“The Lights Go Out in Lebanon as Financial Collapse Accelerates,” declared a recent headline in The Washington Post. The headline refers specifically to worsening power outages but more generally to Lebanon’s ongoing “economic implosion.” This breakdown is due in large part to chaos in Lebanon’s monetary and banking systems. Since October 2019 the Lebanese pound (also called the lira) has lost more than 80 percent of its value on the black market, with USD1 most recently trading around LBP8100. There is a black market because, although the Banque du Liban (the Lebanese central bank) continues to declare an official exchange rate of LBP1507.5 per USD, that rate is now available only to importers of a few favored goods.[1]
The peg became unsustainable, as pegged exchange rates invariably do, when the central bank created more money than was consistent with preserving parity between the purchasing power of its currency and that of the US dollar at the pegged rate. Instead of tightening when necessary to stop an outflow of dollar reserves, the Banque du Liban after 2016 began desperately to borrow from Lebanon’s commercial banks (at high interest rates) the dollars it needed to maintain the semblance of a peg. The commercial banks attracted dollars by passing those high rates on to depositors who presumably hoped to cash out before a devaluation came. The scheme, called “financial engineering” by Riad Salameh, long-time head of the Banque du Liban, devolved into Ponzi finance, racking up an estimated $40 billion in losses.
There are legal exchange houses in Beirut at which the dollar could recently be purchased for LBP3850, but residents may buy only small amounts there, creating a dollar shortage at that rate. Around 75 percent of bank deposits are in US dollars, but commercial banks since October have refused to redeem their dollar deposits in dollars (with remarkable legal impunity), allowing only conversion to LBP at the 3850 rate.
In June, Lebanon’s annualized inflation rate topped 50%. Imported goods’ prices have risen at a much faster rate with the depreciation of the pound.
The monetary chaos is not unrelated to Lebanon’s sovereign debt fiasco. Its ratio of sovereign debt to GDP is the world’s third highest (after Japan and Greece), above 150 percent and climbing with the annual budget deficit running 11.4 percent of GDP in 2019. In March 2020, the government defaulted on its external dollar debt. Behind this fiscal crisis is the tangled history of a state built on clientelism (legislative seats are apportioned among the major religious communities) and fueled by widespread corruption.
Is there a way back to a sane monetary system? Full dollarization offers a reform that has proven practical and effective in Ecuador and elsewhere.
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