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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”.
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What Arthur Burns Broke, Paul Volcker Fixed
Paul Volcker, who served as chairman of the Federal Reserve from 1979 to 1987, passed away this week at the age of 92. He is widely credited with ushering in a new era in Federal Reserve policy making, where much more attention is given to controlling inflation.
When President Carter appointed Volcker to the Fed, inflation was approaching double digits for the second time in less than a decade. Arthur Burns, who began his tenure as Fed chair in 1970 when inflation was around 4.90 percent, saw inflation rise to 11.51 percent in 1974 Q4, fall to 5.13 percent by 1976 Q4, and begin climbing again thereafter. Inflation rose from around 6.43 to 8.52 percent during G. William Miller’s brief tenure from 1978 to 1979.
Before Volcker, Fed chairs occasionally denied their ability to control inflation. Arthur Burns referred to cost-push inflation (in contrast to the demand-pull inflation caused by faster money growth). “The rules of economics are not working in quite the same way as they used to,” he told Congress in 1971.
There were dissenting views, to be sure. But, for most of the 1970s, they were coming from outside the Fed. Milton Friedman, for example, called Burns out at the December 1971 American Economic Association annual meeting. It was not cost-push inflation, Friedman claimed, but “erratic and destabilizing monetary policy [that] has largely resulted from the acceptance of erroneous economic theories.”
Volker changed that. He acknowledged that the Fed could bring down inflation and then set a course to do just that. Moreover, he did so with great resolve.
Engineering a disinflation is a costly proposition. The central bank must cut the growth rate of money to bring down inflation. However, cutting the growth rate of money also tends to fool producers into thinking there has been a decrease in the relative demand for their products. As a result, they produce fewer goods and services — which often means laying off workers — until they realize the error and adjust their prices down accordingly.
The underproduction problem can be mitigated, to some extent, by credibly announcing the policy in advance. If producers reduce their inflation expectations in line with the policy, they will not be fooled into underproducing.
But that is easier said than done. It is difficult to credibly announce a policy in normal times. Most folks just don’t pay that much attention to — or understand — monetary policy. It is harder still when the central bank has failed to live up to expectations in the past, since even those who do pay attention and understand how monetary policy works are unlikely to believe the Fed will do what it says it will. Hence, even when such measures are called for, cutting the growth rate of money virtually guarantees a recession.
Volcker’s disinflation was no exception. Real GDP growth fell from 6.51 percent in 1979 Q1 to −1.62 percent in 1980 Q3 and remained low through 1983 Q1. Unemployment shot up, from 5.7 percent in 1979 Q2 to 7.7 percent in 1980 Q3; by 1982 Q4, it had reached 10.7 percent. Home builders around the country pleaded for cheap credit by sending two-by-fours to the Marriner Eccles building in D.C.
But Volcker didn’t relent. Inflation came down and stayed down. Indeed, the public came to believe the Fed chair was willing to do whatever it takes to keep inflation low and steady. For every ounce of institutional credibility Burns had lost, Volcker gained a pound.
William J. Luther
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How To Stop the Proliferation of Municipal Bond Issues
It seems rather strange that in a putative democracy a handful of people can legally, if figuratively, reach into the pockets of their neighbors but it happens all the time all across America via municipal bond ballot measures.
The main problem is that the measures “pass” if the majority of those who actually vote are in favor, even if hardly anyone votes. That leads to abuses. We should change the rules and mandate that bond/tax measures must obtain the affirmative approval of over 50 percent of eligible voters, not just those with sufficient incentive, education, and information to vote.
In most areas of our lives, no means no in the sense that no decision defaults to no action. You do not have to actively dislike the advertisement of a stationary bike company to avoid buying one of its products, you can vote “no” by not taking steps to purchase one. Heck, you may even approve of its ad but that does not give the manufacturer the right to drop ship one of its high-tech torture machines to your house and dock your checking account in exchange.
The same goes for physical intimacy. A stranger does not get to lawfully have sex with you because you did not actively swipe left on his or her Tinder profile. And Tinder does not get to establish a Tinder profile for you because you did not explicitly tell it not to. Wells Fargo found that out the hard way (though arguably not hard enough).
The need to obtain explicit consent before taking somebody else’s money (or bodily fluids) is one of the key remaining features of liberty. Without it, life begins to look a lot like slavery or authoritarianism.
But the rules change when the compulsory monopoly we call government makes the rules. The original impetus behind municipal bond measures was the notion that voters need to explicitly accept the tax increases needed to service the bonds. No taxation without representation and all that. When most people voted, and where taxpayers and voters were roughly the same people, bond ballot measures approximated consent. (Why fifty percent is often considered the best threshold is another matter, but I will stipulate it here.)
Statewide bond measures pass about four out of five times. Local ones appear to pass at the same rate, even at the 55 percent threshold established in California. And issuers who fail to gain approval can try again year after year, unlike in corporate proxy resolutions where shareholders are banned from reintroducing resolutions that fail to garner sufficient votes. (The SEC, incidentally, wants to raise those thresholds.)
It is a minor miracle when voters in a town like Monument, Colorado repeatedly put the kibosh on bond measures because the issuer, often a school district, is a concentrated interest with the budget authority to hire consultants who appear to make scientific, objective cases for the “necessity” of the bond. Some of those consultants even conduct market research studies designed to help the issuer use words and arguments most likely to sway voters to click “yes” come election day. Opponents are typically individuals with jobs, families, and lives.
Unlike in the commercial sector, municipal bond issuers do not need to persuade people to their cause, they just need to create enough uncertainty, confusion, or complexity to induce most voters to abstain. While often rational in other contexts, inaction on bond measures often means tax increases because the denominator for passage, regardless of the threshold, is always the number of people who actually voted on the measure rather than the number of registered voters.
Issuers know that and use it to their advantage. A suburb of Sioux Falls, South Dakota recently passed a bond measure 1,085 to 129. That seems like a mandate except 14,700 people were eligible to vote on the measure, which went up for vote on 10 September, a time when most East River South Dakotans are busy settling their kids in school, hanging tree stands, and “gettin’ the beans in” (soybeans of course). In other words, only about 1 in 15 people explicitly approved of the bond measure but the outcome is somehow counted “democratic.” (I don’t live in that town, incidentally, and the measure did not raise taxes but merely did not lower them as a previous bond recently matured.)
Other issuers put their measures up in November but only in odd-numbered years, when voter turnout is even lower than during even-numbered years. Often, public discussion of bond measures is muted because debate might draw out voters, which issuers want to avoid because when turnouts are low measures can be won simply by mobilizing teachers and naive statists.
In response to those obvious problems, some have called for minor reforms, like mandating that all municipal bond measures come up for vote on regular election days in even-numbered years. While that would be an improvement, it misses the main point, that no (action) should always mean no (money or booty). In other words, passage of anything authorizing use of the coercive power of the state to take citizens’ money should require the assent of fifty percent plus of eligible voters, not those who turned out at the polls.
When I proposed this recently at a meeting of the South Dakota chapter of Americans For Prosperity, someone immediately objected “but then no bond measure would ever pass!” “Exactly,” was my response. But of course truly important bond measures would pass, after mature consideration and extensive public debate clarified the issues at stake.
Consider again Monument, which sits on the Front Range betwixt Denver and Colorado Springs. Traditionally, taxes and public spending there were low so it attracted childless singles and older couples. Recently, younger couples with children began moving in because it was relatively cheap and improvements on I-25 promise to reduce commute times to both metropoles. Once ensconced, though, those couples began demanding more and better schools, even though that would mean higher taxes and, ceteris paribus, lower real estate values via what economists call tax capitalization.
I do not live in Monument either and would not presume to tell its residents what type of community they should try to create. But I do believe that a nation that purports to be a democracy should encourage citizens to debate the merits of proposals openly and to have to gain explicit approval for taxes, not a bare majority of a few percent of eligible voters in an inconvenient, secretive ballot. Robust debates could raise awareness of charter schools or maybe signal to parents with young children that they should live elsewhere. Or maybe they would lead to even more financial support for public schools. At the very least, full public discussion might expose the exorbitant fees that many municipalities now pay to consultants and issuers. The point is that to win approval, issuers would have to make a case and not just slide in under the radar.
Yes, voters could turn out to defeat bond measures, as they sometimes do, but the burden of proof should fall on the issuer, especially when public school districts seek funding because they have, with few exceptions, failed to create the type of citizens who vote. NGOs like iCivics are trying to improve civics education but the real problem, especially when it comes to bond and tax issues, is the failure of public schools to teach the basic principles of economics and public finance.
Without that background, most people do not feel comfortable voting on complex bond issues. So, as behavioral finance theory predicts, many abstain and the issuers win.
Robert E. Wright
