A Currency Manipulator Country  That's Bigger Than China

BoI Governor Stanley Fischer

The buzz about currency wars and currency manipulation is back. In the last presidential debate, Mitt Romney called China "a currency manipulator for years and years," and said that he would label the country a currency manipulator on his first day in office.
Tonight's debate is expected to focus even more on the China talking point.

However, there is one country you won't hear either candidate criticize tonight, even though it's been intervening to prevent its currency from strengthening against the dollar as well: Israel.
And when you look at Israel's foreign exchange holdings as a percentage of GDP, you see that at 61 percent, Israel's ratio is significantly higher than that of China, which stands around 45 percent.

The chart below shows the Bank of Israel's foreign currency reserves, which have ballooned since early 2008 when the central bank began buying up dollars and selling shekels.

By selling shekels against the dollar, the BoI hopes to keep its currency from strengthening, making exports more competitive vis-a-vis dollar-based exporters like those in the United States.

OECD economist Charlotte Moeser gave a brief history of the Bank of Israel's recent interventions in a 2010 paper and explained a bit of the rationale behind them:

In March 2008, the central bank began intervening in the foreign exchange market – for the first time since 1997 – stating that its goal was to increase international reserves up to 100% of short-term debt, as prescribed by the “Greenspan-Guidotti Rule." At the time, foreign reserves (USD 29.4 billion) stood at 81% of external short-term debt.

There was an initial unannounced intervention, which was followed by announcement of a schedule of foreign-currency purchases. At first, the bank purchased the equivalent of USD 25 million per day with a view to raising reserves to a value of USD 35-40 billion. In July 2008 the daily purchase was increased to USD 100 million, and in November the reserve target was raised to USD 40-44 billion.

Moeser wrote that as a result of the BoI's interventionism, markets assumed the central bank was secretly, but loosely, targeting a certain exchange rate:

By March 2009, foreign exchange reserves had increased to USD 40.6 billion, nearly 100% of external short-term debt; and, relative to GDP, reserves had reached a very high level compared with other small open economies and with historical Israeli values. Nevertheless, the Bank announced that it would continue the intervention, and its press releases increasingly referred to concerns about the level of the exchange rate, rather than reserve levels.

Regular intervention was finally stopped in August 2009, but a week prior to this the Bank announced a new policy of discretionary intervention. The Bank does reveal how much it purchases in monthly data on foreign-exchange reserves, and these confirm that intervention has continued. Markets now consider the Bank to have a “dirty float” policy on the exchange rate and speculate as to what its intervention price is. For instance, some observers believe this to be around 3.8 shekels to the US dollar.

The chart below shows the U.S. dollar against the Israeli shekel over the past few years:

Near the end of April 2011, Bank of Israel Governor Stanley Fischer gave an interview with the Wall Street Journal, right when the Shekel had appreciated against the dollar to levels not seen since mid-2008.

At the time, Fischer said the stronger shekel was not a problem, but he also hinted at more intervention. Via WSJ's Anjali Cordeiro:

Fischer said that if the shekel starts to move in directions that aren't in keeping with the central bank's estimates of where the market and the economy are, "we will have to intervene."

"We don't know what the level of intervention is going to be. We hope it will be minimal," Fischer said, adding that the bank doesn't publish its views on appropriate levels for the currency.

Since then, the shekel has weakened significantly against the dollar.

The Bank of Israel's website states that the interventions are designed to contribute "to the success of the whole economy, to economic growth, and to increased employment," and that as a result of the policy, "the whole economy reaps the benefit of economic strength, enhanced financial stability, protection against unexpected events, and reduced vulnerability to various crises."
And some of those dollars have ended up in an interesting place. On March 1, the BoI announced that it would actually invest $1.5-2 billion of its reserves in the U.S. stock market.

The BoI has faced some internal criticism recently over its interventionism. The State Comptroller's Office released a particularly negative report last week calling the operations into question.  

Via the Israeli business daily Globes:

Management of the bank's reserves is conducted in comparison with a benchmark portfolio, known as the numeraire, a hypothetical currency made up of the currencies of Israel's trading partners. The report criticizes the lack of transparency in setting the makeup of the numeraire, and also mentions that the audit failed to find tools with which the division could measure the overall risk of the reserves portfolio in extreme conditions.

It was also found that the foreign currency committee and the narrow monetary committee, two committee's chaired by Governor of the Bank of Israel that set policy for managing the reserves, have been acting without written procedures regulating their activity and the relationship between them.

Those criticisms were obviously not leveled at the Bank's attempts to weaken the shekel against the dollar.

Of course, the Israeli economy is so small, nobody thinks it's a serious threat to big US industries, but the point remains that China is far from unique in its efforts to control its currency for export purposes.