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Chronicle of the Middle East and North Africa

Lebanon’s Gold: A Casualty of the Financial Crisis?

Lebanon’s Gold
An employee puts a bar of gold on a scale. FRANK RUMPENHORST / DPA / AFP

Ali Noureddine

The Mikati government in Lebanon has presented a comprehensive picture of how to distribute the banks’ accumulated losses in the budgets of the Lebanese financial industry in its most recent preliminary talks with the International Monetary Fund. The difference between the banking sector’s mammoth obligations to depositors in foreign currencies and the remaining liquidity in commercial banks and the Central Bank, which according to the government’s plan exceed $69 billion, is what must be addressed in order for the banking sector to regain stability and solvency.

This chasm was created as a result of a number of circumstances, including the massive sums of liquidity that lenders deposited with the Central Bank and then spent in an attempt to prop up the local currency. Furthermore, much of this liquidity was used by the Central Bank to pay huge amounts in interest to lenders, benefiting bank owners who lent depositors’ money to the state in order to finance the public debt, which has grown multifold since the 1990s as a result of the Lebanese state’s failure to repay its debts.

Financial plan, losses and risk to gold

To curtail massive losses, the Lebanese government has recommended a set of steps in its plan to the IMF, which the latter must approve before Lebanon can enter a loan program with the Fund. Lebanon is seeking a loan from the IMF of up to $4 billion, which can be paid back in installments if the Lebanese government adheres to the measures outlined in the financial plan. The financial plan to cover the deficits is mostly dependent on printing money to disburse deposits denominated in foreign currencies in Lebanese pounds. These would be paid in 15-year increments, at unfavorable exchange rates compared to the real exchange rate. Other options include converting some deposits into bank shares or state-owned investment bonds, according to the plan.

In essence, based on the objectives of the government’s plan, depositors would shoulder the aggregation of the losses with the reduction of their deposits’ value through the adoption of low exchange rates to pay back foreign currency holdings. The losses will also spill over to all residents through the expected decline in the exchange rate of the Lebanese pound in the future as a consequence of the increased cash creation to pay back depositors. Finally, the most dangerous aspect of the proposal is relinquishing the Lebanese state’s assets – which rightly belong to the current and future generations – in order to rid Lebanese banks of the crag of accumulated losses in their budgets.

However, this is hardly the worst aspect of the Lebanese government’s budgetary plan. The proposal also includes the liquidation or sale of gold held by the Central Bank (approximately 286.8 tons) in order to address a portion of the monetary and financial crisis, noting that Lebanon ranks 20th globally and second in the Arab world after Saudi Arabia in terms of the amount of this precious metal held. Simply put, this gold, which Lebanon has been holding since 1948 and is now valued at about $17 billion at today’s market prices, is now up for sale as part of a strategy to offset the losses of the Lebanese banking sector.

Thus, the Lebanese government has returned to the practice of squandering public funds in order to bail out the banking sector from a crisis resulting from the decisions of its investment departments, as well as the Central Bank’s decision to channel profits to the bank owners themselves, at the expense of depositors. After profiting from their banks’ investments in the Central Bank and funding the public debt in the past, bankers are now attempting to recoup their losses with the public’s money rather than incurring the expense of monetary reforms. It should be underlined that the additional monies expended to save the banks are intended to lower the extent of the losses that the banks’ owners will have to face, either by reducing the value of their stock or by forcing the banks to recapitalize to deal with some of the losses.

From this, it is reasonable to deduce the Central Bank’s decision to conduct a full inventory of the gold it holds for the first time in more than thirty years, which appears to be a prelude to the process of selling of this gold after ensuring the stock’s size. This coincides with Lebanon’s presenting of a preliminary deal with the IMF, an arrangement that prepares the way for the signing of a final agreement with the Fund later, on the basis of the government’s financial plan, which includes the sale of gold held by the Central Bank.

Lebanon’s history with the yellow metal

Lebanon began amassing gold for the first time in 1948, when it bought some 1.5 tons of the yellow metal in order to disengage the Lebanese pound from the French franc after the country gained its independence from France in 1943. At that time, the aim of storing gold was to enhance confidence in the value of the local currency, which had become pegged to the value of gold on the one hand, and on the US dollar as a global currency on the other. Lebanon chose at the time to incorporate measures in the Monetary Law of 1949 requiring the establishment of sufficient gold and hard currency reserves to cover 50% of the cash circulating in the local currency market. This was done to keep the Lebanese pound’s credibility and worth, and it has subsequently pushed successive governments to increase their deposits of this valuable mineral. As a result, gold reserves continued to grow over the years until 1971, when they reached 286.5 tons, at which point no more purchases were made.

The world entered the stage of floating currencies in 1971, when the US dollar’s value was de-pegged from the country’s gold stock and other currencies’ values were allowed to freely fluctuate without consideration for the value of gold. The Bretton Woods system, which had been in place since 1945 and dictated that the world’s currencies be tied to the dollar, which was in turn pegged to gold, came to an end as a result of this. With the exception of minor regulatory constraints, Lebanon’s Central Bank was no longer required to cover issued banknotes with gold holdings or other reserves under the new monetary system. The preservation of previously accumulated gold, on the other hand, remained a strategic imperative for enhancing confidence in the Central Bank’s assets and the solvency of its balance sheet.

Following the start of Lebanon’s civil war in 1975, the Central Bank transferred nearly 75% of its gold to Fort Knox, Kentucky, where it was placed in a deposit controlled by the Central Bank of Lebanon. In view of the decline of the Lebanese state’s ability to secure its institutions, particularly the Central Bank, the goal of that step was to protect the gold from the military upheaval that the civil war saw between 1975 and 1990. It should be emphasized that the Central Bank building, which houses the institution’s gold reserves, was subjected to deliberate or accidental shelling at several points throughout the war, prompting the decision to store the gold at Fort Knox.

In 1986, Lebanon enacted Law No. 42 as a precautionary measure to protect gold from the effects of political and security instability during the civil war. Unless Parliament issued a specific law, it was illegal for any party to dispose of gold by selling or mortgaging it, directly or indirectly. As a result, the law established extra restrictions that banned the transfer of gold ownership in any form, especially since the operation of state institutions was marred by turmoil, strife, and disorder during the civil war, raising the likelihood of a party misappropriating the Central Bank’s gold.

All of this emphasizes the Central Bank’s gold holdings’ historical positionality, which the government has long regarded as a strategic stockpile that should not be jeopardized because it is the last line of defense for the Central Bank’s balance sheet’s stability. In reality, despite Lebanon’s fiscal losses, this residual solvency is the single factor that gives the Central Bank of Lebanon confidence when dealing with foreign correspondent banks abroad that are still willing to provide it some financial operations facilities.

Gold-selling schemes

In contrast to all the historical propensity to preserve the Central Bank gold, the government today shows an unfathomable disregard for this strategic wealth, as illustrated in the most recent plan presented to the IMF. Initially, the plan stated that gold would be sold in the future in order to use the proceeds to address the monetary crisis, but it did not specify how these proceeds would be used or the quality of the controls that would ensure their optimal use within the framework of the financial recovery path. The ambiguity surrounding how these returns will be used has fueled widespread fears that this move will be a foolish waste of strategic gold reserves, similar to how the Central Bank has squandered the majority of its foreign currency reserves in a haphazard and ill-conceived manner since the start of the crisis.

Later, negotiations with the IMF began to reveal the government’s inclination to use the proceeds from the sale of gold within the framework of the bank rescue process and to rid the lenders of the bulk of their losses by using the proceeds to pay part of their obligations to depositors. In particular, it was discovered that the gold would be squandered only to curtail the accumulated losses that banks would bear, while increasing the proportion of the losses that would be charged to public funds. Thus, in the event the gold is sold, instead of using the proceeds from the highly sensitive sovereign wealth governed by a well-thought-out and productive long-term financial vision, the government is predisposed to use it to serve the most influential class in the financial system.

To date, the government has not received initial approval from the IMF regarding its approaches, including those related to the how losses would be distributed, which has stymied the plans for the gold in the Central Bank’s possession. In the coming days, the government is expected to start a new round of talks with the Fund which will focus on the financial plan on whose basis Lebanon will obtain the IMF loan. Consequently, the coming days will determine the fate of Lebanon’s gold, within the framework for the distribution of losses that will be agreed upon by the Lebanese government and the Fund. Subsequently, any designs on the gold in the future will require special legislation from Parliament, given the existence of a law that prevents the government from disposing of it without the Parliament’s approval.