Why the dollar doesn't go crazy
Governor of the Bank of Israel David Klein threatens that if the budget deficit grows and devaluation continues, he'll raise interest rates - because his goal is to keep inflation down.
An economics lecturer for a BA course at a university poses a question to his students: A country, which we'll call Imaginary, has become engaged in a war. As a result, economic activity has declined to new lows; growth has turned negative; the budget deficit is heading toward threatening levels of 5-6 percent of GDP; and the public, fearing what the future holds, has stopped purchasing consumer goods - some have even taken to sending assets overseas. Furthermore, foreign investors have ceased to pump money into companies; and some are even withdrawing their investments. There are even some initial signs of an overseas boycott on products from Imaginary.
So, given all this, the lecturer asks, what will happen to the exchange rate?
One student raises his hand and says he expects a 100 percent devaluation. Another says that it's impossible to predict the exact magnitude of the devaluation, but that a major one is obviously in store for Imaginary.
So, how come the dollar in Israel has appreciated in 2002 by only 10 percent, and since the beginning of 2001, by only 20 percent?
The answer is because there's one person in Israel that doesn't exist in Imaginary. He's at the Bank of Israel and he threatens that if the budget deficit grows and the devaluation continues, he'll raise interest rates - because his goal is to keep inflation down. And because everyone believes David Klein, they're afraid to buy dollars at too high a price; because if prices start rising, he'll follow through on his threat and raise interests rates. The market will respond by devaluing the dollar, and then those who bought dear, will lose.
Belief in Klein is the barrier between a reasonable devaluation and financial collapse.
But Klein does not have unlimited powers. An even more important figure is the finance minister, whose job, to preserve economic stability, is decisive. The first thing Silvan Shalom should do is swallow his pride and call an urgent meeting with Klein. With the country face-to-face with an emergency - military, political and economical - it's unreasonable for Shalom to boycott the governor, neither meeting with him, nor talking to him about critical issues.
The second thing Shalom should do is formulate and submit a plan to reduce government expenditure and allocations, without increasing the tax burden on the public. This is the only way to preserve stability, to prevent a run on the dollar, massive devaluation and a financial crisis. The keys are in Shalom's hands.
The professionals at the treasury are talking about a NIS 13 billion cut. Of this, they say, NIS 7.5 billion would come from direct cuts to ministry budgets and allocations; NIS 3.5 billion would be derived from increased taxes; and NIS 2 billion would result from increasing the deficit.
The above is not good enough a plan: The deficit should not be increased and it's absolutely critical not to increase any taxes right now. Increasing income tax is contrary to what is called for - it diminishes a readiness to work, harms growth and encourages emigration away from the country. Raising VAT is also a mistake because the 17 percent tax already causes many people to work without invoices and receipts. Increasing VAT will only increase tax evasion. Tax on fuels would also be wrong, since it would harm industrial production. A tax on cigarettes and liquor only brings in small amounts, increasing smuggling and counterfeiting at the same time.
On the other hand, cutting government expenditure is not much of a problem. The ministries are awash with redundancy, inefficiency and eye-popping waste. There are unnecessary ministries and ministers. The only problem is political - the harm that will be done to this or the other's minister's little patch of heaven.
It would also be appropriate to impose burdens on working-age individuals who live at the expense of the public without working. This is not a reference to those collecting unemployment allowances, but those to whom the state affords guaranteed income allowances, allocations and allotments under conditions that make it tempting to refrain from working. And it is also time to annul the increased family allowances for the fifth child, the Negev Law, and tax breaks for the settlers.
On November 30, 2001, Shalom was asked during an interview if he was ready to guarantee that he would not increase taxes in 2002, even if the deficit were to grow and the security situation were to worsen. His answer was: "Yes, definitely. I will not impose new taxes on the public. The only situation in which certain taxes might go up is within the context of a general tax reform, when some taxes will drop and others will rise. But the overall tax burden won't rise. I promise that."
George Bush Sr. once said: "Read my lips;" but eventually raised taxes, paying the price with his seat in office.