Taking Stock / Silvanian Complacency

Silvan Shalom must be losing his mind. True, his life as foreign minister is sweeter than ever: His responsibility is minimal, his foreign travel is maximal, and there are endless opportunities for photo-ops. His is probably the best job in government.

Silvan Shalom must be losing his mind.

True, his life as foreign minister is sweeter than ever: His responsibility is minimal, his foreign travel is maximal, and there are endless opportunities for photo-ops. His is probably the best job in government.

But Silvan bears the scars of trauma from his stint as finance minister, which will be remembered for years to come as one of the worst in Israel's history.

And then Silvan goes and reads in the paper that the incumbent finance minister, Benjamin Netanyahu, has decided to trample the law setting the deficit target at 3 percent of GDP. He plans to raise the deficit target by 15 percent to 3.4 percent. And not only isn't the press making a fuss; nobody seems to care.

I'd have been crucified for a deviation like that, Shalom must be fuming. The press would have pounced, the commentators would have had me for breakfast, the Bank of Israel governor would have published a seven-page paper denouncing the move, the bond market would have collapsed and everybody would bellow that the markets were voting against Silvan.

Indeed, why is it different when Silvan breaches the deficit and when Netanyahu does it?

The Bank of Israel governor's behavior is easy enough to explain. David Klein's term in office ends in three months. He isn't only a limping duck, he's a trained one. He's in his own personal primaries now, and if he annoys the finance minister or prime minister he'll be out of the running.

What about the business sector? The commentators? They are apparently preoccupied with the drastic reform of the banks and capital market that the finance minister is spearheading, which if implemented will have vast repercussions for the structure of Israel's economy.

And the markets? In the last two days government bonds have been dropping, but it isn't a retreat. Interest rates on shekel and linked bonds are not substantially different from a month ago.

The Uncle Sam factor

The answer apparently lies in two factors. One is that the American loan guarantees make the financial markets feel more confident. The Israeli government has more wiggle room in financing its debt and rolling it over, as long as the Americans keep that credit-line umbrella over our heads.

During Silvan Shalom's tenure as finance minister, the treasury had to finance every shortfall in tax collection through ever-increasing issues of bonds, which unnerved the markets and led prices to tank. Today the treasury has no such problem and the bond players know it well.

The second reason is the strong back wind arriving from overseas. The global economy is growing at a pace of 5 percent this year, which is a 30-year record. The growth is being fueled mainly by China, the recovery in the U.S. and the reversal in Japan.

China is not only a roaring engine of growth, it's a tremendous quasher of inflation. The cheap goods with which it's flooding the world and its enormous trade surplus are depressing prices everywhere, allowing the U.S. economy to finance its gargantuan trade deficits.

The result is inflation-free growth, which enables central banks to keep interest rates low. Israel's capital market, which is becoming more and more drawn into the global marketplace, is benefiting from that back wind.

But we should not get complacent. Global growth could well slow and interest rates would start to climb. And the tolerance Israeli and foreign investors are evincing for the Israeli government's deficit deviations is limited in time.

The problem is that Finance Minister Benjamin Netanyahu's mantras are reducing government expenditure, meeting the deficit target and staying attuned to market discipline, and he isn't worried, if anything he seems to be rather cocky. Instead of sticking to that 3 percent deficit target and assuring there are plenty of safety valves in the 2005 budget, he's delivering up a budget that's not only deviated from the target, but particularly stretched.

No less worrisome is that his team, including budget director Kobi Haber, accountant-general Yaron Zelekha and director-general Joseph Bachar, are staying silent. They accepted that deficit increase to 3.4 percent too easily while letting Netanyahu continue as though business were as usual.

The treasury commented in response that there was no choice but to increase the deficit target, because Sharon's disengagement plan has to be financed somehow.

That is a very bizarre answer, especially coming from people who have been saying for two years that Israel's public sector is too bloated.

Were all the public sector bubbles deflated? Were the pork barrels dismantled? Can no more efficiency measures be taken?

Far from it. The reform of the public sector has just begun. The problem is that the first fruits came so quickly that Bibi and his people lost their sense of urgency. Unless they come to their senses and fast, Silvanian complacency will gradually take them over.