The Shattered Cedar: Lebanon’s Catastrophic Collapse

Lebanon is often referred to as the Switzerland of the Middle East. A country that witnessed thousands of years of rich culture inspired by Romans, Greeks, and French has now turned into a corruption-infested, and politically unstable country with its (the Lebanese Pound) in complete freefall.

But the real question is, how did a country go from having an Iron Clad banking system to complete collapse in such a short amount of time? What made the people of Lebanon loot banks in order to get their own money back?

Today, we will answer it all!

On the world map, Lebanon is a small country in the middle east, geographically neighboring war-torn countries like Syria and Israel.

With a 225 km long coastline, harboring the city of Beirut as its capital Lebanon was known for its famous ports that facilitated easy trade with Europe, Africa, and Asia.

The Seeds Of Collapse

The seeds of the crisis were sown back in 1975, the time when Lebanon faced a civil war between the Christians and the Muslims. A war that went on for 15 long years and with a mounting death toll of 120,000.

The conflict which lasted for more than a decade was finally resolved after the religious groups agreed to create a Confessionalism (A secretariat power-sharing structure where each group will get representation and power in specific sectors/ministries as well as a % representation in the parliament)

The sector division resulted in providing power to each party in various ministries which, essentially divided the government into a Five-dom.

This agreement provided the country with some sense of political stability, however, the Five-dom system was supposed to be temporarily implemented for a period of 3 years, after which a more democratic structure was expected to be framed but unfortunately, it never came into existence, a fact that would play a critical role in the crisis.

The divisional structure of the government allowed politicians from each party to selectively elect individuals into positions of power who served their own aspirations and agenda, thereby ensuring maximum convenience and suitability.

Nevertheless, the country for the time being was stable but in dire need of rebuilding. However, the GDP of the country rose by 400% within the next decade.

The growth was primarily initiated by 3 factors:

1. Rising domestic demand and trade

2. Foreign capital influx

3. Remittances from abroad

Lebanon turned into a tourist destination and along with it a service-centric economy, where 60% of the GDP came from Financial Services, Trade, and Tourism.

Often, Trade and Tourism based countries that import essentials like Food and Fuels require a stable currency and often go for pegging in order to achieve it. Lebanon opted for this by pegging its currency with the US Dollar in 1997.

Pegging in simple terms is maintaining a fixed rate/range of rates for the domestic currency with a foreign currency to provide stability in prices when exporting or importing. Whenever the price moves in the exchange market the Central Bank intervenes as the counterparty to prevent fluctuations.

This phenomenon was actively exploited by Mr. George Soros, the man who broke the Bank of England.

Lebanon was actively booming, and its citizens were happy. However, the surface-level issues of misallocation of foreign capital into the pockets of politicians were prevalent and rampant.

From this point on, things took a very dark turn when foreign aid started to dry up and the politicians wanted to find new ways to fill their coffers.

Fake it until you BREAK it

The aim for the people at the top positions in the government was to siphon funds from the reserves of the central bank of Lebanon(Banque Du Liban). To do that they needed foreign capital and they devised a plan which gave the country the name Switzerland of the Middle East

Banque Du Liban started to offer high-interest rates to the commercial banks of the country which incentivized them to park their funds in the Central bank.

High interest rates given at a time when major markets like the US and Europe were giving little to at times no returns for the same Dollar Deposit led to Lebanon becoming a hub of foreign investment.

From clients of the Middle East, Europe, and Asia, Lebanon’s commercial banks gained massive funds all of which were parked in the Central Bank which in turn loaned to the government for functioning.

The result of this scheme was the Government Debt surging beyond 100% of the GDP, and to make matters worse this money was still actively being used by officials instead of spending on infrastructure opportunities.

Uprising

This time the plan worked but didn’t go unnoticed when the entire country faced water, electricity, and fuel issues which led to revolts and street killings. The government had to deploy the army to prevent further chaos.

The public outcry was heard and major ministers swapped places over a period of a few months, but the underline problem was far from resolved.

The entire economy persisted on this house of cards which started to shake when the war in the neighboring country Syria led 1.5 million people to enter Lebanon’s borders as refugees. Lebanon’s social system and resources were barely enough for the local population. This new pressure along with the drying up of foreign reserves was the first blow and shook the first foundation of Lebanon’s economy.

A cry for HELP!

The economy was saved from collapse by Riad Salameh, the Chairman of the central bank who using his expert financial skills created complicated securities and offered them to the commercial banks.

A simplified version of these securities is that the Commercial banks were given very attractive incentives in exchange for bringing new dollars into the reserves of the Central Banks.

Riad further increased the interest rates and used any means necessary to bring in foreign capital. This method worked as the country started to see a surge in foreign investment. This, however, was short-lived as what Riad created was a double-edged sword.

National Debt is serviced by the government in the domestic currency at their rates, this, however, changed when complex securities were used to fund the national debt and effectively, turn it into foreign debt.

The issue was further reinforced due to very high-interest servicing, to the extent that debt servicing was 1/3rd of the National Budget. The foreign currency reserves started to decline.

All this time there was one factor that remained constant, which was the political structure. This last critical factor also changed when in 2017 the government was unable to bring in reforms and Prime Minister Saad Hariri reigned.

To service the high-cost debt (170% of GDP) the government decided to refinance until in 2019 the government defaulted.

A series of Disasters

After the government default, inflation and unemployment were quick to catch, leaving the country in a very fragile state. The global pandemic made things worse but the real disaster was yet to come.

On August 4, 2020, a warehouse on a port in Beirut exploded, with 2,700 tonnes of Ammonium Nitrate which was stored since 2013 due to the inability of the government to process it out of the country.

This explosion had a death toll of hundreds with billions of Dollars in damages, the real catastrophe was that the port was responsible for 70% of all the imports in the country, a country that imports both food and fuel.

Inflation in triple digits coupled with even higher import costs due to the disaster, intensified the already existing problems and the unrest reached the country’s population very soon. The widespread protests and disputes engulfed the country, all the officials were denied accountability and every attempt to bring any reform was overturned. After months of violent protests, the government started to take action by imposing high taxes around the country in a desperate attempt to gain funds.

One such example was the Whatsapp Videocall tax which was 20 cents per day. An obvious implication is a further increase in protests. The consensus for these protests was a complete overhaul of the government and its system.

Banking Sector

The banking sector is the backbone of every economy, and due to the grace of Fractional Reserve Lending majority of banks around the world run on trust.

With all the political issues and protests in the country, the banks were worried about a bank run and started to hold out on funds from people, especially US Dollars.

The remittances from abroad that Lebanon was using to boost its economy were majorly denominated in US dollars and due to very high-interest rates, people deposited almost everything they had to take advantage of the high-interest rate.

Implication?

The banks dug their own graves and the trust in the currency was lost. People started to convert their money to US dollars and banks now stopped offering exchange services as the currency was effectively in a Freefall.

To give a comparison, before the fall 1 USD = 1,500 LBP, and as of January 2022, the rate plummeted to 23,000 LBP.

And further down to a street rate of 100,000 LBP for 1 USD. The pegging was stable until 2019, after which all the exchange activities were effectively obsolete.

The Tragedy called Lebanon

To look at the numbers, Lebanon since 2018 has lost half its GDP. The economy was officially in Hyper Inflation as of July 2022 with inflation rates at 124% by the end of 2022. To put things into perspective, someone earning 900 USD pre-crisis had a parity of fewer than 50 USD.

30% of the entire working population was unemployed, and up to 70% of households were unable to make ends meet and had to resort to skipping meals and sending their children to orphanages simply because they couldn’t afford to feed them.

The numbers at a national scale look like statistics, but the human suffering caused by the food, water, and fuel shortages had an implied consequence on the healthcare sector which further led to the suffering of 5.4 mil citizens and over a million refugees in the country.

Access to education was cut short as the teachers went on strike because their monthly salaries were not enough to cover a day’s worth of commuting charges. Local businesses were on the brink of bankruptcy and the country witnessed sky-high crime rates.

People started to leave Lebanon, some attempting it by taking dangerous sea journeys. This also implied a brain drain as those in high-paying jobs were the first to leave.

The people responsible are still in positions of power and those who should be behind bars roam freely.

For most of us living in a country with a stable economy and a powerful administration in place, situations and sufferings like these are unfathomable.

The Future

So does Lebanon have a future? Or is it impossible to fix this tragedy and its aftereffects?

On careful analysis of the numbers and condition of Lebanon, a possible solution is to first gain access to cash flow into the country to restart imports of essential services like food, water, fuel, and medicines.

It could be followed by a simultaneous restructuring of the Banking Sector, and letting the Lebanon Pound freely trade in the market will slowly and steadily rebuild the trust that might possibly last over a generation.

Though, these are solutions stemming from a rather optimistic assumption. The reality is different as reforms are pushed against a political wall. Lebanon has been seeking funds from the IMF for 3 years, however, given the history of deals IMF has done Lebanon would require political reforms and restructuring to ensure the country can repay.

Due to this a regime change from the sectoral politics is the only way that change can be brought within the country. As it is evident from government reactions, the people in power are not incentivized enough to bring positive reform even if the population is suffering.

A makeshift solution, currently implemented is the dollarization of the entire country as a way to sidestep the LBP, the result of which is however largely questionable and unforeseen. Another implication of the banking sector closing down is that the entire economy is now effectively a cash-based economy which means even less revenue for the government to rebound back with.

This wraps the story of the economic and administrative crash of Lebanon, Switzerland of the Middle East, but far from heaven.