A currency board would stabilize the Lebanese economy.
Aclose Thirteen months in limbo, Lebanon finally formed a government on September 10. It is headed by Najib Mikati, billionaire and seasoned politician. As prime minister, Mikati faces the daunting task of bringing the Lebanese economy back from the dead.
The death spiral in Lebanon began two years ago. After pegging to the US dollar at a rate of 1,507.5 for 22 years, the parity of the Lebanese pound broke and a currency crisis erupted. As the pound plunged – ultimately losing 92% of its value against the dollar – inflation soared. At the end of July 2020, Lebanon became the first country in the Middle East to experience a hyperinflation crisis, with a monthly inflation rate reaching 53%. Caught in the midst of the monetary storm, the banks became insolvent and the economy collapsed. In a futile attempt to maintain an import lifeline, the central bank devised a concoction of multiple exchange rates. This massive import subsidy program drained more than half of the central bank’s foreign exchange reserves in two short years. What should Mikati do?
It could proceed conventionally by dusting off the government’s April 2020 stimulus package. Its centerpiece was a more flexible exchange rate regime coupled with capital controls and foreign lending with conditionalities. But when introduced during currency crises in countries with weak institutions and endemic anomie, such systems have a poor track record. In Lebanon, failure would be guaranteed, like Argentina’s recent experiences.
The only option that would put an abrupt end to Lebanon’s currency crisis is a currency board. Unlike Lebanon’s old fixed exchange rate regime or Argentina’s similar and unfortunate convertibility system, which lasted from 1991 until its collapse in 2001, a currency board issues banknotes and coins. convertible on demand into an anchor foreign currency at a fixed exchange rate. It is required to hold anchor currency reserves equal to 100% of its monetary commitments.
A currency board does not have discretionary monetary powers and cannot issue credit. It has an exchange rate policy but no monetary policy. Its only function is to exchange the national currency it issues for an anchor currency at a fixed rate. The currency of a currency board is a clone of its anchor currency.
A currency board does not require any preconditions and can be installed quickly. Public finances, state-owned enterprises, and commerce do not need to be reformed before a currency board can issue money. Currency boards exist in some 70 countries. None have failed.
The most notable modern currency board is Hong Kong, set up in 1983 to combat exchange rate instability. After the fourth round of Sino-British talks on the future of Hong Kong, market volatility has reached epic levels. Between July and September 24, a date known as Black Saturday, the Hong Kong dollar lost 24% of its value against the greenback. Hong Kong’s economy was in a state of panic. The chaos ended abruptly on October 15 with the establishment of the currency board. The board hasn’t missed a beat since, resisting a myriad of crises – even during Hong Kong’s recent political turmoil.
Estonia took less than a month to establish its currency board in June 1992. At that time, Estonia’s currency was the excessively swelling Russian ruble, and the newly independent Baltic state did not had not yet approved a post-Soviet constitution. The currency board was installed, the Estonian kroon was issued and inflation was instantly extinguished. After expressing its initial skepticism, the International Monetary Fund praised Estonia’s currency board.
In 1994, neighboring Lithuania adopted a currency board to halt central bank funding of public spending. The currency board has indeed imposed budgetary discipline. Subsequently, the IMF hailed Lithuania’s economic recovery and performance as one of the best in the European Union, to which it joined in 2004.
In 1997, Bulgaria faced hyperinflation and raging banking crises. With the currency board installed in July, hyperinflation stopped immediately. By 1998, the banking system was solvent, money market interest rates had risen from triple digits to 2.4% on average, a huge budget deficit had turned into a surplus, a deep depression had turned into growth Bulgaria’s economic and foreign exchange reserves were more than tripled. The IMF has given rave reviews to the currency board. Today, thanks to its currency board, Bulgaria has the second lowest debt-to-GDP ratio in the EU, behind Estonia.
Bosnia and Herzegovina set up a currency board in 1997, in accordance with the Dayton / Paris peace agreement ending the civil war. Amid ethnic strife and economic ruin, the currency board did what currency boards do: it established stability, a prerequisite for reconstruction.
The only way to end Lebanon’s nightmare and be successful politically is for Mikati to establish a currency board. Indeed, it is always better for your reputation to succeed in an unconventional way than to fail in a conventional way.
Jacques de Larosière is a former Managing Director of the International Monetary Fund, Governor of the Banque de France and President of the European Bank for Reconstruction and Development. Steve H. Hanke is Professor of Applied Economics at Johns Hopkins University in Baltimore. He is a senior fellow and director of the Troubled Currencies Project at the Cato Institute in Washington, DC.