Is there a ray of hope for the Lebanese people?

Firstly, I want to wish anyone well who has family, friends or contacts in Lebanon. If it wasn’t already a difficult time, it is now.

If you haven’t seen the shocking footage of yesterday’s explosion – this is probably the clearest I have seen:

Click here to watch the video.

Lebanon is a fascinating place, a cradle of history for millennia, a place of religious tolerance and strife, of incredible food and culture, of corruption and disaster. It’s in the Middle East but you can ski there, it has huge wealth, but plenty of extreme poverty too.

It’s been compared to Paris for its architecture and luxury, Switzerland for its financial power, but draws less favourable comparisons due to its corruption and recent hyperinflation.

In short, like everywhere else, it cannot be boxed in by generalisations.

Was this a bomb, or an explosion? Accident or aggression? It’s certainly too soon to say anything with certainty, so instead I’d like to look at a few other forces at play in this tremendous, but troubled country.

One of the key contradictions within its society, from a financial and investment perspective, is in its monetary policy. It has high levels of gold reserves, a pegged currency, and now, a banking and inflationary crisis.

Its GDP per capita (measured in $USD) has come along in fits and starts since the 1980s…

Source: The World Bank

But it is also corrupt – scoring only 28/100 on the internationally recognised Corruption Perception Index (100 is the best – the Nordic nations, Singapore, Switzerland and New Zealand are top in the high 80s).

The problem with Lebanon, as one academic put it, is that “corruption has been democratised, it’s not sitting centrally with one man. It’s all over.” The Telegraph reports that the people of Beirut were already cursing the government this morning, having long been taught that incompetence or negligence would be behind the disaster.

Just last week, a long-serving foreign minister resigned because he said there was just no appetite for real reforms to help the country. He warned that there was a real risk Lebanon would become a “failed state”, and this explosion hasn’t exactly helped to challenge that analysis.

Corruption leads to inefficiency, and potentially also to the kind of mismanagement which leaves huge stocks of flammable ammonium nitrate in warehouses at the port – which is one possible explanation for the explosion which is doing the rounds.

The most urgent problem though, is inflation.

This chart provides a stark warning to the rest of the world, that inflation (red line) doesn’t have to go in line with monetary recklessness (central bank balance sheet – blue line). It will catch up eventually though, and once it’s broken out, it’s very, very hard to control.

Source: Koyfin

According to the Financial Times, Steve Hanke of Johns Hopkins University estimates that inflation in Lebanon has been running at a “sizzling” 52.6% per month. Since the monthly inflation rate has exceeded 50% for 30 consecutive days, it now qualifies as hyperinflation, he says.

Wages are paid at the pegged currency rate, but prices have moved in line with the real situation, meaning that a $500 equivalent paycheque will only buy $75 of goods, if that. Red meat is going at $50/kg and is so expensive that it’s been struck off the army’s ration book.

If you saved money in Lebanese pounds, your life’s savings have been pretty much wiped out.

Only the corrupt elite and politicians can still get $1 for each £1,500 LBP they have – the official rate.

The thing is, the Banque du Liban (central bank of Lebanon) does have one thing going for it…

It has very high levels of gold reserves.

Especially when measured relative to the size of its economy. According to Banque du Liban statistics, the value of Lebanon’s gold holdings is equivalent to nearly 50% of the country’s money supply. That makes it one of the best-backed currencies, in gold terms, in the world.

Here’s a chart of the value of its gold reserves in billions of US dollars, up until 19 July.

Rest assured it’s much higher now, one year on, as yesterday gold broke through the $2,000 mark – surging after a lengthy pause just beneath that psychological barrier.

Source: CEIC

Look familiar? Here’s the price chart of gold in USD terms – that ginormous technical formation of the “cup and handle” is visible in both, with a previous peak in 2011.

Source: Koyfin

As of August 2020, Lebanon had 286 metric tonnes of gold reserves, giving it the 18th largest pile in the world. It has the 83rd largest economy, according to the World Bank.

That hasn’t saved it though, not yet. The peg to the USD has failed. Officially pegged at 1,507.50 Lebanese pounds to the dollar, the devaluation on the street means we’re talking 10,000 Lebanese pounds or more are being demanded as equal to a single dollar.

This puts immense amounts of pressure on a pegged currency, which must draw on dollar or gold reserves (risky and unpopular moves) in order to maintain the official peg.

Some commentators (Kyle Bass in particular) see a similar scenario playing out in Hong Kong, where devaluation and falling reserves threaten the Hong Kong dollar’s peg to the USD.

That’s what happened in the Asian Crisis of 1998 – the Thai bhat broke its peg, and the ensuing carnage toppled a number of Asian economies, and via the hedge fund Long-Term Capital Management, almost took Wall Street with it.

The Turkish lira also saw an extreme move in overnight borrowing costs for its currency a couple of days back.

Together, you can look at these two countries to argue against anyone who says that the currency crisis is over.

But mainly, this brief glimpse at the situation in Lebanon shows, yet again, a conflicted picture. It has held on to impressive levels of gold reserves as most countries have seen theirs dwindle, but corruption and bad economic management have led to a truly dire situation, which is crushing the middle class and evaporating savings.

Hopefully the surging price of gold can provide some much-needed relief to the situation in Lebanon in the months and years to come.

But for now, the rest of the world should heed its warning.

Best wishes,

Kit Winder,
Editor, UK Uncensored

PS To learn more about investing after gold’s latest surge (is it too late??), click this link.

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