Shekel Slide: Good in the Past, Bad in the Present
In March, I wrote that the shekel did not fully reflect the 'Caligula effect', the dangers stemming from the extreme and irrational behavior of the Prime Minister. I predicted that at some point, the shekel would cross the 3.80 to the dollar mark. This occurred last week. However, as of now, the shekel has slightly appreciated and is hovering around an exchange rate of 3.79 NIS to the dollar. Today, I am optimistic about the shekel's future, as I believe the coup has mostly lost its momentum in the Knesset. If I'm proven wrong, and Bibi indeed has a trick up his sleeve, the shekel might further deteriorate
The fluctuation in the shekel's value indicates Israel's weakening under the current government. It's becoming a less attractive place for money and investors, and the currency rate reflects that, of course. Sharp thinkers might question - isn't it often said that devaluation is good for the economy? That devaluation can lead to growth, that it's beneficial for exporters, and if so, why blame the government that depreciates the shekel? On the contrary, we should praise it for the fact that the shekel's devaluation aids growth and is a blessing for exporters who benefit more from their dollar reserves.
To understand why the shekel's current devaluation is not a blessing, whereas it could have been a great blessing if carried out by the Bank of Israel, for instance in 2018 or 2019, one must consider two decisive differences.
Interest rates are no longer zero
When the Bank of Israel's interest rate is set around zero, the governor doesn't have the means to encourage additional growth by lowering the interest rate. It's like trying to drop something downwards when you're already lying on the basement floor. In such an economic climate, the only strong tool available to the Bank of Israel to stimulate growth is to adjust the currency rate. However, whereas in the past decade the interest rate was firmly stuck at zero, today's interest rate is relatively high. The simple and right tool to encourage growth now is to reduce the interest rate. A weaker shekel isn't a blessing that couldn't have been achieved by an interest rate cut.
However, now, it will be harder to lower the interest rate as the shekel weakens, lest the shekel completely collapses following the rate cut, leading to a sharp rise in the prices of imported goods and subsequently the entire market.
Foreign currency reserves are not accumulating
Had the Bank of Israel been engaged in lowering the shekel rate a few years ago, there would have been a side effect: it would have accumulated huge reserves of dollars and other foreign currencies. The Bank of Israel reduces the currency value by selling shekels and buying dollars in return. The dollars are stored in the bank's accounts worldwide and serve as Israel's ultimate insurance for catastrophic events requiring immediate financial rescue. There's an inherent paradox in devaluing the shekel that's worth noting: the state weakens the shekel's rate in the present but acquires foreign currency reserves that give a real reason to trust in the shekel in the future. The financial security of a country with reserves of 20 billion dollars is not the same as that of a country with reserves of 200 billion dollars. Therefore, weakening the shekel's rate is, in the long term, strengthening the shekel.
Unlike this, the sharp depreciation of the shekel during the tenure of the current government is not accompanied by accumulating dollars or euros in the central bank's reserves. It's a pure weakening of the shekel, without any long-term gain. One might guess that such a devaluation of the currency, if initiated by the Bank of Israel for growth purposes, would have enriched the country's foreign currency reserves by tens of billions of dollars. Hence, one can equate the cost of a spontaneous currency devaluation, one that doesn't come with reserve accumulation, to a waste of tens of billions of dollars.