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It isn't easy to explain the shekel's latest moves against the dollar. In just over two months, the shekel has strengthened more than 7.4 percent.

Some experts, including Finance Minister Benjamin Netanyahu, opine that the gains posted by the shekel and stocks, and the dropping yields on bonds, are "conditional." Namely, the public believes that the Knesset will pass the treasury's economic program, and has started to invest. If the program falls through, the trend will reverse.

Other economists, including top Bank of Israel people, believe the gains were fueled first and foremost by America's success against Iraq. In other words, the gains are not supported by economic developments, and ultimately investors will realize that.

Surprisingly, a top treasury official has reinforced that claim. In an interview with the daily Yedioth Ahronoth published last Friday, accountant-general Nir Gilad said that in the summer of 2002, Israel had been on the brink of economic catastrophe because of the government's towering deficit and the loss of confidence in economic policy.

The mood today is different, which is apparently why Gilad felt free to baldly state what had been, until Friday, top-secret.

Yet the budget cut isn't even close to being implemented, nor is it clear how the government can end 2003 with a deficit of less than 5 percent.

Which returns us to our point here: Is the shekel finished striding upward? Or could it strengthen even further? It's anybody's guess, but we can search for clues.

The Big Mac test

One clue lies in the PPP - purchasing power parity, the balance between currencies. This theory states that exchange rates are in equilibrium when their purchasing power is the same in their home nations. If inflation rises, the affected currency must be depreciated.

Factoring out transaction costs, taxes and uncertainty, in a state of PPP, a basket of goods should cost the same in both countries. And when there is a discrepancy, traders will carry out arbitrage deals until product prices are equal again.

The best-known check of PPP is The Economist's Big Mac index, which examines the price of the popular McDonald's patty, sold in some 120 nations, to determine whether a currency is overvalued, vice versa, or in equilibrium.

In April 2000, Israel's burger was found to be the most expensive in the world, in dollar terms. Its price reflected overvaluation of 43 percent for the shekel.

By April 2002, with the dollar trading at NIS 4.80, the beef burger was selling at roughly the same price as in the U.S., indicating that the shekel-dollar exchange rate had reached equilibrium.

Israel did not appear in the magazine's Big Mac index published in January 2003, possibly because Big Macs hardly sell here. Israelis prefer bigger burgers. That said, it would be interesting to check its relative price.

So we did. Big Macs are selling, when they do sell, for NIS 12.90 a pop. At an exchange rate of 4.56 to the dollar, that means that in January, they cost $2.83 in Israel, compared with $2.65 in the U.S.

In other words, according to the Big Mac index, the shekel is 7 percent overvalued.

Of course, judging a currency's equilibrium by Big Macs is frivolous. But it can teach us that the shekel isn't as cheap as it was.

The international Fisher effect

Another rule of thumb, known as the International Fisher Effect, states that future spot exchange rates can be calculated by their nominal interest differential.

Israeli nominal interest is at 8.7 percent, compared with 1.75 percent in the U.S. The differential is 7 percent. Therefore, theoretically, we would expect the shekel to weaken by about 7 percent in the future, meaning the dollar should climb to 4.9 shekels.

The logic behind the Fisher rule is that in exchange for forgoing interest when holding dollars, investors expect compensation through the currency gaining strength. Alternatively, the system could reach equilibrium by rapid interest rate cuts in Israel, meaning, reducing the interest rate gap between Israel and the U.S.

Again, the figure of 7 percent should not be given quantitative meaning, yet the interest rate gap is the main factor setting prices on the currency market today. That is because much of the uncertainty shrouding the Israeli marketplace has evaporated, say traders and players. Also, the market is now ruled more by financial considerations than geopolitical ones, they add.

Ultimately, the shekel's direction will be dictated by the changes to Israel's marketplace since the "near catastrophe" Gilad mentioned, which was all of 10 months ago. At the moment, the change seems to be more one of mood and expectations, than of substance. Unless you believe another misfortune awaits us, then the enormous interest rate gap offers one of the highest real rates of interest around.

Plenty of foreign investors seem to find it alluring, as they storm the emerging markets again, now that the war with Iraq is essentially over. Israel is one of their targets too. But if you feel otherwise, then you'd be well advised to wait until more economic data are in, and the real value of Israel's economy and its currency becomes clear.