Rising shekel a curse

A month ago when it was first proposed here that the dollar exchange rate could drop NIS 3.85, foreign currency experts responded with ridicule.

They, just like stock market analysts, can usually foresee what has happened but not what is likely to happen. And if they do risk forecasting future developments, they do so very cautiously: They take the existing trend and add another inch - an additional quarter of a percent. That's how the status of forecasters is maintained without the risk of refuting forecasts.

However, this year the shekel is behaving contrary to the forecasted trend and is surprising the predictions. The emphasis is on the shekel and not on the dollar: Although the dollar has also weakened against various other currencies, it depreciated far less than it did against the shekel.

At the end of May last year the dollar exchange rate stood at NIS 4.5. Since then until Monday, the shekel has strengthened by 12 percent. A shekel can now buy a quarter of a dollar. At the end of May last year the British pound exchange rate was 8.5 shekels. Since then the shekel gained against the pound - one of the strongest currencies in the world - by 7.5 percent. At the end of May last year the euro exchange rate was NIS 5.80. Since then it has dropped by 6.6 percent against the shekel.

This trend shows that at least half of the shekel's revaluation in the past year doesn't reflect the decline of the American currency worldwide, but that it is a clear Israeli product. The shekel is on the rise because:

• Inflation in Israel is zero/negative and is much lower than the inflation rate throughout the West -from the UK to the US. The rate of annual inflation in these countries is close to 3 percent and above.
• Israel has a large and growing surplus in its current account of the balance of payments, which has flooded the economy with foreign currency. And where there is excess - prices drop.
•  Israelis have loaned and deposited more money overseas than foreigners have deposited and loaned to Israel. This has resulted in an exterior "negative" debt and a positive flow of income for Israel. The State's account is no different than a family account. Those whose total bank deposits are greater than their debts to the bank earn interest and become wealthier every month.
• The Bank of Israel was too cautious in lowering interest rates and linked itself too closely to the actions of the governor of the Federal Reserve Bank - inflation, debts and deficits are not Israel's problems.

Does anyone know where the strengthening of the Shekel will stop? The answer is no: An NIS 3.85 exchange rate - which would equal the purchasing power of the shekel against the dollar as it was eight years ago - is indeed possible.

Forget the dollar

There's no point in searching for economic rationale in the foreign currency market. It tends to be exaggerated, particularly in short timeframes. Thus, speculators are having a ball. That's why small investors should keep away.

Our fixed recommendation hasn't changed: As long as the shekel is the legal tender in Israel, go for the shekel and forget the dollar. High-tech employees have long reverted from a dollar to a shekel based salary. Real estate dealers have also reverted to the Israeli shekel. Rental fees are still supposedly linked to the dollar, but only supposedly. Even this strange market is undergoing an accelerated transition to the shekel. We're all better off for it.

As to the question whether it is worthwhile investing in the dollar at this time, as it hit a nadir? The answer is: Who said the dollar hit a nadir? Continuation of the shekel's revaluation in Israel's current economic condition is not paradoxical. An NIS 3.85 exchange rate would not surprise anyone. It can even have a macro-economic and financial explanation.

This does not apply to the rise of the stock exchange. Tel Aviv's stocks have been rising in recent months not because of the strengthening of the shekel, but despite of it. And this is a classic bubble situation.

The profits of the majority of companies traded on the Tel Aviv Stock Exchange are dependent on exports, and exports suffer a further blow very time the shekel gaines in strength. A much too strong shekel adversely affects the competitiveness of Israel's exports - the most advanced and traditional alike.

A shekel that is too strong reduces the profitability of the entire business sector, represses economic activity and drives a wedge in the wheels of fast growth that is dependent on export. A strong shekel even increases the cost of Israeli shares, whose rates are listed in shekels, for foreign investors. An NIS 3.85 exchange rate is more of a curse than a blessing for the Israeli economy.

We're not Japan

It's time to lift our heads up from the darting screens. Nothing lasts forever. Signs of renewed inflation are already on the horizon. The Bank of Israel is rapidly increasingly the quantity of money and meeting the surging demand.

Go to the shopping malls and see for yourselves. The cost of housing is rising due to a severe shortage of new apartments in areas of high demand. And unemployment is dropping.

In October of last year I recommended here that the Bank of Israel reduce interest rates at an accelerated rate to the European level and to stop eyeing the actions of the Federal Reserve. It sounded somewhat strange then.

Today the Bank of Israel's interest rates are similar to those of the Central European Bank, 3.75 percent, and it is reasonable to assume that it will fall beneath the euro interest rate.

The next stop will be the Swedish interest rate (3.25 percent), then Switzerland's (2 percent) and finally, who knows, we'll be tempted to match Israeli interest to Japanese interest rates - half a percent. I wouldn't recommend this. Whichever way we look at this, we are not Japan or Switzerland.