Spinning Out of Control

One topic on the agenda at Sunday's cabinet meeting will be the economic situation. At the Bank of Israel, they expect it to be a serious discussion that will lead to practical decisions.

1. When will the bubble burst?

One topic on the agenda at Sunday's cabinet meeting will be the economic situation. At the Bank of Israel, they expect it to be a serious discussion that will lead to practical decisions. They hope that it will be preceded by careful preparations in the form of unofficial consultations between the prime minister, the finance minister and the Governor of the Bank of Israel. The attitude at the Finance Ministry this week, however, was somewhat different. The feeling there was that the upcoming cabinet discussion was not going to be much more than a formality; after all, two weeks ago, even though the subject was on the agenda it was not even discussed. The emergency economic plan has already been approved by the Knesset and the ministers have no intention of introducing any significant changes, so the thinking here goes.

The cabinet's postponement of the discussion of the economic situation two weeks ago is a cogent indication of the priorities of the government and its leader. Ariel Sharon left that meeting to go negotiate with members of United Torah Judaism in an effort to entice the party back into the coalition. After he left, Benjamin Ben-Eliezer took over running the meeting and decided that discussion of the economic issue should be not tabled until the Shas ministers returned to the government. Then came word that the meeting had been adjourned early because the ministers wanted to watch the World Cup matches. But, of course, they really had their hands full with other things: the security situation, the political crisis created by the firing of the Shas ministers, the affairs of their ministries. They simply didn't have the time or interest to deal with the economic crisis.

The way Bank of Israel Governor David Klein and his aides see it, the economy is in a grave situation and approaching the point where things could spin out of control. Unlike the prime minister and finance minister, they feel there is a pressing need for serious discussion of the economic situation, for drastic changes in the government's approach to it and for major changes in the budget. Klein recently told the prime minister that the defense budget must be trimmed if the hoped-for turnaround is to be achieved. He also told him that the private legislation that strains the budget by billions of shekels must be annulled.

These recommendations are unlikely to have any impact. Can anyone really picture Sharon subtracting from the defense budget at this time? Does anyone seriously think that he is prepared to butt heads with his coalition partners in order to save the economy?

At the Bank of Israel, they speak of the economic crisis in very serious terms, even comparing it to the 1983 bank shares crisis. Now, as then, the government's handling of the economic situation is based on false suppositions. Now, as then, those in power are well aware of the direness of the situation, but no one is bold enough to burst the illusory bubble. A collapse is to be anticipated, they say at the Bank of Israel, but its precise timing is difficult to predict. The timing does not depend solely on economic developments: It could also be influenced by other events, such as the occurrence of a massive terror attack. In other words, the moment could come when a major shock causes the government to lose control of the economy.

According to the prognosis at the Bank of Israel, conditions are ripe for an opening of the floodgates: The appalling security situation shows no signs of improving and is having a serious effect on the economy, the government is not exercising proper control over the budget, and the prevailing political norms allow the prime minister and his cabinet to behave irresponsibly. They say that the government as a whole is not behaving responsibly. Its members don't view the economic crisis as their problem. They say that government reform is needed and that were Israel to ask the United States for an emergency aid package, Washington would insist on such reform as a prerequisite - just like someone else happens to be demanding of Yasser Arafat and the Palestinian Authority at the moment.

2. It's all up to the Palestinians

As far as one can tell, Ariel Sharon is well aware of the seriousness of the situation: Renowned economists have been warning him of the slippery slope down which the economy is sliding and, for a short time at least, Sharon appeared to be heeding them: He explained his aggressive stance toward the Shas ministers as mainly due to his desire to prevent an upheaval in the stock market and in the stability of the shekel. This step helped for about two weeks; then the real powers reasserted themselves. This will almost certainly be the case following the "summit" meetings of the last couple of days: the facade of harmony between Governor of the Bank of Israel Klein, Finance Minister Silvan Shalom and the prime minister, won't be sufficient to heal the economy; at most, it may have a brief calming effect. Group photos are not a substitute for group responsibility.

In December 2001, Sharon tried to take some action: He summoned Klein to a number of meetings at which a series of serious recovery measures were decided upon: significantly trimming the budget, reducing the deficit, and redirecting resources to growth and employment. Klein did his part when he sharply lowered the interest rate by 2 percent. At the time, friends said to him: "Are you crazy? How can you rely on the promises of those politicians?" Within two weeks, reality gave Klein a slap in the face: The content of Sharon's economic leadership speech to the public had been totally eviscerated. The prime minister had decided to leave the Negev Law and the Large Families Law intact. And he had good excuses: the zigzags in the positions of Silvan Shalom and Benjamin Ben-Eliezer coupled with the pressure from the ultra-Orthodox parties. Klein compared the government's conduct to the so-called "Night of the Ducks" in July 1979, when then finance minister Simha Ehrlich announced dramatic decisions to be expected at the next cabinet meeting (cutting billions from the budget and canceling subsidies), when in fact nothing of the sort happened because there was no support for it. What happened six months ago is now affecting the current economic situation: The government is projecting confusion and weakness, and the public is losing faith in its ability to find a way out of the crisis.

At the Bank of Israel, they're conscious of the complex political circumstances in which Sharon and Shalom must proceed. They know that under these conditions it's not easy to make the moves necessary to halt the economic deterioration and turn things around. But they still say that Sharon must nonetheless show leadership and act aggressively to carry out the required changes. Yet they don't have much faith that this will happen: The key to a change lies in the security situation, in an alleviation of the violent conflict with the Palestinians. Sharon doesn't appear to be about to undergo the essential psychological and ideological change; he's not the man to make the concessions necessary to reach an accord with Arafat.

At the Finance Ministry, they also believe that a cease-fire is crucial for resolving the economic crisis. This assessment is so prevalent that it has become an alibi for faulty economic management: No matter how many individual improvements are made in the government's functioning, with the absence of a resolution of the conflict with the Palestinians, the economy's distress cannot be genuinely remedied. To buttress this argument, they point out that direct spending on security increased by NIS 6 billion in the past year (and will increase by another NIS 2-3 billion in the coming year), and that overall losses as a result of the intifada total NIS 36 billion. Under these conditions, with a war of attrition going on for nearly two years now - in large part, in the heart of the country - and directly affecting the behavior of the public and of foreign investors, no heroic measures the finance minister might take will be of any real help, they say.

Silvan Shalom agrees with this assessment: He explains that his call for Arafat's expulsion is based in part on the belief that it would hasten the end of the armed conflict. He emphasizes that he is not advocating bringing down the PA, just the eviction of its leader. He believes that it will be possible to reach an accord with the Palestinian leadership that replaces Arafat, and that one of the major benefits of such an accord would be an improvement in Israel's economic situation.

Shalom was feeling pleased two nights ago. It had been a good day: He'd announced upcoming tax reforms based on the recommendations of the Rabinowitz Commission, the shekel appeared to be stabilizing, and he'd had a highly publicized meeting with the Governor of the Bank of Israel, designed to show the public that the two men had settled their differences. Shalom has been under a lot of pressure in recent weeks and has been booed at public appearances. Some ministers said he told them he hadn't been sleeping at night. But he endeavors to display sangfroid (which is not in keeping with his natural temperament) and insists that he has been sleeping just fine. Some at the Treasury noted an improvement in the finance minister's mood following the Knesset's approval of the emergency economic plan.

Shalom is careful to present a more restrained assessment of the situation: The economy is not on the brink of collapse, he says. The situation is completely different from the economic crisis of 1985. Then, there was no money left for purchasing basic items and it was necessary to appeal for American aid. Today, the state has large reserves of foreign currency. The sense of crisis stems mainly from the race after the dollar. It's a limited phenomenon that is not indicative of the state of the economy as a whole. It is due largely to the manipulations of speculators and foreign banks.

The vast majority of households are not buying dollars or transferring money abroad (the Bank of Israel confirms this), and continue to have faith in the shekel. Israel's economic image is better abroad than it is at home, and the proof is that the country's credit rating has not declined. Shalom points to his success at getting the budget trimmed by NIS 13 billion while the country is at war as a praiseworthy achievement, and is proud of the emergency economic plan he submitted and of the reforms he introduced. He dismisses the dire warnings from economists of an impending crisis of major proportions, saying that's merely the popular thing to say these days.

3. D?j? vu

Ariel Sharon returned from Washington feeling quite gratified. He was pleased by his talks with President Bush and the degree of agreement he was able to reach with the American administration. What does this accomplishment really entail? Apparently, an understanding to perpetuate the existing situation and to put off the moment when political negotiations between Israel and the Palestinians must begin - which suggests something about the odds of climbing out of the economic crisis anytime soon.