Is a Strong Shekel Really So Bad?

The time has come to rethink the Bank of Israel’s low-interest-rate policy and dollar buying on the open market.

Bloomberg and Tomer Apelbaum

The dollar has been sinking against the shekel recently, despite all the efforts of the Bank of Israel and the Finance Ministry to keep interest rates low, buy up dollars and swap dollar debt for shekel debt. The greenback remains below 3.50 shekels; last week it sank to around 3.44, its lowest level in three years. It’s not much higher than it was back in March 2008, when the Bank of Israel governor at the time, Stanley Fischer, began buying dollars to prop up the greenback.

As expected, Israeli exporters have been demanding that the authorities do something, anything. They’ve been asking the government to use public funds to protect their profits. Of course, they’ve rolled out the doomsday threat that workers will have to be laid off if the companies don’t get what they want.

For example, Elbit Systems chief executive Bezhalel Machlis, while acknowledging that his profits had grown in tandem with record order volumes, said the government needed to set an exporter-friendly exchange rate. Back in January, at a special meeting on the “low dollar,” the head of the Manufacturers Association, Amir Hayek, said the sagging greenback was bringing exporters to the breaking point.

So who’s the culprit? The Bank of Israel, of course. Manufacturers don’t think it’s doing enough to support the U.S. currency, even though it has lowered interest rates to almost zero and often buys up dollars. In fact, just last week, the Bank of Israel bought up hundreds of millions of the stuff.

Playing the layoff card

Still, the manufacturers don’t just blame the Bank of Israel. In a conversation with business daily Globes in December, the chairman of the Association of Electronics and Software Industries, Elisha Yanay, warned that layoffs of thousands of high-tech workers were in the cards if Prime Minister Benjamin Netanyahu, Finance Minister Yair Lapid, Economy Minister Naftali Bennett and Bank of Israel Governor Karnit Flug don’t come to their senses.

As good lobbyists, the manufacturers have asked for more concessions, like lower water and municipal tax rates, and the elimination of other taxes and fees.

There’s no need to get ruffled over such protests, which are part of the ritual in which industries portray the world in a way that suits their needs. But would it really be such a disaster if the dollar sank to three shekels?

It’s no so clear. A strong dollar helps the bottom line of manufacturers of all kinds. It improves exporters’ profits because if they charge in dollars, they get more shekels for every dollar that an overseas customer pays them. A strong dollar even helps Israeli manufactures that produce for the Israeli market, because a strong dollar makes the imported goods with which they compete more expensive.

On the other hand, a weak dollar raises living standards for most of the population and reduces Israel’s notorious economic inequality by lowering prices of imports — increasing competition with locally produced items and curbing the cost of living. So in the Bank of Israel’s deliberations over the “low” dollar, has it taken the standard of living into consideration?

Fischer’s hard heart

Apparently not. A former senior official at the central bank told me that Fischer, who launched the bank’s big battle against a strong shekel, didn’t take much of an interest in social-welfare goals.

“He usually put the interests of exporters ahead of any other consideration, while the implications of these steps on import prices, the cost of living and the public’s standard of living usually weren’t taken into account,” the former official said.

But there’s one major exception here: the cost of housing. Low interest rates have been a main cause of surging housing prices. Fischer addressed the issue when he spelled out his policy decisions, but he ultimately went with the exporters’ interests.

According to the former official at the central bank, Fischer explained his stance by noting that exports accounted for 30% of Israeli gross domestic product while housing represented just 8%. “And with that the discussion was over,” the source said.

Still, the central bank’s intervention in the foreign-currency markets may not only have failed, they may have damaged the economy. It’s hard to argue with the view that the policy hasn’t achieved its goals.

After the purchase over six years of about $57 billion, the dollar is at around 3.45 shekels, again, similar to where it was in March 2008. Bank of Israel officials would say that the situation would be worse without the purchases, but actually the effects of the dollar buying have been short term.

The damage the policy has caused is indisputable. Beyond that, the Bank of Israel’s huge $86.4 billion in reserves (as of the end of April) is susceptible to losses in the event of another global economic crisis, a decline in share prices or a number of other factors.

The alternative

Monetary policy is a series of experiments and the Israelis are the subjects. At this point, after six years, it’s worth asking whether the current approach is the right one.

Low interest-rate policies have sent housing prices skyrocketing, raised the cost of living and exacerbated inequality. They’ve also lowered the manufacturers’ incentive to become more efficient and learn how to function in a free foreign-currency market. So what’s the alternative?

There is the option of reversing priorities and declaring as national goals a lower cost of living and lower economic disparities, in addition to support for exporters. That would halt the current policy of buying dollars and even cause a gradual sell-off of the currency reserve.

The central bank would then gradually and cautiously raise interest rates, because there would no longer be a need to support the dollar. The new policy would also cool demand for housing by diverting some real estate investments to the capital markets.

The Scandinavian model, again

But what about the threat of major layoffs? It’s not clear this would happen. Some manufacturers might suffer lower profits but they wouldn’t necessarily collapse.

Besides, some plants are inefficient and shouldn’t be propped up indefinitely by the public coffers. A company that sells its wares domestically and can’t compete with imports survives only because of government protection, which leads to higher retail prices.

The successful workforce models abroad — in Scandinavia, for example — show that governments have to protect workers but not their inefficient employers. In Sweden, they call it saving the sailors but not the ship; better to help workers who have been laid off, including the provision of retraining programs, than to subsidize inefficient firms.

Opponents of the alternative approach warn of mass layoffs, but Israel’s unemployment rate has never been so low. Opponents will raise the specter of a financial crisis and the collapse of banks if housing prices drop, but the banking sector itself says such fears are exaggerated.

It’s all part of the game, and that’s all right as long as the policy of the past 10 years is not seen as etched in stone. The economic debate needs to be open; everyone involved needs to be able to see who wins and who loses based on each option on the table.