When Currencies Fail: A Primer on the Dollar Crisis in Lebanon

A massive shortage of dollars is instigating economic chaos, including a more than 50% loss of value in the Lebanese pound and what looks like an enormous local premium for bitcoins. Presented in podcast and full-transcript formats.

The Lebanese pound has lost at least 50% of its value against the dollar since last year. About 220,000 people have lost their jobs. Food prices are up 58%. An estimated 75% of the population needs assistance of some kind. And over the last two nights, at least a dozen banks have been torched by protesters.   

The catalyst? Not coronavirus but a massive dollar shortage destroying an economy that relies on inflows of U.S. dollars to function.

In this episode, NLW breaks down how Lebanon models what it looks like for a currency to fail, and why this likely isn’t the last emerging market currency to experience a similar crisis in the months to come. 

Transcript

Welcome back to The Breakdown, an everyday analysis, breaking down the most important stories in Bitcoin, crypto and beyond with your host NLW. The breakdown is distributed by CoinDesk.

NLW: Welcome back to The Breakdown. It is Wednesday, April 29th and today we are going to be talking about Lebanon, specifically the currency crisis overlapping a political crisis overlapping a larger economic crisis that is engulfing Lebanon and I think has relevance for how we understand the dollar in the world, the dollar’s role in the world and the fallout from COVID-19. I wanted to bring this episode to you because I noticed last week Lebanon start to emerge in the crypto sphere and there were two contexts: 

The first was Dan Tapiero. He picked up on a piece by newsBTC noticing that Bitcoin seemed to be trading at fifteen thousand dollars in lebanon via localbitcoins.com which is a peer to peer platform for trading Bitcoin between people. He said the classic emerging market funding crisis was made worse by deflationary dollar peg that is breaking. Study this case as it will be modeled for other weak emerging markets. It will be a key part of the macro story behind the upcoming Bitcoin price rally. 

NewsBTC… They titled their article Bitcoin trades at 15 K in Lebanon amidst economic turmoil showing its real potential. That was part one of how this showed up on the Bitcoin radar. And of course you see Bitcoin trading at a seemingly 100% premium against what we were seeing it at. It’s going to cause notice. 

The second context that Lebanon has had within the Bitcoin sphere, the Bitcoin Twittersphere, is images and videos of riots in Lebanon… Where protesters are smashing banks and setting fire to banks over the last two days. And that is happening, but it has a specific context and I think it’s incredibly important to dig into this because this is not just a single country, this is a country that is representative of I think a number of potential challenges that a variety of huge emerging market contexts are going to face in the coming months and the coming years.

And it deeply implicates the question of the role of the dollar in the world and the role of external currencies. So what I’m going to try to do today is give you a primer on how Lebanon got here, how this crisis happened, what this crisis means, and what the real implications are. Now, a couple caveats. First, I am obviously not a Lebanon expert. It is not my main field. It is not my main point of view and I have put this primer together humbly by doing my own research of the last six months of Lebanese political and economic turmoil. That said, I do have some context in this region. I first went to the middle East in 2004 to study in Cairo. I went back and forth a number of times, probably a dozen times over the course of the next five years or so.

I thought that I was going to spend my life doing either Middle East conflict resolution or just conflict resolution more broadly and spent time all around the region, including in Lebanon and Syria. Again, this was a long time ago. I was in Lebanon last in 2006 and Syria last in 2006 as we know, those places are very different than they were then, but this is not a complete neophyte perspective. I guess I do have some time booked both in the region and spent looking at the history of the region. I’m not going to get too deep into history today. I’m really just going to focus on what’s been happening over the last six months and put it in the larger global economic context we have. Here’s the TLDR on this. This is not a story of Bitcoin trading at a premium because people are desperate to get into Bitcoin.

This is a story of a local currency failing and people trying to find any on-ramp to access any US dollars that they can. That’s the real story and that’s the important piece of this conversation. Let’s do a little bit of Lebanon economic basics first. A key thing to note is that this is a country where almost everything consumed is imported. That’s a really important note because as we’ll see, imports are purchased with dollars and then sold for Lebanese Lira. Even before all of this happened, Lebanon had a huge debt to GDP ratio, one of the worst in the country between 150% to 170% debt to GDP ratio. This is a country that borrows a lot. It has had a dollar peg since 1997 of approximately 1500 Lira to one US Dollar. It has had a dollar peg since 1997 of 1500 Lebanese pounds or Lira to one USD.

An article in the New York times described this rate thusly, they said, “but maintaining that rate required continually bringing new dollars into the country, usually by enticing wealthy investors to make large dollar deposits for high interest rates. A strategy that some economists have compared to a Ponzi scheme.” We’ll get into this more in the banking system more in a minute. But the key part for our purposes is that since 1997 the dollar has been pegged 1500 Lebanese pounds to one US dollar and it’s been maintained through central bank policy. This is an economy that is 70% dollarized and it has only been sustainable because of diaspora inflows back to the country. So a huge number of Lebanese depositing money into the Lebanese banking system from abroad as well as from inflows from other regions. So Lebanese banks have attracted huge foreign inflows for years and years and years through offering high interest rates and basically that allows the country to pay for imports even though it has such low exports.

So in this way, the banking system is really key to the economy. The deposit base in fact in Lebanon is usually something like 2.5 to three times the size of the economy. However, the banking system is hugely compromised right now. And this is not just a coronavirus thing. In fact, as you’ll see, this story is not particularly a coronavirus issue, although as with everywhere else, the coronavirus shutdowns have exacerbated the situation, so the banking system is compromised. 70% of assets are lent to the state itself, but government bonds are trading 40 to 50 cents on the dollar. Of those 30% of loans that are to the private sector, 25% of those are non-performing. And what that means when you add everything up from the central bank balance sheet is that half of the assets of banks are impaired. They’re problematic. This could be okay in some short term way if there were still huge inflows from abroad into the banking system, but there haven’t been in the same way because of regional turmoil.

There is the obvious crisis of the war in Syria, which has been ongoing and dragging the entire region down. There is trouble with Iran who basically uses Hezbollah to meddle in Lebanon’s affairs and has for decades. There is a crisis with the relationship with Saudi Arabia, which went really bad in 2017 to say the least and I will point you to more resources to learn about that, but when that relationship went bad, we saw some of the first gasps of dollar outflows in late 2017 1.5% of cash deposits were withdrawn from the Lebanese banking system in fear of what that regional turmoil might do. So effectively we have a very unstable economy that is largely propped up by a robust banking sector that has been attractive to both foreign Lebanese as well as to the region for years, but as political crisis engulfs the region and compromises that banking system, it makes the system of continued inputs very compromised.

And so this is the context for where we started to see real problems happen last year. The center, underlying problem which metastasizes and metastasizes in this situation is not enough dollars to keep this economy going. As I was mentioning before, if you have a net import economy that uses dollars and your local currency interchangeably, what happens is that all of those purchases of imports happen in dollars, right? If the U S is sending wheat or anything else to you, it’s going to bill you in dollars, not in Lebanese pounds, but then your local market, your local consumer base, uses those Lebanese pounds to buy that good. The peg keeps that system working, but if the peg starts to break, it can deteriorate incredibly quickly. Keep in mind as well that there is a dollar shortage around the world. This is not a Lebanon unique situation.

The U S dollar has been the strongest and clearest asset, the world’s global reserve currency, not just theoretically, but in a way that is profound for a long time. And so imagine the pressure of trying to get dollars everywhere, but manifested in a specific nation-context like Lebanon. That’s what we’ve been dealing with. So last August the 1500 Lebanese pound to us dollar peg started to break. In September, an economic state of emergency was declared and the government actually used WhatsApp to say that they plan to raise taxes to cover government expenditures. This sparked protests because there was already a lot of questions around the legitimacy of government and corruption in government. So when the government said that they were going to come seize citizen money through taxes, basically to cover their expenditures, there was a wave of protests. This was exacerbated in October. On October 11th there was a nationwide strike demanding the ability to pay for fuel imports in Lira, in Lebanese pounds rather than dollars. A sign seen on Twitter said, we apologize to the Lebanese people due to the lack of dollars to buy fuel.

“We are closing our petrol station until we can secure this product in Lebanese pounds.” So again, this is the situation we were just describing. Petrol station owners sell their fuel in Lebanese pounds, but have to buy it in US dollars from importers. This also happened to mill owners. People who are bakers who buy imported wheat in US dollars. What happens of course, is that as the peg starts to come undone, that itself creates more demand for dollars, which causes the peg to come further undone. So put yourself in the situation of your average Lebanese person. You’re seeing these strikes around fuel importers around bakeries who aren’t able to get the dollars they need to buy the imports that allow their businesses to work. You’re an average citizen. You say, well, damn, if there’s dollar shortages, I need to go get my dollars out, which causes a run on the bank.

Banks start to limit withdrawals, which is exactly what happened. Banks started to limit how much could be withdrawn in USD and that creates more demand for dollars. All of a sudden that activity moves to the black markets because if banks won’t allow people to withdraw money or get access to dollars, black markets will, but the black market price is not going to stay the same as that official peg. This keeps going on. As people start to see the peg fall further, they want to minimize loss. They go from, “I don’t want to lose the value that I would have had at that official peg going on the black market” to “The black markets, the only place I can get those dollars, if it’s 2000 Lebanese pounds to the dollar, now, I want to lock in that loss rather than worry or take the risk of a loss of greater debasement of the value of the Lebanese pound in months to come.

So it’s a very vicious cycle. So, big protests start in October. Prime minister resigns at the end of October. Protests continue through November. Fast forward to February, early March… GDP is down from 55 billion to 44 billion. 220,000 jobs in a country of 5 million are lost between October to February. Food prices are up 58% and key parts of the industry are just totally left shuttered. So this is a quote from an article. Importers of critical goods such as medical supplies, say their requests for dollars have gone almost entirely unmet since February. Leaving many hospitals dangerously low on everything from heart stents to dialysis equipment on March 7th an extraordinary thing happens for the first time Lebanon defaults on a foreign currency debt payment. This is one thing that was holding Lebanon together is that it had a relatively high standing in foreign markets because it didn’t do things like default on debt payments.

It did in March for the first time and then COVID-19 hits and the economy is locked down since the middle of March, which is just pouring gasoline on an absolute dumpster fire already. So let’s look again at what’s happening in the currency markets as this foreign currency default happens in the beginning of March, the official exchange rate remains at 1500 Lebanese pounds to the dollar, but on the black market, money changers are getting 2,500 pounds to the dollar. There are a growing wave of people who are extremely worried, right? Think about middle-class Lebanese who are paid in Lebanese pounds, but who owe tuition or mortgages that are denominated in dollars. It’s the story that we hear over and over again in dollar denominated debt. No one can get dollars to bring in goods from abroad. So businesses are shuttering and to make matters worse, and this is how these economic crises play out.

Lebanese banks, which are terrified of bank runs, are continuing to reduce how much people can actually take out of their accounts and they’re doing so with caps, they are setting the exchange rate price lower than what the black market is saying. Then we get to April and things get really bad. The official peg is still at 1500 but it’s gone to 3,500 in black markets. A few weeks into April bank start making some small concession. They allow small depositors to cash out dollar savings, but at 2,600 pounds, so this is obviously more than the 1500 but way less than the 3,500 pounds that the black market was saying a dollar was worth. The blame game heats up between the prime minister and the central bank governor in a televised speech, the prime minister said the central bank is either incapable, absent, or directly inciting this dramatic depreciation.

There’s clear politicking involved in, like I said at the beginning, there’s so much to Lebanese politics that I can’t get into it now, but it’s worth looking into, but there’s credence for these accusations, at least in the context of regular citizens and protestors because the Lebanese bank has at this time been trying to buy up all the dollars they can from money transfer companies at a rate of 3,625 Lebanese pounds to the dollar. So in short, the Lebanese bank is trying to buy as many dollars as they can get their hands on at a rate that’s much higher than the exchange rate that they’re allowing Lebanese citizens to withdraw at, which is obviously going to cause incredible foment. There’s no way that people are going to just let that pass, especially when the prime minister is saying that the central bank governor is to blame for this crisis, which brings us to this week and the videos and images you’ve seen on Twitter of banks burning around Lebanon.

Aljazeera called this the night of the Molotov and for the last two nights at least a dozen Lebanese banks have been torched, vandalized as part of this growing frustration. Effectively these protests are now turning violent because the desperation is getting to reach a fever pitch with no end, no clear plan in sight. Even before all this, it was estimated that poverty was around 50% in the country at the beginning of the year. Now, the social affairs minister of the country is estimating that some 75% of the population require aid. Meanwhile, the economy, what’s left of it is still shut down because of the coronavirus. That’s where we are now. We have a crisis in freefall which has lost at least 50% of its value against the dollar and realistically more since the middle of last year with a rate of descent that is increasing.

We have a political instability where an already compromised and unloved government is blaming the central bank for this machination. We have an economic system that’s based not on economic fundamentals but financial engineering that requires an ever growing influx of foreign investment, foreign currency into the system that once that dries up just shuts down. All told what you have is that complete currency collapse and by extension economic collapse of a nation that has at times been one of the bright lights of a very troubled region. Let’s return back to the article that got Bitcoin’s attention in the first place. This idea that Bitcoin was trading at 15,000 Lira in Lebanon amidst economic turmoil showing its real potential. The article was based on the sell price on local bitcoins.com of a Bitcoin going for as high as 22,678,227.03 Lebanese pounds per token. If you divide that by the official expressed Lebanese pound to dollar rate, which is 1500 you get this 15,000 number.

That’s where it comes from. It is factoring in or it is assuming that the exchange rate of 1500 is the actual exchange rate. As we’ve discussed, the real exchange rate in Lebanon right now is somewhere between 2,600 which is what the banks are offering people to withdraw there. Lebanese pounds at or 3,600 which is what the central bank is paying for dollars on the open markets and what Lebanese are paying in the black markets. When you divide this offer of 22 million Lebanese pounds per Bitcoin by those numbers, you get a number that looks pretty much exactly like what Bitcoin was selling for everywhere else. Does this mean that we shouldn’t see Bitcoin as an interesting, relevant asset for this region? Should we dismiss this idea that it is “showing its real potential?” My answer is “absolutely not”, but we have to understand how Bitcoin and other digital assets are functioning in the real world right now.

The story of Lebanon that I’ve just told, which is the very TL;DR version is a story where people don’t have control over their money. Their money is predicated on a banking system that has its own interests, its own machinations, its own incentives that for a while aligned with theirs. But as soon as it didn’t, shut down their ability to actually control their wealth and effectively enabled their wealth to be reduced by a factor of 50% in the course of just a few months. Imagine that you had been saving in a bank doing what you’re supposed to do, being a good citizen, putting away your money for years and years and years and over six months. It’s cut in half simply by the debasement of the currency. That’s what we saw. What Bitcoin is reflective of and how people are using it in this crisis is trying to escape a local monetary regime that is crumbling.

What the world is doing though, and I think that we have to expect this is going to be the case for some time, is they’re escaping, not into Bitcoin per se, but the dollar. The dollar is the world’s escape valve currency. Even in Lebanon, before this turmoil, the whole system was predicated on being able to move easily into the dollar. The problem is that as the dollar becomes the only asset for the entire world, there’s a shortage of them and it becomes harder and harder to get into the dollar. Now, the interesting thing is as we watch the total circulating supply of USD based stable coins rise, I think that’s part and parcel of this as well. It is people trying to get dollar exposure and escape from local monetary regimes by accessing the digital currency world. This is not a diminishment of Bitcoin, but we also need to be clear that it’s not some super premium because Lebanese who are desperate are trying to get into this new currency.

Lebanese who are desperate are trying to get to the currency that they’ve always used to actually pay the key debts that they have, which is dollars. We live in a dollar denominated debt world until that is no longer the case, part of Bitcoin’s role is going to be to help people escape out of these local monetary regimes, which are collapsing and get money to where it needs to be into different currencies. Even synthetic ones. I don’t think that’s a knock on Bitcoin. I think it’s in fact an affirmation of its power as an uncontrollable non-sovereign currency. But we have to speak about what is actually true, not just go for the headline. So hopefully this has been an interesting or enlightening look at what’s going on in Lebanon. As I said, I am not a Lebanese expert. I put this together on the basis of just my own research and reading, but I fear that it is reflective of a lot of places we’re going to see around the world that face this same perfect storm of a bad local monetary regime and currency crisis that ensues, a shortage of dollars that makes it worse and the lack of a fundamental basis for the economy that can solve it.

Anyways, guys, let me know what you thought about this episode. Hit me up @NLW on Twitter and if you liked it, share and subscribe. Let me know because this is a little bit of a departure, although to me, I think this is the type of issue that is sort of the most important for us to really, really understand. If we want to think about how digital currencies and Bitcoin specifically have a role in the world to come. Thanks as always for listening and until tomorrow, be safe and take care of each other. Peace!