Turkey’s main stock exchange halted trading on Friday when the circuit breakers kicked
in after the main index fell 5 per cent.
After trading resumed, the benchmark index was more than 8 per cent lower.
Turkey’s stock market has up until now been a safe haven from the chaos engulfing the
country.
Investors were willing to own stocks, betting that a weaker lira is good for exporters.
Even after Fridays fall the Turkish stock market is still up by more than 40 per cent
this year in local currency terms.
That sounds good, but in dollar terms, it has fallen by 36 per cent.
This sell-off came as the Turkish lira fell a further 7 per cent to new all-time low on
Friday, a day after the central bank again lowered interest rates despite a reported
annual inflation rate of more than 20 per cent.
This morning it has continued its collapse down an additional 6%.
Usually when researching a topic like this, I like to speak to financial experts on the
ground in the country in question.
It has been easy to talk to experts on the ground in China in making my Evergrande series,
but because of the political situation in Turkey, anyone I have contacted has said that
they don’t feel they would be safe if they had an honest conversation about the economy.
They weren’t even comfortable with the idea of an off the record conversation.
Ok, So lets start with some background on Turkey and its economy.
Turkey is a country with a proud history, The Anatolian peninsula, which makes up most
of modern Turkey, is one of the oldest permanently settled regions in the world.
Modern day Turkey was established in 1923 after the Turkish war of independence when
Mustafa Kemal Atatürk became the republic's first President.
He transformed the old religion-based constitutional monarchy into a parliamentary republic with
a secular constitution, implementing social political and economic reforms.
Turkey is a transcontinental country located in both Asia and Europe, it has a majority
Muslim population.
It is one of the most visited tourist destinations in the world, and is notable as the only country
in the world where they drink more tea than the Irish do.
The United Kingdom only comes in at number four on the list – and that’s because
they classify PG Tips as tea – which even the advertising makes clear is only suited
for monkeys- but – that’s for another video.
Turkey had a painful experience of high and chronic inflation over the period from 1975
through to 2004 caused by political instability, poor institutions, high public sector budget
deficits and depreciation of the Turkish Lira which culminated in a severe financial crisis
in 2000-2001.
The establishment of an independent central bank in 2001 which focused mainly on fighting
inflation along with tight fiscal policies implemented at the same time finally brought
inflation under control.
Starting in the early 2000’s an economic boom transformed Turkey into an upper middle-income
country, The poverty rate collapsed between 2002 and 2014 and Turkey was even hoping to
become a member of the European Union.
While still classified as an Emerging Market, Turkey was seen as one of the most developed
developing countries in the world.
According to the IMF, in 2020 it was the twentieth largest economy in the world by GDP.
A crackdown that came after an illegal coup attempt in 2016 damaged Turkeys relationship
with the European Union.
Turkish President Erdoğan indicated his approval of reinstating the death penalty to punish
those involved in the coup, with the EU suggesting that this would end the countries EU membership
ambitions.
The European Parliament temporarily suspended membership negotiations due to the "disproportionate
repressive measures" of the government to the coup in November of 2016.
As I mentioned earlier, Turkey's national currency has been in freefall.
It has fallen 60% against the dollar year to date and down 93% since 2008.
The Turkish Stock Market is down 36% this year in dollar terms and down 61% over the
last four years.
On Thursday after a widely expected interest rate cut, the Turkish Lira fell 5 percent.
President Erdogan had announced his intention last month to lower rates despite soaring
inflation of more than 20 percent.
This currency crash has hit Turkish citizens hard with almost daily price increases and
officially reported inflation rates of 21 percent - analysts say true inflation rates
may be double that.
Right after Thursday’s rate cut, President Erdogan announced that he would be raising
the minimum wage in the new year by 50 percent.
In his speech, he described the increase as a “historic” pay boost for the country’s
workers, about 40 per cent of whom earn the minimum wage.
While this increase might sound good in lira terms, it represents a 27 per cent decrease
in pay for workers in dollar terms compared with the start of this year due to the collapsing
currency.
There is of course a feedback loop between inflation and wages.
As the inflation rate increases, you have to increase the minimum wage, but then the
minimum wage increases, create more inflation.
So, how is this affecting people in Turkey?
An inflationary environment is obviously very difficult for those on the lowest incomes
and for retirees.
The press is filled with stories of minimum wage workers and retirees struggling to afford
food.
Farmers are struggling too.
Tomato prices, a key ingredient in Turkish food are up 75% since last year which you
might think is good for farmers, but the cost of fertilizer, pesticides and fuel all of
which are imported are up even more meaning that farmers are struggling to break even.
Small businesses and tradesmen are struggling too.
It is hard to hike prices on your customers when they can barely afford to pay, but input
prices are going up day by day.
Bakeries have started posting signs explaining their higher prices by listing surging costs
of ingredients like flour, oil and sesame seeds.
Many small businesses don’t know how they will be able to keep their staff when the
minimum wage rises.
Exporters have been doing better, as they benefit from the low wages in Turkey and the
rise in the value of foreign currencies, of course a lot of these businesses have more
than half of their customers in Turkey, and that business is drying up.
Bigger companies are better able to use financial instruments to hedge against rising input
costs and currency fluctuations.
Wealthier individuals with savings, seeing the value of their savings decline began moving
their savings into US Dollars and Euros, causing the currency to fall more.
Many people even turned towards cryptocurrencies until they were made illegal in April of this
year.
A lot of Turkish businesspeople have debt in foreign currencies and their income is
in Turkish Lira, this group have possibly been squeezed the most.
Now, Some analysts are claiming that Turkish authorities might be manipulating consumer
price inflation data, a claim that the government deny.
Consumer prices and producer prices have tracked each other quite closely over the last twenty
years.
In the last year producer prices have risen 46% when the Turkish CPI is showing 20% inflation.
This disparity might be somewhat explained by businesses choosing to absorb some of the
costs for fear of killing customer demand.
If this is the case though, it could be a warning sign that further consumer price rises
are likely in the near future.
So, What’s causing this?
Well, there are a variety of things causing inflation in Turkey and putting pressure on
the Turkish lira.
We can start out with the simple explanation that as an importer of energy and intermediate
goods, Turkey is exposed to inflationary pressures, caused by a rise in energy prices and supply
chain disruptions.
These problems are being seen all around the world.
Next up, we can point out that emerging market currencies have mostly performed badly against
the dollar this year.
The expectation that the US Federal Reserve will reduce its asset purchase programmes,
means that capital that was chasing higher interest rates in developing countries is
now being brought back home.
This has led to an appreciation of the dollar against most emerging market currencies.
None of these issues really explains the problem in Turkey.
The simplest explanation for the extreme level of inflation being seen in Turkey and for
the collapse of the Turkish lira is President Erdogan’s unorthodox economic policy of
cutting interest rates during a period of high inflation, with the belief that this
policy will boost Turkey's economic growth and export potential.
Erdogan’s unconventional economic theory is rooted in Islamic economics and Marxism.
He has invoked Islamic precepts against usury and referred to interest on loans as the “mother
and father of all evil.”
He mostly blames foreign interference for rising prices and claims that lower interest
rates lead to lower levels of inflation.
This is the opposite of what most economists believe to be true.
Erdogan argues that if the lira loses value against the dollar, Turkey’s exports will
simply become cheaper and foreign consumers will want to buy even more.
While this idea does contain some truth, these gains come at a heavy price.
Turkey is heavily dependent on imports, and as the lira depreciates, imported products
cost more to buy.
In recent months, Erdogan has cited China’s economic transformation as evidence that his
model would work, and while it is true that China devalued its currency in the 1980s and
1990s, this devaluation was combined with a clearly defined industrial policy.
It is not clear what industries Turkey is trying to promote with a currency devaluation.
It is also not settled that this is a winning policy for China.
If a country could simply build an export-oriented economy by destroying their currency, Zimbabwe
would be the world’s factory today.
There is a certain incoherence to Erdogan’s ideas.
Turkish authorities have spent billions of dollars defending the lira in recent weeks
while simultaneously praising the virtues of a cheap currency.
Erdogan increasingly looks like a gambler doubling down after each losing bet.
While his core idea of defeating inflation makes no sense at all, one slight positive
is that his Islamic ideology helped keep government debt levels lower than they might otherwise
be.
Most of the problems in Turkey are tied to low interest rates which led to real estate
malinvestment.
The low interest rate policy led to a debt-fuelled construction boom which collapsed in 2018.
At its peak the property development sector made up 20% of Turkish GDP growth.
Turkish property developers often funded their buildings with cheap loans in foreign currencies.
At the end of 2016 nearly 90% of the credit in Turkish real estate companies came from
loans in foreign currencies.
The Istanbul Sapphire – one of the tallest buildings in Europe – was financed through
US dollars.
As the Turkish Lira collapsed, those loans exploded.
The construction boom peaked in 2014, 69 skyscrapers more than 100 meters tall were built in Istanbul
alone since 2008, many are still unoccupied.
Up to half of the buyers of luxury properties were expected to be wealthy investors from
Gulf countries.
But that demand never materialized.
The lack of demand, along with the rising costs for construction materials, caused many
of these projects to stall.
Much like in China, real estate speculation affected many ordinary Turks who paid for
new apartments upfront, off the plans, these homes were never built as the developers ran
out of money.
Unlike Beijing, the Turkish government actually tries to keep the construction bubble inflated.
In June 2020, the government banks were instructed to lower their interest rates for mortgage
loans for new apartments to 7.68% per year — and add a period of no payment for the
first 12 months.
During that time, Turks could earn 10% interest in their savings accounts.
So, the banks were pushed to lend at 7.68% when they were paying their customers 10%
interest rates – a crazy situation.
All these efforts did move the market, but the number of homes that have never had an
owner in Turkey have risen to over 1.5 million in the first quarter of 2021.
This is a huge stockpile of property waiting to be sold.
Aside from the local construction projects, there were also massive government construction
projects like Istanbul Grand Airport, the largest airport in the world and a number
of large bridges.
The Osman Gazi bridge for example, cost almost a billion dollars to build and guaranteed
the operators 40,000 cars per day at a toll of 30 euros plus tax per car.
It is rare for 40,000 cars to ever cross the bridge in a day.
The toll is very expensive in Turkey, especially because it is payable in Euros and the Lira
has collapsed against the Euro.
The toll has since been cut to make it more affordable for Turks with the government paying
out the difference to the operators.
One of the big problems with low interest rates is that they can lead to malinvestment
like this.
I mentioned at the start of this video that the Turkish economists I tried to speak to
were unwilling to talk, even off the record.
There is a good reason for this.
Since 2014, the year Erdogan became president, over 160 thousand investigations were launched
into people for insulting the president, and almost 13 thousand people were convicted.
People who “insulted the president” during a chat on a public bus, would find themselves
arrested at the next stop.
The Human Freedom Index shows that in the past ten years, the nation gradually lost
much of its freedom.
This loss of freedom is tragic, but also economically harmful.
Moving away from democracy is shown to cost a country around 20 per cent of its gross
domestic product in the long run.
While older people are being more careful in Turkey, the most visible display of public
dissent is among younger Turks on social media.
A recent viral video in Turkey showed a mother praising the President to a reporter, while
her eight-year-old son contradicted her, pointing out his poor handling of recent disasters.
Young Turkish people are not at all happy with the way things are going.
One in five young people in Turkey is out of work.
Turkey has the world's fourth highest rate of youths who are not employed, in education
or training, according to the OECD.
Almost nine million Turks born since the late 1990s will be eligible to vote in the next
election in 2023 and that could spell trouble for Erdogan and his party, the AKP.
So how might this crisis end?
Well, Normally, investors look to a nation’s central bank to keep inflation in check and
to set interest rates.
Turkeys president has repeatedly shown that if Turkey’s central bankers and finance
ministers won’t do what he wants, he will fire them and replace them with someone who
will follow his directions.
He has fired three central bankers in the last two years.
In 2018 he even made his son in law the Finance minister.
With an election coming up in 18 months, Erdogan seems convinced that his growth strategy will
enable the Turkish economy to grow out of its problems.
Most economists, however, say a crash is more likely.
For a country in crisis, Turkeys problems are not really that difficult to solve – it
is not a total basket case like some emerging markets.
The country mostly just needs a sensible interest rate policy and an independent central bank.
Turkey has a lot of positives, it has a diversified economy, growth is good, it has good demographics
and an educated workforce.
There are of course issues with corruption, but they are not as bad as in many emerging
markets.
Turkey still is a democracy where elections do matter, but whether Turkey will find a
way out this mess soon, is unclear.
There are elections scheduled for June 2023, and polls show that this time Erdogan may
be defeated.
Whether he would accept defeat is a difficult question with no clear answer.
If the president continues to pursue a programme of interest rate cuts then the lira will fall
further and prices will continue to rise.
In those circumstances the only way for Turks to defend their savings will be to turn to
a currency outside of Erdogan’s control.
Unless he suddenly changes course, the most important question facing Turkey, a country
with great potential, is how much longer the president will stay — and how much damage
he can do before leaving.
If you enjoyed this video, you should watch my video on Evergrande and the Chinese Economy
next.
Have a great day, and see you soon, bye.