streams of foreign currency, which kicked up the exchange rate and made entire industries sclerotic in their failure to compete with prices abroad.
The dwindling of the foreign currency flow triggered a significant real devaluation in the exchange rate - for the first time in years. Companies groaning under the appreciated exchange rate are flourishing anew, as imports climb in price and exports start making substantial profits.
The process of acknowledging reality, increasing efficiency and depreciating the exchange rate are the foundations for the healing of the business sector. And its recovery might have been rapid, and borne fruit by year-end, if not for the bloated public sector sitting like a yoke around its neck.
The public sector uses up 57 percent of Israel's GDP. It dictates that interest rates and taxes will remain high, and that the fog of uncertainty will continue to shroud the marketplace, reducing the motivation to invest and take risks.
The treasury's plan to reduce public sector wages by 5-20 percent that the government debated on Tuesday is the first step toward making Israel's a mark-to-market economy. It is the first attempt at adapting Israel's economic management to the change in circumstances.
Some companies - the exporters, the big veteran firms, the monopolies, the ones sheltering under protection of others close to the powers that be - will recover. They will regain profitability because of the steps taken in the last two years. Some will even be toughened by their travails.
But the majority of Israel's companies are doomed to continue struggling unless the broader public sector also undertakes adjustments.
When the public sector needs money, it tramples the business sector. And unless the public sector accepts a crash diet, it will slow, or altogether halt, the process of healing the economy.