The Phantom Menace

There is now, finally and very belatedly, a broad consensus among economists and analysts of the Israeli economy, both in Israel and abroad, that the Israeli shekel is overvalued. It is agreed by most — although still not all – of these mavens that this state of affairs is problematic, because it causes cumulative damage to the corporate sector, and in particular to exporters and their sub-contractors. The corollary of this consensus that there is a problem, is the conclusion that something should be done about it. However, at this point, the consensus collapses into a welter of disagreements as to what exactly should be done.

In medical terms, it may be said that although considerable progress has been made — in that there is now a generally-agreed diagnosis — there is no agreement whatsoever among the doctors on the case as to what kind of treatment is necessary, let alone at what level of intensity. At the low end of the spectrum of prescriptions is the Bank of Israel which, to its credit, identified the problem almost six years ago, and prescribed a treatment which hitherto it had considered as toxic – namely intervention in the foreign exchange market to buy foreign currency and sell shekels, thereby pushing the price of the shekel back down or, at the least, slowing the rate of its rise.

Extending the medical metaphor, the Bank of Israel’s assessment is that the economy is suffering from a chronic ailment, in the form of upward pressure on the shekel’s value. The central bank believes there is no cure for this problem – on the contrary, it may well get worse over time, as revenues from the sale of natural gas increase. The prescribed treatment is, therefore, primarily aimed at relieving the symptoms, so that the exporters do not suffer too much pain. The policy of intervention in the markets is thus a symptomatic drug, the dosage of which can and is ratcheted up and down in response to the degree of discomfort or pain being felt or measured.

The intense debate now under way about what to do stems from the fact that this form of treatment is not working. The proof of that is that the shekel continues to push upwards, despite the intervention aimed at holding it or pushing it down. Evidence is mounting of damage being done to the wider economy, which becomes more severe and more widespread the longer this problem continues. That is why the debate is focusing on other possible treatments, some of which are quite mild and others rather radical. Each proposal has potential benefits but also distinct disadvantages and side-effects, so that none seems likely to be a ‘miracle cure’. On the other hand, something that offers a significant measure of relief for a reasonable period of time seems very attractive to sufferers.

The architect of the Bank of Israel’s current policy is the previous Governor, Stanley Fischer – and his prescriptions are being faithfully followed by his successor, Karnit Flug and her colleagues. However, Fischer has presented other ideas over the last year, both before and after he left the Bank of Israel, including conditional support for prescriptions seen as very radical, such as capital controls or fixing a ‘minimum rate’ for a currency, which the central bank would defend at all costs. These ideas feature prominently in the policy debate under way, but they have – so far, at least – been rejected by Israeli policy-makers.

Until now, it would have perfectly feasible for Flug, and even for Binyamin Netanyahu, to have picked up the phone to Stanley Fischer and had a chat – she with her mentor and/or he with his ‘mate’. Now, however, there will be a dramatic and fundamental change in those relationships, because tomorrow (Feb 1) Fischer formally assumes his new post as Deputy Chairman of the Federal Reserve Bank of the United States. That casts everything in a different light, because the job description and mandate of the Fed deputy chair does not include giving free advice to the heads of foreign governments, even friendly ones. Bibi can no longer phone Stan; for the Prime Minister of Israel to call the Deputy Chairman of the Fed is a very different story.

Nor is it just about job titles and functions. For those, like this column, who view the Fed as the source of the deliberate and massive distortions inflicted on the US and global economies via its policies over recent years – distortions that are beginning to show up as a new crisis in ‘Emerging Markets’ — Fischer’s appointment is equivalent to his going over to the Dark Side of the Force. The Fed is the Evil Empire, Bernanke and now Yellen are the Emperor, and Fischer has assumed the role of Darth Vader.


If Bibi (Luke) and Karnit (Princess Leia) seek the help of the legendary Jedi knight they still think of as Obi-Wan Kenobe, they may be in for a rude shock:


Darth Vader: Obi-Wan never told you what happened to your father.
Luke Skywalker: He told me enough! He told me you killed him!
Darth Vader: No. I am your father.

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