Comprehending the Currency Crisis

by Dr. Said Elfakhani, AUB professor of finance, accounting, and managerial economics, has tracked the fall of the LBP since it unhinged from the pegged dollar rate in October 2019. He spoke to us about the mysterious plateaus and lurches downward that have confounded and impoverished so many.
Fall 2021

What is the true value of the LBP? And what keeps driving the price down?

First, no model can accurately determine the intrinsic value of the LBP, or any currency. Hence, the true value or price floor is not currently known, but it is certainly not 1,500 to the USD. There is no factual data that can justify a particular value, generally, and even less so for Lebanon. Currencies are usually valued in proportion to one another, like the LBP to the dollar. Supply and demand determine price and is dictated by many factors, like the ratio of one country’s inflation rate and average per capita income to another, government fiscal and monetary policy, balance of payment and trade, public confidence in the future, respective interest rates, and the respective reliability of banking systems.

The Lebanese Central Bank had been trying to defend the 1,500 rate by balancing the amount of dollars entering Lebanon against those leaving the country (incoming dollars represent demand for LPB, whereas outgoing dollars represent the contrary). In 2019, Lebanon imported $20 billion worth of goods and services, but exported $3 billion. This trade balance deficit would, by itself, kill the value of any currency. But remittances and money attracted by high interest rates made up the shortfall. Eventually, those cash inflows dried up and exposed the economy’s hollow foundation. We don’t produce enough locally to satisfy local demand, so we need to keep importing, but we can’t import as much as before because of the devaluation; that’s lowered living standards.

Lebanon doesn’t have enough land to support much agriculture. Mostly we rely on services and tourism for generating much of our national income. More political instability means less tourism. We used to receive a lot of Gulf Arab tourists. That’s all dried up. Foreign aid too is very limited because of political issues. So where will the cash come from? If I’m an importer and I want wheat sold on the international market in dollars, I and all the other wheat importers will be on the hunt for dollars. We’ll crowd around the exchange office. The money changer, who has a limited amount of dollars, will auction what he has. The importers, and anyone else chasing dollars to buy paint, oil, or food from abroad, will bid up the price. The money changer will sell his or her dollars to the highest bidder, thus the new lower price of the Lebanese pound.

How can you explain the volatility? Why the plateaus, the sudden downward lurches, the rebounds?

There are all kinds of signals that those importers and others standing in lines at the money changer are paying attention to. When rumors circulate that there aren’t enough dollars, the price of dollars goes up. When the media announces that there’s still no government—and by extension no rescue plan—the price goes up. But when Hariri visited Aoun, the price fell from 15,000 to 10,500 in an hour on the assumption that government formation is imminent. What’s the correct USD price? It could be LBP10,000. It could be 100,000. When the government defaulted on its foreign debt, now more than a year ago, the pound crashed. No one wanted to bring any more dollars into Lebanon. Now foreign exporters want advance payment from Lebanese importers for all goods and services, from basic necessities to luxury items. Meanwhile, importers have a hard time paying at all because of the financial controls in place. They need to have a foreign bank account or to smuggle the money out in bags. On the other hand, they will have to demand dollars for their local sales. Hence, more downward pressure on the Lebanese pound.

And who should bear the losses? It must be the banks and the government, not the Lebanese depositors. The banks lent to the government, which defaulted on the banks, who then defaulted on depositors. The government is a bad debtor. It has run a budget deficit for the past 30 years. And it’s been printing money to pay its debt, meaning, again, downward pressure on the pound.

How are people adapting to the crisis? How do they circumvent the financial controls and protect themselves against the exchange rate?

People are converting their LBP only if absolutely necessary, so they can avoid the punishing exchange rates. Sellers only accept LBP at whatever the daily market rate is, while some don’t accept LBP at all, just to avoid disputes, given the fluctuations. Some have invested in real estate with their frozen funds, paying via check. Owners were accepting those checks to pay down outstanding bank debt, but that’s all but dried up now.

On the other hand, believe it or not, there is a big emerging market for digital money, that is USD deposited in banks. People are trading bank checks. I give you a $100,000 check, you give me around $20,000 in fresh USD banknotes, or even less than that. It’s essentially exchanging “lollars,” the USD banks claim to hold, for actual, physical, unrestricted USD. Finally, people are turning to buy gold and probably smuggling their holdings outside the country. There are no figures given as to the volume of this.

I’ve heard that the urban areas are suffering more than rural ones. Is that true? If so, could you elaborate?

It’s true. While rural areas have always been neglected, they are more self-sufficient in terms of agriculture products, which have become expensive. So overall, people in rural areas have fared relatively well compared to those in urban areas.

What’s the solution? What can be done to halt the crash right now?

Money or capital is cowardly, as they say. Faith must be restored in the Lebanese economy to attract cash. But international agencies such as the International Monetary Fund will not jump in without a clear reform plan. In the long term, the economy must be restructured away from services toward something more balanced. In my opinion, our salvation lies in completing land and sea border negotiations with Israel-Palestine and Syria, and producing oil and gas. I am confident that many international investors would be willing to advance Lebanon sizable hard currencies in seven-or eight-year loans, which is the time it would take to produce and sell oil and gas. Other steps include developing an independent judiciary and finding a solution for Syrian refugee, and eventually Palestinian refugee, issues. This is the way to recovery. Otherwise, the local productive economy remains weak. It is easy to destroy, but it is much harder to rebuild.