By Peter Tase
On June 17, 2020, Mr. Richard Banks hosted Prof. Dr. Steve H. Hanke, Professor of Applied Economics at the Johns Hopkins University, as the keynote speaker of a prestigious Euromoney Conference that was moderated in a webinar format and entitled: “Sovereigns: who’s going to default and when?”
Euromoney Conferences is the world’s leading organizer of events for capital markets and investment professionals. It is a prestigious organization with almost 50 years of experience connecting global companies and governments with the financial institutions that support their growth.
In his lecture, Prof. Dr. Steve H. Hanke shared a series of valuable economic assessments, elaborated on the current global situation, and was very articulate on the prognosis of countries such as Lebanon, Albania, and Greece. The following is a summary of his highly praised lengthy statements about the three Mediterranean countries.
Who is going to default Next?
Recently, I have been looking at Lebanon very carefully because Kurt Schuler and I actually had one of our books, Currency Boards for Developing Countries, published in Tripoli last month at the Lebanese Institute for Market Studies. Lebanon has the same problem as Argentina: a collapsing currency and a near-Ponzi scheme set up between the central bank and the fiscal authority. We don’t need to get into the weeds or go down a rabbit hole on that topic, but the end of the story is that they were running a big fiscal deficit due to government expenditures, and the central bank was financing much of it. Later, however, the commercial banks were basically forced to take over financing responsibilities. The currency has lost about eighty percent of its value relative to the US dollar. To lose 80 percent of a currency’s value, inflation must be running around 200 percent per year. So, a very high inflation rate is at the root of the loss of internal purchasing power value. But, the Lebanese are also in default. Of course, they are in default because the Lebanese pound has collapsed. The weight of all this debt is enormous.
The only way to get out of this crisis is to install a currency board system in Beirut, in which the pound would be traded at a fixed exchange rate with the US dollar. For example, the dollar would be the anchor of the currency board so that 100% of all currency in circulation would be backed with US dollar reserves. The pound and dollar would then trade freely at the set exchange rate. This would impose a hard budget constraint in the system and put some discipline on the fiscal authorities. This is just what is needed because the political institutions have become very weak in Lebanon.
Most emerging market countries have very weak institutions and chaotic political arrangements. Lebanon is quite unique and dysfunctional. When you do not have a monetary authority that can extend credit to the fiscal authority, a hard budget constraint is put into place. The trouble with the Lebanese is that their political system is so dysfunctional that they are basically waiting for the IMF to come in and bail them out. And, they are trying to guess what kind of program they can put together that could satisfy the IMF. The Lebanese themselves have no idea what to do and are just guessing what Washington and the IMF want them to say.
What they should do is what Bulgaria did in 1997 when I was President Petar Stoyanov’s adviser. After hyperinflation occurred in February 1997, with a monthly inflation rate of 242%, we decided the only way to put a stop to it was to forget the proposed IMF program. The IMF wanted their usual program, a managed floating exchange rate and an inflation target among other standards. That would not work in Bulgaria because the institutions were fuzzy. Remember, Bulgaria was under communism until 1990 and this was in 1997. So, their institutions were fuzzy, and the political system was fairly dysfunctional.
We put in a currency board in July 1997, stopped the hyperinflation within 24 hours, and normal interest rates returned within 30 days. You can imagine anyone investing in the Bulgarian bond market made a fortune.
Back to Lebanon. The nation should propose a currency board to the IMF. Then, the IMF would do just what we did in Bulgaria, when they said, “Great, you want to put yourself in a straitjacket with a currency board and stabilize the economy? Fine. We are all for it.” That is what the Lebanese should do. The Lebanese have not figured out that if they come up with the good idea to put themselves in a straitjacket and basically institutionalize themselves, the IMF would love it and give free cheers.
Furthermore, the Managing Director and Chairman of the Executive Board of the IMF happens to be from Bulgaria, and she knows exactly how a currency board works. The Lebanese are lost and right now their pound is trading at around 5000 per dollar. It will go to ten thousand or even fifteen thousand if they keep doing this, maybe twenty thousand. It will blow out completely.
Countries that have had currency boards or have been dollarized since 1950 have grown at a much more rapid rate and have witnessed income per capita rise much more rapidly than countries with a central bank. Deficits, debt, and default levels are smaller in countries that have currency boards or are dollarized than those with central banking. And, there is essentially no chance of a banking crisis. So, the proof of the pudding is in the eating.
Most of these emerging market politicians are so stupid they do not even know what the historical record is, and of course, they don’t want to wear a straitjacket because most of them are completely corrupt and spending like drunken sailors. Lee Kwan Yu in Singapore is the only guy who figured things out.
Greece is in a much better shape than it was in 2008. The Prime Minister seems to have a reasonably good grasp of what is going on. Concerning the coronavirus, I don’t know what magic wand they have down there, but they seem to have come out of it pretty much unaffected. Now, they are desperately trying to open up for tourist season.
I am looking forward to seeing the president of Albania in September. If I can talk him into adopting a currency board, Albania will not be going through default. Otherwise, it probably will.