The financial press commentary on the meltdown in the Turkish lira and worries about contagion has for the most part stuck to tried and true tropes. For instance, a hackneyed first page story in the Wall Street Journal claims that early in the new century, all those sorta seedy countries decided they were going to get on the path of becoming good capitalist democracies. But they they backslid.
Since my knowledge of Turkey and emerging markets are limited, hopefully the informational nuggets below are on target, and as usual, reader input is very much appreciated. Interestingly, Jesse speculated yesterday that a short-term bottom might be in and obligingly, the Turkish lira rose 6% this morning, almost fully recouping Monday’s losses. But it is still down roughly 25% for this month.
Turkey was overdue for an economic reversal. The US didn’t cause the financial crisis in Turkey, but it is doing its best to make a bad situation worse.
The best overview by far was at Moon of Alabama late last week. The short version is that Erdogan inherited a Turkey that was an economic mess, and got the benefit of reforms implemented by his predecessor plus additional ones he made. However, Erdogan was inattentive as to the pattern of the resulting growth, which was very heavy on unproductive real estate investment (sound familiar?). He was also unwilling to allow a recession to moderate inflation. But the biggest problem was that Turkey’s chronic current account deficit was getting larger and reached 6%. A rule of thumb is higher than 4% will lead to currency depreciation. Erdogan has made matters worse by not being willing to increase interest rates to choke rising prices.
Trump’s threat to impose steel and aluminum tariffs on Turkey thus added fuel to an existing conflagration.
But the Fed played a role too. The US has long taken the position that it bears no responsibility for how lax or tight money in the US plays a big role in the movement of hot money in and out of emerging economies. From a 2014 post:
As Bernanke is about to take leave of office, attacks on his policies are becoming louder, thanks to financial markets turmoil resulting from the Bernanke/Geithner approach to the crisis: do whatever it takes to restore as much of status quo ante as possible. The problem, of course, is that status quo ante is what got us in this mess in the first place…
India central bank governor Raghuram Rajan took to Bloomberg to criticize the Fed for its failure to coordinate policies with the rest of the world. And Rajan can’t be dismissed as a partisan defending his country’s policies. Rajan is a Serious Economist, former IMF chief economist, and best known in popular circles for presenting a badly-received paper at Greenspan’s last Jackson Hole session that said that financial innovation was making the world riskier and could well cause a full blown financial crisis. And he assumed office only last September, so he’s also not defending policies he implemented. ….
Some of his key points:
Emerging markets were hurt both by the easy money which flowed into their economies and made it easier to forget about the necessary reforms, the necessary fiscal actions that had to be taken, on top of the fact that emerging markets tried to support global growth by huge fiscal and monetary stimulus across the emerging markets. This easy money, which overlaid already strong fiscal stimulus from these countries. The reason emerging markets were unhappy with this easy money is “This is going to make it difficult for us to do the necessary adjustment.” And the industrial countries at this point said, “What do you want us to do, we have weak economies, we’ll do whatever we need to do. Let the money flow.”
Now when they are withdrawing that money, they are saying, “You complained when it went in. Why should you complain when it went out?” And we complain for the same reason when it goes out as when it goes in: it distorts our economies, and the money coming in made it more difficult for us to do the adjustment we need for the sustainable growth and to prepare for the money going out.
Economist Ann Pettifor took up this theme in the Independent yesterday:
Today’s financial turbulence can be traced back to Fed decisions in June 2017 to begin the “normalisation” of its balance sheet, gradually shedding its bond holdings in monthly stages. This monthly “runoff” of $10bn of maturing assets on to capital markets causes bond prices to fall, and yields to rise…
To add to the strains caused by the “runoff” of assets, in June 2018, the Fed raised rates for the seventh time in three years and Libor followed suit. These rising rates of interest have led to the strengthening of the dollar and capital flight from emerging markets…
Thanks to capital mobility, quantitative easing enabled companies, like many based in Turkey, to borrow in dollars on the international capital markets at low rates of interest. Now, as Turkey’s currency and those of other emerging markets fall, the cost of servicing debt denominated in dollars rises dramatically, threatening default.
Last week, the contagion worry was exposure of wobbly Eurobanks like BBVA and UniCredit to Turkey; yesterday, the focus turned to emerging markets. Recall that emerging markets were already looking fraught, thanks to both Argentina and Pakistan seeking IMF rescues. From the Financial Times:
Highlighting the spreading turbulence, Indonesia’s central bank reportedly intervened to support the rupiah, while Argentina’s central bank unexpectedly lifted its main interest rate by another 5 percentage points to 45 per cent. The unexpected hike came after the Argentine peso had fallen for a sixth consecutive day to hit a record low against the dollar.
JPMorgan’s EM foreign exchange index tumbled 1.3 per cent to a record low, and is on track for its worst monthly performance in more than six years. European financial stocks also came under pressure on Monday, especially banks such as BBVA and UniCredit that own stakes in Turkish lenders. US stock were also hit by the turbulence.
Erogan is unlikely to be dented much by this turbulence. Despite being widely disliked overseas for his authoritarianism, such as purging academics, Erdogan still enjoys solid support at home. The country endured far greater instability before Erdogan’s rule, and at a much lower level of general prosperity, so Turks are likely to tough this out. But a “new normal” is being ushered in, and Erdogan is already on track to make it even leaner than it need to be. How popular he will be after several years of belt-tightening, particularly if the currency crisis produces energy shortages, remains to be seen.
It’s not clear what Trump thinks he will gain from punching Turkey. Anyone with an operating brain cell can see that this row is not about a deal to release US pastor Andrew Brunson falling through. Turkey is critical to China’s One Belt, One Road initiative, and has also been working with Russia. From the Chicago Tribune in April:
Russian President Vladimir Putin heads back to Turkey on Tuesday, joining Turkish President Recep Tayyip Erdogan at a symbolic ground-breaking ceremony for a Russian-made nuclear power plant being built on Turkey’s Mediterranean coast at Akkuyu. On Wednesday, Putin, Erdogan and Iranian President Hassan Rouhani are expected to hold a summit in the Turkish capital of Ankara to discuss Syria’s future.
Turkey and Russia have put aside their traditional rivalries and differences on regional issues to forge strong economic ties. In December, they finalized an agreement for Turkey to purchase Russia’s long-range S-400 missile defense system, a deal that raised eyebrows among some of Turkey’s NATO allies. Aside from the power plant, the two countries are also building the “Turkstream” pipeline to transport Russian gas to Turkey.
Moon of Alabama’s take:
The pressure is, and has been since 2013, to bring Erdogan in line with the U.S. agenda. He will have to stop his good relations with Russia. He will have to stop his purchase of the Russian S-400 air defense system. He may be ordered to stop the Russian pipeline. He must follow the U.S. lead on Syria. As long as he does not do so the U.S. will try everything to bring him down.
The only chance Turkey has to escape from U.S. demands is to further ally with Russia. Putin knows that Erdogan needs him. He will play for time to increase the pressure and then make his own demands. Erdogan will have to give up completely on his plans for Syria. All Syrian land Turkey or its proxies hold must be put back under Syrian government control. Only then will the Turkey’s trade route to the Gulf states reopen. Only then will Russia (and Iran) help Turkey though its crises.
Trump isn’t bothering to pretend to treat Erdogan as an ally but as a subordinate. I can’t see that working. Turkey has important assets, in particular, the Incirlik air base. Recall that the US has no major air bases in Iraq or Afghanistan. If the priority is a united front against Iran, pummeling Erdogan into (minimal) cooperation is a presumptuous way to try to get there.