Turkey is in the oven

By August 14, 2018 March 28th, 2019 Blog, Uncategorized

When much of your national debt and domestic corporate borrowing is in foreign currencies and an upward cycle in interest rates follows, you have a fighting chance to trade your way out, with a bit of luck and skilful steering.

But when the main levers in the economy are politicised and when one strongman reckons he can outfox free market economics by dictating terms to the Central Bank, you’re in trouble. This time it is Turkey, but another extreme example is Bolivarian Socialism as practised in Venezuela – where inflation is expected to run to one million per cent this year and where the people’s prosperity has been incinerated despite sitting on vast oil wealth.

Hugo Chávez, who was eulogised for his loaves and fishes strategy by Irish President Michael D Higgins when he died in 2013, sold products from nationalised industry to Venezuelans at prices below the cost of production, financing the gap with oil revenues. The inevitable destruction wrought on Venezuelan citizens after his economic wheeze collapsed was stark, not just in lost wealth but lost body weight too while chunks of the population exited, as the young emigrated to societies that work.

The Turkish president, Recep Tayyip Erdoğan, follows in the footsteps of other strongmen who initially give the appearance of defying economic gravity, borrowing to invest in pet projects and infrastructure and rolling back institutional freedoms like Central Bank independence, to bend market forces to his will. Erdoğan is lately fingering Trump as the bogeyman responsible for his currency meltdown, but the truth is that the lira has been declining throughout his tenure and US tariffs are merely the straw that broke the camel’s back. Look past Erdoğan’s propaganda and Turkey exports 5.5% to the USA, which is not enough to trigger this crisis. Erdoğan’s money printing, leading to currency devaluation that fuels exports, became unstuck as the Turkish lira took a nose-bleeding fall at the end of last week.

This week, Turkey faces a crisis as its currency plummets. At close of play yesterday (13th August) it was at about seven lira to the dollar and about eight to the euro, but in August alone the lira has lost 30% of its value, jacking up the cost of servicing its dollar and euro-denominated national debt in a maw shared with many of Turkey’s big corporates who’ve borrowed big in foreign currency.

With the levers for money supply in his political pocket after kidnapping the Central Bank, Erdoğan printed lira out the door, tripled money supply over seven years, slashed interest rates and bought popularity by flinging borrowed money about to attract votes. In August 2018, this homespun economic model became undone.

Turkey joins a club that includes Argentina, Venezuela, Zimbabwe and Greece where structural problems were papered over with debt until the game was up. Consider the 30% fall in the lira in August so far against servicing US dollar loans, estimated to account for 30% of GDP and euro loans at 20% GDP. It is a self-inflicted trap.  Turkey is on the cusp of bankruptcy.

Erdoğan’s response has been typically politicised, calling on Turkish patriots to sell their hard currency and gold to buy lira, blaming Trump’s steel and aluminium tariffs, and setting his face against raising interest rates, already elevated at 17.75%. Crisis analysts estimate that the Central Bank would need to lash on at least another 10%, pushing interest rates to 27% to stem the panic.

“By relaxing reserve rules at banks, Erdogan hopes that the extra liquidity released will act as a buffer. He is wrong.”

The reason Turkey matters is that those unconvinced by the decade of extreme Keynesian economic experiments which has added another 50% to the global debt bubble think Turkey could be the tip of the spear. It is early days in the crisis for the world’s 17th largest economy, but already emerging market currencies are taking hits and banks in Europe – BNP Paribas, Unicredit and BBVA – are heavily exposed to Turkish loans and face losses.

Currency falls are not in themselves game-stoppers but where a decline in currencies is symptomatic of unaddressed structural problems and entrenched imbalances in an economy, recessions follow. Add to the mix weak institutions and ideologies replacing rational economics and these type of structural recessions can morph into something quite nasty, engulfing a country in economic, banking, political and social unrest.

Since the Global Financial Crisis (GFC), we’ve learned the very hard way that everything is interconnected in the complex wiring of the global financial system. European banks have exposure to Turkey, whose corporates will struggle to not default on loans if the crisis isn’t stabilised. Meanwhile, markets will reprice the risk to capital deployed to emerging markets generally, triggering a greater flight back to currencies – likely the US dollar – and for which interest rates are now rising.

The point is, what is happening to Turkey can spread. Turkey, like many countries including Australia, has ingested huge capital flows, the outcome of extreme monetary policies worldwide. It is inevitable that the tightening cycle now underway will expose the weakest parts of an ‘everywhere bubble’ caused by the response to the GFC.

The tide is going out and Turkey will not be the first or the last to be found naked.

Eddie Hobbs

August 2018