Debt Monetization: Corrupt Politicians’ Number One Policy Option!

The Dollar, The Lira and The Lollar are all destined to fall in the absence of TRUST.

The country's financial and economic collapse is accelerating, signaling more misery for the millions of Lebanese who have seen the value of their savings and salaries wiped out. All eyes and all blames are on the chaotic US$/LBP foreign exchange markets (there are so many of them!). What is happening in this foreign exchange market is only one of the consequences of many years of corruptions, and dismissing frequent calls for reforms from many credible sources such as the IMF, the EU, the USA, and many others who are friends of Lebanon. The strain on liquidity in US dollars, and the abundance of Lebanese pound in circulation, which emerged recently, are other lingering symptoms of this corruption. Lebanon has only one problem: corrupt political system; and every other ill the nation has is deep rooted in corruption! It is no longer if, what or when; it’s clearly corruption which caused a total loss of trust & confidence in the financial system – financial institutions and monetary authority, which is reflecting on Lebanese’s willingness to accept any money that is produced by this ‘system’ in the productive exchange of goods and services!

Money occupies a unique position in a free economy. In its absence, the whole prosperous economic life would collapse like a pack of cards. Money must be made available in an adequate quantity to serve its functions, which are:  

1. Primary functions also called fundamental and original functions like the Medium of Exchange and Measure of Value.
2. Secondary functions like Standard of Deferred Payments, Store of Value and Transfer of Value.
3. Contingent functions like Distribution of Income, Measurement and Maximization of Utility etc.

Here, I am talking about money in general. In Lebanon we have been blessed with a multi-currency monetary system; and, thanks to our corrupt politicians, the blessing turned into an utter curse! The blessing comes from Lebanese’s ability to switch to an alternative currency (the US Dollar) in case the government resorted to debt monetization to deal with its overwhelming debt burden. For years Lebanese have been able to use the US, European, and Local currencies to finance their household and investment expenditures. In fact, a number of foreign currencies functioned like money side to side with the Lebanese pound. The choice of currency favoured the Lebanese Pound up until late 2017. Awareness over the unsustainability of the public debt and the refusal to reform forced economic agents to seriously consider resorting to a safer currency, the US Dollar. However, the sudden eruption of the financial crisis made that jump near impossible. Unexpectedly, banks decided to seal their drawers on dollar withdrawals and transfers outside of Lebanon! Now that safety net is no longer available, the corrupt government embarked on a fast-track journey to debt monetization causing an alarming and a fast-moving drop in the buying power of disposable income! Debt Monetization is a corrupt politician’s number one policy option.

Corruption and Debt Monetization are two sides to the same rotten coins. Let’s explore this. Any government that issues its own currency could, in theory, continue to create money without limit. The idea that governments either have to tax or borrow in order to spend is really just a consequence of the legal and institutional infrastructure we, as a society, have created. Things could be different, but when the monetary printing press is in the hands of corrupt politicians, the temptation to inflate currency is strong. There is the fear that excessive printing of money and subsequent spending will lead to inflation, then hyperinflation, and then eventual abandonment of the currency. We are there: we have abandoned the Lebanese Pound! Further, we live in an era of very limited (beyond scarce) economic resources, if the government has unlimited amounts of money, then it could potentially control all of those resources, essentially “crowding out” the private sector. Obviously, this is problematic, and any attempt to compete with the government in utilizing resources leads to a bidding up of the price of those resources.

To mitigate these fears, responsible governments have delegated the power of money issuance to independent central banks, hoping to keep fiscal policy considerations separate from monetary policy ones. Since the primary goal of central banks is to maintain price stability (usually interpreted as low and stable inflation), governments should not depend on central banks to fund their operations! Now you know where things went astray here in Lebanon; the Central Bank lost its independence to corrupt politicians, and the temptation to inflate the Lebanese pound became possible and way strong!

On the other hand, any government that issues debt far in excess of what it could collect in taxes is perceived as an excessively risky investment and will likely have to pay increasingly higher interest rates. Therefore, the willingness of the private banking sector to hold government debt must depend on the return and riskiness of that debt relative to alternative investments. Clearly, Lebanon experienced double the pleasure: excessive issuance of government debts, and banks’ excessive exposure to sovereign debt.

Now that the Lebanese government seized the moment and embarked on the path of debt monetization, what’s the fate of our money? We cannot think of life without money; IF AND ONLY IF MONEY SERVES ITS RAISON D’ETRE!

What is money? It is anything which is generally accepted exchange for other things and which can discharge all obligations, past and present. According to the conventional approach, money is defined on the basis only of its function as medium of exchange. When so defined, money includes:

• Fiat Money which is a currency established as money, often by government regulation, but that has no intrinsic value. Fiat money has value only because a government maintains its value. The extent of acceptability of Fiat Money as money is contingent upon the level of trust one has in the government issuing the currency. 
• Bank Money (deposits, plastic cards, etc.) which takes on a different form. Checks, for example, are not accepted by all. They are accepted only from known persons and/or entity! If you have a reason not to trust the issuer of the check (the account holder and/or the depository institution), you would not accept it. The same holds true for plastic cards (or eMoney). The extent of acceptability of Checks and eMoney (i.e., bank money) as money is contingent upon the level of trust one has in the institution issuing the check/card. 

For money general acceptability is essential. One can easily infer what the essentials of good money can be:

1. The basic ingredient of good money is that, it must be stable and not rapidly change in value,
2. It must then be a generally acceptable medium of exchange,
3. It must be a suitable unit of account.
4. It must be a suitable store of value,
5. Being generally acceptable, it should be capable of transferring value.

By now one can easily understand why we have a currency crisis in Lebanon. Even the cash dollar in our pockets is no longer stable in exchange! OUR MONEY IS AS GOOD AS WHAT WE CAN DO WITH IT; and that’s what is no longer clear in the hearts and minds of Lebanese households and investors! When we have a stable and a generally acceptable medium of exchange that is suitable as a unit of account and a store of value, then we have ‘money’ and the choice of money (fiat and/or bank money) becomes of little significance.

The main issue is, then, money not currency! If the road to economic recovery is likely to be very long, the road to reclaiming the real worth of our Money (Fiat and Bank) will be much longer! In the absence of trust, there shall be no money! It is not about the Dollar, nor the Lollar, nor the Lebanese pound! Government actions, or lack of, continues to be at the root cause of every ill Lebanon is suffering from. The financial crisis could have been avoided had reforms been applied! The economic fall could have been gentler had the decision to suspend the payment of "Eurobonds" bonds been taken in conjunction with several measures, including communicating with bondholders.