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What’s Going on in Turkey?

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You’ve probably heard about economic troubles in Turkey. But what’s really going on and what caused it?

In simplest terms, Turkey is in the midst of a currency crisis. The value of the lira has dropped to record lows. Year-to-date, the Turkish currency has fallen 45% against the US dollar. The official inflation rate is over 15%, but economics professor Steve Hanke said the real annual inflation measured for today tops out at 101%.

Many analysts fear the crisis will spread beyond Turkish borders. The plunge in the lira has made investors jittery about other emerging markets and set off a wave of selling. Reuters said the situation in Turkey has “revived fears of contagion that has been the sector’s Achilles heel for decades.”

The mainstream has primarily focused on dollar strength along with Turkey’s growing diplomatic and trade spat with the US. Many analysts say the doubling of steel and aluminum tariffs by the US set off the lira crisis. This week, President Recep Tayyip Erdogan announced retaliatory tariffs on US passenger cars, alcohol, tobacco, cosmetics and other products.

Mainstream analysts tend to focus on the here and now, but economist Daniel Lacalle says the crisis has been a long time in the making. In an article published by the Mises Wire, he wrote, “The Turkish Lira collapse should have surprised no one. Yet, in this bubble-justifying market, it did.”

Lacalle says the lira crisis has little to do with the strength of the dollar.

The collapse of Turkey was an accident waiting to happen and is fully self-inflicted.”

Monetarists claim a country with monetary sovereignty can create all the currency it wants without any threat of default. But as Lacalle says,  monetary sovereignty means nothing without strong fundamentals to back the currency.

Erdogan effectively seized control of the central bank and pushed a policy of money-printing and artificially low interest rates to “boost the economy.” Sound familiar? Turkey’s money supply tripled in seven years.  Several mainstream articles note that the Turkish president’s refusal to allow rates to rise is one of the factors exacerbating the meltdown today.

Of course, the lira depreciated as the central bank inflated the currency. As Lacalle explains, this was all very intentional.

However, the lira depreciation was something that was not just accepted by the government but encouraged.  Handouts in fresh-printed liras were given to pensioners in order to increase votes for the current government, subsidies in rapidly devaluing lira soared by more than 20% (agriculture, fuel, tourism industry) as the government tried to compensate the loss of tourism revenues due to security concerns with subsidies and grants.

“Loss of foreign currency reserves ensued, but the government soldiered on promoting excessive debt and borrowing. Fiscal deficits soared, and the rapidly devaluing lira led to a rising amount of loans in US dollars.

“This is the typical flaw of monetarists, they believe monetary sovereignty shields the country from external shocks and loans in foreign currencies soar because no one wants to lend in a constantly-debased currency at affordable rates. Then the central bank raises rates but the monetary hole keeps rising as the money supply continues to grow to pay for handouts in local currency.”

When you look at the Turkish policy that led to the currency crisis, it looks an awful lot like Federal Reserve and US government policy. That led Peter Schiff to call the United States the “real Turkey” in a recent podcast.

If you think about this theory again, that the US is going to borrow $2 trillion and the rest of the world is going to fund it, and therefore there is going to be no money left over for anything else, that just shows you how economically unviable this current monetary system is where the dollar is the reserve currency and the world has to finance American profligacy no matter how much we want to borrow … No matter how much we want to borrow, all of that saving all over the world is going to get sucked into the US Treasury market to the exclusion of all else? So the rest of the world, starting with the emerging economies, everything is going to implode because all of the money that would normally be going there to finance legitimate investment is going to be loaned to the US government so they can clip coupons for 10 years at 3%? I don’t think so …  What if nobody wants to buy all of those Treasuries. What if the idea of a 3% yield on a US Treasury bond, what if it’s not as great a deal as everybody seems to think is? What if people actually look at the numbers and say, ‘You know, I don’t want to buy US Treasuries at 3%. I wouldn’t buy them unless they were 7% or 10%. The problem is the US government can’t afford to pay 7% or 10%. They can barely afford 3. So, if the world decides that they don’t want to buy all of these Treasuries that everybody just assumes are going to be bought, to the exclusion of all else. So the Turkish lira and all of these other currencies are going down because everybody assumes all of the money is going to flow to the dollar; what if they’re wrong? What if the world doesn’t want our paper? What if even Americans don’t want our bonds? And why should they? Again, why should an American citizen buy a US Treasury when he’s guaranteed to lose money? There’s no reason to do it. There should be no demand anywhere for US Treasuries. And when that happens thent he roles are reversed and America is Turkey.”

Of more immediate concern, the mess in Turkey could easily spread into Europe. As Lacalle notes, the exposure of eurozone banks like BBVA, BNP, Unicredit to Turkey “is very relevant”  – between 15% and 20% of all assets. Turkey’s loans in dollars account for about 30% of GDP. Loans in euros could be as much as another 20%. Turkey bet that the dollar would continue to weaken and that the Fed wouldn’t actually raise rates. It lost that bet. But Lacalle says the erroneous bet only adds to the already existing monetary and fiscal imbalances.

Money supply continues to grow at almost double-digit rates, the government’s outlays exceed the diminishing reserves and capital flight starts to be evident as savers and investors fear that the Erdogan government prefers to take the option of capital controls in order to seize complete power than to restore economic credibility with sound money policies.

“Like Argentina before, raising rates too late does not calm the market when the risk is capital controls and a bank run. Raising rates to 18% does not encourage anyone in Turkey to keep money in the bank when the risk is to lose all the money. Rates went from 8 to 17.5% and the crisis worsened. It will not stop because of slightly higher rates.

“Because the problem of Turkey is monetary and fiscal. Turkey will need a massive adjustment program and a credible opening of its institutions and markets to attract capital and restore growth. Unfortunately, the route seems to be more government control of institutions, less investment security, and deepening the crisis blaming the inexistent external enemy.

“Erdogan is fighting against a very dangerous economic foe: himself.

“For Europe, this is a devil’s alternative. Bailing out Turkey will give further control to Erdogan and increase the imbalances of the economy while imposing higher restrictions to freedom.

“Not bailing out Turkey, on the other hand, would cause a  much larger crisis than Greece was. Because too many eurozone funds and bank investments have been directed towards Turkey as a way to get access to some growth and inflation. What they got was a risk of capital controls and currency debasement.

“The biggest risk for Europe will be to try to cover this mess with some aid in exchange for refugee and border support. Because what is already a relevant risk, but contained, will likely balloon to unmanageable proportions.”

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