Monetary/Foreign Exchange question

[Az]

So, in the last couple of years, the Israeli shekel (NIS) has been having a huge resurgence against the USD. It rose from being 4.85 NIS/$ to 3.2 NIS/$ at it's peak.

In the last year or so, the Israeli central bank has decided to step in the forex trade to protect exports, which are the most important part of the Israeli economy.It prints shekels and buys dollars with them. This has led to a gradual fall of the shekel to 4.1 NIS/$ and now the shekel is trading at ~3.8, and to the almost tripling of Israel's reserves from ~20 bil USD to some 56 bil USD. the CB is bying approximately 100 mil USD every day, with peaks of up to 800 mil dollars today. all of this shekel selling led to an incrimental increase in inflation.

There is a rumor circulating that foreign speculative interests are buying shekels. The industrial interests are saying that if the dollar reaches anywhere below 3.5, they're doomed.


questions:
1) what are the possible negative long-term consequences of the continuation of amassing foreign currency?
2) What do you think that head of the ICB should do?
3) are the industrialists right, in light of the fact that israel's exports are mostly not in the commodities or simple industrial goods sectors, but in complex manufacturing goods for which substitution is more difficult?

[Jon Miller]

Because China holds so much more reserves than you, any problems with be more severe for them.

I wouldn't want a large fraction of their reserves.

JM

[Ben Kenobi]

There are advantages to a strong dollar vis-a-vis the USD. Basically what your central bank is doing is paying money to buy USD rather than keeping your own money and investing it elsewhere in the world. I don't really understand why the central bank would chase after a low dollar policy.

[Flubber]

Basically what your central bank is doing is paying money to buy USD rather than keeping your own money and investing it elsewhere in the world. .

yes thats exactly what the OP said they were doing

I don't really understand why the central bank would chase after a low dollar policy.

Well the OP gave the reason the central bank has stated-- they are attempting to "protect exports" but the OP questioned the wisdom of this .

Ben its not unheard of to wish your currency to be lower. Many Canadian economists felt that way when the loonie went high against the US and for the same reason-- many exports can become less profitable or unprofitable if the costs in the purchasing country's currency gets too high. What the OP is stating is a belief that essentially demand for the Israeli products is less sensitive to price since they are hard to substitute for. If the OP is correct there is no need to protect the Israeli currency for the stated reason.

[Ben Kenobi]

Ben its not unheard of to wish your currency to be lower. Many Canadian economists felt that way when the loonie went high against the US and for the same reason-- many exports can become less profitable or unprofitable if the costs in the purchasing country's currency gets too high.

That is true, but it costs money to buy USD to keep the Canadian dollar low, money which we can use for other things. With a high dollar it means we can buy stuff up abroad that has a greater return. They should just let the market work. If the Canadian dollar is truly that much more valuable than the USD, then they will be fighting a losing battle.

[Flubber]

The issue continues. The analysis is pretty basic but its an issue that doesn't go away

Bank of Canada in bind as loonie continues climb toward parity with U.S. dollar


2 hours, 7 minutes ago


By Julian Beltrame, The Canadian Press



OTTAWA - The Canadian dollar's apparently relentless climb back to parity with the U.S. dollar is leading to speculation that the Bank of Canada may be considering doing more than talk about the dangers of a strong loonie.


The loonie has appreciated more than two cents in the past few trading days and many are projecting it could attain parity by the end of the year. It closed at 92.64 cents U.S. on Tuesday, after briefly hitting 93.44.


While that may sound good to snowbirds contemplating a trip south in a few months, bank governor Mark Carney has warned such a move puts the strength of the economic recovery in jeopardy.


Avrim Lazar of the Forest Products Association of Canada estimated for each penny rise in the loonie's value, the battered pulp industry loses 15 per cent in returns.


"We export more than two-thirds of what we make, so any sign of recovery will be undermined by the dollar going up," he said.


"Mr. Carney is right to be concerned and he's right to look at all tools at his disposal."


Most observers fully expect Carney to once again hector about the dollar's inflated value at Thursday's policy announcement, and leave it that.


"The Bank of Canada has a great opportunity. If U.S. weakness continues, the Canadian dollar might actually underperform other currencies waiting for what the bank might say," Scotiabank currency analyst Camilla Sutton said.


However, economists caution the central bank risks losing credibility if it keeps warning about action, without following through. Few think Carney should intervene or will intervene at this point.


The 11-member C.D. Howe Institute's 11-member monetary policy council said Tuesday the bank should restrict it's statement Thursday to repeating its promise to keep the policy interest rate at 0.25 per cent until mid-2010.


"Few felt that the Bank of Canada should react in words or deeds, and several stressed that attempts to steer the exchange rate had led monetary policy badly astray in the past," the think-tank said in a statement.


The problem is that words have proved insufficient.


Carney and his deputies have issued sporadic public warnings about the strong loonie's impact on the economy since June, with only anecdotal evidence that the exhortations had the desired effect, even fleetingly.


Deputy governor Timothy Lane issued the sternest warning two weeks ago, going beyond stressing the dangers to the economic recovery posed by a strong loonie, to suggesting that the bank "retains considerable flexibility," including so-called quantitative easing, to ground the bird.


UBS Securities Canada chief economist George Vasic said he understands why Carney would want to talk the loonie down since the bank's calculus likely considers the "fair value" for the currency under current commodity prices at about 85 cents.


But Vasic says in the longer term a weak Canadian dollar is not welcome.


"The only reason the dollar will stay strong is if economic conditions stay strong," he explained. "The dollar is a reflection of these conditions, so if we went down to 80 cents, it's likely because we would have had a deflationary shock and that's good for no one."

The economist does not believe that will happen. He has updated his forecast for the economy to coincide with the central bank's, saying growth will return to a relatively strong 2.9 per cent next year.

The bank's other difficulty dealing with the dollar is that its options are limited. With the policy rate as low as it practically can go, Carney cannot reduce short-term interest rates to cool the market's appetite for the Canadian currency.

And TD economist Charmaine Buskas called the unconventional quantitative easing option, which would increase the money supply, an idle threat given that even the bank believes the economy is bouncing back.

"This will not stop the Bank of Canada from reiterating its 'considerable flexibility' with regard to the conduct of monetary policy," she added.

Buskas believes the dollar would have to rise a lot further and very fast for the bank to intervene.


.

[KrazyHorse]

all of this shekel selling led to an incrimental increase in inflation.

This is precisely why in the long-term FX interventions don't actually change the real exchange rate. They can counteract certain short-term fluctuations in the exchange rate, on the other hand. In a crisis, the "beggar thy neighbour" strategy actually works, as does protectionism (again, in a crisis, and in the short term).

If the Israeli CB continues its FX interventionism it will be doing nothing more than taxing the holders of shekels (mainly its own citizens) in order to provide the US with an interest free loan (cash holdings) or extremely cheap loan (Treasuries).

[Az]

If the Israeli CB continues its FX interventionism it will be doing nothing more than taxing the holders of shekels (mainly its own citizens) in order to provide the US with an interest free loan (cash holdings) or extremely cheap loan (Treasuries).

This actually isn't that bad since we were bordering deflation at times since 2008. the increase in money supply and inflationary pressure isn't that big an issue- and hasn't been for a year and a half - UP TO THIS POINT.

the NIS was gaining against the Euro as well in 2008, however since the cb intervened and sorta pegged the NIS to the dollar it obviously has been falling. and is now at the same rate as it was in the beginning of 2008.

We have been weathering the storm rather nicely, especially for an export-oriented country with the US as a major export destination, however it seems that weathering the storm rather nicely, with 0 GDP change in 09' forecasted - but this sort of trouble can really hamper recovery - as the CB wonders whether to raise the reserve rate to curb the inflation....

[KrazyHorse]

This actually isn't that bad since we were bordering deflation at times since 2008. the increase in money supply and inflationary pressure isn't that big an issue- and hasn't been for a year and a half - UP TO THIS POINT.

Dude, I'm not saying that inflation is an unmitigated evil. What I am saying is that buying dollars with newly printed shekels is a hell of a waste of seignorage.

[KrazyHorse]

The point is that in the long term you CANNOT change the relative price of goods in two countries simply by mucking about with FX, any more than you can by reducing interest rates. You can mess with nominal prices. That's it.

[Az]

The point is that in the long term you CANNOT change the relative price of goods in two countries simply by mucking about with FX, any more than you can by reducing interest rates. You can mess with nominal prices. That's it.

obviously not inside the country - that's mental mastrubation. However, the alternative scenario - an increase in dollar salaries for employees does have an negative effect on manufacturers and service companies dealing worldwide - raising their costs.

Flubber was right saying I am questioning the industrialists' claim - I am questioning, I am not sure what the right answer is. In case of Canada this claim is stronger, since Canada exports plenty of commodities.

Israel is successfully braving the current crisis, having its' industries and foreign investments mostly well hedged in relatively stable industries (except a certain tycoon that was way over-exposed to eastern europe and USian real-estate) - I just wonder if this sort of strong shekel is endangering it.

[KrazyHorse]

obviously not inside the country - that's mental mastrubation. However, the alternative scenario - an increase in dollar salaries for employees does have an negative effect on manufacturers and service companies dealing worldwide - raising their costs.

OMFG, Az. Here's the mechanism, which you yourself pointed out:

Print shekels, buy dollars. Immediate result: more shekels to buy one dollar. Over time, more inflation in Israel than in the US -> nominal salaries in shekels increase faster than nominal salaries in dollars -> back to where you started

[KrazyHorse]

Classically (ignoring the disruption this would cause), if you double the number of shekels in circulation then the new equilibrium is simply that the number of shekels to buy one dollar doubles AND the nominal salary in shekels of Israeli workers also doubles. Net effect on relative prices = 0

[Az]

this implies that the Israeli workers' salaries are tied to CPI. which is far from always being the case.

[KrazyHorse]

a) the prime determinant of CPI over long periods of time IS the cost of labour
b) no, this does NOT imply that their salaries are "tied" to CPI; it simply means that IN EQUILIBRIUM a change in the value of money leads to a proportionate change in the price of labour, as well as everything else. This is known as the "neutrality of money". The amount of money in circulation changes nominal variables, but not real variables. Again, this is only true in equilibrium; you can argue about what happens when there are unexpected shocks to the money supply, or under fast rates of money supply growth yadda yadda yadda, but it's completely unreasonable to go from this type of exception to claiming something about multi-year FX interventions.