Central Banks—What Lebanon Teaches Us

A raging debate is taking place in many countries about central banks, perceived by many as responsible for inflation and other monetary dislocations that are hurting ordinary folks. The United States is one of them, but there are many more. In Argentina, one of the countries with the highest price inflation, an outsider has gained traction in the polls by, among other things, promising to abolish the central bank and adopt the U.S. dollar as the national currency if he wins this year’s elections. 

Lebanon, where I recently spent some time, is another country with out-of-control inflation and a highly unpopular central bank. It is a case study on the pernicious effects central banks can have. 

It’s been four years since a major financial crisis erupted. The dramatic economic and social consequences are far from going away. Adding insult to injury, the authorities, starting with the notorious Riad Salameh, the central bank governor (Banque du Liban), who has been at the helm for thirty years, are still in place (he will probably soon be replaced by another insider). They and a coterie of bankers, business people, and politicians (the borders among the three categories are blurry) have blocked the possibility of restructuring the banking system anytime soon.

The crisis was years in the making. Lebanon’s hundred-year-old banks, once the pride of the nation and justly so, engaged in practices bound to engender a major crisis. They offered grotesquely high-interest rates to the funds expats and investors (many from Gulf countries) sent to Lebanon. The reason they were able to sustain this was the central bank, to whom they, in turn, lent these funds in exchange for even higher interest rates that produced a nice margin. Little credit was left for the real economy.

This took place in the context of a monetary “peg,” a fancy term that simply means the exchange rate between the lira (local currency) and the U.S. dollar was fixed. Two conditions have to be met when a local currency is pegged to the currency of a country with a stronger economy: discipline (not living beyond one’s means) and having enough foreign reserves to sustain the peg, which in this case meant not just having sufficient dollars at the central bank to begin with, but also attracting dollars from abroad permanently.

The first of these conditions was far from being met, with Lebanon’s government accumulating deficit after deficit and, therefore, a huge debt. The second was met for a while, but over time it became clear that an artificially overvalued currency was making Lebanon’s exports uncompetitive abroad. This was partly offset by the money that kept coming in from those who thought the high-interest rates could be sustained. This sort of Ponzi scheme (the ability to pay high interest depended on new money coming in) seemed to work for a while. 

Meanwhile, the central bank kept using the scheme to fund the government’s extravagant finances and massive imports that were not paid with exports (sometimes the banks financed the government directly). On average, the country’s trade deficit in the last thirty years has amounted to 32 percent of the size of the economy.

The house of cards fell in 2019 as depositors began to withdraw their money, and the Banque du Liban’s reserves fell; the system, which had enriched the few and left the many in dire straits, was exposed as a fraud. In the aftermath of the collapse, many of the big players, including the central bank and the coterie of financial, business, and political interests I mentioned before, took billions out of the country just as capital controls were imposed on those with no influence and the great majority of depositors faced draconian limits on foreign currency withdrawals from their accounts.

How much do the losses brought about by the corrupt scheme amount to? In a report produced a year ago, the International Monetary Fund put the figure at US$90 billion and laid out many recommendations, including making the large depositors and shareholders bear the brunt of those losses. Since just six thousand depositors owned US$90 billion, which amounted to 52 percent of total deposits, it makes sense that the big fish should bear the brunt of the losses. The pushback from the big fish has made it impossible to allocate the losses and start restructuring the financial system.

Many people I talked to suspect the central bank and the banking lobby are still in cahoots with each other (the Banque du Liban and the private banks have not been independently audited yet). They fear that the authorities and the banks have decided to pass on the bulk of the losses to the rest of society, meaning that the accounts of the Lebanese people, most of which are denominated in dollars, will eventually be “lirified”—i.e., turned into local currency accounts at a highly devalued rate. This expropriation will, in turn, add to the runaway inflation (which will also help liquify some of the government debt). In practice, this is what has been happening for four years.

The revolutionary spirit that led people to revolt against Lebanon’s system in 2019 seems to have died down since people are too busy surviving or migrating. Or it could be a lull before the storm. But what has not died down are the reasons that pushed them to rebel. They are alive and kicking.