This is Turkey.
The 17th largest economy in the world.
A country and an economy which is no stranger to controversy.
Yet its ongoing currency troubles with the turkish lira
are arguably its greatest macro economic headache, at the moment.
But why?
by half versus the dollar since 2018?
Ultimately
this is due to turkey's vulnerability to capital inflows,
the perils of high inflation
and out of step interest rates
though to truly unravel this complexity
I need to tell you a story
A story which involves the credit crunch,
cheap credit
and an every day economic instrument
that the President of Turkey
has called the mother and father of all evil
So in order to tell this story we'll be addressing
When Turkey's problems first started to appear?
What Turkey's macro economic problems actually are?
How Turkey has tried to solve its lira crisis.
and why initial plans didn't work out?
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In the aftermath of Turkey's 2001 financial crisis and IMF bailout.
Which was ironically due in part to high inflation and foreign capital outflows,
the economic good times rolled in.
But and there is a big but here.
These good times sowed the seeds for where Turkey finds itself today.
Between 2002 - 2007 the economy grew rapidly.
At an annual rate of 7.2%
Following a short recession in 2009,
it bounced back strongly in 2010 - 11,
with growth over 8% a year.
Such stellar growth
made Turkey one of fastest growing economies in the G20
However as time went on
this rapid growth became more unbalanced.
Being driven mainly by fast capital accumulation.
This capital accumulation,
was based on rapid foreign capital inflows,
of so called "hot money".
Which was used to largely finance construction activities.
Highlighted by an interesting little fact
that Istanbul,
now possesses the second highest number of skyscrapers in Europe,
after Moscow.
The majority of the capital accumulation,
was financed through foreign debt.
As the country had access to cheap credit,
in a world of low interest rates,
a global economic recovery at the time
and significant quantitative easing.
However,
when you build your economy on the sand,
at some point or another it will come crashing down.
For Turkey this crash came about in 2018.
When rising inflation,
concerns about an over extended banking system
and the independence of the central bank all coincided.
You see, in most advanced economies
enables it to set interest rates
and implement macro economic policies which protect the economy.
Unfortunately in Turkey's case,
the government passed laws, giving it a say
over elected positions
and put their central bank under pressure to drop interest rates
and expand credit.
In doing this it was effectively planning for Turkey
to borrow its way out of the crisis
A big part of its current problems.
The point about interest rates
can't be emphasised enough.
Contrary to conventional economics, President Erdogan
referred to interest rates as the mother and father of all evil.
Arguing lower interest rates would see them through the economic turmoil.
An unconventional economic approach,
which goes against the widely held view
that low interest rates
are an expansionary policy which tends to lead to higher inflation.
Not to mention a weaker currency.
Now,
this all helped set the backdrop
for Turkey's current crisis.
An economy which slid into recession in 2018.
A currency which has fallen by 60%
and an inflation rate in the double digits.
So given these events and factors
If we were to point to one thing,
it would be Turkey's high inflation rate.
You see, inflation is like father time.
Slowly, or quickly in Turkey's case,
eroding the value of money.
At the beginning of the video,
I mentioned that Turkey has suffered from high inflation in the past.
And to put it in context
the country's inflation rate is a lot better than it had been in the 90s
but has been above 15% since 2018.
Typically, some inflation is expected
and a sign that an economy is moving.
With most central banks targeting 2%.
Whereas Turkey has been targeting over 7% a year.
From a currency perspective,
the problem with inflation
is that if it is more than the inflation of other currencies
it can diminish the value of the currency.
This is because currencies are constantly seeking to balance out with one another.
To find out how much one currency is worth in another.
In Turkey's case, high inflation
was an important factor in the lira's decreasing relative value compared to other currencies.
Now,
one way to counter higher inflation,
is to simply offer higher interest rates
on Turkish lira holdings.
Yet as explained,
Turkey has not been a fan of higher rates.
dropping them from 24% to 8.25%
A trend which was broken in September 2020
with a 2% rate hike.
Though most economists below this 2% increase
didn't go far enough.
As Turkey's real returns
after offsetting any interest payments for inflation
is negative.
Negative real returns are a huge problem
for a country dependent on capital inflows or so called "hot money".
which follows opportunities across the globe.
Yet we can take inflation
to be as much a symptom as an underlying cause.
The core issue for the lira,
is excessive supply relative to demand.
Turkey consistently spends more on imports than exports.
Leading to a large current account deficit.
Now you may be thinking
so does the US or the euro
and they don't experience the same issues.
Well that's another story
partly to do with reserve currency status
which I explained in a previous video.
The link to which should be appearing on your screen now
and in the description below.
In Turkey's case
a big problem is that demand for the lira
through Turkish exports
is less than the supply of lira through paying for imports.
A problem made a lot worse
by the complete collapse of tourism in 2020.
You see tourism is a key economic sector for Turkey
and crucially a usually reliable source of foreign currency.
About 45 million overseas tourists visited Turkey in 2019
equivalent to 60% of the population
and all those tourists
brought with them a combined $35bn
but that was in the good times.
With arrivals in the first half of 2020
down by 3/4s.
A big shock to the system.
Like any currency which quickly loses value
this has forced households to swap their quickly diminishing liras
for a more stable foreign currency.
A trend known as dollarisation.
Why dollars?
Well, because as the world's main reserve currency
it is considered a safe store of value.
As such, Turkey's dollarisation has been high.
With the share of Turkish deposits held in foreign currencies
reaching 50%.
Whilst dollarisation may help protect household savings.
It can actually make a currencies decline worse.
As more of the population sell more liras
for less dollars.
It also restricted the effectiveness of economic intervention
as there are less liras been held by Turkish households
to be impacted by government policies.
At this stage
things appear pretty bad, especially for households.
The the country's financial companies
are also facing challenges which are contributing to the crisis.
Chief among them is looming repayment deadlines.
If you remember earlier,
I mentioned that during the good times
Turkish companies borrowed heavily externally.
Well yeah, this was largely done in dollars.
And now an estimated $170bn of debt
is coming up for repayment.
The trouble is that whilst the debt is in dollars
Turkish companies earn mainly in liras.
So the size of the debt grows,
as the lira plummets relative to the dollar.
A key risk
to the financial system if the companies can't refinance their dollar denominated debts.
So after all of this
The central bank has been trying to reach a number
of mutually exclusive goals:
maintaining low interest rates,
reducing inflation,
promoting economic growth
and keep the lira stable.
How it has tried to achieve this
reveals the catch-22 Turkey finds itself in.
Earlier in the video I mentioned Turkey's central bank
has lost some of its independence.
This has been made evident in its low interest rates.
Done in an attempt to keep the economy moving
to easy access to cheap credit.
Credit which has fuelled Turkey's economic performance in the past.
The problem is that low interest rates
have been a significant factor in high inflation
and the lira's devaluation.
So to address this currency slide
the Turkish central bank
has been propping up the value of the lira
through buying it up on the open market.
Whilst the lira is meant to be a free floating currency.
In a bid to maintain price stability
the Turkish central bank
has spent a considerable portion of its foreign reserves
buying liras on the open market.
To boost its ability to do this
Turkey tripled a foreign currency swap deal
with close ally Qatar
for $15bn.
In addition to buying dollar reserves
the central bank has been hedging its bets
by buying up the world's ultimate reserve currency
gold.
In fact, Turkey has been doing this
to such an extent that in July 2020
it became the world's largest buyer of gold.
Overtaking Russia.
Why?
Well, the jury is still out on this one.
But commentators suggest
it's to do with rising concerns over its ability to access dollars.
With a direct dollar swap
with the US on a similar basis as the Qatar deal
being turned down by the US government in the recent past.
The country also took the rather usual step
of temporarily banning
six large currency trading banks from trading the lira.
In the hope of stopping speculation on its weakening currency.
A moved considered a step away from an open market liberalised market.
Well,
basically these plans are underpinned by the assumption
that the liras crisis will be over in the short term.
As you can imagine,
selling your foreign currency reserves to support a currency
is only a viable option
for as long as you have reserves to sell.
Unfortunately for Turkey
it is quickly burning through these resrves.
Goldman Sach's estimates that the central bank
has spent $65bn
on supporting the currency this year alone.
With gross dollar reserves having fallen to $93bn.
This may sound like a substantial amount
but over half of these reserves are borrowed.
With the bank relying on an elaborate system
which borrows from the foreign currency savings
owned by Turkish citizens in Turkey's bank vaults.
A way to capitalise on the high dollarisation rate
we mentioned earlier.
In fact, taking a deeper dive into the accounts
suggests that the central banks net reserves
are in fact in deeply negative territory.
Raising concerns that the bank
is "robbing Peter to pay Paul".
Leading some wondering
how long this can go on for?
Well, some analysts think
this will go on for as long as there isn't a run
on Turkey's banks by local savers
wanting to withdraw their foreign holdings.
So, not a sustainable strategy.
As alluded to earlier,
the country's efforts have been significantly hampered compared by negative real returns.
Demonstrated through high inflation
compared to low interest rates.
These are keeping foreign capital
or "hot money"
out and investors away.
Economists are in general agreement
that Turkey will need to raise its rates substantially
if it is to get the situation under control.
Something it has been reluctant to do
given its reliance on credit linked growth
and questions over the independence
of its central bank.
Nonetheless,
the Turkish central bank's 2% September 2020 rate hike
has been welcomed by analysts.
But whether this is too little too late
remains to be seen.
We've seen Turkey's growth was largely funded by "hot money" inflows,
which can leave an economy,
just as quickly as it enters.
Growth was underpinned by borrowing on construction related activities.
The cracks really started to appear in 2018.
When the related concepts of high inflation,
low interest rates,
looming foreign debt repayments
and negative real rates
all combine to depreciate the lira.
Turkey has followed an unconventional approach
to address the crisis.
Not really addressing its low interest rates
and propping up the lira through dwindling foreign reserves.
This strategy assumes a quick recovery,
as it only works for as long as FOREIGN reserves hold out.
Recent moves to raise interest rates
are widely believed to be positive.
But perhaps too little too late
to prevent a full blown currency crisis.
As we come to the end of this video
we at AltSimplified really hope you've enjoyed it.
We're interested to hear what you think about Turkey's
currency crisis in the comments below.
Do you think it's the result of inflation?
An non-independent central bank?
Or something else?
Let us know in the comments.
And as always
if you've enjoyed this video
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See you in the next video!