Since the first assault on Turkey’s finances in 2018, which I wrote about multiple times (here, here, and here), I’ve been the lone voice telling everyone that President Recep Tayyip Erdogan is a lunatic but he’s a lunatic with a plan.
That plan is to de-dollarize the economy of a valuable member of NATO geostrategically. Since the first shots across the bow by the Trump administration at Erdogan’s toying with those powers east of the Bosporus (Russia, China and Iran) the Turkish lira has been the primary mode of attack against Erdogan.
Erdogan has pursued what has been deemed unorthodox monetary policy since firing his Central Bank during the lira’s 2018 crisis. Then the Bank of Turkey wanted to raise interest rates to 30% to tame inflation. Erdogan, rightfully, in my opinion, stepped in and said no.
Earlier this year he went after Bitcoin exchanges to stem the tide against the lira and buddy back up to Davos a little, but they are more than wise to his game and Erdogan’s reckoning with them was always on the horizon. Today we’ve reached the horizon and the attack on the lira has him in his weakest state politically in all the years he’s been in power.
And with the lira blowing out to 18(!!) versus the dollar this week, Erdogan’s monetary policy has been all the news, especially with him promising to cut interest rates rather than raise them which is the conventional wisdom.
This blowout finally pushed Erodgan to unveil a new package of interventions to stabilize the lira.
The idea that monetary policy should only be conducted on the basis of creating ‘low inflation’ is nonsense, but that is what everyone focuses on with respect to interest rate policy.
It is certainly one factor, and as a committed Austrian in my thinking, I’d rather not even be talking about such things as central banks, monetary policy and what’s a sustainable rate of inflation, since that last part just sounds like a sustainable rate of theft.
But, I digress.
Erdogan was right to lower rates with the Fed raising rates in 2018 and 2019. His central bank threatened to push rates to 30% and that would have broken the country. He fired them and lowered rates, defying conventional wisdom.
Stop and think for a second. There is no reason why any currency should carry a 30% risk factor unless the the goal is to destroy it. Because nothing says you have no confidence in your own currency than someone paying 30% to borrow it.
At rational risk levels, where investment returns govern interest rates, yes there can be a somewhat linear relationship between central bank lending rates and price inflation. But to project that linearity, if it exists at all, out to positive and negative infinity is asinine.
I’d rather you think of the efficacy of interest rates vs. inflation as a sigmoid curve rather than a straight line.
If that wasn’t the case then the negative rates in Europe would have produced massive inflation by now and 20% rates in Turkey massive deflation by now.
But neither thing has come to pass because Keynesians, in their obsessions with aggregate demand, ignore both supply issues and marginal demand effects of policy.
In short, there comes a point where models break and the theory proves incorrect. So, with rates at 24% in 2018 not stemming inflation or the slide in the lira, what would be the point of going to 30%? If 30% didn’t work then 40%? 50%?
It’s this strict adherence to dogma which is the problem, as opposed to saying, “Hey, maybe at these rates other factors are more dominant than central bank lending?” That never enters into the thinking of even the most savvy analysts, preferring instead to parrot clearly broken models because it’s easier to throw shade at a lunatic with power (who may actually be right) than think through what’s actually happening.
There comes a point where one has to ask a series of important questions:
- How did this crisis start?
- Who benefits from it?
- What would be the geostrategic goals of collapsing Turkey’s economy?
Because even the smartest, most savvy analysts always seem miss the bigger picture. Zerohedge has missed the boat in multiple articles, focusing on whether Erdogan’s new package of interventions will work or not, given the state of things.
But no one asked the question, “How does a country like Turkey see its currency with some of the highest interest rates in the world already, collapse over a five month period?”
How does something like this start? Without considering what prompted the slide you’re ignoring what causes it to end. Who has the motive to attack Erdogan through his currency?
Frankly everyone. Is there a limit to creating panic? And if that limit is reached what would it take to reverse it?
How to Lose Friends and Alienate People
The key thing to remember about Erdogan is the following. Everything he’s done, including taking control of the Bank of Turkey, has been to call out the IMF and the banking institutions of Europe as ravagers of emerging markets like the one he runs.
He categorically ruled out ever taking another dollar in aid from the IMF during the last time the lira was attacked (2019). Remember, as well, he’s convinced (and I have no reason to disbelieve him) that the coup in 2016 against him was orchestrated by the U.S. and NATO, his nominal security partners.
So, there are a lot of powerful people who have a history of wanting Erdogan gone. Now, at the same time he’s done very little to secure friends. But, then again there are no friends in geopolitics, only temporarily aligned interests.
So, after that first attack on the lira which took it from around 1.8 to over 7.0 versus the US dollar and he made nice with Trump, goin on a rampage across the eastern Mediterranean acting as NATO’s spear to undermine Russia’s efforts to stabilize North Africa, most notably his excursions in Libya and continued betrayals of the Russians in Idlib province of Syria.
Last year he backed Azerbaijan in the Nagorno-Karabakh conflict while selling drones to the UAF in Ukraine which he was then likely framed for encouraging the use of to escalate the conflict there to drive a further wedge between him and Russian President Vladimir Putin.
Putin, for his part, doesn’t care who rules Turkey as long as it isn’t a NATO satrap. It’s why he’s put up with Erdogan’s nonsense. He knows the situation on the ground would result in a Davos-backed ghoul coming to power.
With that in mind, the whys of getting rid of Erdogan are clear. Now let’s go one step further. What does getting control of Turkey mean geostrategically?
Clearly the 1936 treaty of Montreaux, which gives Turkey full control over what ships can pass through the Bosporus and Dardenelles, is the prize here. Getting rid of Montreaux will allow NATO to bring ships into the Black Sea to ostensibly pressure Russia into giving up Sevastopol.
Good luck with that.
So, with the full court press on against Russia diplomatically by the U.S. with the EU doing its typical “Oh, woe are we, we have to go along with the evil Americans…” bullshit, it’s no surprise to me that Erdogan is under extreme pressure through Turkey’s biggest weakness, its currency, at the same time.
There are no coincidences in geopolitics.
Challenging the Orthodoxy
The collapse of the lira has been epic to behold. And none of this is a defense of Erdogan per se. He’s a lunatic to be sure.
To create a collapse in a currency as weak as the lira was already takes a small net drop in marginal dollar inflow. Erdogan worked to reduce Turkey’s foreign-currency debt situation, but this was complicated by easy money from the Fed post Coronapocalypse.
De-dollarizing is hard if the country’s accounts are open and the Fed is at the zero-bound.
Once the Fed pulled back on foreign dollar liquidity in June the situation in Turkey was going to deteriorate.
So, is the right response raising interest rates when they are already 1) stifling domestic investment in local currency and 2) retarding savings in that currency because of inflation?
NO. Raising interest rates is a statement by the Central Bank that it has lost the confidence of the market and it has low confidence in its ability to get things under control. Raising rates further only makes that perception that much more ingrained.
Truthfully, when has the IMF ever been right about ANYTHING!?
So, now let’s look at what Erdogan has done over the past three years, he’s run monetary policy exactly opposite of the Rest of the World (RoW). He cut while the Fed was tightening. Then tightened while the Fed was easing and is now easing while the Fed is tightening (see Chart Above).
During all of this Turkey’s inflation has been crazy. But this is a consequence of zero-bound policies by the major central banks, flooding the world with dollars, euros, yen, etc. Remember, for us to not have inflation at home while printing trillions, the inflation has to be sent overseas.
Money printing leads to inflation always and without fail (Martin Armstrong’s lame protestations to the contrary). The question is where the inflation shows up and does the government include it in the CPI? Lies, damn lies, British Polling and Government Statistics, is how I think the saying goes.
But, back to Erdogan’s unorthodox methods. He actually rebuilt Turkey’s foreign exchange reserves, which no one gives him credit for and brought in more than 300 net tonnes of gold into the Turkish banking system.
Turkey’s current account deficit disappeared and by allowing the lira to properly fall because it was a mess in 2018, it improved Turkey’s trade balance.
Now, one could argue my embedded point above, that Turkey’s currency woes are a function of outside hot money flows pushing and pulling on the lira based on the geopolitics of the moment and say that once Erdogan was a good US lapdog, the pressure abated and nothing he did in 2019-2020 actually mattered.
Fair enough. But, then that begs the question what is he doing now?
And he’s made it clear that the goal is to de-dollarize the Turkish economy. That he’s going to take Turkey on the same path forced onto Russia and Iran in the last ten years — finding ways to be members of the global economic system of trade while using as few US dollars as possible.
Turkey has to do the same thing. And to do that you have to tell people you believe in both the lira and your ability to get things under control.
Erdogan has been fully cut loose by the West and they want him gone. The polls in Turkey have moved against him and it’s now time for him to put up or shut up.
I said in 2019 there was no easy way out of Turkey’s predicament, that it would not be allowed to leave NATO without a major cost. That cost will be a short-term hyperinflation of the lira and a radical reorganization of the country’s finances, trade partners and everything else.
European banks are still net short a lot of Turkish debt, blowing up the lira and potentially a bunch of Turkish banks would have big blowback effects on banks like Unicredit, BBVA and others.
That’s all the background stuff. Now let’s talk about what he’s actually doing. And the proof is in the details, which we only got on Wednesday.
The centerpiece of Erdogan’s de-dollarization strategy is a pledge to Turks that it was time to end their reliance on the U.S. dollar as the place to go in times of stress. He would guarantee their savings in lira if it depreciates versus the rate of inflation.
Through the program, the government will compensate lira deposit holders if the currency’s value depreciates by more than the interest rate offered by banks on these deposits. The objective of the scheme is to stop retail demand for hard currencies like USD and EUR.
Now, many think this is just MMT(no!) or unbacked money printing (yes, but who cares in this world today?).
This is a bluff, ultimately, but given that all fiat currencies are bluffs then, again, so what? Turkish lira deposits are running double digit rates of return and U.S. rates are zero-bound, the question now is will this bluff be called?
Remember, the Fed is draining the world of dollars and has pledged to do so radically.
Erdogan has to do something to put reserves into Turkish banks, i.e. savings, and have that savings begin forming the pool of real capital for lending. And that pool of capital can’t come in from those hostile to Turkey. It has to come from Turks and those that still want to do honest business with them not subjugate them to the mercantilist machination of Malthusian fascists.
The conventional wisdom is that Turkey should be raising rates here to attract foreign capital. But it is foreign capital that is the source of the lira’s weakness. Why does a currency halve in 3 months? Because foreign money pulls out en masse.
Remember Question #2 above? Cui Bono?
The very people pulling their money out are the ones who run the IMF who then say, “Hey, we’ll give you a loan at reasonable rates to fix your short-term problems.” This is the standard Economic Hitman Playbook. Erdogan refuses to play that game.
The right move is to stiff-arm any foreign creditors dumb enough to think Erdogan won’t punish them, like what China is doing via Evergrande. Expect targeted defaults here by Turkish corporates. Expect favorable treatment by Erdogan for those that no longer have exposure to his enemies.
Because of Turkey’s importance, i.e. access to the Black Sea, he’ll be able to ask for help from Russia and China, who should be happy to help backstop Turkey in their quest to de-dollarize… for a price, of course.
And that price will be doing all trade between the three of them in lira, yuan and rubles… not dollars. You wean the Turks off easy dollars by backstopping their savings, and cutting taxes on savings as well as investment taxes, which is also part of Erdogan’s package.
1. A new Lira deposit instrument that will compensate depositors for losses from Lira depreciation. If the loss from Lira depreciation is higher than the interest gain on the deposit, the difference will be transferred to the depositor and will not be subject to withholding tax.
2. The TCMB will offer Lira forward rates to exporters having pricing difficulties due to the exchange rate volatility.
3. The withholding tax on returns from domestic government bonds will be removed. The withholding tax on corporate dividends will be reduced to 10%.
4. Exporters and industrialists will be given a corporate tax discount of 1pp.
5. The state contribution to the personal retirement system will be increased to 30%.
Yes, there are a lot of risks in this plan but only if there is more foreign money to pull out of the country. The reality is that people don’t run on the banks unless there has been an inciting incident to run the bank’s deposits.
And at some point you’ve pulled all the money out, at some point you reach peak panic and all it takes is someone having the confidence to put their ‘tuppence’ back in the bank’s hands. (You had to know I’d work a Mary Poppins reference in here somewhere.)
A Road to Somewhere New?
So, what if we’ve already seen the worst of the situation and the epic collapse both ZH and Goldman are betting on doesn’t materialize? Will someone finally figure out that central bank interest rates and inflation are something other than a linear relationship?
I heard this same crap in 2014-15 when Russia was going through the same blowup of the ruble. It fell alongside oil prices from 28 to 80 versus the dollar. The assault on oil prices was revenge on Putin for stopping the invasion of Syria by NATO. Russia was sanctioned to the point of forcing corporate debt re-denominations because there were corporate bond rollovers due.
This was the same issue that began the run on the Turkish lira in 2018.
Putin allowed the ruble to float freely, Nabullina at the Bank of Russia raised rates aggressively (to 15.5%), they liberalized a lot of the economy spurring new investment and accepted a yuan/ruble swap arrangement to get dollars into the country to assist in the paying out of the corporate debt.
It worked for Russia and I expect you’ll see the next pieces to the puzzle unveiled in due course as Turkey becomes the next node on the Asian anti-dollar currency bloc that’s forming.
Turkey’s debt to GDP ratio is low (39% in 2020). The government has plenty of room to take on the FX risk here and revalue a lot of the foreign currency debt which is the source of the trouble.
That Turkish banks can hold gold as a reserve asset directly means that as we move into a gold bull market thanks to the Fed finally admitting its lost control over inflation Turkish bank balance sheets will offset any lira weakness with gold now that the government has backstopped savings.
You’ll see more investment by both Russia and China in Turkey thanks to the devaluation, increasing tourism and local investment by their people.
There comes a point where you can only hurt a currency so much by pulling out foreign capital. And once it’s all been pulled out all that’s left is people making do with what’s available.
Turkey is too valuable a piece of real estate and too valuable a partner geostrategically to let fall here. China needs it for OBOR; Russia for holding onto control of the Black Sea and Iran as a conduit through which it conducts trade while under extreme sanctions.
The West is taking a major shot at he Turks here. But the numbers we are talking to backstop the banking system there are peanuts versus the potential long-term benefits of cleaving Turkey from NATO for Russia and China.
I expect some of that newly-freed up capital within the Chinese banking system thanks to the PBoC easing will make its way through swaps into the Turkish system.
The thing is, with a strategy like this, you have to let things get so bad that the currency goes bidless. Stocks go bidless etc. It’s only then that you can attract the maximum amount of speculative money into the market as well as give your potential partners the best return on investment if they come to bail you out.
When there’s blood in the streets betting that it’ll become a river of blood is a bad bet. The better bet is that the madness of crowds is in the past and the immense opportunity to clean things up arrives.
This is what China did when they came in to stabilize the ruble in December 2014. The announcement of a currency swap line arrangement between China and Russia is what marked the end of the ruble crisis. Any Chinese money that flowed into Russian banks in 2015 did very very well as bond yields fell steadily until 2020 and the Coronapocalypse.
The same thing is going to happen here with Turkey. And conventional wisdom will be wrong…. as always.
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