Lebanon’s Economic Crisis and How To Trade Q1 Forex Moves

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Picture this: you wake up on a sunny Sunday morning to get your groceries for the family breakfast. But unfortunately, the price of your usual groceries has suddenly skyrocketed. 

Not the ideal way to start your Sunday, right? Unfortunately, this is the reality for many people in Lebanon these days.

The Lebanese currency crisis is one of the most severe economic crises in modern times, with the country’s currency losing over 90% of its value against the U.S. dollar.

The crisis has caused inflation to soar and poverty rates to increase, resulting in major economic concerns.

In this article, we will examine the factors that led to this crisis, if the U.S can experience such a disaster, and how you can potentially trade this market environment.

The Crisis

Let’s start by saying that Lebanon is in big economic trouble.

The country is sinking at a rapid pace, all thanks to the sky-high inflation that has shot up in the last couple of years.

Here’s a look how inflation in Lebanon compares with other economies over the years:

Lebanon Inflation Compared with EU, USA, and the Global Economy

Source: worlddata.info

And the situation hasn’t changed since. 

In January 2023, inflation hit an annual rate of a whopping 124%, causing communication costs to soar by 331%, while education, health, and restaurant and hotel prices rose by 191%, 176%, and 174%, respectively. 

All this is happening amid a political deadlock in Lebanon that has blocked the formation of a new government and the enactment of reforms required to unlock billions of dollars in aid.

But the crisis has been a long time in the making, with multiple factors contributing to its development.

It came to the fore in 2019 when the Lebanon government defaulted on its foreign debt, meaning it could not repay its debt to foreign nations.

One of the primary factors in the country’s crisis has been a high level of public debt, which stood at around 170% of the gross domestic product (GDP) in 2019 and 197% of GDP in 2021.

This made Lebanon one of the most indebted countries in the world, and servicing the debt became increasingly challenging as the economy deteriorated.

Another factor that contributed to the currency crisis was the country’s political instability.

Lebanon has a complex sectarian political system with political paralysis and the lack of confidence in the government’s ability to manage the economy led to a loss of trust in the currency.

Finally, the crisis was exacerbated by the pandemic, which led to a decline in economic activity and a drop in remittances from Lebanese expatriates. This put additional pressure on the already fragile economy and the sinking currency.

And the deal with hyperinflation and poverty is straightforward: Lebanon’s economy has been dollarized as the local currency is nearly worthless.

People have been buying and selling using dollars as the value of the Lebanese pound has been fluctuating drastically every day. So, the government allowed using dollars in the economy. But this didn’t go well as the government had to stop dollar withdrawals (because Lebanese banks didn’t have enough) which has pushed citizens into poverty.

The ultimatum here is that people are setting ATMs on fire as they can’t withdraw money to pay for necessities. And every time this happens, the cost of goods they can’t buy keeps rising significantly because of the demand-supply imbalance.

Here’s how inflation in Lebanon has soared in the last couple of years:

Lebanon Inflation Rate (in %)

All the above developments had some major economic repercussions…

Effects on the Lebanese Economy

The Lebanese currency crisis has had a major impact on the country’s economy, leading to soaring inflation, rising unemployment, and a sharp decline in economic activity.

According to the World Bank, Lebanon’s economy contracted about 58% between 2019 and 2021, with GDP falling to $21.8 billion in 2021, from about $52 billion in 2019 — the largest contraction on a list of 193 countries!

Here’s how the country’s real GDP growth has been over a decade up until 2022:

Lebanon Real GDP Growth (yearly, in %)

Source: www.ceicdata.com, Central Administration of Statistics

One of the most visible effects of the crisis has been the sharp depreciation of the Lebanese pound against the U.S. dollar. This has made imports more expensive, leading to soaring inflation and a decline in purchasing power for Lebanese citizens.

The crisis has also led to a decline in foreign investment and a drop in bank deposits. 

All this has put additional pressure on the country’s financial system.

How Are These Crises Formed and Busted?

Currency crisis bubbles are formed when there is a significant imbalance between the demand and supply of a currency.

This can be caused by a variety of factors, such as high inflation, high levels of debt, political instability, and a lack of foreign investment.

It can also be seen when the government prints tons of paper money to prop up the economy. 

This has been the case with Lebanon and many other countries such as Turkey, Pakistan, Argentina, and Venezuela where the local currency is witnessing a sharp devaluation.

In the case of the Lebanese currency crisis, the imbalance between the demand and supply of the currency was caused by various factors, including economic and political instability.

As the crisis deepened, the demand for U.S. dollars increased, leading to a sharp depreciation of the Lebanese pound.

When a currency crisis bubble bursts, it can lead to a sharp depreciation of the currency. This can impact the economy with rising interest rates and even social unrest and political instability. Moreover, it can upset global financial markets.

Could the U.S. See Such a Crisis?

Well, the short answer to this can be Yes and No.

Yes, because the U.S. has printed an ungodly amount of paper money or ‘easy money’ in the last few years. Have a look:

United States Money Supply M2 (in billion dollars)

And this money printing has led to a consistent rise in inflation in the U.S. recently.

U.S. CPI Inflation (in %)

However, the U.S. central bank has been prudent to avoid a full-blown economic crisis as it has been raising interest rates significantly to curb the resulting inflation. 

The Federal Reserve has raised interest rates 7 times in 2022 and by 25 basis point in 2023, as can be seen below:

 Fed Rate Hikes in 2022

Fed Rate Hike in 2023 so far…

Source: federalreserve.gov

So, as long as the central bank is vigilant in keeping the financial stability of the economy in check, there’s hope for revival in the coming quarters.

Nevertheless, the Lebanese currency crisis is a stark reminder of the dangers of economic mismanagement, excessive money printing, high levels of debt, and political instability.

It highlights the importance of implementing structural reforms to address imbalances in the economy and to restore confidence in the currency.

Traders and investors should take note of the lessons from such a currency crisis and consider diversification and risk management in their investment strategies.

Our pro analysts are closely following these trends and they predict major shifts in these USD pairs

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Predicted movements expected to last through the end of Q1 2023.

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