While the people of Israel have been on vacation, perhaps getting a peek at the implosion of the Ma’ariv bridge in Tel Aviv to make way for a new rail line, or reading with anguish about the personal power plays within their government, the Israeli and global financial markets have sustained a resounding late-August slap across the face.
So why now?
There is almost never one clear single reason for major drops or jumps in the markets, but this month has seen growing concern not only about a slowdown in China, to which the latest drops have been attributed, but also a deepening recession in the emerging markets that had extracted the world from its last financial crisis. Economic growth in Europe has been anemic and if economic data from the United States has been mixed, that’s not enough to offset the other troubles. All of that combined with the drop in the price of commodities in general and oil in particular put the markets in a panic.
What will happen to interest rates?
In recent months the expectation had been that American interest rates would rise in September for the first time since the 2008 economic crisis. The person responsible for creating those expectations and for preparing the markets accordingly was none other than Stanley Fischer, the vice chairman of the U.S. Federal Reserve and the immediate past governor of the Bank of Israel. The slowdown in developing countries and the drop in the value of their currencies has put a damper on these expectations, however, which have been further quashed by the wild ride on American stock markets over the past week.
On a visit to Israel about two months ago, Fischer said that if and when American interest rates are raised, it would not be a dramatic hike. How much exactly? U.S. interest rates are currently between zero and 0.25%, and the increase that traders have been so fearful of would simply set the rate at 0.25%, the high end of the current range. But now even that may be put off.
U.S. rates do of course affect interest rates in Israel. At the beginning of last week, against the backdrop of poor second quarter Israeli economic data, market observers expressed the view that any increase in the base rate here would be put off. Indeed, there has been growing pressure to lower rates, even if rates in the United States go up. On Monday of this week, the Israeli central bank announced that the base rate would remain, at least for the time being, at 0.10%. And recent events only buttress the view that Israeli interest rates will remain where they are for a considerable time.
Scrambling the deck
Oil prices have declined sharply to levels not seen since 2009, some of the worst days of the global financial crisis. Natural gas prices have also fallen, as the markets report large supplies of both fuels.
Last week, the Israeli cabinet approved a plan that it is proposing for regulation of the country’s major offshore natural gas industry. At the insistence of the companies controlling the offshore cartel, the plan promotes the export of gas, but the falling prices are scrambling the deck and disrupting the calculations of the Finance Ministry and Bank of Israel. It is true that the market is volatile and that the price could again rise, but any calculations based on current prices – and the recent declarations by Prime Minister Benjamin Netanyahu and Infrastructure and Energy Minister Yuval Steinitz about hundreds of billions in royalties from offshore energy flowing into government coffers to fund health, education and social welfare needs – currently seem divorced from reality.
The mechanism is simple. When global prices decline, the revenues of the companies exporting fuel also decline, along with the government’s share. Although the government’s royalty calculations are projected over a period of 10 to 20 years, if the current trends continue and oil and gas prices don’t recover, there are doubts over whether the government will see a substantial take from certain energy exports, including the agreement to export oil to Egypt so that it can be liquefied and sold on the world markets.
Last week, highly disturbing data about Israeli economic activity were published for the period between March and June of this year. The Israeli economy grew at an annualized rate of just 0.3%, the Central Bureau of Statistics said, a figure that translates into a drop in living standards on a per capita basis, because Israel’s population grows by about 2% a year. Exports declined by 12.5% during this period, and investments by 3.8%.
Now the reason for the data is becoming clear. The global economy is slowing and since Israel’s economy relies on exports, we are slowing along with it. What is particularly concerning in this entire story is not necessary the data, because Israel has limited control over them, if at all, but rather the government’s response: which is to do nothing.
As of last week at least, the Finance Ministry didn’t intend to reexamine the data and revise the budget, claiming that for the time being, the situation has not affected tax receipts. That’s crazy. It’s clear that tax revenues will in fact decline and this will create a budget hole. Then members of the cabinet will begin scurrying around and arguing among themselves.
The current situation should set off warning bells, but instead the government is continuing to dole out perks and funding to companies, to coalition partners, to the defense establishment and to other pressure groups as if Israel were cut off from the rest of the world.
During periods of fear and panic such as the past week, the response of traders is to sell shares of stock and to park funds in less volatile investments such as government bonds and even cash. That’s rational when the markets are highly unstable and real returns are hard to come by.
The big question, of course, is whether the turmoil in the markets is a harbinger of worse things to come for the global economy and the markets or a passing phase after which the markets will continue to climb. No one can answer this. All one can do is gather forecasts from people with experience who don’t have vested interests. There are not a lot of people like that, but one of them is the economics professor and Nobel Prize laureate Robert Shiller.
In an interview last Friday, prior to the stock market tremors of this week, he told the CNBC television network that more and more volatility was possible and that he had a general belief that the market would head downward because share prices are too high. But it could take years, he said. In the short term, he stated, there could be gyrations in both directions, but he cautioned investors to take a longer view. A “correction” he said, is not the end of the world; this uttered, however prior to this week.
It’s not hard to predict how our leaders will react. Cabinet ministers, politicians and tycoons will act in accordance with their own interests. The natural gas companies, together with the prime minister and bureaucrats who support the framework for the industry, will insist that the volatility abroad proves that not a single day’s delay in Knesset approval for the plan should be permitted. Otherwise there won’t be anyone to sell gas to. Instead, they will say, it will remain under the sea.
The banks and insurance companies will claim that periods of uncertainty and recession are no time for economic experiments since the stability of the financial system will soon need to be put to the test. They will therefore demand an immediate suspension of a proposed plans to increase competition in the credit market as well as of all of capital market commissioner Dorit Selinger’s ideas to make the pension market more efficient. One can also assume that the concerns expressed will also attract the support of the Bank of Israel, which traditionally hates change and views the world from the same perspective as senior financial market executives do.
Construction contractors, one might guess, will demand a freeze to plans to tax people buying apartments as an investment and to flood the market with land, because, they will claim, the coming crisis will hurt the market and put a halt to activity. And this is just a partial list.
The truth, of course, is just the opposite. It is precisely when the economy and the markets are in distress and when there is a crisis that reforms are necessary that will make the markets more efficient and lower the cost of living. Otherwise, the people of Israel will again get the worst of all worlds: an economic slowdown, frighteningly high housing prices and the highest cost of living in the West. And that’s in addition to a system in which those with personal interest and personal privilege stand guard and don’t allow competition to develop.
Theoretically, the global crisis could be an opportunity from the standpoint of Finance Minister Moshe Kahlon to demonstrate leadership and professionalism. He could convene the heads of his ministry along with an appropriate government team and announce that he is also looking into the implication of the crisis on the budget and will push ahead with reforms.
In the past, there were political leaders who knew how to rise to the occasion in times of crisis, but we have not seen such things from Kahlon since he took office at the Finance Ministry.
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