Bank of Israel Beware: Printing Money Can Worsen Inequality

The central bank governor is considering buying government bonds. If she does, she’ll be favoring big investors over the average Yossi.

Eytan Avriel
Eytan Avriel
A cost-of-living protest in Tel Aviv in 2012.
A cost-of-living protest in Tel Aviv in 2012.Credit: David Bachar
Eytan Avriel
Eytan Avriel

It’s already happening. Someone in the capital market is pushing the idea that soon, maybe even in the monthly interest-rate announcement Monday, the Bank of Israel will hint at Israeli-style quantitative easing; that is, the purchase of government bonds by the central bank.

Actually, the hints are coming from several directions. The end of last week saw lively demand for government bonds, on a day when government bonds worldwide declined.

The result is a strange phenomenon: Israel’s 10-year shekel bonds at a 2.10% yield, with 10-year U.S. bonds cheaper and providing a 2.27% yield — 17 percentage points higher.

You can see it in the media. Globes informed its readers on Thursday — in large print — that the Bank of Israel governor is mulling whether to launch a bond-buying program à la the U.S. Federal Reserve.

Traders themselves are wondering whether the central bank is trying to tell them something. The Bank of Israel, as expected, declined to comment on the eve of an interest-rate announcement.

It’s not at all certain that the Bank of Israel is even considering quantitative easing. Israel’s economic situation is different from Europe’s, while the United States is expected to end its dollar printing next month.

Market behavior last week might even have been another case of manipulation for the sake of a quick profit. People buy bonds and spread a rumor that the central bank is about to enter the market. They jack up prices, wait for other investors to jump in and take profits.

The evil 10%

But before Bank of Israel Governor Karnit Flug decides to print money – the bond buying would be carried out by creating money ex nihilo – she should ask herself what such alchemy does to inequality, the main concern of Israelis these days.

Make no mistake. As Guy Rolnik has written in TheMarker, what preoccupies Israelis is not the price of chocolate pudding or the fantasy of moving to Berlin, but the realization that Israel has become a plutocracy. And in a plutocracy, you either belong to the minority of the rich who live at the expense of everybody else, or you’re doomed to a life of struggle to make ends meet and endless anxiety about the future.

A plutocracy is frustrating because of the inequality it creates. Most people are willing to accept a given economic situation but find it hard to deal with a scenario in which 10% to 15% of society enjoys economic security, tenure and growing wealth as everybody else stagnates or regresses.

In a well-run country the government addresses inequality via democracy; the majority sends people to parliament who work for their benefit. But the Israeli government doesn’t function well, which shouldn’t surprise anyone. Politicians are loyal mainly to people with power who can help them get reelected.

The evidence: The current government has done very little; it surely it hasn’t taken care of a litany of issues that create inequality: the cost of living; the price of food, real estate and cars; and the waste of public money and the channeling of it to the haves.

Nor has the government restricted the power of the plutocrats who control the public purse, or protected the people when it comes to buying goods and services that every Westerner in the 21st century thinks he has coming to him. After all, the 2015 budget is a copy of the 2014 budget, with an increase for defense and a postponement of the challenges to 2016, when we might have a different cabinet.

But unlike the government, which does nothing but react to crises, the Bank of Israel has actually been forced to make significant decisions. It lowered interest rates toward zero and now might also buy bonds. How will this affect inequality?

If you ask Flug, she’ll tell you her policy is designed to help the weak and therefore reduce inequality. She’ll tell you the idea is to help companies in trouble and therefore reduce the number of situations like the closing of Arad Towels.

She’ll tell you the strengthening dollar is rescuing exporters that employ people in the country’s outskirts; we’re not talking high-tech. And in the coming months, she’ll probably talk much more about inequality and the crisis it’s creating in Israel’s economy and society.

That’s not a very daring gamble; it’s been done. A week ago Fed chief Janet Yellen surprised everyone in a speech that was only about inequality.

Still, it’s a new subject for central bank governors. After all, they aren’t politicians, they don’t have to be elected, so in the past they didn’t have to address issues seen by economists as populist. In her speech, Yellen presented numbers that might have come out of Occupy Wall Street.

The inversion of economic logic

The following are quotations from her speech that The Wall Street Journal chose to emphasize.

“By some estimates, income and wealth inequality are near their highest levels in the past hundred years, much higher than the average during that time span and probably higher than for much of American history before then.”

“After adjusting for inflation, the average income of the top 5% of households grew by 38% from 1989 to 2013 .... By comparison, the average real income of the other 95% of households grew less than 10 percent.”

“The distribution of wealth is even more unequal than that of income .... The wealthiest 5% of American households held 54 percent of all wealth reported in the 1989 survey. Their share reached 63 percent in 2013.”

And finally: “The lower half of households by wealth held just 1% of wealth in 2013 .... The average net worth of the lower half of the distribution, representing 62 million households, was $11,000 in 2013. About one-fourth of these families reported zero wealth or negative net worth .... This $11,000 average is 50% lower than the average wealth of the lower half of families in 1989, adjusted for inflation.”

With such figures and statements, we might have thought the Fed chief would also talk about the policy U.S. officials could adopt to change the trends, but she didn’t. She apparently knows why; the effect of her policy on inequality is no sure thing.

According to studies, interest-rate rises worsen inequality while cuts reduce it, an expected outcome we saw in the United States from 1980 to 2010. But when an economy is undergoing an economic crisis and interest rates decline to zero, logic sometimes becomes inverted and inequality can worsen.

The economic reason can be understood as follows. Since negative interest is an impossibility, another phenomenon must take the lead to address the social gaps: the difference between income from work and income from capital.

Zero interest and printing money inflate the value of bond and real estate portfolios, while people without such assets, most of whose income is based on wages, stagnate or regress. The result, as could be observed in the years since the 2008 financial crisis, is once again an increase in inequality.

Politicians, get with it

Flug must therefore take care before joining the central bank governors who’ve bought bonds and printed money. The results have been increases in the prices of bonds, shares and risky assets such as real estate and low-quality credit.

Along the way, the markets got addicted to printing money and cheap and accessible credit; it’s very hard for them to wean themselves away. These withdrawal pains will be the main trend dictating the capital markets during the coming year.

In a depressed market with low prices — for example after a financial crisis — there’s logic to such an approach, if only to encourage people’s consumer instincts. It’s a policy designed to persuade business owners not to leave their cash in the bank but to invest in economic activity.

But in Israel bonds and shares are already at record prices, real estate is setting new records by the month, and business owners are launching projects only after they’re convinced they can create monopolistic profits from them. Or they invest their surplus cash in the stock market — by buying back their own shares, for example.

All signs show that such a program is likely to, once again, favor the wealthy, worsen Israel’s inequality even more and achieve the opposite of what the governor hopes.

Flug should especially remind herself that the discussion on the economic consequences of inequality is over. It’s clear the accumulation of capital in the hands of the few causes a decline in consumption and economic activity, while the power accumulated by the few interferes with attempts at reform and debt reduction.

And all this happens before we’ve said a word about the damage to solidarity, or about the efficacy of the political system.

It’s true the Bank of Israel can’t handle inequality on its own, but it has to be careful not to worsen it. In its role as the government’s main economic adviser, it must pressure the political leaders to stop thinking about themselves – all the more so on the expected eve of an election.

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