Closing Our Eyes and Counting Slowly to Four

As the dollar and shekel approach that nice round number, the exchange rate is about to become news.

The "dollar rate" in Israel - or, more accurately, the exchange rates between the shekel and various major currencies - is about to make headlines again.

The immediate reason is psychological: The dollar has been closing in on NIS 3.99 this week in trading, just one agora short of the NIS 4 mark that will give Israel's foreign currency market star billing in news broadcasts. Yesterday afternoon's Bank of Israel rate was slightly lower, at NIS 3.982.

Aside from the psychological element attached to it, the number 4 itself has no obvious significance. It isn't even new, or an all-time high: The dollar has traded above the NIS 4 level for long stretches of time before. The round figure of NIS 4 constitutes, at most, a temporary level of resistance due to stop-loss orders left by traders and market operators in their trading systems. Such orders are meant to limit the loss of traders wagering in the opposite direction by closing their positions if the dollar reaches NIS 4.

But after rising above the NIS 4 rate, the dollar is expected to continue climbing - and nobody has any idea where it will stop.

There are several reasons why the dollar happened to jump the last few weeks, but the main one is this: After years of enjoying a current account surplus - more foreign currency flowing in than flowing out - in the past year the country has switched to having a negative balance that is worsening from day to day.

The current account has two key elements: the trade deficit - pitting exports against imports; and the one-sided currency transfers - foreign currency entering Israel for all sorts of other reasons, like the purchase of securities or homes, donations or anything else.

And Israel's current account deficit keeps getting deeper since all these factors are working in the same direction: Exports are decreasing; foreigners are pulling out of the capital market and local currency; and even the Israeli public - through the institutional investors managing its savings - has lately decided it's better off placing large chunks of its securities portfolio abroad.

As Israel's outflow of foreign currency grows stronger, demand for dollars rises - resulting in creeping devaluation of the shekel. This trend can be expected to continue as long as the current account is negative, and to grow stronger if the current account deficit gets larger. There is no point arguing with logic and history: This correlation generally holds true.

There are also several isolated factors spurring the pace of devaluation. First, the eurozone crisis and the cut in interest rates there two weeks ago have weakened the euro and boosted demand for the dollar on a global scale - against other currencies too, including the shekel.

Secondly, the 0.3% drop in the consumer price index for June, disclosed Sunday, is generating expectations that the interest rate will be cut sooner than the market had thought, further weakening the shekel.

As usual in economics, everything eventually adds up to create one big-picture scheme - and Israel's is blackening.

Everyone - and certainly currency traders - knows Israel is developing a problem with exports, which are stagnating and perhaps even declining against the backdrop of the global economic slowdown.

Everyone knows that Israel has a problem with its budget deficit, which will stand at 4% this year. And everyone knows that Israel needs to take painful economic steps involving cutbacks and tax hikes, but its politicians are mum.

Figures released just Monday point to a sharp drop of investments in the high-tech and start-up sector, one of the economy's strongest growth engines until recently. And there are plenty who think the risk of an incident involving Iran will mount in the months to come, a reality that, at the very least, will weigh heavily on chances to implement any cutbacks in the military budget.

As a result, exports are lame, high-tech is faltering, foreign investors are reluctant to come forward, and Israelis are sending money abroad. All these together create expectations, forecasts, and a mood that can push the dollar in only one direction: Up.

How high? Nominal figures haven't any significance. After breaking through the NIS 4 barrier, the dollar will move on to NIS 4.10, and from there to NIS 4.20, continuing to advance as long the current account deficit persists.

How long?

Until the foreign investors decide to return and the trend in Israel's current account is reversed. This will only happen once foreigners are convinced that the politicians running the economy are capable of arriving at the right economic decisions and implementing them, and when they see the first signs of positive results from these decisions.

Traders are goal-driven and want to turn a profit: They aren't easily confused chumps and they don't buy spin like most of the Israeli public.

Creeping depreciation