The latest interest rate cut decided on by Governor of the Bank of Israel Stanley Fischer at the beginning of this week has brought the Israeli economy close to an unprecedented position. The central bank's key interest rate fell to 1%, and the prospect of the interest rate being zero, or close to zero, looks real.
It isn't just the low level of the interest rate that should provoke public debate, but also the speed at which the economy has reached its current position. Until September, the interest rate was 4.25%, and the world looked completely different less risky, less crisis-stricken. But then, at the end of September, Lehman Brothers collapsed, confidence crumbled, the bottom fell out, and the world, and Israel along with it, hit an unprecedented crisis. The rapid fall in interest rates is a sign of the alarm that gripped the world's economic leadership, which has reacted to events with massive monetary expansion. Israel is only part of that process.
It's hard to exaggerate the importance of this phenomenon. Every financial decision making process will have to take this new and strange reality into account, and adapt to it quickly. This doesn't just apply to CFO who have to decide what to do with their companies' cash balances, but to everyday decisions by households. How worthwhile is it to save? What should they invest in? Should they take greater risks in order to boost returns? It's a world turned upside down. A generation has grown up that has never known a prolonged global crisis, only a few short episodes. Until a year or eighteen months ago, the financial headlines were about where to find extra returns. The question is how far people in Israel and elsewhere can adapt so quickly to zero returns, how far decision making is well-founded, an dhow far people understand that it could be that this is not an exceptional or passing phenomenon, but an expression of new structural conditions in the global market.
What are those conditions? It should be borne in mind that they are not just a matter of zero or very low interest rates, but of deflation. In the coming months, global inflation will be very low, and there are those who predict falling prices. This applies to Israel too. If the prediction is correct, it means looking again at linked and unlinked securities. The nominal return could be zero, but if the CPI falls by 1.5% in the next year, the real return will be higher than was achieved in 2008 in many cases.
That, then, is the world we will live in from now until a global economic recovery. It’s a world of zero interest rates, falling prices, very high unemployment, financial instability, and growing government intervention in economic activity. A world like that has rules of its own, different from what we have known up to now. In fact, as has been said so many times in the recent past, the world now looks like a film of the 1930s. One can only hope that the scenario will not be too close to the original.
Published by Globes [online], Israel business news - www.globes.co.il - on January 29, 2009
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