Part 1: Causes
Even
though economics is not my profession, I’ve had the privilege of having some
economic training in my undergraduate pursuit, and it was highly relevant when
I practiced management consulting and still is highly relevant to me as an entrepreneur
and a business owner. I felt like writing about the current economic situation,
in order to help my friends and family form a better opinion of what’s going
on, especially information relevant to the crisis is disseminated on the news
in a scattered and reductionist manner, which doesn’t allow people to form a
holistic idea of what is going on.
The
past year was bleak in terms of what has went on in Lebanon from popular
uprising, devaluation of the national currency, siphoning of depositor funds, sovereign
debt default, blatant corruption and incompetence, and the cherry on top was
the global Coronavirus pandemic, which has made our already horrible economic
situation worse. Before going into how all that affected the devaluation of the
Lira, it is important to go over a few concepts and definitions.
What
is currency/money? (Webster, 2020)
According to classical economic theory, currency or money is anything that
fulfills the following requirements:
1. Medium
of exchange
2. Store
of value
3. Unit
of account
Does
the lira fulfill all of the above requirements?
The Lira is used in circulation and
can be exchanged for anything in Lebanon, so it is a medium of exchange, it
also used to be a store of value until it started devaluating, as for unit of
account, here is where it gets tricky. The Lira in itself has no intrinsic
value because it wasn’t measured relative to how well the economy was
producing/doing, instead it simply derived its value by pegging/fixing it to
the US dollar, Therefore, in essence, the “real” unit of account was the US
dollar, even before the crisis. So does it fulfill all the requirements of a
currency? Hardly and it’s the fault of those who have set our weak monetary
policy (Furness, 020).
Moreover, the concept of value is
abstract, psychological, and difficult to quantify. How can you really know
what anything is worth what? Whether its economic value or psychological value,
it all breaks down to usefulness/utility (Baumol, 2020). For example, if you
are a cyclist, a bicycle will likely be more valuable to you than a pair of
skies, especially if you don’t ski. Same principle applies to money, if you are
an importer or manufacturer of goods, and can’t use the currency to purchase
what you require, your perceived value of that currency will diminish.
How
are national monetary policies set?
Simply
put, monetary policy is how a country’s central
bank manages money supply in order to stimulate domestic economic
growth (Economic
Times , 2020).
There are two other variables that are linked to monetary policy which are
the free flow of capital and fixed exchange
rates, however they are mutually exclusive to each
other and to monetary policy, resulting in what
economists deemed as a Trilemma or Impossible Trinity. This means
that countries can only choose two at a time. The options are follows: a) free
flow of capital b) fixed exchange rates c) independent monetary policy.
How
did the Lebanese government take into account the Trilemma?
(Majaski, 2020)
Lebanon
imposes minimal restrictions on the flow of capital in and out of the country,
and even after the financial crisis hit, depositor accounts were frozen, but
whomever has paper international currency such as USD, EUR, GBP, etc. can
freely transfer the money abroad with no questions asked (TDS, 2020). As for the exchange
rate it’s officially pegged i.e. fixed at 1507.5 Liras to 1 USD while
maintaining and independent monetary policy where the central bank is issuing
and managing government bonds, lending to the government, managing bank
reserves, managing exchange rates, etc. In other words, the Lebanese
state gave its citizens the illusion that it had resolved the trilemma,
but in reality our exchange rates were not fixed and were backed by foreign
currency reserves that belong to depositors and not the central bank.
Lebanese
monetary policy
Ideally, monetary policies
are set to stimulate domestic economic growth (Economic Times
, 2020).
In other words, they are macro financial tools to aid in building
a stable, productive and self-sufficient domestic economy that is able
to compete and survive in the international economy. Instead of building a
strong domestic economy by using those tools to finance productive sectors such
as agriculture and industry. The government instead gave the illusion of
financial stability by fixing the exchange rate of the Lira, in order
to encourage the remittance of expatriates, in order to finance
government spending plagued by embezzlement and corruption through
central bank lending, where the central bank itself borrowed
money from local banks that used depositor’s funds for lending
and payment of profits made by accrued interest. Therefore, the current
Lebanese monetary policy was designed to siphon depositor funds, making it the
largest and most scandalous heist in history.
So
what devaluated the Lebanese Lira and amplified the financial crisis?
There
are multiple variables that have influenced the devaluation of the Lira, almost
all of them were caused by the government.
1. The
Lebanese Lira was pegged to the US dollars since 1997 and the central bank was
backing up this peg with foreign currency reserves that belong to Lebanese
depositors.
2. The
government has been operating at a deficit for the past 30 years and was
borrowing money to cover that deficit, then it was borrowing money to cover its
maturing loans and interest payments, and eventually defaulted with no plan of
how to move forward.
3. The
main creditor of the government was the central bank which borrowed money from
the banks, which used their depositor’s funds, which the government defaulted
on paying.
4. Lebanon
has a negative balance of trade, meaning we import more than we export, in
other words the dollars that we transfer out of the country are more than what
we get in.
5. The
Lebanese economy is a consumer economy rather than a productive one, that is
due to the government’s focus on tourism and services sectors to bring in
foreign currency rather than relying on productive sectors, such as agriculture
and industry.
6. Aside
from lending to the government, in the past 10 years, the banking sector
investments were focused on a non-productive sector, real-estate.
7. The
government has transformed the Lebanese economy from a regulated economy
reliant on banking transactions into a deregulated and untraceable cash based
economy that facilitates corrupt financial activities, money laundering and
capital flight.
8. Corruption,
embezzlement, and incompetent public administration is probably the main reason
that is behind all of the above.
2: Implications
How did the government deal with the financial
crisis that it caused?
The Lebanese government appears to be colluding with the
banking sector instead of regulating it, which is further amplifying the crisis.
Since the banks lent the government from depositor’s funds and the government
spent it, instead of addressing the situation head on and allocating
responsibilities and losses, they decided to leave the nominal values of the
depositor accounts in foreign currencies intact, but froze them indefinitely
while allowing them to only withdraw at reduced rates of 3,900 LL of the actual
dollar at a certain limit and the rest at 1500 LL to the dollar (TDS, 2020), while the exchange
rates have been rising beyond 8000 LL to the dollar (at the time of writing) in
the cash market. Therefore, if you take the limits on withdrawal at the 3900 LL
rate and the rest at 1507 LL rate, in reality, this results in a haircut above
80% on withdraws from depositor dollar accounts when you withdraw above the set
limit by the bank that permits withdrawals at 3800 LL.
Moreover, the shift from a banking economy into a cash
economy is also forcing depositors to withdraw cash from banks at undesirable
rates, which is accelerating the haircut on their foreign currency deposits (Schneider,
2019),
which in turn is leaving the bank shareholder assets intact and richer since
they are reducing their liability in actual/real currency.
Shifting into a cash economy has more dangerous
implications, which is deregulation of financial transactions. Banking transactions are easily regulated
because they are traceable, whereas cash transactions are much more difficult
to trace. The main beneficiary of a cash economy is anyone that is complicit in
an illegal activity of any kind. The main loser is the government in
lost tax revenue, legitimate businesses which
have decreased access to international currencies and
shrinking markets, the consumer in price inflation in Lebanese Lira, and
employee layoffs and devaluation of salaries. This is an explosive
cycle which is reducing productivity, shrinking the market and raising
unemployment and poverty.
Moreover, a cash economy with the current framework
where outbound international transfers require cash currencies without any
regulatory limitations is facilitating capital fight and money laundering
activities, transforming Lebanon into a money laundering hub, where
anyone that has cash, especially corrupt politically exposed people, can easily
transfer his or her laundered cash abroad. In addition to that, the central
bank is siphoning depositor’s funds from its reserves and injecting it
into domestic cash circulation under the pretext of stabilizing exchange
rates (Yassine, 2020), which
eventually end up sold in the domestic economy at higher black market
rates, shorting the Lebanese Lira and devaluating it, transferred
abroad, funding illicit activities or stashed in people’s safes as long-term
savings, which in turn makes the dollar a scarcer commodity
in the domestic market and devaluates the Lebanese Lira further.
What are the implications of the devaluation of
the Lebanese Lira?
As mentioned earlier, a currency is a medium of
exchange, store of value, and unit of appraisal. In lay terms
currency is the facilitator of economic, social, psychological, biological, and
political transactions. So, since we are having this facilitator drying
out from the market, the following implications are certain to arise.
1. Economic
implications:
This model is reductionist in order to simply explain what is
happening in Lay terms, there are other variables that influence this model,
such are expat remittances, emigration, political spending, conspiring bankers,
just to name a few, can influence this cycle in many ways. However, putting
aside the multiple causes and influences that can and possibly are occurring,
we are currently stuck in an explosive cycle where the lira devaluation
is reducing purchasing power. Most consumer goods, even commodities
like wheat and refined sugar are imported, which means they are imported in
foreign currency, and people will have to pay for it in Lira. When the
lira is devaluating, prices will inflate in local currency and deflate in
foreign currency at the same time, this means that it becomes too
expensive for the Lebanese consumer to buy while at the same time erode
the margins of businesses. So people are buying less of goods that are
becoming less profitable, hence the local market shrinks and business
close down due to both eroding sales and margins. Also, when margins
shrink, inefficient businesses close down, and those that are
attempting to survive will cut their fixed expenses, and a huge
chunk of their fixed expenses are payroll, so unemployment
will rise. As businesses close and businesses are understaffed,
productivity in the economy goes down, there are less business and less
employees in the market, so the chances of bringing in more export revenues
will go down, and that’s without factoring in a global economy
disrupted by Coronavirus. Less exports means less influx of foreign
currency into the domestic market, which means that foreign currencies
become an even more scarce commodity, which would drive their prices up
if left unchecked, and the explosive and vicious cycle goes on and on (Amadeo, 2020).
2. Social
and Political Implication
This crisis has dire consequences on both, people’s psychological
wellbeing and on the fabric of society as a whole. Psychologically, when
people are threatened with their livelihood, it is normal to feel
negative emotions (Jost, 2020), but it
doesn’t mean that its healthy mentally and physically. Negative emotions such
as fear and anger can make people distrustful and unwilling to collaborate with
each other. Anxiety is another dangerous negative emotion that is brewed
by uncertainty stressors, eroding one’s sense of control over one’s
life, which also can result in loss of hope and motivation to move
forward. Not to mention the multitude of
psychological disorders that can arise from negative emotions, and worse is the
high correlation of negative emotions with chronic disease, such
as diabetes, hypertension and heart disease (Rob-Drove, 2020).
A poor society with a high
incidence of negative emotions will surely result in an atmosphere where people
will compete for resources. When people that hate and distrust each
other compete for resources, it is sure bound to result in increased
violence and crime (Jost, 2020). Not to
mention a deranged political class that is willing to do anything to stay in
power, who knows what evil they might concoct?
Part 3: Possible Solutions
Full Disclosure: This is by no means the only or complete
solution for the economic crisis, there are a multitude of variables that need
to be addressed, however this essay is only intended to demonstrate that there
are practical solutions to this financial crisis that can halt the
collapse and pave the way into economic growth.
How can this crisis be dealt with immediately
and efficiently?
Left unchecked, Murphy's law will surely run its course, if it can get worse,
it will. However, there is much that can be done. Let’s look at the situation
from a macro perspective. To do so, we’ll revisit the economic Trilemma that
was explained in part 1. It states that countries can choose from three
options, and every two options are mutually exclusive, so you can only choose
two at a time. The options are: a) free flow of capital b) fixed exchange rates
c) independent monetary policy (Majaski, 2020).
So the options are as follows:
1. People
can transfer their funds in and out on the country freely with fixed exchange
rates but can’t have an independent monetary policy.
2. Have
fixed exchange rates and an independent monetary policy but financial transfers
in and out of the country have to be regulated.
3. Money
can be transferred freely while having an independent monetary policy while
having fluctuating exchange rates.
Like anything in life, there is no such thing
as one size fits all, each option should have its circumstances, because each
variable has its benefits and drawbacks, however, to summarize we’ll go over
the most important pros and cons, which are as follows:
a.
Free-flow of capital
Pro:
attracts foreign investment and facilitates international trade
Con:
less control over monetary policy and easy capital flight
b.
Fixed exchange rates
Pro:
stabilize domestic markets and reduce domestic poverty
Con:
reduce international competitiveness and political accountability
c.
Independent Monetary Policy
Pro:
more control over the domestic economy, less exposure to foreign liabilities
Con:
less control over domestic economy, exposure to foreign liabilities and control
Since Lebanon is suffering from
hyper-devaluation of the Lebanese lira versus hard currencies, especially the
US dollar, which is disintegrating our economic, social, and political fabric;
for the very least in the short run, the indispensable variable is fixed
exchange rate. This leaves us with a question of which is better for
the coming period to be coupled fixed exchange rates, controlled flow of
capital or forfeiting our independent monetary policy to third party
multinational institutions or governments?
To answer this question, we have to look back
at the root cause of the crisis, which is a banking crisis resulting from
the banking sector lending a kleptocratic regime from depositor’s accounts. Then it becomes obvious that you want to limit
capital flight and tackle the causes one at a time until we have a
healthy governance and economy.
The solution starts with capital control
(regulating the flow of capital in and out of the country). There was a lot of talk by governing bodies
in late 2019 and 2020 that capital control was being implemented in order to
protect bank depositors. In reality, depositor’s accounts in foreign
currencies were illegally frozen, and the free flow of capital in and out of
the country was further liberated by allowing cash transfers. What
should happen is the exact opposite, heavily regulate outbound international
transfers, and liberate domestic financial transactions.
Another major reason why outbound
transfers need to be regulated is due to the fact that the banking
sector is insolvable and needs to be addressed by the government and the legal
system. It is essential that whatever is remaining from depositor funds
not to be transferred out by those who caused the crisis. How the banking
sector is addressed is a subject on its own, however it can be summarized in
the following example:
The banking sector behaved like a business that
owed money and had bad debt in the market with managers and owners that were
embezzling from the business. The first thing the legal system does is
remove the executive managers and owners and restrict their movement in
territories under its jurisdiction, it then installs legal guardians to manage
and audit the company to determine what had happened, quantify the losses, what
does the company owe, who owes the company, and if there was any illegal
activity going on. The legal system then decides what to do, usually some of
the legal financial options are (Wex, 2020):
-
Company owners personally paying company debt
-
Company’s accounts receivable is distributed
among creditors
-
Company is liquidated or auctioned off and
proceeds go to its creditors
-
Creditors become its new owners
The above example demonstrates what could and
should be done to the banking sector because a healthy banking sector is
essential for a quick and healthy recovery.
As for choosing an independent monetary
policy versus forfeiting it to international third parties has
political and economic causes. Having an independent monetary policy gives the
local government more control over the tools that it can use to stimulate
growth while minimizing liabilities, and minimizing liabilities is essential
since what has led the country to where it is now having to do with over
exposure to liabilities and international markets (FT, 2020).
Moreover, an independent monetary policy
facilitates implementing the following temporary measures:
1.
Address the insolvency of the banking sector,
distribute losses equitably and restructure the sector (bail-in, haircut,
liquidation) in a manner that makes it liquid again.
2.
Restructure failed institutions like EDL,
sewage treatment, railway management, etc.
3.
Transform the economy from a cash based
economy into a banking / digital economy.
4.
Abolishing the “fresh money” requirement for
international transfers, all cash currency in circulation in Lebanon will be
valued by a fixed exchange rate set by the government.
3. Regulate
and tax outbound cash transfers.
4. Facilitate
inbound cash transfers via any money transfer business in any currency.
5. Reduce
the amount of physical cash in circulation.
7. Any
funds that are transferred abroad should be traceable and taxable.
The idea is that if you can’t
transfer cash dollars or any currency abroad freely, it
will diminish its function as an international medium of exchange and lose its
inflated value. Moreover, money in the banking sector is traceable,
which makes illicit activities easier to stop and gives legitimate
businesses a chance to access funding for essential import. As for
inbound transfers, they should be facilitated by the government by reducing
fees and lowering taxes on financial activities that encourage remittances. As
for outbound transfers, they should be heavily regulated and
categorized.
There should be one exchange rate, but an
incremental direct taxation policy that depends on what the government wants to
prioritize or decrease its import/consumption. The government can tax outbound transfers or
it can levy incremental taxes on imports. The below charts can serve as
an example:
|
Outbound Transfer Tax Example
|
|
Basic foods
|
0%
|
|
Energy
requirements
|
5%
|
|
Agricultural
and Industrial Raw materials
|
0%
|
|
Consumer
goods
|
50%
|
|
Education
& Family Aid
|
20%
|
|
Foreign
workers
|
50%
|
|
Luxury Goods
|
300%
|
|
Import Tariff Example
|
|
Basic foods
|
0%
|
|
Energy
requirements
|
5%
|
|
Agricultural
and Industrial Raw materials
|
0%
|
|
Essential
Consumer goods
|
25%
|
|
Non-Essential
Consumer goods
|
100%
|
|
Private
Cars
|
100%
|
|
Buses &
Public Transport
|
10%
|
|
Luxury Goods
|
300%
|
Implementing such measures on a macro scale
will stabilize the Lira because it will transform the economy from a
consumerist into a productive economy, where the value of the lira is
derived from its utility and the productivity of the country relative to the
international market. Moreover, such measures restrict speculative devaluation
because it will fulfill the three requirements of currency.
To summarize and reiterate, the monetary policy
set by the government should halt the devaluation and boost the domestic
economy by managing the flow of capital in and out of the country.
Restructure the banking sector in order to shift the economy from a cash
based economy into a banking / digital economy that is traceable and
manageable by the government. Also, investments should be directed into
productive sectors that can cater to the needs of the domestic market while exporting
goods and services, which results in a sustainable and positive balance of
trade.
Even though this is one direction
that can be taken to salvage the economy and put it on a growth path, I don’t
believe that anything can be achieved if serious political reforms happen,
especially since the people that caused the crisis in the first place are still
running the show.
References
Amadeo, K. (2020). Hyperinflation: Its Causes and
Effects With Examples. Retrieved from The Balance :
https://www.thebalance.com/what-is-hyperinflation-definition-causes-and-examples-3306097
Baumol, W. (2020). Utility & Value . Retrieved
from Britannica: https://www.britannica.com/topic/utility-economics
Economic Times . (2020). Monetary Policy .
Retrieved from The Economic Times :
https://economictimes.indiatimes.com/definition/Monetary-Policy
FT. (2020, May 4). Bankrupt Lebanon’s turn to IMF
is overdue. Retrieved from Financial Times :
https://www.ft.com/content/ae2484c4-8bc1-11ea-a01c-a28a3e3fbd33
Furness, V. (020, May 7). Lebanese pound sees end
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https://www.euromoney.com/article/b1lj8l1twpn8zh/lebanese-pound-sees-end-of-dollar-peg
Jost, J. (2020). Frustration Aggression
Hypothesis. Retrieved from Britannica:
https://www.britannica.com/science/frustration-aggression-hypothesis
Majaski, C. (2020). Trilemma . Retrieved from
Investopedia : https://www.investopedia.com/terms/t/trilemma.asp
Rob-Drove, K. (2020). How negative emotions
affect health. Retrieved from FHE Health:
https://fherehab.com/learning/negative-emotions-health
Schneider, F. (2019, August ). Restricting or
Abolishing Cash: An Effective Instrument for Eliminating the Shadow Economy,
Corruption and Terrorism? Retrieved from The European Money and Financial
Forum :
https://www.suerf.org/policynotes/6951/restricting-or-abolishing-cash-an-effective-instrument-for-eliminating-the-shadow-economy-corruption-and-terrorism
TDS. (2020, April 24). Bank Audi offers clients
option to double fresh dollars if converted to local account. Retrieved
from he Daily Star:
https://www.dailystar.com.lb/Business/Local/2020/Apr-24/504877-bank-audi-offers-clients-option-to-double-fresh-dollars-if-converted-to-local-account.ashx
Webster, M. (2020). Money . Retrieved from
Meriam Webster : https://www.merriam-webster.com/dictionary/money
Wex. (2020). Insolvency . Retrieved from
Legal Information Institute: https://www.law.cornell.edu/wex/insolvency
Yassine, H. (2020, June 17). Central Bank
Injecting 5 Million Dollars a Day . Retrieved from The 961:
https://www.the961.com/central-bank-injecting-5-million-dollars-a-day/
