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.
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
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
How are national monetary policies set?
put, monetary policy is how a country’s central
bank manages money supply in order to stimulate domestic economic
How did the Lebanese government take into account the Trilemma?
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
Lebanese monetary policy
Ideally, monetary policies
are set to stimulate domestic economic growth
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.
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
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
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
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
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
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
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
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
- 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
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
Agricultural and Industrial Raw materials
Education & Family Aid
Import Tariff Example
Agricultural and Industrial Raw materials
Essential Consumer goods
Non-Essential Consumer goods
Buses & Public Transport
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.
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Effects With Examples. Retrieved from The Balance :
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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 of dollar peg. Retrieved from Euromoney: https://www.euromoney.com/article/b1lj8l1twpn8zh/lebanese-pound-sees-end-of-dollar-peg
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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
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