Lebanon Hyperinflates

Just how has Lebanon found itself in such an inglorious position? For years, the Lebanese government, the central bank (Banque du Liban), and savers played a game.

July 23, 2020 • Commentary
This article appeared on National Review (Online) on July 23, 2020.

Yesterday will go down as a dark day in Lebanon’s history. That is when Lebanon was entered into the Hanke‐​Krus World Hyperinflation Table. When I measured Lebanon’s inflation rate yesterday, it was a sizzling 52.6 percent per month. That was the 30th consecutive day in which Lebanon’s monthly inflation rate exceeded 50 percent. So, on July 22, 2020, Lebanon entered the record books with the dubious distinction of recording the world’s 62nd episode of hyperinflation — the only episode to ever occur in the Middle East and North African (MENA) region. Now there are two ongoing hyperinflations: Lebanon’s, where the annual inflation rate is 462 percent, and Venezuela’s, where the annual rate soars at 2,219 percent.

Just how has Lebanon found itself in such an inglorious position? For years, the Lebanese government, the central bank (Banque du Liban), and savers played a game. The government spent more than it collected in taxes and financed its resulting deficits by paying sky‐​high interest rates on the debt it issued. The central bank bought some of the debt and kept the official pound-U.S. dollar exchange rate pegged at 1,500. The peg was designed so that those who purchased the government’s debt would have confidence that it would retain its purchasing power in U.S. dollar terms when it matured. Banks offered relatively “high” interest rates to depositors and were also part of the game. For a surprisingly long period of time, the money poured in from domestic savers, the Lebanese diaspora, and other foreign investors. They were all chasing yield and blind to the nature of the game.

Eventually, though, it became apparent that the government’s mountain of debt had become so large that the dollar‐​denominated portion could not be repaid in full. It also became clear that the government could not even repay the Lebanese pound‐​denominated portion in full unless the pound was officially devalued. At that point, the government faced an investors’ strike and was forced to default on a maturing foreign bond on March 9. The default triggered a sharp depreciation of the pound in the black market and a surge in inflation.

The game was over. Confidence in the pound’s peg vanished. All those yield chasers were running for the exits, and as they did, the pound collapsed in the black market.

Indeed, since January, the pound has shed 82 percent of its value against the greenback in the black market. As for the official exchange rate, the Lebanese can forget it. Their savings are frozen in Lebanon’s banks. The banks have no dollars to exchange and have imposed capital controls (read: strict withdrawal limits) to avoid collapse. Not a pretty picture.

What can be done to end Lebanon’s currency crisis? Lebanon should do exactly what I did in 1997 in Bulgaria, where I was president Petar Stoyanov’s chief adviser. A hyperinflation was raging at 242 percent per month. I designed a currency board system, which the Bulgarian government proposed to the International Monetary Fund. The IMF accepted the proposal immediately and a currency board was installed on July 1, 1997. Inflation was crushed and stability was established from one day to the next.

A currency board is a monetary institution (or a set of laws that govern a central bank) that issues a domestic currency that is freely convertible at an absolutely fixed exchange rate with a foreign anchor currency. Therefore, under a currency board arrangement, there are no capital controls. The domestic currency, which is issued by a currency board, is backed 100 percent with anchor currency reserves. So, with a currency board, the local currency is simply a clone of its anchor currency.

For over 170 years, currency boards have had a perfect record of establishing and maintaining currency confidence. In total, there have been over 70. Today, the largest and most notable currency board is Hong Kong’s.

Lebanon would be a perfect place to install a currency board. A Lebanese currency board would establish confidence and stability immediately. And while stability might not be everything, everything is nothing without stability.

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