Israelis call Israel 51st state, yet shun the dollar

Yes, the rest of the world is not alone - Israelis agree - Israel is the United State's 51st state.

But, strangely - these days at least - Israel's affinity for the US does not extend to the dollar.

Could it be that they don't like clinging to a sinking ship?

So what is happening to the dollar? It has plunged 2.5 percent in the last three weeks, which now makes a 5 percent drop in two and a half months. This has left many, in what we here in Israel often call the 51st state, rather surprised. Yesterday, the dollar closed at a representative rate of NIS 4.25.

After the economy ended two months of uncertainty because of the war, politics and the budget, we expected Israeli investors to flee to their traditional haven: the dollar.

But even reports that the governor of the Bank of Israel [Stanley Fischer] might lower interest rates were not enough to stop the stampede driving the American currency downward.

Fischer, btw, previously served in the IMF and the WorldBank, and also taught at MIT. Oddly enough, despite being lily white, he was born in Zambia.

Hmmmmm . . .

Getting back to the dollar - why are Israelis shunning their heretofor favorite currency?

1. Investment managers are afraid to move money overseas

The drop in the dollar in the last two months is only part of the 9 percent drop in the last half year. There are those who claim that this is actually a sign of the growing maturity of Israeli investors as a result of the surging local investment markets in recent years.

"This is the culmination of a process whereby the Israeli public has internalized the fact that the dollar is not a shelter, or a safe investment," explained Eli Zahor, the CEO of the Barometer investment house.

On the other hand, the "immaturity" of institutional investors may explain why the drop in the dollar has stopped. "Institutionals love to advise all the time to send money overseas, but in practice for many of them this is just talk, and in reality not a lot of money is leaving. Even the big time managers act like the smallest investors, and are afraid to buy dollars when the exchange rates are low," said another market player.

2. Low inflation and high real interest rates

Interest rates of 5.5 percent, as in Israel, are not low in comparison to other countries around the world. When inflation is low, as here in Israel, real interest rates are in the 4 percent range.

It is not easy to find such interest levels, unless you are not scared to invest in developing - and risky - economies such as Brazil. These countries are riskier than Israel, which makes it an attractive destination for foreign investors who think it is worthwhile buying shekels with their dollars.

This touches on an important trait of Stanley Fischer, the Governor of the Bank of Israel. In spite of the exchange rate, Fischer continues to believe that the central bank does not need to intervene in the market, [I wonder why] and has - for now - left it alone.

In a world where countries such as Japan and China struggle to keep their currencies undervalued in order to protect their exporters, Israel is quite an attraction because Fischer seems unperturbed by the situation - at least for now.

Take for example an economy of a completely different magnitude, China. The Chinese yuan is not rising, and the they are very carefully protecting their low exchange rates.

3. Foreigners are searching for investments

The world is awash with a huge amount of cash searching for investment opportunities. This is made clear by the fact that dollars are being converted to shekels for investment purposes, and because of an occasional big deal that appears in the news. The purchases of Iscar, the Psagot Ofek mutual funds, and other local high tech firms keep up a flow of dollars into Israel. Such purchases, which are real and not financial investments, [please note the discrimination between that which is real and that which is imaginary] have the biggest influence on local forex markets. But the real investments bring along financial investors and speculators in their wake - those who are willing to bet on the strength of the shekel.

"We are seeing the evolution of the shekel exchange rates as a result of an open foreign currency market, and because of international market forces," explained Shmuel Berger, the head of the Marvichim investment house.

"Today, as opposed to two or three years ago, the major players who set the agenda for the shekel are foreign institutions. It is like a bull in a china shop. Up until two years ago, the local business sector and currency traders set the tone," added Berger.

4. A strong economy and the treasury

"The strengthening of the shekel reflects the faith of foreigners in the Israeli economy, and their appraisal that the exchange rate is too low," said Berger. "The war actually showed the strength of the Israeli economy, since it came exactly at the time of Israel's greatest strength since the state was founded. [So, it wasn't about poor Israel defending itself.] Global analysts who set the credit ratings for Israel do not relate to the same things that worry Israelis, such as faith in the government or political instability," he added.

"Even this instability is not too bad, since even as governments have changed, the power of civil service officials has grown, and the ministry with the most powerful officialdom is the treasury," [surprise, surprise] said Berger.

5. The Bank of Israel has not lowered interest rates

The real story behind the dollar's exchange rate plunge is the Bank of Israel. A drop in the dollar means a drop in inflation - and that is the flagship of the central banks' monetary policy, said Zahor.

Bingo. When we lose, they win.

The floating exchange rate system is a freaking joke - completely unsustainable and totally irredeemable.

The single biggest problem Americans face today (outside of our out-of-control military industrial complex and our boy-loving Congress) is our colossally corrupt monetary system.