Examined one by one, Governor of the Bank of Israel Prof. Stanley Fischer's policies turn out to have been badly wrong, and the Israeli economy will pay a heavy price. It's hard to understand what the basis is for the statement on everyone's lips "it's lucky we've got Stanley." It seems that the positive image that the Governor of the Bank of Israel enjoys in economic circles stems from a well-oiled public relations machine, and in the main from the inexplicable deference on the part of Israelis towards anyone who comes here from abroad with a past that includes senior posts in international organizations.
When Fischer's actions at the Bank of Israel are examined one by one, the failure of each of them becomes stark.
Inflation
In no twelve-month period since Fischer was appointed in May 2005 (that is, from May 2005 to April 2006, and so on) has inflation in Israel come within the target range set by the government of 1-3% (including one year in which inflation was below the target). Fischer took up his post with the annual rate of inflation 0.5% in the previous twelve months, and under his management inflation has been off target, even soaring to an annual rate of 5.5% for a few months during the crisis of 2008.
Trade deficit
Today, Israel has the largest trade deficit in its history, over $15 billion. For the sake of comparison, in 2007, which was a boom year and preceded the global financial crisis, the trade deficit was $10 billion, and in the year following the outbreak of the crisis it fell to $4.5 billion. Two years later, the deficit has swollen by a factor of four - unbelievable.
The real estate market
There has never been such a price rise here and such high exposure of the banking system to the sector. The developing recession, and the steep fall in prices of which the first signs are already visible, will shortly explode the myth that "the banking system showed extraordinary robustness in the crisis of 2008" (with the Bank of Israel taking most of the credit for that), which will emerge as groundless. The housing market was also one of the main causes of the social protest that broke out hre last summer.
Exchange rate policy
Never, to the best of my recollection, has a central bank conducted an exchange rate policy that has led to such a dismal result as that of the Bank of Israel's policy under the current governor. Fischer received the shekel at 4.45 against the US dollar, and managed to take it to just 3.30. Even though the bank bought $60 billion over the period, the shekel-dollar rate remained at an average of 3.50. The way that the Bank of Israel chose to intervene in the foreign exchange market, at first by buying $25 million a day, was ridiculous. If it were not so sad, indicating a deep gap of understanding between the heads of the central bank and what actually happens on the market, it would be funny.
It's hard to count the number of times that the Bank of Israel and its head in recent years have said that it is impossible to fight market conditions over time. This is a foolish and incorrect argument when it comes to moves to curb the strengthening of a local currency. There is no central bank in the world that over an extended period of time has tried to prevent its currency from appreciating and has not succeeded, as long as it acted correctly. Unfortunately for the Governor of the Bank of Israel, the Swiss central bank has only recently demonstrated that, when it is done properly, intervention in the foreign exchange market works well.
The export sector, which represents 45% of Israel's GDP, has recently begun to feel the outcome of Fischer's foreign exchange policy all the more keenly, after the economic correction of 2010 temporarily offset the disastrous effect on it of that policy.
Foreign currency reserves management
It is hard to understand how, on the way from currency reserves of $20 billion to reserves of $80 billion, the Bank of Israel has not bought a single ounce of gold. This in a period in which the price of gold rose from $900 to $1,600 an ounce, and central banks around the world, including those of China, India, Bangladesh, and Sri Lanka, bought gold methodically. Several times, Fischer even boasted that the Bank of Israel held zero gold reserves, and declared that he had no intention of changing that.
Another question that arises from things Fischer himself has said is: what is the Bank of Israel's current exposure to the euro and to bonds of European countries that, over the past year, have run into severe economic difficulties, and how big a loss has the bank sustained as a result of the euro bloc crisis? The losses are presumably heavy, since Fischer has admitted that, until not long ago, he had not foreseen how the crisis in Europe would develop.
Handling of the financial system
As the world stands on the brink of another global recession, in which the condition of the Israeli economy will undoubtedly be worse than what it was during the 2008 crisis, it can be stated that in the three years that followed, the Bank of Israel allowed the banks to greatly increase their exposure to the real estate sector. At the same time, he did not exploit the economic recovery in Israel and the world to reduce the banking sector's exposure to non-financial activity, or to reduce investment institutions' exposure to the bonds of tycoons, some of whom are about to give haircuts in the form of debt settlements that will shave billions of shekels from the public's savings.
Predictive ability
Assessments by Fischer and the central bank that he heads have been shown to be horrifically inconsistent. It should be remembered that, in September 2008, two weeks before the collapse of Lehman Brothers, the governor was still battling inflation and raising the interest rate.
But it did not end there. In June 2010, Fischer still believed that the euro would become the world's leading international currency, and that the European currency crisis would vanish. Just two months ago, he said that if were told that the eurozone would be on the verge of break-up, he would have said that the chances of this were zero (which naturally raises concerns about the Bank of Israel's exposure to bonds of countries affected by the crisis). It should also be remembered that, in June 2011, the Bank of Israel raised its growth forecast for Israel, and just three months ago, it said that the interest rate would be 3%.
No wonder that Fischer wants to go home
After the damage that the Bank of Israel and the man who heads it have caused the economy in the past few years, it is on the brink of an even greater disaster which will not only have economic repercussions, but also political and social ones. Prime Minister Benjamin Netanyahu, whose understanding of economics is dubious, and Minister of Finance Yuval Steinitz, who has no understanding of economics at all, oppose expanding the budget, and the legitimacy they draw on for this policy comes from the unequivocal support of the governor for a tight budget and no breaching of the budget framework.
What does this resemble? It resembles the military concept of "Let's wait for the Syrians to reach the Kinneret and then will call up the reserves". In other words, they are saying let's wait for the crisis to hit, and then we'll deal with it.
The results of the policies that Fischer has led at the Bank of Israel have already resulted in the social protest that broke out last summer, and they will receive further expression as the recession in Israel worsens. I believe that this will be accompanied by a sharp drop in real estate prices, a severe crisis in the banking system, and rising unemployment. This will increase social ferment in Israel, and add hundreds of thousands to the circle of protestors - people who bought apartments in recent years and who will be hurt by the expected drop in prices and the loss of the capital gains they made on paper during the wild rise in prices.
In is no wonder, then, that the governor wants to go back to the US. He perfectly understands the strength of the crisis that is about to fall on his head, and knows that it will turn him into the next Alan Greenspan. Fischer recently submitted his candidacy for the presidency of the IMF, even though he knew that there was no chance that the age limit for the job would be changed to accommodate him, and that there was no candidate for the post besides Christine Lagarde.
In this way, he signaled that he wants to leave, and in my opinion he is already energetically seeking the job that will take him out of here. It is quite amusing to hear Fischer's explanation of his suitability for the IMF job: "I have expertise in dealing with crises."
It should be remembered that Fischer, when he was no. 2 at the IMF, during the Asian debt crisis in the late 1990s, completely misdiagnosed the crisis and how to treat it. Even now, the IMF is persona non grata in these countries.
All the people who hold onto the upgrade in Israel's credit rating during Fischer's tenure should remember that these ratings were given by the same companies that gave perfect AAA ratings for subprime mortgages that turned out to be insolvent. And people pleased with Israel's accession to the OECD should remember that countries whose economies have recently collapsed, such as Greece, Portugal, and Ireland, are also members of this organization.
The most infuriating thing to me is that Israel is a small economy, which can be strongly affected by an expansionist fiscal policy and by an effective aggressive cut in the interest rate, thereby preempting the global economic blow. To finance such a large fiscal expansion, it is necessary to immediately cancel Netanyahu's capital market reforms and issue designated government bonds, which investment institutions will be happy to buy.
The Bank of Israel should make massive purchases, as needed, of government bonds, as most of the world's important central banks are doing, including the US Federal Reserve Board, which is headed by Fischer's student Ben Bernanke, and which has bought $2 trillion of T-Bills to date.
In the past, the economic concept was that "the government is the problem, and the private sector is the solution". But today, regrettably, this has been turned on its head: the private sector has become the problem and the government must be the one to provide the solution.
The Bank of Israel declined to comment on this article.
Avi Tiomkin is an advisor to macroeconomic international hedge funds. He splits his time between Israel and the US. He is close to Minister of Defense Ehud Barak, and advises him on economic matters. He is known for predicting the 2008 crisis, the eurozone crisis, and the rise in the price of gold.
Published by Globes [online], Israel business news - www.globes-online.com - on January 16, 2012
© Copyright of Globes Publisher Itonut (1983) Ltd. 2012