Taking Stock / Climbing the Shekel Mountain

Tell the truth: Are you stressed out? Did you buy dollars? Have you transferred your money from dollar deposits to the pound sterling? Or maybe from short-term shekel notes to euro denominated deposits? Have you hidden a few greenbacks under your mattress? Or maybe you've sent a bit of money to Switzerland? Or London?

If we had to judge by the behavior of the exchange rate of the shekel versus the dollar and versus the major currencies, and based on the makeup of the public's financial asset portfolio reported every month by the Bank of Israel - then it seems that the answer to all of the above questions seems to be no in most cases.

You are not stressed out, and not overly enamored of foreign currency investments - and are continuing to keep most of your capital in shekel denominated assets.

Anyone who has been reading the business press carefully over the last decade might possibly be a little bit surprised at your behavior and attitude. For many years, Finance Ministry officials, most of the senior business figures, a number of well-known economists and respected commentators all have been saying that the fact that the public has been increasing its shekel denominated holdings is the biggest time bomb ticking away at the Israeli economy.

The reasoning was simple and captivating: The Bank of Israel was fighting inflation by means of high interest rates, and these rates were drawing the public into shekel investments. It was also pulling speculators and hot money into Israel. But the claim was that the minute that the Bank of Israel would start lowering interest rates to Western levels, there would no longer be any reason whatsoever to hold on to shekels. The hot money would flee back overseas, and the dangerous "shekel mountain" would collapse and bury us all under it.

This apocalyptic scenario always amazed us: On one hand, there is nothing more natural and economically sound for an Israeli citizen than holding most of his assets in the local currency in the country he lives in - as long as inflation is under control and there are no worries about the financial stability of the economy.

Just like the British have a mountain of pounds and the Americans have their dollar mountains, we Israelis should have a mountain of shekels.

The years have passed, the shekel mountain has grown and grown, and the cries warning of its collapse have grown and grown.

However, one day the expected happened: The state's responsible economic policies started to bear fruit and inflation disappeared - and Israeli interest rates started to drop quickly.

Five months ago, the symbolic event that many thought would never happen did: Here in Zion interest rates for the shekel dropped below those for the dollar.

Today short-term shekel interest rates are 4.3 percent, while the similar rate for the dollar is 5.3 percent. The same rate for the pound sterling is 5.7 percent, and for the euro 4 percent.

Israelis' insistence on holding their money in shekels is doubly impressive when you remember that only two years ago the cabinet decided to remove the last remaining safety net for local investments, by equalizing tax rates on overseas investments with those in Israel. Today there is no reason whatsoever to keep your money in shekels, if you no longer believe in the local currency.

Of course we have been seeing a praiseworthy international diversification of investments over the past two years. Large Israeli institutional investors are gradually increasing their overseas investments in international markets.

But this has not been driven by interest rate differentials, but in particular by financial logic: An investment portfolio needs to be diversified, and the large investors all over the world - not just in Israel - have been increasing the international component of their asset portfolios.

Many Israelis, in particular those who have already seen the better side of 30 and still have traumatic memories of Israeli inflation and economic crises; have stood by in shock as the shekel gained against the dollar in recent years. The shekel reached a new record last week when the shekel-dollar exchange rate returned to where it had been eight years ago.

But economically speaking, there is no special reason to be shocked: Financial stability, massive foreign investments and local inflation that is lower than in most countries around the world are the classic background conditions for the continued strengthening of the local currency.

Of course the trend can flip: Volatility in foreign exchange markets all over the world has increased greatly over the last decade. If the dollar can drop 10 percent against the euro in 12 months, then there is no reason that the shekel cannot move wildly some day.

But today, with the shekel strengthening to a rate of NIS 4.1 per dollar, you will hear almost no crying, complaints, criticism, demands or threats from the heads of the business community against the Bank of Israel, the treasury or the cabinet to lower interest rates - and raise the dollar or weaken the shekel to help the economy.

This is not just because the now low interest rates in Israel are significantly lower than those on the dollar - it is hard to blame the Bank of Israel for the shekel's strength. However, today everyone knows that in these days of open globalized markets, the Bank of Israel is not able and does not want to influence the exchange rate.