--- title: "The Causes and Risks of the Drift Toward Dollarization | Ghazi Mahmoud" url: https://ghazimahmoud.com/en/articles/2023-02-25-fc8ba6/ lang: en description: "The ongoing collapse afflicting the national currency brings to mind the 1980s, when the exchange rate of the US dollar against the Lebanese pound rose to more than 450 Lebanese pounds at the end of 1987, after having stood at no more than 6.8 pounds in 1982." --- [All articles](https://ghazimahmoud.com/en/articles/) # The Causes and Risks of the Drift Toward Dollarization [Brig. Gen. (Ret.) Dr. Ghazi Mahmoud](https://ghazimahmoud.com/en/about/) 25 Feb 2023 · 9 min read [Banking and money](https://ghazimahmoud.com/en/articles/money/) The ongoing collapse afflicting the national currency brings to mind the 1980s, when the exchange rate of the US dollar against the Lebanese pound rose to more than 450 Lebanese pounds at the end of 1987, after having stood at no more than 6.8 pounds in 1982. That period marked the prelude to a surging exchange rate, which reached 842 pounds at the end of 1990 and surpassed 2,800 pounds in 1992. Looking closely at the causes that led to the depreciation of the national currency at that time reveals deep similarities with the circumstances, causes, and repercussions of the current collapse. The collapse of the national currency's exchange rate starting in 1984 coincided with the growth of both the fiscal deficit and the balance-of-payments deficit in the 1983-1984 period, two developments that frequently accompany a decline in the value of the national currency and a rise in the exchange rate. Public spending expanded and increased during that period at rates Lebanon had never previously witnessed, without taking into account the lack of sufficient resources for that purpose. This pushed the government to borrow from the central bank and commercial banks to finance its expenditure. As a result, the size of the public debt doubled within a single year, rising from less than 7 billion Lebanese pounds at the end of 1981 to more than 14 billion Lebanese pounds at the end of 1982. State borrowing from commercial banks curbed the capital available to the private sector and reduced hard-currency reserves, at a time when the revenues of oil-producing countries had declined for three consecutive years in the 1983-1985 period, shrinking the remittances from abroad on which the Lebanese economy had long relied. Throughout the 1979-1982 period, those remittances had accounted for the equivalent of half of national income. Consequently, the exchange rate rose as a result of increased demand and the need for capital by the autumn of 1984. Conversely, the drop in remittances was not reflected in import volumes during the same 1983-1984 period, as imports remained at levels similar to those of previous years. This exacerbated the trade deficit and produced a balance-of-payments deficit in those two years reaching $933 million and $1,242 million, respectively. The deficit stemmed from the persistence of existing consumption patterns despite the scarcity of external remittances, and the same applied to the state's continuation of spending at the same level adopted during the years of financial abundance. Today, despite the financial and economic crisis battering Lebanon since the end of 2019, imports in 2022 recorded high levels exceeding $19 billion, whereas exports were limited to 3 billion US dollars. Public debt continued to grow, reaching the equivalent of $103.65 billion at the end of August 2022 compared with August 2021, an increase of nearly $4.9 billion, or 4.97%, after having stood at roughly $91.64 billion at the end of 2019. Meanwhile, the value of the foreign-currency-denominated portion reached approximately $40.22 billion, recording an increase of 4.42% over its level at the end of August 2021, after having been limited to $38.41 billion in the same period of 2019. Ironically, the political authorities failed to learn from the experience of the 1980s and the high cost of public spending policies reliant on domestic or foreign loans that disregard available tax and fee revenues as well as the capacity to repay debts and honor obligations. Whereas earlier spending policies led the state to live off advances provided by Banque du Liban starting in 1985, in the words of Banque du Liban Governor Edmond Naim in 1989, today it lives off money printing by Banque du Liban as well, along with its inflationary consequences. Experts attribute the collapse of the Lebanese currency's exchange rate to a wave of flight from the Lebanese currency (flight from money) starting in 1984, carried out by converting Lebanese pounds into hard currencies, although the flight had begun as early as 1983. Turning to foreign currencies, particularly the dollar, which enjoys widespread acceptance in both domestic and external transactions, was the result of inflation, itself a reflection of the national currency's collapse. Dollarization is directly and closely correlated with inflation, and the higher inflation rises, the greater the drift toward dollarization. The latest flight from the national currency began in 2020, after having taken place on a narrow scale following the first wave and up until 2019 among those intimately familiar with Lebanon's financial situation. What made matters worse, however, was that public officials smuggled their foreign-currency deposits abroad starting in the second half of 2019, prompting Lebanese citizens to flee the national currency for the US dollar and other foreign currencies. With this new wave of currency flight and the emerging wave of capital smuggling, the saga of the national currency's collapse resumed alongside rising inflation rates and overall price levels. The closure of banks at the end of 2019 represented the tip of the iceberg of the crisis gripping Lebanon, exposing facets of the financial crisis that had been growing rapidly within the Lebanese economy since 2011. The persistence of the budget deficit and the trade deficit, which had paved the way for the collapse of the national currency during the second half of the 1980s, served as a direct cause of the new collapse, whose circumstances and outcomes resemble those of previous collapses. What is new in the current crisis, however, is the losses of the banking sector, or what has been termed the financial gap, estimated at $72 billion, in addition to the squandering of more than $30 billion of Banque du Liban's foreign-currency reserves. The state's default on Eurobonds maturing in 2020, without regard for the financial and economic repercussions of that step, constituted a further factor complicating the crisis and deepening its ramifications for the fiscal and monetary situation. Meanwhile, the exchange-rate peg adopted by Banque du Liban for more than twenty-two years failed to achieve the stability needed to break free from the pegging policy, which cost the national economy opportunities for sustainable growth generated by the expansion of its various productive sectors. Repeated Israeli aggressions (1993, 1996, and 2006) and recurring political crises, in addition to diverging approaches to economic solutions among political factions, played a central role in squandering efforts aimed at economic recovery. At the same time, the mounting high cost of pegging the exchange rate deprived economic and particularly productive investments of financing at a reasonable cost that would allow their products to compete in foreign markets. While good governance requires monitoring the effects of adopted monetary policies and evaluating their impact on economic activity, the pegging policy persisted without its stewards envisioning an exit from it and a return to market mechanisms so that the national currency might once again serve as a mirror of the national economy. Moreover, the financial engineering operations carried out by Banque du Liban under financial pressures on the one hand and political pressures on the other thwarted their intended objectives, indeed worsening the country's fiscal and monetary fragility and heightening investors' fears over their placements in it. Whereas some Latin American countries resorted to austere fiscal and monetary policies aimed at reducing budget deficits in order to curb inflation, others resorted to freezing wages and prices (Wages and prices freezing) by consensus among social partners. The latter approach did not succeed in the long run, despite its success in countries such as France, because the nations that adopted it lacked a domestic productive base. Budget-deficit reduction policies, by contrast, achieved their goals by shrinking the available money supply, given that rising inflation goes hand in hand with money-supply growth. Reducing the budget deficit also had to be paired with stabilizing the exchange rate in order to curb inflation and its harmful effects on the national economy. Had Banque du Liban used its reserves to stabilize the exchange rate from the very first day the political and financial crisis erupted in October 2019, it could have reined in the rate and limited its inflationary effects. Indeed, the measures devised by Banque du Liban and its intervention in the parallel market to collect dollars and then inject them through the Sayrafa platform attest to the opportunity that existed, one squandered on the one hand by officials' diverging approaches to available solutions and perhaps by Banque du Liban's unwillingness to use them. Even though dollarization has touched everything in the country, some of it by decision of the relevant ministries, it remains a partial dollarization implemented as a fait accompli (De Facto) rather than as a deliberate policy choice addressing the complications caused by inflation at various levels. While the pricing of goods and services has been left to merchants and the businesses concerned, Banque du Liban handles the dollarization of public-sector salaries and pensions through the Sayrafa platform, without regard for equality between private-sector and public-sector employees, even as salary dollarization faces the threat of halting due to a shortage of cash dollars, leaving everyone to face their fate. Dollarization cannot, however, be a solution to the financial and economic crisis gripping Lebanon, given the loss of the national currency, which represents a symbol of national sovereignty and an economic instrument of the state that is hard to replace. Nor is dollarization feasible in the absence of a comprehensive plan through which Banque du Liban reclaims its national-currency liabilities toward banks and financial markets and replaces them with US dollars from its reserves, at a time when the financial gap noted above poses an insoluble problem for the foreseeable future. Although the crisis afflicting Lebanon is financial and economic, the solution must begin as a political settlement that puts an end to political divisions among factions and forges a unified approach to financial and economic remedies, starting with establishing a state of law and institutions grounded in good governance, accountability, and oversight, a state anchored by e-government that facilitates and expedites citizens' transactions, an approach that lays the foundations for the revival of Lebanon and its economy, places the national interest above all else, and guides Lebanon toward economic growth and modernity. Even so, this revival will not be achievable in the near future even if political factions reach an agreement tomorrow, owing to the scale of the financial losses and the heavy damage inflicted on the national economy. Austerity and cuts to expenditures and benefits have been dictated by inflation and declining state revenues amid the state's inability to borrow, while the structural adjustment policies required by the International Monetary Fund have become a reality even as those responsible evade implementing the necessary reforms. - Unifying and stabilizing an adjustable exchange rate by managing supply and demand for the national currency and foreign currencies, accompanied by capital controls. - Establishing an administration independent of Banque du Liban to regulate the use of hard currencies on the basis of priorities related to imports of goods and services and other external transactions. - Restricting imports to match the level of expatriate workers' remittances, thereby curbing excess demand for the dollar and helping to stabilize the exchange rate. Translated from Arabic with AI. [Read it in Arabic](https://ghazimahmoud.com/articles/2023-02-25-fc8ba6/) ## Published in - [LinkedIn](https://www.linkedin.com/pulse/%D8%A3%D8%B3%D9%80%D8%A8%D8%A7%D8%A8-%D8%A7%D9%84%D8%AC%D9%86%D9%88%D8%AD-%D8%A7%D9%84%D9%89-%D8%A7%D9%84%D8%AF%D9%88%D9%84%D8%B1%D8%A9-%D9%88%D9%85%D8%AE%D8%A7%D8%B7%D8%B1%D9%87%D8%A7-ghazi-mahmoud/) - [OZ Arab Media](https://ozarab.media/أسـبَاب-الجنُوح-الى-الدولَرة-ومخَاطر/) - [Radar News](https://www.radar-news.net/أسـبَاب-الجنُوح-الى-الدولَرة-ومخَاطر/) ## More on banking and money [All articles on this subject](https://ghazimahmoud.com/en/articles/money/) [5 Feb 2023 · The Lebanese Between the Anvil of the Pound and the Hammer of the Dollar · LinkedIn, OZ Arab Media ](https://ghazimahmoud.com/en/articles/2023-02-05-9d85b6/) [31 Jan 2023 · A Reading of the Future of the Lebanese Banking Sector · LinkedIn ](https://ghazimahmoud.com/en/articles/2023-01-31-676434/) [12 Mar 2023 · A Reading of the Preludes to the Collapse and Its Causes · LinkedIn, OZ Arab Media ](https://ghazimahmoud.com/en/articles/2023-03-12-54d29f/)