David's Harp Fischer's Act of Desperation

Why the abrupt policy switch on stifling the shekel? The BoI governor may feel that not only his legacy but Israel is at stake.

David Rosenberg
David Rosenberg
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David Rosenberg
David Rosenberg

Is the threat of Dutch disease so imminent that Stanley Fischer felt compelled this week to commit the Bank of Israel and his successor as governor to a major new policy?

The Bank of Israel has intervened in the foreign currency market before, albeit reluctantly, most notably between 2008 and 2011. But Fischer's announcement last week marks a major new departure.

The bank is no longer defending the shekel against market distortions. It is now embarking on a fixed policy to routinely intervene to remove the effects of a market fundamental, namely the riches being produced by the Tamar gas field.

This means that an exchange rate policy is now one of the bank's core activities, side-by-side with ensuring price stability. Moreover, this new task will in all likelihood grow over time.

The shekel shrank strongly the day after the announcement, but given what forex traders and economists are saying, the central bank will have to do even more for the shekel. Having crossed a red line, Fischer and his successor will have no choice but to tread deeper into this territory of market intervention.

Dutch disease is like gout in the 18th century, an ailment of the privileged. It is an economic malady caused by a country's exporting so much of a particular natural resource that its currency appreciates in value so much, that it undermines the competitiveness of other exports.

The first symptoms of the disease began manifesting immediately with the start of production at the deep-water Tamar natural gas field. In mere weeks the shekel appreciated 2.7% against the dollar even though the Bank of Israel intervened in the currency market, albeit on a small scale, through April and May.

But the fact is - the shekel has been trending up since last summer, thanks to the Israel's strong economic performance in a not very competitive playing field, where the U.S. is weak and Europe is even weaker. Speculators and others were attracted by Israel’s relatively high interest rates. The Tamar field has simply added another source of strength for the shekel, by saving the economy billions in energy imports and sparing it heavy expenditure in dollars.

But Fischer has only six weeks left in office. He could have done the gentlemanly thing and let the next governor decide how to treat the disease.

In the meantime, he could have made due with cutting interest rates at the end of May and simply stepping up the pace of buying dollars, which the Bank of Israel was already doing. Exports, which had been depressed by the strong shekel for some time, have been ticking upward.

But Fischer committed the next governor to a major new policy of buying $2.1 billion in foreign currency this year and perhaps billions of dollars more for years to come, until the government’s sovereign wealth fund kicks and absorbs all those excess dollars generated by Tamar and eventually the bigger Leviathan field.

What was Fischer's hurry?

It's hard to be an adult

The real emergency wasn't the economy but economic policy.

It’s bad enough that Fischer has been the sole responsible parent of the economy for much of the time he has been at the Bank of Israel. He was the one who acted in 2008, when the government was paralyzed by elections, to ward off the effects of the global financial crisis. As home prices have risen and the government dithered, he took up the cudgels by containing demand for mortgages.

Over the last two years, as the government has engaged in a budget bulimia followed by the fiscal anorexia, Fischer was a lonely voice of responsibility.

But it is even worse that our only responsible parent is leaving home very soon and we have no hint of who will be taking his place, much less whether that person will be up to the task.

Possibly, Fischer felt he had no alternative, for the sake of his legacy and for Israel : He would have to be an active and effective governor not only into the final days of his term but even after he leaves. He did that by setting up a course of treatment for the economy to deal with the Dutch disease before the patient got really sick.

The program Fischer established this week effectively assigns the Bank of Israel a new task, one outside its traditional ambit of ensuring price stability, and one that might fail.

It is not the kind of thing that a new, untried Bank of Israel governor would necessarily run to do or could do in the first weeks in office. Whoever, the new governor is, he or she will need time to settle into office and establish his or her authority. Those months can't be wasted.

Fischer has had nothing but kind words for Finance Minister Yair Lapid in the last few weeks. They may have been spoken honestly, too.

But the budget soap opera that Lapid has been directing can't be too encouraging. Lapid seems to be trapped between his natural desire to be popular and well-liked, the politician who will answer the public's deepest desires (which has inclined him to make promises he can't keep) and his inexperience and ignorance of economics (which has made him an easy boss for the treasury chiefs to manipulate).

Nor can Fischer be sanguine about the future when Netanyahu - the man, after all, responsible for the mess we're in right now - flits off to China at the peak of the budget debate and appears to regard fiscal policy as a way of cutting Lapid down to size and ensure that he won't be prime minister anytime in the foreseeable future.

So Fischer evidently felt compelled to act. The treasury is in the hands of a politically weakened finance minister, the prime minister seems to rank political machination higher than managing the economy, and the governor's suite at the Bank of Israel has no one to take over come July 1.

Fiscal policy is in disarray and economic growth is destined to slow under the Lapid budget. There's not much Fischer could do to tackle these problems – certainly not in his final six weeks of office – but he could at least ensure that the shekel's appreciation didn't add to the economy's' woes by undermining the key export sector.

The good news that Fischer's program brings is that for next few weeks we have a decisive and activist governor who is not wedded to ideologies or past practices and wants to leave the household he has been running in some semblance of order. But the good news is more than offset by the bad: By acting as he did, Fischer sent everyone a signal that he has little confidence about what will happen after he is gone.

Outgoing Bank of Israel Governor Stanley Fischer.Credit: AP
Policy - is it like beauty, a thing best seen in the eye of the beholder?Credit: Sharif Waked

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