Money Talks
By: Prof. Shlomo Maital

Money talks. In Hebrew, the equivalent saying is: Those who hold the pot (of money) call the shot.     

Money talked far too much in the past few years. Those who used money to make money took excessive risks and caused great destruction in the global economy. As a nation that makes its living from flows of trade and money, Israel's economy has been badly hurt.     

As an economist, I try my best to listen to money, to understand what it is saying and report what I hear to our readers. That has become increasingly difficult. Some of what money has been saying lately is quite clever. Some is, in my view, rather dumb. Here is what I have been hearing.
 
Smart money.

Over 70 years ago, Joe Louis fought Max Schmeling in New York for the heavyweight boxing championship of the world. Louis knocked Schmeling out in round one. But suppose Louis had fought with one hand tied behind his back? He would have lost. That is Israel's situation today in fighting the recession. Israel needs two fists − fiscal (government spending) and monetary (interest rates and credit). But it has only one. Why? Israel's finance ministry is obsessed with slashing the growing budget deficit rather than fighting unemployment. It is reportedly planning spending cuts in defense and in education. That leaves only one fist, that of Bank of Israel Governor Stanley Fischer. 

Fischer is employing smart money. He has announced that the Bank of Israel will continue to buy $100 m. American dollars a day, for shekels, to help Israel's exporters by maintaining a favorable shekel-dollar exchange rate. He also said that the Bank of Israel will purchase several billions of shekels worth of government bonds. Why? Higher demand for bonds raises their price. The higher the price of a bond, the lower its yield, or interest rate.  

On March 23 the Bank of Israel lowered interest rates by 0.25%, to only 0.5%, by far the lowest they have been in history. But these are very short-term rates. And at these rock-bottom rates, there is little room for further cuts. 

Long-term interest rates have actually risen. This hurts businesses and investment. So Fischer is working to cut them by buying up to NIS 10-15 billion worth of bonds. Won't this dangerously flood the market with shekels, when bond sellers receive huge Bank of Israel checks? No, says Fischer; the Bank will 'neutralize' the money by 'mopping it up'.   

Smart money indeed. But alas, it is only one fist. Where is the other, fiscal fist? When will the Finance Ministry wake up and act?  
   
Dumb money.    

In the Bible, Samson pulled down the Philistine temple, killing himself but taking a lot of Philistines with him. Big money threatens working people with the same fate today.

Very large borrowers in Israel implicitly threaten that like Samson, if they default on loans or bonds, the system will crash, because the stability of large Israeli banks that lent them money will be undermined. 

These people took big risks, investing mainly in speculative real estate abroad, not in Israel. And we the people, through the Bank of Israel, may now foot the bill. If one or more billionaire dominos fall, they threaten to topple us all.

Financial Times columnist Martin Wolf writes that "The global crisis has broken the American social contract: people were once free to succeed and to fail, unassisted. Now in the name of systemic risk, bail-outs have poured staggering sums into the failed institutions that brought the economy down." 

Are we in Israel about to do the same? Must we make all the tragic errors that our friend America makes? I say, call their bluff. Let them default. If needed, only then, offer new liquidity to the banks that are hurt. If you and I overspend, nobody lets us off the hook. Why, then, should billionaires get away with it? 
 
Dumb money.

On Monday March 23 American Treasury Secretary Timothy Geithner announced another new bailout plan for rescuing America's crumbling financial system. After successive failures, this time "He wows 'em", raved the International Herald Tribune. The Dow-Jones Industrial Stock average rose nearly 7% that day! Wall Street money loved his new plan. No wonder.

When stocks rise while the economy is still sinking, don't you wonder why?  

Here's how Geithner's scheme works. The U.S. government provides virtually all the finance to private investors to buy troubled bank assets. If those assets rise in value, those investors are richly rewarded, with returns of 50% or more. If the assets bought by private investors don't rise? Well -- "the government bears nearly all the risk", notes Wolf. 

Nobel economics laureate Paul Krugman calls this "cash for trash". Heads, the private investors win. Tails, the taxpayer loses. This is not just dumb money. It is infuriating money. The American taxpayer is richly rewarding some of the same people who caused the current global disaster.

Fortunately, Geithner's scheme won't get to first base. As the Wall Street Journal notes, banks will not sell troubled assets at bargain-basement prices, because to do so would require them to recognize huge losses. And if they have already recognized those losses, they will hang on to the written-off assets hoping they will rise in value. Either way, the banks won't sell to the private investors. But the very proposal is an insult to hard-working citizens. It is dumb money.
   
Smart money.

At recent conferences, I spoke with some of Israel's leading venture capitalist (VC) investors, including Eyal Kaplan (Walden), Nehama Sneh (Cyrus Partners), Jacob Ner-David (Jerusalem Capital), Avi Broder (BDB) and Hillel Milo (AquAgro Fund). We all agreed on one key issue. Israel's 650 existing startup companies (nearly all of which are losing money) are in real danger. So are the hundreds of startups not yet born. 

The reason? Venture capital is like a pipeline. In one end goes money from investors, including pension funds. Out the other end goes money to fund high-tech startups. Less money is now going in to the pipeline, in the wake of the global meltdown, so far less will come out. And the little that does come out will largely go toward keeping alive a handful of the existing startup companies, so that the VC funds will not have to write them off as losses. The experts all agree that this is a serious mistake on the part of the VC funds, because it is short-sighted and will impair both their own future and that of Israel. 

There is a solution, mentioned by Stanley Fischer and others. In 1993 the Israeli government created 10 venture capital funds, each with $20-$25 m., with 40% government funding and 60%, foreign. This encouraged venture investments in Israel by reducing the risk. The funds were called Yozma (Hebrew for 'initiative'). Ultimately this 'yozma' helped create and expand Israel's VC industry. Yozma was eventually privatized − sold to private interests.  

Fischer, the VC experts I spoke with, and others agree that it is vital at this time for the Israeli government to create a new version of Yozma. Many high-tech engineers are losing their jobs. Why not let them use their brains to build new companies, rather than sit at home frustrated and idle? This will create employment and exports. But they need funding. Private VC funds have dried up. There is a major role here for government, as in 1993. This is definitely smart money. 

Welfare Minister Isaac Herzog said recently that in March alone, over 20,000 Israelis lost their jobs. The size of the job losses is a major crisis. It was caused globally by dumb, greedy money. Justice will be done if smart money helps solve the problem.