Opinion Economic Analysis by Sandro Joseph Azzam, Staff Writer

October 24th, 3030

Legal disclaimer: this article is for informational purposes only and should not be considered to be financial advice

The reactions to Saad Hariri’s nomination as PM designate were quite polarized across the board. Some found it inconceivable that Hariri would return to office some 51 weeks after he was ousted in the October 2019 uprisings but others welcomed Hariri back with open arms claiming that he was the only person capable of circumnavigating the crisis, rather, crises that Lebanon has been dealing with for the past 12 months. One thing is for sure however, Hariri’s designation provided certainty: there will be no power vacuum and this was seen as a positive factor. In the days leading up to his nomination and carrying on with momentum afterwards, the USD/LBP exchange rate dropped from over 8700 down to 6400 at the time of writing. Was the appreciation of the Lira due to the increased sense of certainty that comes with the designation of a PM? Or is there something fishy going on?

Let’s take a walk down memory lane to about 10 months ago. When the Diab cabinet was sworn in, an appreciation of the LBP against the dollar became noticeable with the lira rallying as much as 15%. Think of it this way – assume the dollar was a good, just like a tub of hummus or a bottle of olive oil. The more hummus there is in the market, the less rare it is and the cheaper it will be. This is regulated by simple concepts of supply and demand. How does the lira and dollar exchange rate relate to a delicious vat of creamy chickpea goodness? Well, the USD/LBP exchange rate is nothing more than the price of acquiring a dollar in Lira terms. The more dollars there are on the market, the “cheaper” it will be to purchase a dollar in Lira terms. The more dollars there are, the less scarce the greenback becomes. With a large available supply of dollars, the exchange rate, and thus the price of a dollar, drops. When there is a lack of dollars in the market, the exchange rate, and thus the price of a dollar, increases

With Diab’s cabinet, many had faith in what the future would hold and that the newly formed government would lead us to prosperity. Citizens regained confidence in Lebanon, its banking sector and its currency so they went down to the exchange desks and traded in their dollars for Lebanese Lira. Why would anyone be so out of their mind to do so? Well, when the lira rallied 15% against the dollar in the days following the formation of the cabinet, lira holders essentially made a 15% profit on their money (in the short-term of course). Since there was a chance of making some extra cash, hundreds of thousands of dollars were injected into the market hoping to make a profit off the short-lived appreciation of the Lira, and since everybody loves free money, thousands participated. With this stark increase in supply of dollars, the exchange rate went down. Needless to say, this appreciation was short-lived as the exchange rate soon rocketed to over 9000LBP/USD. 

In the days leading up to Hariri’s appointment as PM designate, we saw a similar reaction in the foreign exchange (FX) market. With certainty comes an appreciation of the exchange rate and Hariri, or any other PM’s appointment, would be met by a Lira appreciation. We saw exactly that when the Lira appreciated over 25% against the dollar meaning that holding Lira was advantageous. People ran to the exchange desks and traded in their dollars for Lebanese pounds flooding the market with the greenback and bringing the exchange rate further down. 

Financiers look for one very important value when it comes to trading stocks, bonds or FX and that is trade volume – how much is being sold on the open market at any given time. There is a stark difference between what happened after the Diab and Hariri appointments and it all boils down to volume. Under Diab, the dollars were there to begin with, all that happened is that more of them became available to the general public due to people selling their greenbacks. This exchange rate appreciation was due to what we call “fundamentals,” that is, the true value of the dollar as determined by supply and demand on the market while considering expectations for the future.  This time around it’s very different. 

What we know for certain is that in the days preceding Hariri’s appointment and up to this very moment, between 2 and 4 large actors on the Lebanese FX market started acting up and injecting massive dollar liquidity in the market. These are likely the exchange desks that are endowed with the right to import physical currency from abroad. The actual source of these funds is unknown but it would not be farfetched to assume that the money comes from the political sphere with a certain party (you know who I’m talking about) having a clear interest in bringing the exchange rate down… What’s happening is an artificial decrease in the dollar exchange rate. Where the exchange rate in early September and after the Diab appointment was set by fundamental values, that is, supply and demand, what we are currently witnessing is market manipulation. Someone has a demonstrated interest in bringing down the rate and is doing so by flooding the market, thereby increasing supply. More supply of dollars means that the price of a dollar, aka the exchange rate, goes down. 

Now that we have demonstrated that the current Lira appreciation is artificial, we will move onto the risks that playing around in such a market pose. One theory is that the decrease in the exchange rate is set up so as to reclaim the dollars that people have under their mattresses. Think about it – if I told you that you could make a 25% profit from selling your dollars, chances are you’d take it. The problem comes in the medium to long term. How long will these artificial injections last? Given that this new 6400LBP/USD exchange rate is purely driven by the market being manipulated because of some players pumping liquidity into the market, what we can expect to see is a reversal of that trend as soon as the newly injected greenbacks dry up. Think of the market as a dry sponge and the dollar injections as sink. In the normal state of affairs, the sponge is left alone, dry, because, absent any liquidity it can’t absorb any water. But what’s currently happening is that the sponge is being run under the sink to have it absorb as much water as it possibly can. What happens when you turn off the tap and put the sponge back to the side of the sink? Well, the water starts to slowly but surely evaporate, and the sponge returns to its original dry state. September 2020 was the dry sponge initially. The past 3 weeks have been running the sponge under the sink and the next 3 weeks will be the water evaporating and the sponge going dry again sending the exchange rate back towards the values it reached in September. 

Since the only expectation here is that the market is being manipulated, we can safely assume that the exchange rate is artificially low today but will be naturally high in the future. It would thus make sense to actually buy dollars rather than sell them. You’re buying the dollars for “cheap” and you’ll have them in the hard times later on.

The big question is, how long will these liquidity injections last and how long will the actors in the FX market be able to sustain essentially sending their dollars down the drain? Chances are it won’t last another week so don’t be tempted to sell your dollars today with the hope of the rate going down even lower. Look at what happened in January. People did sold their dollars and made a cool 15% profit. But if they had kept their dollars on hand rather than sell them, they would be up over 300%...