What Israel would gain if it linked shekel to dollar
Israel's brand-new government, led by Yitzhak Shamir, is trying to launch a vast economic experiment fraught equally with promise and risk. That is how American experts assess Israel's proposal to make the United States dollar legal tender in the Jewish state and to set wages, prices, and the national budget in terms of dollars rather than shekels.Skip to next paragraph
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Opposition to the plan caused Finance Minister Yoram Aridor to resign from the new government. ''It is clear that after its premature publication, it is no longer feasible to carry out the plan,'' Mr. Aridor said.
This leaves unclear whether Prime Minister Shamir will press forward with the bold effort to turn Israel into a dual-currency state, with the shekel and US dollar both legal tender.
Given an unbridled annual inflation rate of 125 percent, however, and with a huge foreign debt, Israel appears to have no choice but to set an economic course of austerity.
''For many years,'' said a top US monetary official, ''Israel has resorted to the printing press to print more money,'' with the result that Israel's inflation rate has steadily soared.
''Now,'' the official said, ''Israel will deprive itself of the ability to inflate, because they can't print dollars. Israelis will tie their own hands by switching to a dollar system. What they are trying to do is to stop inflation in its tracks, rather than gradually.''
But another American official asked, ''How do you link an economy with 125 percent inflation to an economy with 5 percent inflation? Normally, if you are linking two currencies, you have to have something like the same economic conditions in both.''
The social, economic, and political costs of carrying out the new Israeli economic plan - of which the proposed switch to dollars is only a part - may be extremely high, posing a potential threat to the Shamir regime.
Already the new government has devalued the shekel by 23 percent and sharply boosted retail prices for basic commodities, including bread, dairy products, frozen meat, and gasoline.
Devaluation of the shekel will put the cost of imported products out of reach of many Israelis, at the same time that they are having to pay more for food and fuel.
The new government needs urgently to convince Israelis that their fragile shekel would be tied in a stable way to the value of the dollar.
A number of nations - notably Panama, Liberia, Mexico, and some other Latin American and Caribbean countries - already base their economies on the US dollar , either wholly or in part.
''The exchange rate between the dollar and the shekel fluctuates,'' said a top US official. ''One element in that fluctuation is different inflation rates.''
In a world of floating exchange rates, investors assign higher value to the currency of a nation with 5 percent inflation than to the money of a country with 125 percent inflation.
Years ago, American economist Milton Friedman told the Israelis in effect: ''If you can't stop printing money, you will have to switch to a currency which you can't print.''
That is what the new government of the Jewish state, with the highest per capita foreign debt in the world and with uncontrolled inflation, is trying to do.
Will the Israeli move make it harder for the Federal Reserve to control the US money supply?
If a demand for dollars by Israel were enough to expand the US money supply beyond Federal Reserve targets, the Fed would have to tighten credit, putting upward pressure on interest rates and perhaps slowing US economic recovery.
''There will have to be a financial flow (of dollars) from the US to Israel, '' a senior US official said. ''But Israel is such a small country that it should not make it harder for the Fed to control the money supply.''
Another top monetary official was less certain. ''During the Falklands war (between Britain and Argentina),'' the official said, ''there was in one week an supply in the US.
''When we tracked it down, we found that Argentine citizens were withdrawing large amounts of dollars from their Argentine banks. These banks in turn were drawing down their accounts in the US.''
Israel, in any event, seems bound to become more dependent on a continuing stream of dollars from the United States - privately from American Jewry and publicly from the US government - than ever before.
''Israel is almost certain to run short of a sufficient volume of dollars,'' said another US expert. ''If the shekel were firmly tied to the dollar, there would be no particular reason to convert shekels into dollars - if you were confident that the shekel's value would be maintained.''
An Israeli citizen, in other words, could buy, sell, and save in shekels, if he were convinced that the shekel's value would not suddenly plunge in value. If he had doubts, he would want to convert his shekels into dollars.
Such a reaction, if widespread, would strain Israel's ability to obtain enough dollars to keep the shekel-dollar relationship stable.
A Federal Reserve official said that Israel has the advantage of a large flow of dollars into the country through the sale of Israel bonds in the United States and through official US grants and loans.
The total package means that most Israelis will find - abruptly - that their wages and salaries buy a good deal less in goods and services.