Turkey’s currency turmoil follows a well-known scenario. It is one more case in the long series of financial crises that afflict the international monetary system. Just over the past two-and-half-decades, international markets experienced the crisis of the British pound (1992), the Mexican and Argentinean currency crises (1994), the East Asia currency turmoil (1997), and the collapse of the Brazilian currency (1999).
In 2007, the liquidity-driven housing boom in the United States began to falter and Lehman Brothers filed for bankruptcy threatening the global financial system. In 2009, the Greek debt troubles started as the overture to the European financial crisis of 2010. The European Central Bank and the International Monetary Fund bailed out the troubled countries with Greece receiving several packages that ended in 2018 without a significant recovery of its economy.
Now it is Turkey’s turn. The dispute about an American citizen as a religious prisoner in Turkey, a tweet by the American President about higher tariffs on imports from Turkey, and the Turkish Lira spiraled into a hefty devaluation.
After some recuperation after the severe losses which the Turkish Lira suffered in the first wave of the sell-off in early August, the currency’s value sank again against the US-dollar and the euro thereafter. Since January 2018, Turkey’s currency devalued from around 3.5 Turkish Lira per dollar to almost seven Turkish Lira per dollar at its peak in August 2018 (Figure 1).
Figure 1: Exchange rate of the Turkish currency (Turkish Lira per US-dollar)
\Since 2010, the balance sheet of the Turkish central bank has more than tripled. This expansion came as the result of putting an end to the independence of the Turkish central bank by Turkey’s president Recep Tayyip Erdogan. He was democratically elected in 2014 and re-elected in 2018. Over the years since he took power, he has become increasingly authoritarian to the dismay of his Western allies, including the United States.
Turkey is just one more example of the many emerging economies whose leaderships have put their countries on a splurge of debt. Over the past ten years, emerging market dollar debt has more than doubled. The extremely low interest rates of the dollar, the euro, and the yen attracted many governments in the emerging economies to borrow in foreign currencies. There are many candidates which will have to confront external debt problems when interest rates in the United States and Europe should continue to rise.
No Plan
As a response to the currency crisis, the Turkish president did not come up with a solid economic policy plan, which would include a cut in government spending and curbing the money supply. He rather accused ‘foreign powers’ for the mess, with the American President as the prime culprit of his accusations. Instead of signaling economic policies which could stabilize the currency, president Erdogan denounced the fall of the Turkish currency as an ‘enemy attack’ on his country. This reaction of the Turkish president has contributed to a further loss of the value of the Turkish currency.
The devaluation of the currency means that Turkey’s debt burden has doubled in terms of its domestic currency. At the end of the first quarter of 2018, Turkey’s foreign debt amounted to 466.7 billion US-dollars or 55 percent of Turkey’s gross domestic product. While the overall ratio of public debt to the gross domestic product is relatively low, almost 50 percent of the public debt is in foreign currency, which makes the budget vulnerable to a currency devaluation and the stoppages of international capital inflows.
The reduction of the relative burden of public debt was mainly due to a good growth performance over the past decade. After a swift recovery from the international debt crisis of 2008, the annual real growth rate of Turkey’s gross domestic product averaged around seven percent. In the first quarter of 2018, the annual growth rate reached 7.4 percent after 7.3 percent in the quarter before. This spectacular performance is now in jeopardy.
Even if Turkey can avoid an outright default, the economic impact of the sharp currency devaluation with the consequent rise of the interest rate will reduce investments and squeeze profits. As a consequence, unemployment will rise. The Turkish consumers will face rising prices and higher unemployment. The price inflation rate already stands at 16 percent and is two times higher than the mean of the ten years before (Figure 2).
Figure 2: Turkey. Price inflation rate (annual percent)
President Erdogan’s government has lost the confidence of the international investors when the president undermined the formal independence of the Turkish central bank after he took office. At the beginning of his new term, president Erdogan practiced outright nepotism when he appointed his son-in-law as treasury and finance minister in June 2018 right after his re-election.
Turkey’s foreign debt exposure results from the country’s persistent current account deficits as these require the import of capital. With the decline of the Turkish lira, it will become harder to finance these deficits. From 1980 to 2017, the current account balance was on average at -2.5 percent. Since 2001, the country has experienced a sharp deterioration, and the deficit hit nine percent in 2011. After some recuperation to about four percent in 2014, the current account deficit widened again and stands at 5.5 percent in 2017 (Figure 3).
Figure 3: Turkey. Current account balance in percent of the gross domestic product
Since 2002, first as prime minister and since 2014 as president, Erdogan has intensified his grip on the country and abolished civil liberties. The failed 2016 coup has given him a free hand to intensify the authoritarian style of his rule. Erdogan challenges what has defined modern Turkey since the end of the sultanate. As president, Erdogan has moved to authoritarianism driven by religious zeal. He thus represents a break with Turkey’s modern history.
Erdogan’s new mandate extends until 2023. He can act freely based on the new institutional framework of an ‘Executive Presidency’, which gives him broad legal authority over almost all governmental activities, a privilege he won after winning the referendum to his favor of a new presidential system for Turkey.
With a better economic management, Turkey would have the chances to become a wealthy country. It has a diversified economic structure. Turkey’s domestic financial system is flexible and resilient. Over the past decades, Turkey has experienced remarkable economic progress. Since the beginning of the new millennium, the economy has registered high growth rates with a moderate price inflation. Over the past two decades, the purchasing power per capita has almost doubled (Figure 4).
Figure 4: Turkey. Gross domestic product per capita in purchasing power parity (in US-dollar)
President Erdogan’s aspirations to establish an Islam-based authoritarianism and his erratic, incoherent, and nepotistic economic policy puts Turkey’s progress at risk. The crucial reforms of the Turkish economy were made before he came to power. Erdogan could enjoy the favorable economic situation prepared by his predecessors and gain the laurels while in fact he has been on the path to destroy not only what was accomplished in the decade before his rule but since the 1920s.
After the end of the Ottoman Empire, Turkey became a republic in 1923. Since then, the country has become one of the most secular countries in the Middle East. Under the leadership of Mustafa Kemal Pasha, later called Atatürk (father of the Turkish people), Turkey experienced a profound and broad transformation.
After Atatürk’s death in 1938, the subsequent leaders continued Turkey’s path to modernization. In 1952, Turkey joined the NATO, became a founding member of the OECD in 1961, and an associate member of the European Economic Community in 1961. Yet the path to a modern economy and a democratic political system became stony thereafter. There were military coups d’état in 1960, 1971, and 1980, and a ‘military memorandum’ in 1997, which forced the ruling prime minister to resign.
With this intervention of 1997, the role of the military as a guardian of secularism has ended. Since then, Turkey has been exposed to a rising tide of re-Islamization. Erdogan is the catalyst in this development whose geopolitical implications are enormous. The Middle East is a powder keg and Turkey had been an important economic and political partner of the West. If the current crisis should deepen, and the split with the West should widen, Russia and China will try to get their share of influence.
Yet Turkey’s current crisis has more than one father. A country’s currency turmoil and foreign debt drama has many players and none of them is innocent. Although governments typically deny any own contribution to their country’s downfall, facts show that the outbreak of a debt crisis is the result of careless spending and incoherent economic policies.
Lenders have also their share to bear. International investors often lend despite better knowledge because they count on a bailout if things should go wrong. The governments and central banks in the creditor countries contribute their share because they provide the safety net and thereby originate moral hazard.
The International Monetary System
Besides these main actors – for debt accumulation to happen it takes two to tango and a band to play the music – there is also another factor at work that usually receives less attention: the international monetary system. Since the end of the gold standard, the international monetary system is without an anchor and subject to massive waves of liquidity expansion and contraction. When liquidity is rising, extended periods of current account imbalances occur, which, the longer they last, the harder they are to amend. When the correction happens, the adaptation is abrupt and harsh.
After the end of gold standard, currency crises are a recurring feature of the international monetary system. A functioning gold standard would do away with trade imbalances continuously. The deficit country would lose gold and would be forced to contract its money supply while the surplus country would experience the inflow of gold and a monetary expansion.
Through this mechanism, the price level would adjust and rectify surplus and deficit. So long as there is no new gold standard or at least one that would mimic its features, currency crisis will continue to happen. It would be a great illusion to believe that only low-income and middle-income countries could be the victims. It is only a matter of time when one of the big players is subject to a massive debt crisis.
The lesson to learn from the Turkish crisis does not only concern Turkey. It is one more crisis which calls for a reform of the international monetary system.
Antony Mueller
Antony P. Mueller is a professor of economics at the Federal University UFS in Brazil where he is also a researcher at the Center of Applied Economics, and Senior Fellow of the American Institute for Economic Research. Antony Mueller earned his doctorate in economics summa cum laude from the University of Erlangen-Nuremberg, Germany. He was a Fulbright Scholar in the United States and a visiting professor at the Universidad Francisco Marroquin (UFM) in Guatemala as well as a member of the German academic exchange program DAAD. Antony Mueller has recently published the book “Beyond the State and Politics. Capitalism for the New Millennium”.
Related Articles – International
The Economics of Hitchhiking
As I argued in my book Tomorrow 3.0, there is a lot of excess capacity in durable commodities in modern economies. We pay for everything twice, first to buy it and then to store it so that no one else can use it. Locked doors, parking lots, closets: it’s very inefficient. The alternative to having to lock stuff up is to reduce the transaction costs of sharing. The three categories of transaction costs, I argued, were triangulation (find each other, reach an agreement), transfer (agree on payment, and make delivery), and trust (ensure safety and honesty).
One of the most glaring examples is all those empty seats of cars and trucks sitting in huge traffic jams in our cities every morning and evening rush hour. Long ago, there was a system for using some of that excess capacity, on a kind of charity basis. It was called “hitchhiking,” beginning in the 1920s when cars were first beginning to travel long distances between cities. It works in transaction-costs terms, or rather in terms of the types of transaction costs I lay out in the book.
Triangulation: The passenger and the driver needed to find each other, to communicate where the passenger wanted to go, and where the driver was headed. They needed to arrange a time and location for the pick-up; that time and location had to be convenient for both (not far from the passenger, and on the route the driver was going to be traveling anyway). Hitchhikers used a simple but not very convenient system: find a road that goes (more or less) in the general direction of the desired destination, stand on the side of the road heading that direction, and then stand by the road and indicate the “demand” for a ride by holding out your hand with the fingers closed but the thumb sticking up.
Transfer: Both the driver and the passenger have to be able to go where they want to go, at the time they want to go. But this is hard to coordinate. Also, the driver might be more willing to pick someone up if the passenger could pay even a small amount. But arranging the payment, and the amount of the payment, and the process of making payment are not easy. Generally, hitchhiking was free, though the passenger might offer to make a token payment to share the cost of gas if the shared journey was long.
Trust: Trust, or the “creepiness” factor, is the central reason why hitchhiking is so rare in the US. Traditionally, the triangulation problem was solved by standing by the road with a thumb up, announcing the desire for a ride. And transfer was solved by having the rider stand on an entry ramp or by the side of the road in the direction of the desired destination. Those aren’t great solutions, but they worked well enough that hitchhiking was fairly common, reasonably efficient, and very cheap as a way of traveling.
As Steve Levitt put it, on the Freakanomics radio show:
Hitchhiking is a classic example of what an economist would call a matching market where there’s a person who wants a ride, and there’s a person who’s willing to give a ride, and typically no money changes hands, so somehow there are people getting a benefit on each side of the transaction. In the fifties, the sixties, and maybe even the seventies, there was some sort of equilibrium in which there was a set of people who wanted to hitchhike, and there was a set of people who were willing to pick them up. And somehow that equilibrium got destroyed. So the question is what happened to the equilibrium?
The answer is actually not clear. There was the “bad hitchhiker” in fiction, as in the movie Texas Chainsaw Massacre. There was the “rapist driver” in reality, as in the bizarre case of Colleen Stan, imprisoned and tortured from 1977 to 1984. In terms of objective probabilities, there is little evidence that hitchhiking became much more dangerous. But “trust,” or the lack of it, is likely one of the factors that clearly increased the perceived transaction costs of hitchhiking, which became much less frequent. Instead of trying to hitchhike, travelers used other systems. And instead of picking up hitchhikers, drivers rode alone.
In many countries, especially in Europe, there is an app designed to mitigate the high transaction costs of hitchhiking: BlaBlaCar. Unlike many other software platforms, BlaBlaCar offers pure sharing. The software provides key pieces of information: (1) the passenger’s location, (2) the passenger’s destination, (3) the time the passenger wants to leave, and (4) how much the passenger (and, ultimately, the matched driver) wants to talk.
Someone who has an extra seat in their car or truck and who is traveling that route at about that time is matched with the passenger. The passenger pays part of the cost of the trip that the driver is going to take anyway. The result is a pure efficiency gain with close to zero marginal cost to the system but benefits to both, or all, participants.
BlaBlaCar has more than 25 million users in 22 countries. At least 10 million trips are arranged per quarter, and of course each “trip” requires at least two members. In fact, the average car occupancy is 2.8 in a BlaBlaCar ride, compared to 1.6 to 1.8 (depending on the country) for car trips in general. BlaBlaCar estimates a reduction of CO2 emissions on the order of more than 1 million tons per year, but of course that estimate assumes that all riders would have taken their own trips solo, rather than take a train or simply not travel if the service were not available.
One of the interesting things about economics is that economists “in their studies” (to use the ambiguous phrase of A. C. Pigou, referring either to a published paper or the room in their own house where many economists do their “field” work) often miss the creative capacities of groups of people to build institutions that solve collective action problems. Elinor Ostrom was famous for discovering and telling the world about these kinds of institutions.
Another interesting thing is that these “market” institutions may not formally involve markets, in the sense that there is a payment and a good or service. Instead, cooperative private voluntary institutions can arise just around the existence of a shared interest. In this case, there is a shared interest in commodifying excess capacity, in the form of empty seats in cars and trucks. But there is an artificial sweetener, an important one, that makes cooperation much more valuable.
Like many artificial sweeteners, this one leaves a bad taste in many people’s mouths. It’s the legal right to use the HOV lane at rush hours. “HOV” means “high-occupancy vehicle,” of course, and is variously defined. The important thing is HOV lanes move faster, sometimes much faster, than the normal lanes of traffic. Access is partly the “honor system,” but you can get an expensive ticket if you use the HOV lane and get caught. Some people have tried to use mannequins, or inflatable dolls, as “passengers” to qualify for access to the faster HOV lanes. A hearse in Nevada did have a driver and a second person in the car, but the state trooper interpreted the law as requiring that second person to be alive to count.
Real legal access generally requires two, or in the case of the Washington, DC, area, three passengers, but motorcycles or alternative “green”-fuel vehicles can also qualify. Some people think that’s arbitrary, or unfair.
Other people, though, have found ways to reduce the transaction costs of cooperation. After all, hitchhiking would solve the problem. Instead of mannequins, a couple of real humans give a driver access to HOV and a much faster ride. And for the riders, the benefit is the ride itself. There are obvious gains to cooperation.
The problem, as is always the case, is transaction costs. The difficulties are the same as with hitchhiking, except that now you have to coordinate a driver and two riders. In the Washington, DC, area a convention has developed around a concept called “the slug line,” where slug is both a noun (the person seeking a ride) and a verb (“slugging” is offering yourself up as a ticket to use the HOV lane in exchange for getting a ride).
There have always been “ride billboards” at colleges, or military bases, for people who need to get home or somewhere. There may be an arrangement where the rider pays for some or all of the gas, but mostly the rider is looking for cheap transport. The HOV requirement adds a wrinkle, because having riders is actually valuable to the driver.
The “slug line” institution started up at least 45 years ago, in the mid-1970s, at least in DC. The creation of HOV lanes and the high price of gas meant that sharing a ride and (sometimes) kicking in a few dollars for gas benefitted all parties. There were a few designated (by convention: nothing was written) places where people who shared a destination would line up. Cars would pull up, call out their destination, and the next person in that destination line would get in. It was reliable enough that people used it to commute to work, which meant there was a high transaction density, where drivers could reliably find passengers and vice versa.
About 10 years ago a website was set up. According to the website, the process worked pretty much the same way:
A car needing additional passengers to meet the required 3-person high occupancy vehicle (HOV) minimum pulls up to one of the known slug lines. The driver usually positions the car so that the slugs are on the passenger side. The driver either displays a sign with the destination or simply lowers the passenger window, to call out the destination, such as “Pentagon,” “L’Enfant Plaza,” or “14th & New York.” The slugs first in line for that particular destination then hop into the car, normally confirming the destination, and off they go.
No money is exchanged because of the mutual benefit: the car driver needs riders just as much as the slugs need a ride. Each party needs the other in order to survive. Normally, there is no conversation unless initiated by the driver; usually the only words exchanged are “Thank you,” as the driver drops off the slugs at the destination.
The difference now is that the system is much more organized, with morning slug lines, and afternoon slug lines, and detailed instructions about etiquette and rules, because there are so many people waiting and everyone is in a hurry.
If you pay attention, you’ll notice a lot of things that “economists in their studies” may not be able to imagine. But they exist. Because people are really good at finding ways to cooperate.
Michael Munger
Michael Munger is Professor of Economics at Duke University and Senior Fellow of the American Institute for Economic Research. His degrees are from Davidson College, Washingon University in St. Louis, and Washington University.
Munger is the author of Is Capitalism Sustainable? (AIER, 2019)
