The almighty shekel
This week, the shekel reached its highest value against the US dollar in almost ten years, at about 3.78 shekels to the dollar. The seemingly relentless rise of the Israeli currency was interrupted on Thursday afternoon, when Bank Hapoalim shocked the local market by announcing another massive write-off of securitised American loans that it had unwisely invested in (so-called subprime, although that’s inaccurate – but never mind). This hit Hapoalim’s share price for six, sent the whole Tel Aviv Stock Exchange south and caused the dollar to gain three agorot against the shekel in an hour – and to lose them again in the next hour.
But the total potential losses of all the Israeli banks together are insufficient to change the larger picture, in which the shekel is rising against all the main currencies – and is likely to continue to do so, at least for the near term. The shekel’s rise reflects the ‘strong fundamentals’ of the Israeli economy – such as the rate of GDP growth, the balance of payments surplus and the negligible budget deficit – are far superior to those of the US, UK and most other developed economies. If that wasn’t reason enough, Israeli interest rates are climbing, because inflation is rising; meanwhile, in the US and UK interest rates are falling – and they are likely to fall in the euro zone too, within a few months, as the slowdown in the European economy intensifies. Interest rate differentials are a key driving force of short-term capital flows, in this case into Israel.It is difficult for many Israelis to grasp the idea that their economy has become a ‘surplus’ economy, with strong fundamentals. For fifty years, economic weakness was the norm and was regarded as a fact of Israeli life. As recently as five years ago, a central tenet of the accepted wisdom in Israeli government and political circles, as well as in the media, was that there could be no sustained economic growth in Israel without clear and ongoing progress in the Middle East peace process. Yet we are now completing the fifth successive year of growth and the fourth of rapid growth, without any peace process, but with a war, a wall and a withdrawal along the way. The left wing mantra have been proven utterly baseless — but the right wing parties have nothing to crow about, because the governments that delivered this unprecedented run of economic success have been led by their pet hates, Sharon and Olmert, on whom they believe Heaven should have vented its wrath, not showered its blessing.
It may be no consolation to frustrated right-wingers, but nothing in Israel’s recent economic achievements is unique. Many developing countries, both in East Asia and in South America, have undergone a macro-economic metamorphosis similar to Israel’s — from running large deficits and suffering chronic instability to running surpluses and enjoying financial stability, whilst achieving high growth rates. In most cases – think Russia and Argentina – the change has been facilitated by the commodity boom. But countries like South Korea, Taiwan and of course China and India have managed – like Israel – to grow strongly despite, not because of, the rise in the price of energy, grains and metals.
Even so, few countries have achieved the degree of financial stability that has characterised Israel for the last 2-3 years, and that even the Second Lebanon War could not disrupt – and that has found expression in a currency gaining value not just against the dollar, but even against the euro. One country that has matched Israel in this respect, is Egypt – but you would never read about that in the Israeli press, which is largely unaware that Arab countries have economies at all. Not all Arab countries, however, are family-owned oil companies with flags and airlines.
How long can the shekel’s rise continue? No trend lasts for ever, but picking tops and bottoms is almost impossible. Nevertheless, the shekel is bound sooner or later to bump into one or other of two potential developments that will weaken it. The more obvious one is that of geo-political risk – another campaign in Lebanon, a crisis with Iran, or some other Israel-specific problem that could impact the currency, at least in the short-term. The fact that this didn’t happen in the summer of 2006 is no guarantee that it can’t or won’t happen in the future.
The other factor is global. The relative strength of the emerging markets is unlikely to hold up for long, if indeed both the US and European economies sink into recession. The belief that China and India can ‘uncouple’ from the developed economies is, for the moment at least, an illusion. By the second half of 2008, if the developed economies are not improving, the developing ones can be expected to deteriorate, taking their currencies – including the shekel – with them.