Taking Stock / Fleeing the Dollar

They're starting to breathe easier. The Dankner family, that is.

No, they aren't home free. The financial thunderstorm is still raging over the family, which is one of the most highly leveraged in Israel. But the Dankners, like many of Israel's biggest businessmen, did at least get a shot of oxygen from the financial markets in the last half year.

The shekel's surge against the dollar in the last four months immediately improved the banks' capital adequacy ratios. Moreover, income from the stock market increased, and rising share prices improved the status of collateral. Suddenly it seems entirely possible that the Bank of Israel's Supervisor of Banks will allow Bank Hapoalim to pay dividends this year and feed its shareholders, including the famished Dankners.

The climbing shekel and share prices that restored color to the cheeks of Israel's leveraged businessmen are two sides of the same coin. The main engine driving the shekel's appreciation, and the demand for stocks, is the massive influx of foreign money into the currency market, into forward transactions, into Israeli government bonds, and into stocks.

If you ask Finance Minister Benjamin Netanyahu how the shekel jumped 10 percent this year, he'll probably explain that investors the world over are demonstrating their faith in the Israeli economy pursuant to his economic program.

If you ask local analysts, they'll explain that the influx of foreign money was driven mainly by the diplomatic upswing, the American victory in Iraq, and the reception of American loan guarantees.

But if you lift your head from the sands of Tel Aviv and look far out, beyond even the Middle East, you'll find that the real story isn't the strengthening of the shekel. It's the weakening of the dollar.

Look at the table above. As you see, from the start of 2003, many currencies strengthened by 10-23 percent against the dollar. What characterizes most of these currencies is that they offer relatively high interest rates.

Is Turkey's economy flourishing? Are investors evincing deep faith in the Australian or South African economies? Are the finance ministers of all the above spearheading sweeping economic programs like Bibi's, which stimulated their local currencies?

Probably not. Their surge is due to a global flight from the dollar to other currencies, from the euro to the Canadian dollar to the rand, even to the Turkish lira and Brazil's real, even though their economies sank into dire crisis last year.

The flight from the dollar is the biggest economic story of 2003. The main reason behind the trend is simple enough. Over the past four years, interest on the dollar has sunk from 6 percent to 1 percent, its lowest level in four decades.

Once investors realized low rates on the dollar are here to stay for some time, a mad dash began around the globe in search for currencies offering higher interest, and investments that could offer better yields.

The whole international financial scene has been adjusting to the bizarre scenario of the world's biggest economy, which attracts the biggest investments, offering almost zero interest. Tens of trillions of dollars looking for relatively safe investments are ravening for yields.

The international greed for returns and interest rates will apparently trigger more big-scale, surprising, movements of capital in the short term. Israel is a small niche in the international marketplace, but its currency market is comfortably wide open, and sways in the strong international currents.

Most experts in Israel and elsewhere are confident that the flight from the dollar will persist for some time. Some are taking low-interest dollar loans. Some are talking about years of a weak dollar, and of trillions streaming to investment in Europe and in new emerging markets.

But we must not forget that when it comes to currency markets, prophets are proved fools. Trends and developments are even harder to predict than in stock markets. Today Netanyahu and the Israeli economy are riding on the wave that is weakening the dollar. But tomorrow another wave could suddenly arise and slam us in the face.