Bottom Dollar / Saving Up Dollars for Hard Times

Stanley Fischer has an interesting new habit. The governor of the Bank of Israel has started, just a few weeks ago, to make surprise announcements on Thursday afternoons after the Tel Aviv Stock exchange closes. He waits and then shocks the public with a new economic surprise.

Two weeks ago, it was intervention in the foreign exchange market and buying dollars; and last Thursday it was his new, unexpected plan for the central bank to increase its foreign currency reserves by buying $25 million a day, for a total increase of $10 billion in two years.

The decision - more the timing of the announcement - was without a doubt meant to change the atmosphere in Israeli capital markets. Of course it was also meant to affect the dollar exchange rate over the long run and push it up in the next few days too.

The Bank of Israel will start buying its dollars already on Monday when foreign exchange markets reopen. To avoid creating more inflation, as the purchases will inject NIS 40 billion in new cash into the Israeli economy, the central bank will increase its issuance of short-term zero coupon bonds (Makams), and/or reduce its daily loans to banks, and/or increase the amounts banks deposit in the Bank of Israel.

At the bank they say the move is actually a planned move that has been in the works for a long time. It seems that for some time the central bank has wanted to increase its foreign currency reserves by another $10 billion, and the trigger only came now.

But you have to be rather naive to believe that last Thursday's announcement was scheduled just then because of a technical decision to increase reserves.

Israel's foreign currency reserves are already $28.4 billion (as of the end of January). According to the bank's new plan, in two years these reserves will reach over $38 billion.

What is Israel's optimal level of reserves? The answer to that question depends. It changes with the times and economic conditions. Ten years ago, the accepted thinking in Israel was that foreign currency reserves should cover six months of imports.

The idea was to keep enough foreign cash on hand for a rainy day. Today's reserves actually only cover four months of imports for the growing Israeli economy. Over the past few years, the Israeli economy has grown quickly, but foreign currency reserves stayed the same. The International Monetary Fund actually commented on this a number of times. International rating agencies have also brought the issues up in their most recent reports on Israel, and have recommended that Israel increase its reserves accordingly.

Fischer has made a few dramatic statements recently - not in words but in deeds: He lowered interest rates last month by 0.5%, he intervened in foreign currency markets and bought dollars, and now with his regular long-term plan for buying more dollars.

He has placed his entire, substantial, reputation on the line. There is no doubt that we have a new kind of governor at the Bank of Israel, one very different from his predecessors. He is first and foremost knowledgeable, creative - and brave. Only the future will tell if, and how much, he was right.