TLR Bulletin – Fischer Rides Again
No-one who follows the Israeli markets can have been surprised yesterday (Monday, April 8), when the Bank of Israel intervened in the foreign currency market. The intervention came after the shekel/ dollar rate dropped below 3.60, with the central bank quickly making an official announcement confirming that it had bought $100mn. Indeed, had this intervention not followed the breaching of the 3.60 level, most traders and analysts would have been VERY surprised.
Now that the dust has settled, it is time to consider the wider picture. ‘The dust has settled’ in two senses: first, the market itself was pretty stable today. Second, more interestingly – the shekel/dollar rate was stable today, despite the fact that the dollar was generally weak. On a normal weak-dollar day, the shekel would have risen, especially in recent weeks, when it was on a tear against both the shekel and the euro. Today, however, it was quiescent.
What is going on? Interestingly, the Bank of Israel announcement – which had clearly been written long before with only the date requiring adjustment – made explicit reference to the policy decision of August 10, 2009, as the basis for the intervention. That is entirely correct in formal terms. But the reminder may also be seen as a warning to the market that, from the central bank’s point of view, the rationale that justified the intervention policy formulated in August 2009 is still valid today. That rationale is, in essence, that the central bank has to protect Israeli exports from an excessively strong exchange rate that will price them out of global markets.
Nothing that has happened in the intervening 44 months provides cause for abandoning or even altering that policy. On the contrary, virtually everything that has happened confirms that it is not only valid but in fact essential. Since August 2009, the concept of a global currency war has emerged and become mainstream. Just last week, that war was ratcheted up by several notches when the Bank of Japan launched the biggest QE ever seen, with the overt goal of devaluing the yen by tens of percent (from where it was last November). Currency manipulation, whether conducted as part of an offensive or defensive strategy, is the norm today – much more so than it was in August 2009, let alone in March 2008, when Stanley Fischer initially intervened in the currency markets, thereby shocking the entire respectable economic world (remember that March 2008 was six months before the nationalisations of Fannie and Freddie, the collapse of Lehman and the bail-out of AIG et al, when there still was a respectable economic world…)
However, whilst the August 2009 ‘doctrine’ is the official sanction for this kind of activity, there has been much more recent discussion of the rationale in two speeches by Fischer. One, which I urge everyone to read because I think it is a kind of valedictory address by him after eight years in the business of central bank governorship, was delivered in Prague on February 7, at a
conference organised by the Czech National Bank (see http://www.cnb.cz/en/public/media_service/conferences/conferences/conference_20_years_cnb_fischer.html). The second was delivered shortly afterwards at the Kiryat Ono college in Israel, and is available (in Hebrew) on the Bank of Israel website.
The critical section, in the current context, comes in relation to the policy adopted by the Swiss National Bank of pegging the Swiss franc to the euro and protecting the chosen rate by buying Swiss francs:
Well, we all say you can’t fight the market, that’s a good story. You can fight the market, if the market wants your currency to appreciate, because if your currency is appreciating what the market wants is your currency. Namely, I’ll talk in shekels because that’s what I thought about. People want to come in to the country and buy the domestic assets, buy domestic currency and so you can produce shekels, we can produce shekels in very large amounts. We sterilize them, we sterilize the shekels by immediately selling short-term paper. But we have that, you can keep doing it forever. It will be very expensive when you’ve issued all this paper to neutralize it, but you can do it.
That is as near to the Draghi “we will do whatever it takes” as you can get, with the critical caveat that whereas Draghi is subject to all kinds of political and institutional constraints, Fischer and the Bank of Israel are not. There is a complete consensus within government over the need to protect the export sector. The main discussion is tactical – when, how and to what extent to intervene.
To sum up: Fischer defined and justified the principle of intervention in August 2009 and subsequently and also defined the parameters of the intervention as being effectively open-ended. Therefore, I believe, yesterday’s move was not a one-off event but a (renewed) declaration of intent to conduct a campaign for as long as needed, on whatever scale proves necessary. The traders and analysts are right to try and figure out whether the next intervention might come at 3.60 or only at 3.55, and so on. But come it will, and on a much larger scale than the first one – if and when that proves insufficient (as it most likely will).
But there is one major factor that has changed vis-à-vis 2009 and that is the onset of the natural gas era in Israel. The impact of the flow of gas from Tamar and, in due course, from Leviathan, has been discussed hitherto as a future event — but now it is happening and is therefore reducing the volume and value of oil imports. That means that the trade deficit is shrinking and the current account surplus will resume and grow. In money terms, it means that more dollars are entering the Israeli economy and less shekels are leaving, so that the value of the former declines versus the latter.
The accepted solution to this strategic long-term problem, which poses a potentially lethal threat to large swathes of Israeli exports, is to channel the excess dollars into a Sovereign Wealth Fund (SWF) and thereby neutralise them. That is what Fischer has recommended and Netanyahu has accepted. Personally, I would rather see the money spent on infrastructure investment (which is import-intensive and therefore swallows up large amounts of dollars, whilst creating jobs and activity in the domestic economy), but the reigning economic philosophy, or what remains of it, will not tolerate that approach. Instead, it will be invested in the bonds of semi-bankrupt developed economies which still have (unjustifiedly) high ratings. Yet, even that is better than letting it run amok and force up the value of the shekel, with lasting damage to industry, output and employment.
But the SWF is not yet up and running. We are therefore in an interim stage, akin to 2009-2011, in which intervention and sterilisation will be used as the weapons of choice. Interest rate cuts are not out of the question, but they seem unlikely at least until the budget is passed. The budget and ‘regular’ macro-economic developments will be discussed in a full issue of the newsletter which should follow shortly.