The Dollar Is Driving People Crazy

A wise man does not step into a trap that a shrewd man knows how to get out of, but even the wisest of bank governors cannot escape from a trap he set for himself - blatant interference in the foreign currency market.

The July consumer price index is about to be published, and the governor of the Bank of Israel, Stanley Fischer, will have yet another reason for a headache. If the index is high, he will be forced to raise interest rates at the end of the month to fight inflation. But raising interest rates will lead to a weakening of the dollar, and that's the last thing he wants.

A wise man does not step into a trap that a shrewd man knows how to get out of, but even the wisest of bank governors cannot escape from a trap he set for himself - blatant interference in the foreign currency market. It's easy and tempting to enter the trap, but it's extremely difficult to get out.

Once upon a time, life was simpler. Bank governors (from Jacob Frenkel to David Klein) understood that their only task was to make sure that inflation was kept low. The other economic indicators were the treasury's business. But Fischer wanted more. He wanted to control the exchange rate, fix it at a certain level and thus encourage exports and growth. How did this significant change take place?

There is one clear reason - the great economic crisis that broke out in September 2008, a crisis that changed the way the economy was seen in the entire world and especially in the United States. Suddenly it became legitimate to interfere in the capital markets.

But that does not explain everything because the change took place with Fischer before that, in February 2008, when Shraga Brosh, president of the Manufacturers Association, and Ofer Eini, chairman of the Histadrut labor federation, tried to force Fischer to lower interest rates. At that time, the dollar dropped sharply to NIS 3.6. Brosh said in media interviews that the weak dollar would harm exports by 10 percent and 17,400 people could expect to lose their jobs in manufacturing.

They did not make do with talk but promoted a bill that would force the governor to lower interest rates by changing the aims of the new Bank of Israel Law. Fischer viewed their intervention as a threat to the central bank's independence and his position as governor. For many reasons, the bill never made it into law, but Fischer understood that he was facing a dangerous alliance between the manufacturers with their vast connections and the Histadrut with its vast political clout. He was afraid they would be able to make amendments to the new Bank of Israel Law, which is extremely important to him. Did the unified power of Brosh and Eini have an effect?

Fischer lowered interest rates by half a percent at the beginning of February and Brosh was extremely pleased. He said that "the very decision to lower interest rates shows that Fischer has adopted the manufacturers' position that the governor must support both growth and employment, and not merely [deal with] inflation."

And so it is that from that day, Brosh has praised Fischer, and the governor has not only brought down interest rates but has also, starting in July 2008, intervened actively in the foreign currency market and bought dollars. For his part, Fischer was able last month to get the Bank of Israel Law approved by the government without any interference from the manufacturers.

Fischer is convinced he can control the rate of the dollar, but the laws of economics say the central bank governor cannot change the basic trend in the foreign currency market for an extended period. He cannot fix the exchange rate for the long run. The rate is fixed by exports, imports, capital movement and the rate of economic growth.

And since we suffered less from the world crisis and our growth rate is higher than in the West, and since our exports are greater than our imports, the shekel must grow stronger. That is, the basic trend is for the dollar to weaken against the shekel, and no governor can change that. If we add to that the fact that the United States is suffering from heavy budget and balance-of-payment deficits, then from the international standpoint, too, the dollar has to drop. And that's exactly what is happening.

Fischer's attempts to fix an artificially high exchange rate achieve the exact opposite, because market players are currently executing deals to sell dollars they have not yet received, for fear that the rate will drop. Speculators are selling dollars to the bank, realizing that the day will come when they will buy them back cheaper. These are forces the bank cannot control over an extended period.

The illusion the governor has created is leading to a dangerous assumption by exporters that salvation will come from Jerusalem. So they are not doing what could be expected in this situation, like streamlining, lowering wages and developing new markets. It's much more pleasant to sit and wait for the governor to save the day than to undergo surgery.

But sooner or later they will understand that the governor is not a juggler who can keep all the balls in the air at the same time. And the most important ball is price stability. As soon as that is achieved, there will be no excuses for labor disputes and no demands for wage increases. The poor will be harmed less (because their salaries will not be eroded) and foreign investors will flood our market.

That is what Fischer's contribution to the economy should be - low inflation. Not a futile attempt to fix the rate of the dollar.