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APR 29, 2014 @ 01:11 PM 41,385 VIEWS

Why Israel's Boom Is Actually A Bubble Destined To Pop

Jesse Colombo, CONTRIBUTOR

I'm an economic analyst who is warning of dangerous post-2009 bubbles FULL BIO
Opinions expressed by Forbes Contributors are their own.

In the past few years, Israels economy has been praised for its stability
and strong performance during and after the Global Financial Crisis.
Israels booming tech industry has earned it the nickname The Startup
Nation and international tech companies from Google to Facebook are
clamoring to acquire the countrys startups. Investors the world over
have been vying to add Israeli investments to their portfolios. Rather than
experiencing a property slump like the U.S. and many countries did,
Israels property prices are soaring and making speculators rich. Sadly,
Israels economic boom is not the miracle that it appears to be, but is
actually another bubble that is similar to those that caused the financial
crisis.

Though it can be argued that Israel is no longer an emerging economy,

Israels economic bubble has been following a similar pattern to the
overall emerging markets bubble that I have been warning about. The
emerging markets bubble began in 2009 after China embarked on an
ambitious credit-driven, infrastructure-based growth plan to boost its
economy during the Global Financial Crisis. Chinas economy
immediately rebounded due to the surge of construction activity, which
drove a global raw materials boom that benefited commodities exporting
countries such as Australia and emerging markets.

English:
Haifa
from
Baha'i
gardens
esky:
Pohl...
Haifa,
Israel
(Photo
credit:
Wikipedia)

Emerging markets improving fortunes attracted the attention of

 international investors who were looking to diversify away from the
heavily-indebted Western economies that were at the heart of the

financial crisis. Eventually, even countries that were not significant
commodities exporters (such as Israel) began to benefit from the growing
interest in this investment theme.

Record low interest rates in the U.S., Europe, and Japan, along with the
U.S. Federal Reserves multi-trillion dollar quantitative easing programs,
caused $4 trillion of speculative hot money to flow into emerging
market investments over the last several years. A global carry trade arose
in which investors borrowed cheaply from the U.S. and Japan, invested
the funds in high-yielding emerging market assets, and earned the
interest rate differential or spread. Soaring demand for emerging market
investments led to a bond bubble and ultra-low borrowing costs, which
resulted in government-driven infrastructure booms, dangerously rapid
credit growth, and property bubbles in countless developing nations
across the globe.

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Capital inflows into Israel immediately increased after the financial crisis
and hit a record high of $7.22 billion in the fourth quarter of 2013:

israel-capital-flows Source: Trading Economics

Strong capital inflows are the reason why Israel has been able to
maintain a current account surplus despite the countrys growing trade
deficit over the past decade.

Foreign hot money inflows into Israel contributed to a 23 percent

increase in the shekel currencys strength against the U.S. dollar since the
financial crisis:

Shekel
 To stem Israels export-harming currency strength and support economic
growth, the countrysbenchmark interest rate, prime rate, and effective


interbank rate were cut to all-time lows:

israel-interest-rate Source: Trading Economics

israel-bank-lending-rate Source: Trading Economics

israel-interbank-rate Source: Trading Economics

The global bond bubble and safe-haven demand helped to push 10 year
Israel government bond yields down to a record low of just 3.34 percent
after the financial crisis:

israel-government-bond-yield Source: Trading Economics

Exports account for approximately 40 percent of Israels GDP, which

means that the countrys economy is adversely affected by appreciation
of the shekel currency. For the past six years, Bank of Israel has been
waging a war against the strong shekel the worlds best performing
major currency in 2013 with a combination of ultra-low interest rates
and aggressive currency interventions.

Since 2008, Bank of Israel has purchased over $50 billion worth of foreign
currencies with newly created or printed shekels in an attempt to
weaken the currency. As a result, Israels M1 money supply, which
includes physical cash and demand deposits (typically checking
accounts), surged by 150 percent even though the countrys real GDP
grew by only 22 percent:

israel-money-supply-m1 Source: Trading Economics

Unsurprisingly, Israels low interest rate, surging money supply

environment of the past half-decade has resulted in inflation and asset
bubbles. The quadrupling of the Israeli Consumer Price Index between
June 2007 and June 2011 led to massive street protests in 2011 and 2012
that drew hundreds of thousands of participants.

Israels inflation protests started in July 2011 when Daphni Leef, a 25-
year-old video editor, pitched a tent on Tel Avivs tony Rothschild
Boulevard after being given a notice to vacate her apartment for
renovations, only to find that the rents of comparable apartments had
doubled since 2006. Leef started a Facebook page that she used to
encourage other Israelis to pitch tents to protest the countrys inflation
epidemic.
 English: Daphni Leef protest against housing c...
Daphni Leef protests against housing costs in Israel (Photo credit: Wikipedia)

Israels inflation protests fixated particularly on the rising cost of food,
energy, and housing, which is partly due to the housing bubble that will
be discussed in greater detail in this report. While Israels inflationary
pressure abated somewhat after Bank of Israel hiked interest rates from
late-2009 to late-2011, inflation may rear its ugly head again now that
interest rates have been reduced to record lows for the second time since
the global financial crisis. Israels M1 money supply growth stabilized in
2010 and 2011 thanks to rising interest rates and the weakening shekel,
but has grown by nearly a third since the start of 2012 after Bank of Israel
cut rates and intervened as the shekel began to strengthen again.

Israel Has A Property Bubble

Israels record low interest rates and rapid money supply growth after
the financial crisis has created a property bubble in which prices have
soared by 80 percent since 2007 and 67 percent since 2009:

Israel Housing Bubble

Since 2006, Israel has experienced the largest property price increase
among OECD nations. Israels property price increases have far outpaced
the countrys average nominal income gains of 23 percent since 2007 and
12.5 percent since 2009, which has contributed to the publics growing
discontent over the rising cost of living. In the year ended Q3 2013, Haifa,
Gush Dan, and Tel Aviv saw the largest price increases with respective
gains of 25.2 percent, 15.2 percent, and 12.7 percent. Tel Aviv, Sharon,
and Jerusalem are Israels most expensive housing markets with average
prices of owner-occupied dwellings of ILS2,250,900 (US$642,870),
ILS1,535,900 (US$438,662), and ILS1,497,200 (US$427,609) in Q3 2013
respectively.

Several affordability and valuation ratios show that Israels housing

market has become overvalued and far less affordable in the past half-
decade as the bubble inflated. From 1996 to 2008, Israels average
apartment price-to-average monthly salary ratio remained stable at 100,
but has surged to 130 in recent years. A recent IMF study showed that
Israels home prices are now 25 percent above their equilibrium value as
measured by price-to-income and price-to-rent ratios that are 26 percent
and 22 percent above their long-term levels. Israels low average gross
rental yield of 3.45 percent is also indicative of an overvalued property
market.
 Israels price-to-rent ratio understates the true extent of the countrys
housing bubble because rents themselves have been experiencing what

can be considered a type of bubble. Since 2008, the average rent in Israel
has risen by 49 percent, with larger increases of 61 percent and 53
percent in Tel Aviv and Sharon. The average rent rose from 30 percent of
the average salary in 2007 to 38 percent in 2013, with rent consuming an
alarming 56 percent of the average salary in Tel Aviv.

Israels Ministry of Construction and Housing (MOCH) claims that the

countrys soaring rents are primarily driven by demand for investment
properties, which has increased as a result of the ultra-low interest rate
environment. A 2013 Bank of Israel study showed that thepercentage of
households that own at least one home for investment purposes
increased by nearly 150 percent from 2003 to 2013. In Tel Aviv, which is
Israels most inflated housing market, investors account for 29 percent of
all home purchases. While foreign investors are often blamed for Israels
soaring property prices, they account for a small and declining
proportion of the countrys overall property sales. Foreign purchases of
Israeli homes dropped from 6 percent of all home purchases in 2005-06 to
3 percent in 2009 and 4.1 percent in 2011.

Israels property market has inflated on the back of a mortgage bubble

that has grown as a result of mortgage interest rates that have
dramatically decreased in the past decade:

MortgageRates

According to Bank of Israel, total outstanding household mortgage debt

increased 78 percent from NIS136 billion at the end of 2007 to NIS242
billion at the end of 2012. Israels banks are exposed to the countrys
housing bubble because mortgages and loans to real estate businesses
account for approximately 40 percent of their assets. Even more
worrisome is the fact that approximately 90 percent of new mortgages
originated during the peak of the bubble have adjustable interest rates,
which is evidence that Israel is making one of the key mistakes that the
U.S. made during last decades housing bubble. When Israels artificially
low interest rates eventually rise again, monthly payments on adjustable
rate mortgages will rise and put homeowners and banks in jeopardy.

Israels entire economy is exposed to the housing and mortgage bubble

because banking is one of the countrys key industries. Banking and real
estate companies account for a combined one-third of the benchmark Tel
Aviv-25 stock indexs capitalization:
 BankSector Source: Tel-Aviv Stock Exchange

Israels growing economic bubble has helped the banking and real estate-
heavy Tel Aviv-25 stock index to triple in the past decade:

israel-stock-market Source: Trading Economics

Like many nations outside of the hard-hit U.S. and Europe, Israels
inflating housing bubble helped to boost the countrys consumer
spending in the wake of the global financial crisis. Unfortunately, this
wealth effect is not sustainable and will actually reverse when Israels
housing bubble pops.

Why Israel Has a Tech Bubble

Housing is not the only sector in Israel that is experiencing a bubble; the
countrys tech sector has been riding the wave of what I call Tech Bubble
2.0, which is primarily centered around companies and startups that are
involved with social media, apps, and,to a lesser extent, cloud computing.
While many of the technological trends of the past few years are genuine
in their own right, I believe that the bubble lies in the frenzied startup
and acquisition activity as well as the valuations of companies that
operate in the aforementioned arenas.

The overvalued U.S. stock market is acting as a benchmark that is helping

to set the tone for the valuations of tech companies and startups.
Profitable publicly-traded social media companies such as Facebook and
LinkedIn are currently carrying very high valuations, while many others
such as Twitter, Pandora, and Yelp have multi-billion dollar market
capitalizations without any earnings whatsoever. Recent acquisitions in
the technology startup space have also occurred at jaw-dropping
valuations such as Facebooks $19 billion acquisition of mobile messaging
company WhatsApp and $2 billion acquisition of virtual reality company
Oculus.

English: Part of Azorim High-Tech park in Kiry...

Azorim High-Tech park in Petah-Tikva, Israel. (Photo credit: Wikipedia)

While Californias Silicon Valley is the epicenter of Tech Bubble 2.0, the
bubble has recently spread to other tech centers around the world,
including Israel. As the worlds second-most important startup center
after Silicon Valley, Israel has been given the nickname The Startup
Nation and its tech corridor is nicknamed Silicon Wadi, which means
Silicon Valley in Arabic and colloquial Hebrew. There are currently
 over 4,800 startups in Israel, including 15 to 20 companies that are likely
to launch IPOs in 2014 in New York, London, or Tel Aviv. Israel had 13

companies IPO in the U.S. in 2013, after only 1 U.S. IPO in 2012. Israels
increasingly frothy startup scene led to a 52 percent surge in demand for
web developers last year.

Foreign companies including Facebook, Google, Apple, Intel, IBM, and

Cisco, which have been emboldened by their soaring stock prices, have
acquired nearly $14 billion worth of Israeli tech companies and startups
since 2012. Total foreign acquisitions of Israeli companies increased by
over 50 percent in value from $5.5 billion in 2012 to $8.4 billion in 2013.
International tech companies are making the same mistakes in their
acquisitions of startups in Israel that they are making in Silicon Valley,
namely overpaying for speculative startups with little to no earnings and
valuing these startups based on their number of users a throwback to
the practices of the late-1990s Dot-com bubble.

In June 2013, Google acquired Israeli GPS app company Waze for $1.3
billion, even though it generated only a nominal amount of revenue from
advertising and data licensing. Two months later, IBM acquired financial
fraud-prevention software company Trusteer for an estimated $1 billion
despite its comparatively anemic $40 million revenues in 2012. In
November 2013, website building company Wix went public on the U.S.
Nasdaq stock exchange with a lofty $750 million market capitalization
against $55.5 million in revenue and $17.8 million in losses in the first
nine months of 2013.

In February 2014, Japanese online retailer Rakuten Inc. acquired Israeli

internet messaging and calling service Viber for $900 million, even
though the company posted just $1.52 million in revenue and a net loss of
$29.51 million in 2013. Total Israeli tech VC exits via IPOs or M&A deals
hit a ten year high in 2013, with the average deal value of $146 million
more than doubling the $67 million average deal value of the past decade.
Foreign acquisitions of Israeli tech companies have contributed to the
shekels appreciation in the past couple of years.

The popping of the Israeli tech bubble is likely to coincide with the
popping of the tech and stock market bubbles in the United States. Israel
has experienced a tech wreck once before when the collapse of the late-
1990s Dot-com bubble (combined with the 2001 Israeli/Palestinian
Conflict) helped to push the countrys tech-heavy economy into the worst
recession since 1953

Why Israels Offshore Gas Boom May Be Overhyped

 The discoveries of the Tamar and Leviathan natural gas fields in the
Mediterranean Sea off the coast of Israel has become a source of

optimism in recent years as it promises to reduce the countrys energy

costs and allow it to eventually become a net energy exporter. While
Israel is undoubtedly fortunate to have discovered this natural bounty,
there is reason to believe that its potential economic impact is being
overstated by the media, the government, and the business community.

According to a recent Ernst and Young study, the Tamar and Leviathan
gas fields are worth $52 billion in total capitalization value to Israels
economy over the next 28 years, with domestic energy cost savings
accounting for $42 billion of this figure and royalties and taxes on gas
suppliers profits accounting for $10 billion. When spread across 28 years,
offshore natural gas resources are expected to provide $1.86 billion in
annual value to Israels economy. A $1.86 billion annual windfall is
certainly nothing to sneer at, but what is overlooked is the fact that its
expected contribution to Israels $242.9 billion GDP is a drop in the
bucket of .76 percent hardly the economic game-changer that it is
being hyped up to be.

In addition, the estimated value of Israels offshore natural gas may be

overly optimistic because it assumes that the country will be able to
export its excess gas to neighboring countries including Turkey, Jordan,
and Egypt within the next several years. Unfortunately, volatile relations
between Israel and its potential gas export partners are likely to hamper
the cooperation that is required for Israels goal of being a net energy
exporter to become a reality.

The difficulties of finding reliable export partners for the regions natural
gas are the reason why a recent piece in The Economist magazine claimed
that Israel and other Eastern Mediterranean countries may be fooling
their people with false promises of an offshore gas bonanza. The
Economist piece also quotes energy analysts who state that Israel is
unlikely to start exporting large amounts by 2020, as it hopes.

On Stanley Fischer: Dont Mistake a Bubble For Talent

No proper analysis of Israels economic bubble should neglect discussing

the role played by Stanley Fischer, the governor of the Bank of Israel
from 2005 to 2013. Fischer, a New Keynesian economist, has been widely
lauded by the international economics community for his management of
Israels economy during and after the Global Financial Crisis. In 2009,
2010, 2011 and 2012, Fischer received an A rating on Global Finance
magazines Central Banker Report Card, and in 2010, Bank of Israel was
 ranked the worlds most efficiently functioning central bank. So highly
respected is Stanley Fischer that U.S. President Barack Obama nominated


him to be Vice-Chairman of the Federal Reserve in January 2014.

I do not share the same reverence for Stanley Fischer that the
mainstream economics community does, however. Rather than credit
Fischer for Israels strong economic performance through the financial
crisis, I view hisKeynesian-inspired policies as responsible for creating
the countrys artificial bubble-driven boom that is, ironically, very similar
to those that caused the global crisis in the first place. Like Alan
Greenspans 2005 departure from the Fed at the peak of the housing
bubble that he created, Stanley Fischer left Bank of Israel in 2013 as a
herobut only because his bubble has not yet popped. When evaluating
central bankers, never mistake a bubble economy for talent.

How Israels Economic Bubble Will Pop

As with most of the post-2009 bubbles that I am warning about, rising

interest rates across the yield curve are the most likely catalyst that will
pop Israels economic bubble. Ultra-low interest rates are the primary
driver of Israels bubble, so the eventual ending of this condition will
cause it to pop. Global and local interest rates are expected to rise in the
coming years as the global economy recovers (which I believe is a false
recovery or Bubblecovery), causing central banks to reduce their
monetary stimulus policies that have been the source of the bubble-
inflating hot money capital flows. For example, the U.S. Federal Reserve
is expected to fully taper or end its QE3 program in 2014 and there are
growing expectations of a Fed Funds rate hike as early as next year.

The popping of the U.S. stock and tech bubbles are another strong risk
factor for Israel in the coming years, though this is likely to coincide with
the popping of the overall post-2009 global bubble.

Here is what to expect when Israels economic bubble truly pops:

The property bubble will pop, causing prices to fall

Banks will experience losses on their mortgage portfolios

The tech bubble will pop in both Israel and the U.S., causing a wave of startup
failures (particularly app and social media startups)

Technology and banking stock prices are likely to fall the hardest, which will
drag the overall stock market lower

Economic growth will go into reverse

 Unemployment will rise


I will be publishing many more reports about dangerous bubbles that are
currently developing around the entire world most of which you
probably never even knew existed. Please follow me
onTwitter,Google+andFacebook to stay informed about the most
important bubble news and my related commentary.

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