Capital Market / All That Glitters / Why Have Dollars Started to Seep Out of Israel?

Global financial systems are mired in a confidence crisis, with one consequence being the flight of speculative investments and funds into familiar financial safe havens.

Bank of Israel governor Stanley Fischer can relax on his way to the annual International Monetary Fund and World Bank meeting this weekend. They probably won't drive him crazy this time over the exchange rate of the shekel and won't be asking why it has stood still - even after he bought almost $60 billion on the open market in the last few years.

There are two reasons for this. First, all the presidents, central bank governors and finance ministers will be focused on efforts to halt Europe's financial collapse. Right now, all other matters seem trivial. Fischer will be asked to express his opinion on possible solutions to the problem.

haifa port
David Ratner

Second, the shekel has dropped hard lately: Since June 9, when it traded at around NIS 3.35 to the dollar, the shekel depreciated about 10% by the middle of last week, before regaining about 1% on Thursday and Friday.

But the reasons the shekel is weakening should worry the governor. Since the finance minister will also attend the meeting, and Prime Minister Benjamin Netanyahu will be in New York to give a speech at the United Nations, perhaps they should all meet for dinner to discuss the economic situation.

The reason for the shekel's decline is ostensibly clear: From the beginning of the summer, the global financial systems have been mired in a confidence crisis, with one consequence being the flight of speculative investments and funds into familiar financial safe havens.

This is a standard ritual. Everytime the markets fear a crash, hot money leaves the stock markets and capital markets of the emerging countries - and flows into a handful of safe havens. These include gold, the Swiss franc and U.S. treasury bonds.

So it wasn't just the shekel's exchange rate that fell. The real of Brazil, a country considered a success story and economically promising, weakened by 7% in the last three months. The South African rand dropped 8%, the Hungarian forint fell 9%, and the Russian ruble lost about 8%. The benchmark MSCI World stock index has lost 11% from the beginning of the year, against a sharper drop of over 17% in the index for stock exchanges in emerging countries. U.S. 10-year treasury bonds, in contrast, have risen 6% since the beginning of June and the price of gold has gained over 20%.

These trends are reminiscent of 2008, but their magnitudes are still more moderate. As soon as the markets stabilize, the money will supposedly return to faster growing countries - and also to the Israeli stock market and shekel.

But behind the shekel's fall lies another story, a much more significant one. After three years of dollars flowing into Israel continuously and steadily, they have now begun to seep out. Official confirmation of this came last week in the Central Bureau of Statistics' foreign trade figures: Israel recorded a $560 million current account deficit in the second quarter.

Good for the short term, danger in the long run

So what does this mean? After counting up all the foreign currency entering the country and comparing this to how much went out - including from trade, services, income from capital and unilateral transfers - Israel enjoyed large surpluses in the billions of dollars the last several years. In 2010, the surplus amounted to $6.7 billion, and the central bank predicted this past March that the trend would continue, with a $5.3 billion surplus in 2011 and $3.4 billion in 2012.

In June, the forecast was adjusted downward to $3.4 billion for 2011 and $1.2 billion in 2012. But now it seems that even the downward adjustment was too optimistic: The surplus didn't just decrease; it evaporated into a deficit. At the current rate, assuming a deficit of around $600 million per quarter, about $1.5 billion will have left the country by the end of the year. This is a reality trading rooms aren't familiar with.

Who's to blame for this situation? A look at the various components of the current account shows that the problem is mainly stagnating exports against a sharp rise in imports. Israel's trade deficit reached $2.6 billion in the second quarter, after being in balance in the parallel quarter of last year. At this rate, it won't take long for Israel in this regard to resemble the United States more than China.

In the short-term, the trend brings good tidings to exporters and a handful of foreign exchange speculators who have waited years for the shekel to fall. In countries where dollars flow out, currencies tend to weaken. But in the long run, this poses a danger: Something is amiss with Israeli exports, and even foreign homebuyers, investors and Jews transferring money unilaterally into the country won't balance the foreign currency picture.