Washington, We Have a Problem

Nicholas Sarkozy's latest attack on U.S. president George Bush was highly unusual in character.

1. France's attacks on the American government are nothing new in the annals of history or in the relations between the two countries. But French president Nicholas Sarkozy's latest attack on U.S. president George Bush was highly unusual in character.

Neither Iraq nor Afghanistan were at the forefront of Sarkozy's mind: it was the American dollar worrying him. In a blunt speech that was as unprecedented as it was tough, Sarkozy called on Washington to instate a "strong dollar" economic policy that would stop the American currency's implosion against the euro.

No, Sarkozy doesn't care about the strength of the dollar and the greater good of the average American. He's worried about the mounting difficulties faced by European and French industries - such as Airbus - as they contend with the surge of the euro against the dollar.

Airbus loses 100 million euros for each eurocent that the bloc's currency gains against the dollar. Since the U.S. greenback began to lose ground in August, the company manufacturer has lost $1.2 billion.

It isn't clear what exactly got Sarkozy going. It might have been the announcement from luxury goods giant LVMH last week, that the euro's might was forcing it to transfer manufacturing from France to India. If Airbus is Europe's pride and joy, then brand manufacturers such as Louis Vuitton, Christian Dior and Fendi are among France's.

2. Sarkozy's media advisors probably advised him to slam Washington and call on it to shore up the dollar. But his economic advisers should counsel him not to harbor hope of effective action, because the dollar's collapse wasn't caused by any recent economic decisions taken by the Bush administration. It was the inevitable outcome of American economic policy and global developments over more than seven years.

The dollar's collapse is one of the ways that the free market mechanism adjusts to rampant consumption, excess and deficits to which Americans and their government are prone.

For a decade, economists have stood open-mouthed at the American ability to consume: eat, drink and make merry and wasteful as though tomorrow would never come; at the Washingtonian ability to maintain astronomical budget deficits; and at the world's willingness to continue financing America's yawning trade deficits.

The bill has arrived. The weakest link proved to be the subprime mortgage market, which is the sector in which banks lent money to homebuyers of dubious creditworthiness. Housing prices, and the standard of living in America, were both pumped up by this incautious lending and now the crunch has come. Convoluted financial engineering by greedy investment bankers created a mechanism that shared around these dubious mortgages. But at the end of the day, the problem isn't confined to Wall Street. Hundreds of thousands of Americans can't pay their debts.

3. Local players say that the rapid appreciation of the shekel against the dollar isn't a function of the shekel's strength, but of the dollar's feebleness. That is true in part: changes in the shekel-dollar rate this year reflect the movement of the greenback against the euro and other major currencies.

Why is the shekel so strong? There are many reasons, including the influx of foreign investment that washed through most of the emerging markets and Israel as well. But there's another reason that we don't always keep in mind.

During the last five years, politicians and big business have called on the government to loosen its budgetary restraints and run big deficits again, in an effort to stimulate economic activity. When advised that running big deficits causes economic pain, they'd leap up and squeal, "But look at George Bush and Alan Greenspan, and how well it's worked for them." Every time the American economy shows any sign of weakness, they pour money into the markets by rate cuts, expand the deficit and issue bonds.

"But that's America," we told them, and what the world's greatest economy and superpower can allow itself, little Israel cannot. America has the great green dollar that everybody wants: the dollar is the world's safe harbor, not the shekel.

Yet even that turns out to be finite. The dollar's collapse in recent months signifies, among other things, a growing comprehension in the investment world that unless Americans fix their economic policy, the dollar won't be a safe harbor any more.

It isn't only the central banks of China, Japan, Russia or Saudi Arabia who have decided to move major chunks of their foreign currency reserves out of the dollar. Even American portfolio managers have been overcoming their natural tendency to stick close to home and are diversifying their portfolios to remote places.

The Americans have begun to pay the price for their extravagance: the implosion of the dollar, the subprime mortgage crisis, gigantic writeoffs among financial institutions and the threat of recession. In Israel, the opposite is true: the economy and shekel are reaping the fruits of the responsible economic policy of the last five years.

Yet that very policy is under threat. Over at the Prime Minister's Office, they're already planning on a resumption of big spending and big deficits.

Prosperity does create an opportunity to budget more for the old, the needy, the sick and the unemployed, but the way to do that isn't through increasing deficits and the national debt. The way is through rethinking resource allocation. Education in Israel can't be improved by pouring more money into a rotten system, but through thorough reform that rewards excellence and achievement and punishes the unworthy.

Israel's economy could slide from prosperity and surplus to weakness and deficit more quickly than America did. Israel is a minnow next to the American leviathan and we have already learned that the skies over the global ocean can grow dark very quickly.