“Turkey: ‘Ground Zero’ for Global Contagion?”
by Brian Maher
"Sound the alarm! “Dow Tumbles Triple Digits as Turkey's Crashing Currency Rattles Global Markets,” shrieked CNBC this morning. “Dow Tumbles 222 Points as a Currency Crisis in Turkey Rattles Wall Street,” quailed MarketWatch. Zero Hedge weighed in with typical understatement: “Turkey Meltdown: Lira Implodes as Panicked Sellers Spark Global Contagion.” “The Turkish currency crisis is finally here and it is sending shock waves around the globe,” they added.
Let us roll up our sleeves, spit upon our hands… and proceed to business... The Trump administration announced plans early today to double tariffs on Turkish steel and aluminum imports. The announcement came in apparent retaliation for Turkey’s refusal to release a jailed American pastor - at least in part. Turkish authorities claim this American man of God supported a failed coup attempt against President Recep Tayyip Erdoğan in 2016. Trump has demanded his freedom. And so at 5:47 this morning, the president announced the tariffs through his usual medium:
Already teetering, the bottom immediately dropped from beneath the Turkish lira - which plunged as much as 24%. Chaos fell upon the Turkish market. A free-falling lira translates to spiraling inflation. Unless the Turkish central bank raises interest rates à la Paul Volcker, Turkey could descend into hyperinflation... and economic collapse.
"Seems like a complete crash, so they need to act now,” panted Morten Lund, strategist at Copenhagen’s Nordea Bank. “The lira will keep falling if they don’t hike rates today." As we go to press… the Turkish central bank has failed to act upon Mr. Lund’s counsel.
Panic raced throughout global markets this morning... like brush fire through a parched wood. European, Asian, U.S. markets all sold off today. The Dow Jones ended the day down 196 points. The S&P fell a good hard 20… the Nasdaq, 53. European bank shares took an especial trouncing today, as investors fretted over their exposure to the ailing currency.
“The sudden falls in bank stocks underscore the potential for contagion,” as reports The Wall Street Journal.” Though it adds the European Central Bank’s concern “isn’t too high at present.” Question: Would they admit if they were concerned?
A panic can spread quick as thought itself. And they do not wish to alarm the rubes - that is how bank runs begin. Today’s financial markets form a deeply intertwined global tapestry. One pull anywhere in the fabric threatens to unravel the entire business. That is the great bugaboo of today’s hyperconnected markets.
Bart Hordijk, market analyst at London-based foreign exchange firm Monex Europe: "In financial markets everything is interlinked. You don’t know if one bank has huge exposure to the Turkish lira." Jim Rickards has been expecting an emerging-markets crisis. “Emerging-market debt crises are as predictable as spring rain,” says Jim. “They happen every 15–20 years, with a few variations and exceptions.” The last emerging-market crisis fell in 1997 - another crisis is therefore overdue. And Turkey was high on Jim’s list of candidates. As he wrote on June 13: “It is likely to start in Turkey, Argentina or Venezuela.” “But it won’t end there,” he continued: "The problem is contagion. History shows that once a single nation defaults, creditors lose confidence in other emerging markets. Those creditors begin to cash out investments in EMs across the board and a panic begins."
And then? Once that happens, even the stronger countries such as China lose reserves rapidly and end up in default. In a worst case, a full-scale global liquidity crisis commences, this time worse than 2008. The good news, Jim says, is that a new crisis could take a full year to spread. That allows time for investors to prepare (go here to learn how).
You can, if you wish, affix blame for the unfolding events on our very own Federal Reserve - at least in part. It is raising interest rates and reducing its balance sheet. These tend to yield a stronger dollar, certainly in relation to foreign currencies whose central banks are still easing. A stronger dollar makes dollar-denominated debt a heavier burden to countries with weaker currencies. And foreign investors flee these currencies for the dollar’s greater returns.
Many Turks in fact blame the United States for the developing crisis. President Erdoğan’s drummers consider it a U.S. attempt to sabotage Turkey and its president. “This crisis is created by America,” said one Turk. “They are ruling the world on their own,” said an Istanbul trader. “Somebody must find a solution and say ‘stop’ to the United States.” But who?
Addressing his people, Erdoğan himself announced this morning: “Don’t forget, if they have their dollars, we have our people, our God.”
Just so. But if the crisis unfolds as Jim Rickards fears, the entire world may need all of the above - especially number three. Below, Jim shows you how Turkey could be “ground zero” in the next global debt crisis. Read on."
"Turkey Could Be Ground Zero in the Next Global Debt Crisis"
By Jim Rickards
"Turkey is a beautiful country with a rich history including Greek, Roman and Muslim influences that make it one of the most fascinating places on Earth. It is literally a bridge between East and West: The mile-long Bosporus Bridge just north of Istanbul connects Europe and Asia across the Bosporus Strait.
Turkey has been a magnet for direct foreign investment from abroad and dollar-denominated loans by international banks to local enterprises. This investment enthusiasm is understandable given Turkey’s well-educated population of 83 million and its rank as the 17th-largest economy in the world, with a GDP of just under $1 trillion. The flood of bank lending and direct foreign investment has given rise to another flood of hot-money portfolio investors in Turkish stocks chasing high returns with cheap dollar funding in a variation of the global carry trade. So-called emerging-market (EM) funds offered by Morgan Stanley, Goldman Sachs and others are stuffed full of Turkish stocks and bonds.
But there’s a dark side to Turkey’s seeming success story, and today reality has finally caught up with it. Its currency is collapsing before our eyes. Turkey’s external dollar-denominated debt is so large that a combination of rising U.S. dollar interest rates and a slowing global economy could quickly turn Turkey from model EM to the canary in the coal mine of the next great global debt crisis.
The risk of a major debt crisis beginning in Turkey is heightened by the rise of Turkey’s President Recep Tayyip Erdoğan as an autocratic strongman in the mold of Argentina’s Juan Perón and other populist nationalists who have ruined strong economies.
Begin with a look at the Turkish debt situation. Turkey’s debt is huge, one of the highest debt burdens of any EM. Turkey owes some $450 billion to foreign creditors, of which $276 billion is denominated in hard currency, mostly dollars and euros. The remainder of $174 billion is denominated in Turkey’s local currency, the lira. Both kinds of debt are problematic. The lira debt is a growing burden because lira interest rates have skyrocketed from 6% to 12% in the past five years.
The foreign currency debt is problematic for two reasons. The first is that the lira has devalued from 1.75 to 6.30 (as of this morning) to the dollar since 2013, which increases the amount of lira needed by local companies to repay their external debt. The second reason is that U.S. and euro interest rates have started to rise, which also makes the external debt burden more difficult to service.
Turkey’s hard currency reserve position is adequate for the moment, with about 100% coverage of foreign debt. The problem is not an immediate debt crisis but the likelihood that foreign credit could dry up or reserves could drain quickly, leading to a tipping point and a rapid loss of confidence.
Unfortunately, there are numerous economic and geopolitical catalysts for such a loss of confidence. The principal catalyst is a sharp deterioration in Turkey’s relations with the West and increasing links between Turkey and Russia that could lead to a crisis. Recent polls showed that 68% of Turkish citizens believe that Turkey’s alliance with Europe and the U.S. is breaking down. The same poll showed 71.5% of Turkish citizens believe that Turkey should enter into an economic, political and security alliance with Russia.
Another irritant is the widespread belief in Turkey that the U.S. played a role in the attempted military coup d’état against President Erdoğan in July 2016. This suspicion is heightened by the fact that the U.S. refuses to extradite Erdoğan’s political enemy, Fethullah Gülen, who lives in exile in Pennsylvania. Erdoğan alleges that Gülen tried to force him from office in 2013 based on false charges - what Erdoğan called a “judicial coup.” The combined impact of a so-called judicial coup and an actual military coup attempt have led to profound distrust between the U.S. and Turkey.
Earlier this year, a U.S. court has also convicted and sentenced a Turkish-Iranian gold dealer, Reza Zarrab, to 32 months in prison for violating U.S. sanctions against Iran. Zarrab turned state’s witness and provided testimony involving bribes and kickbacks by the Erdoğan government. The U.S. government’s main charge was that Turkey helped both Russia and Iran avoid U.S. government economic sanctions. A recent Russian sanctions bill would impose severe penalties on Turkey if it goes ahead with a proposed purchase of Russian anti-aircraft systems.
A more serious point of contention between the U.S. and Turkey involves the role of the Kurds in Syria. From Turkey’s perspective, the Kurds are a separatist movement that threatens the territorial integrity of Turkey. The most extreme Kurds are pushing for an independent Kurdistan that would include parts of present-day Turkey, Syria, Iraq and Iran. From the U.S. perspective, the Kurds are a potent fighting force who have been instrumental in the decimation of ISIS and have played a key role in support of Syrian freedom fighters opposing the regime of Syrian President Bashar al-Assad. The Kurds are bitter enemies of Turkey and good friends with the U.S.
Another confrontation between the U.S. and Turkey is the status of Qatar. Saudi Arabia economically has isolated and physically blockaded Qatar because of its support for terrorists and Islamic radicals. The U.S. has tried to mitigate this conflict but on balance supports the Saudi position. Turkey came to the aid of Qatar with both financial support and a military presence. A war between Saudi Arabia and Qatar would, in effect, be a proxy war between the U.S. and Turkey, two erstwhile NATO allies. In short, U.S.-Turkish relations are at their lowest point since the breakup of the Ottoman Empire in 1922.
This deterioration in relations has important economic implications. If Turkey were to find itself in acute financial distress - which is happening now - the usual place to turn for a financial lifeline is the IMF. However, the U.S. and its Western allies, especially Germany, have effective veto power over IMF bailouts. The U.S. might demand conditions on any IMF assistance to Turkey in the form of compliance with Russia sanctions. Turkey would likely reject such conditions leading to an impasse on the subject of IMF aid.
The single most important trend is Turkey’s growing isolation from the West at the same time that Turkey’s external debt burden spirals out of control. The geopolitical issues noted above - involving Syria, Qatar, the Kurds, Russia and Iran - could lead to a sharp break in U.S.-Turkey relations and Turkey’s departure from NATO.
President Erdoğan is strong-willed but also defiant and stubborn in the face of what he regards as the infringement on Turkey’s sovereignty by the U.S. and Europe. Far from negotiating with the IMF in the event of distress, Erdoğan could easily impose capital controls, which would effectively be a default on all external debt and lock all equity investments in place with no ability to cash out for dollars. Turkish stock and bond markets would plunge at best or cease to function at worst.
The situation in Turkey is uncomfortably close to the situations that arose in Thailand in 1997 and Russia in 1998 in which both countries closed their capital accounts after attracting billions of dollars in foreign loans and investment. Those Thai and Russian defaults precipitated one of the most acute and dangerous liquidity crises in world history. Just the existence of these geopolitical fault lines and potential financial defaults is enough to make unfolding events in Turkey a deadly threat."