Opinion Analysis by Sandro Joseph Azzam, Staff Writer

June 29th, 2020

Preliminary note: This publication is an opinion analysis of the decisions on dollar injections by the Lebanese Central Bank as of June 17th.

With the value of the dollar reaching an all-time high against the Lebanese Lira spiking to 7000LBP earlier this month, Lebanon has taken to the streets yet again to show their anger at the incompetence of their leadership. The solution that Lebanon’s policymakers came up with was a dollar liquidity injection from the Central Bank’s (BDL) reserves, to the tune of some 200 million USD.

 As discussed previously, central banks have reserves that they use to pay for imports as well as preserve the exchange rate. Remember, the USD/LBP exchange rate is simply the price of acquiring a dollar in Lebanese Lira terms. Thus, the scarcer dollars are, the higher their price and the higher the USD/LBP exchange rate. If demand for US Dollars is too high, the central bank injects dollar liquidity into the market to prevent a depreciation.

Whilst BDL’s dollar injection sounds like the necessary solution to the crisis, it is in fact a catastrophic mistake. 

With the Lebanese economy transforming into a cash-based economy almost overnight following the October uprisings, people have entirely lost their trust in the Lebanese banking system and have decided to move their money under their mattresses. BDL estimates that in late 2019, almost 5 billion USD were held up in homes. We can only imagine the size that these “under the mattress” deposits have reached today but it wouldn’t be farfetched for there to be between 7 and 10 billion USD under there, collecting dust. But where did all this money come from?

Well, banks. At the very beginning of the crisis, in what could retrospectively be called “the good old days”, banks were giving out $1000 rations to their depositors who were otherwise demanding that their funds be freed. This lasted about 10 weeks. Some decided to spend the cash, some flew it out of the country, but a vast majority left obscene amounts of money laying around their homes. They didn’t dare transform their real dollars into “lollars”, as coined by Dan Azzi, by moving their cash into the banking system. With banks struggling to stay afloat and deposits essentially being held hostage, Lebanon’s thirst for the greenback grew exponentially. 

Upon earning any amount in Lira, the average Lebanese citizen would take their cash to the exchange desk and get a hold of the greenback equivalent, so as to preserve his or her hard earned paycheck in the future, even if an upfront haircut was needed to make that happen. As the situation got worse, more and more dollars were being kept under the mattress with their value rising day by day as the Lira depreciated. People simply didn’t trust their bankers even though, in a perfect world, if everyone moved their cash into banks, the crisis would have been significantly alleviated. 

Some have seen BDL’s decision to inject massive amounts of US dollars in cash into the Lebanese market as our saving grace, but that couldn’t be further from the truth.  

People will simply keep buying up the dollars on the market and hiding them under the mattress. Within a few days’ time, all the newly injected liquidity will be swept off the market and we will return to square one. Injecting dollars into the market in the current situation is like giving heroin to an addict. No matter how long they have been deprived of their drug, the second it is made available to them, they relapse. 

 This operation reduces the central bank’s reserves by 200 million USD and, that’s pretty much it. There is no upside.  Not a single dollar will be reinvested in the economy to provide circular spending. Instead of me paying you $100 and you going to the supermarket to spend those $100 and the supermarket using those $100 to pay its employees who will then continue the cycle thereby creating more economic activity, all that’s happening is that I’m giving you $100 and you’re hiding it under the mattress with absolutely no contribution to the real economy whatsoever. 

Liquidity is fundamental to emerging from any financial crisis but the problem in Lebanon is that nobody wants to have Lebanese Lira liquidity. Thus, all increases in money supply are passed onto consumers who then go on a spending spree to rid themselves of a currency whose value is unknown to them even in the short run. But here’s what transforms this dollar addiction from a problem into a disaster: inflation. Some 7-10 billion dollars are said to be sitting under Lebanon’s collective mattress. The second it’s time for spring cleaning and what’s under the mattress resurfaces, it will be game over for everyone. Those 10 billion dollars were initially worth 15 trillion lira. They’re now worth 50 trillion (at a 5.000LBP/USD rate). 

To date, Lebanon’s M1 money supply, that is, the amount of notes and bills in circulation, is worth about 25 trillion LBP, approximately 2.5x what it was just 12 months ago. This explains the massive inflation we have seen so far. To run the risk of further increasing money supply means playing with fire: you’re bound to get burnt. If 50 trillion LBP suddenly resurface, Lebanon’s money supply triples overnight. To maintain constant real money balances, prices will triple as well and inflation will take over moving us towards nothing short of a Venezuelan situation. 

In short, BDL’s dollar injection is adding fuel to an already ravaging fire. There simply is no upside to injecting these dollars into the market. They reduce the already dwindling central bank reserves and will in no way, shape or form be used domestically, not to mention the enormous risk of smuggling to our northeastern neighbors… Let’s remember that the central bank holds a negative net foreign reserves position, meaning that it owes depositors more dollars than it currently has. This 200-million-dollar injection would quite literally be theft: stealing 200 million dollars of depositor money and injecting it into the market where they will be hidden under the mattress. 

If BDL wanted to inject more dollars into the market, this was certainly not the way to do it. By taking another approach, the central bank can kill two birds with one stone. It can restore a shred of confidence in the banking sector and give depositors the money that was theirs to begin with. By allowing businesses to make transfers abroad to pay their suppliers via their bank using their own banking system dollars, the average Youssef would successfully transform his banking system “lollars” into real US dollars. Prices would drop due to the lower cost of acquisition of raw materials and inflation would be somewhat alleviated. The central bank’s reserves will be put to good use rather than simply being stuck under someone’s mattress causing an inflationary threat. 

BDL’s dollar liquidity injection is a ticking timebomb waiting to explode and if the central bank is keen on spending 200 million dollars of its reserves, it should seriously rethink its strategy as to how they should do so. This dollar injection might bring down the USD/LBP exchange rate but that will last days, rather than months and years. Fixing a long-term problem with a short-term solution could only be described as laughable and is comparable to taking an Advil to alleviate the pain caused by a brain tumor.