Turkish currency collapse isn’t a slippery slope

In this article, we will critique a recent concern that the weakness in the Turkish economy is a pretext for a global financial correction. This is just one ‘projection’ of turmoil that is sweeping global markets. None of these arguments have any sound footing. Let is however focus on Turkey.

“A decade after the worst financial panic since the 1930s, growing debt burdens in key developing economies is fuelling fears of a new crisis that could spread far beyond the disruption sweeping Turkey”.[i]

Why would a collapse in Turkey spread to the rest of the world? The global economy is actually in good shape. The problem with the media is that they tend to posit scenarios that are ‘too tragic’ in their implications, when there is simply no evidence for it. They are looking for headlines, and today its Turkey. Yesterday, it was Chinese property investors in various Western markets, or banking standards. For the uncritical investor, this can make it difficult to navigate global markets. The media have an interest in ‘feeding the fears’ of readers. Apprehension is their drug of tool of dependence. They didn’t sponsor apprehension among their readers, but they are profiting from it, and they are not curtailing it.

The loss of investor confidence in the Turkish lira has resulted in over a 40% fall in its value this year. Might this collapse signal a repetition in other countries, namely Brazil, South Africa, Russia and Indonesia, as expressed by some economists. [ii]

You could argue that such a collapse in these countries would be a positive development because it would result in these nations being positively restructured.

Sebnem Kalemli-Ozcan, an economics professor at the University of Maryland: “Turkey is not the last one…Turkey is the beginning’. [iii]

Possibly, but ‘the begging of what’? Accountability? A financial correction? You can’t talk about the collapse of these economies without talking about their recovery. Only if the entire global financial system collapses, or if these countries don’t learn from their lesson, can you talk about collapse, otherwise it will just result in as debt restructure under new standards, and that can only be a good thing. These countries could signal a global collapse if there was indeed a ‘global threat’, but there is no such threat as long as inflation remains low. If inflation remains low, then any collapse just becomes a buying opportunity.

“For now, few experts think that a broader crisis is imminent, though Argentina this week asked the IMF to accelerate a planned US$50 billion rescue as the peso crashed to a historic low. But the danger of a financial contagion that could hit Americans by crushing US exports and sending the stock market plunging should be taken more seriously in light of a massive increase in global debt since the 2008 downturn”. [iv]

The problem with this argument is that global trade doesn’t depend on these few nations. In any case, these nations could only benefit from s currency in free-fall, as long as the global market remains resilient.

McKinsey Global Institute: “Total debt is a whopping US$169 trillion, up from US$97 trillion on the eve of the Great Recession”. [v]

Are McKinsey worried? The reason not to be worried is that ‘inflation is destined to remain low’, and 10 years of growth is destined to see a rebuilding of confidence in debt after a low. What is more important is ‘the outlook’ for inflation and interest rates, and one can draw confidence from the current softness in global asset prices. Asset prices are having a healthy correction.

“While previous debt crises involved US households and, later, profligate European governments such as Greece, this time the concern centres on companies in emerging markets that borrowed heavily in dollars and euros”. [vi]

Poorly judged loans in emerging markets is not grounds for concern because the financial instititutions holding these debts will be able to recoup equity in quality assets in growth markets. Local incompetent managers/owners will lose out, and the assets will be resuscitated as ‘growth assets’. This is not the type of crisis that will sink the globe.

“In Turkey, for example, companies and banks borrowed in recent years to finance bridges, hospitals, power plants and even a mammoth port development for cruise ships”. [vii]

These types of developments are actually healthy, whether they provide an opportunity for a tycoon to come in and seize the opportunity at low prices, or a government steps in and socialises the assets. In a growth context, few of these assets fail to recoup their money for the intervening investor, even if they fail to restore their original sponsor to solvency. This is the creative ‘destruction’ we can celebrate under capitalism because it rewards the competent decision makers, thwarts the incompetent, and by doing so, it concurrently raises the competency and standards of all market participants. You would hope that ‘good standards’ are internalised and entrenched as institutional provisions, however this is not always assured.

“Foreign investors, particularly European banks, lent freely in search of the higher returns these markets offered at a time when the US Federal Reserve and European Central Bank were keeping interest rates low”. [viii]

This is not good analysis because ‘interest rates are still low’. The Federal Reserve and European Central Bank have raised rates from ‘ultra-easy’ to ‘neutral’ over the last few years. This has not sunk the global market, it has only wiped out a few poor project sponsors a long the way. Given that these financial institutions, who lent money, have a great number of investments, they will be able to absorb these failures relatively easily. Even if they took a bullet wound, it will not sink the global economy. In the long run, the lenders and borrowers will be stronger for having adopted better standards. If we are lucky, there might even be some privatisations and liberalisation to serve as progress towards stronger economies, as there was after the Asian Currency Crisis.

Now, the Asian Currency Crisis could be construed as a similar event. There are however several important differences: [ix]

  1. Asian tiger economies were swept up in a culture of prosperity, that was swollowed by the West. In contrast, Turkey has always carried a healthy scepticism about its governance.  Tiger economies were recording growth of 6% per annum largely unabated during the early 1990s.
  2. The scale of capital inflows were relatively high compared to Turkey
  3. The misallocation of resources in the form of ‘poor loan quality’ could be construed as analogous to Asia’sinvestment in over-capacity, and their failure to identify the headwinds of lost competitiveness
  4. There wasn’t so much as an ‘over-heating’ in Asia as suggested by Wong (2000).
  5. There was a disregard for the sustainability of reoccurring export growth, given the high levels of short-term debt, and the reliance on foreign debt, as is evident in Turkey.
  6. The subdued global economy and political apprehensions about Turkey are also analogous to ‘export fears’ in Asia during the Asian Currency Crisis.
  7. In those Asian countries affected, the currency dropped by as much as 30-40%

The problem for Thailand in 1997 was that is was ‘too similar’ to other Asian economies in the area, so it was readily apparent that the concerns being echoed in Thailand warranted consideration for similar markets structured on similar terms. i.e. Malaysia, South Korea, and to some extent the Philippines and Indonesia. It is telling that, having collapsed, and absorbed their debts, Asian countries rebounded, and were stronger for it. They were fundamentally sound, even if there was a systemic point of vulnerability that ‘short term’ investors spurned.

David Rosenberg, chief economist at Gluskin Sheff, a wealth-management firm: “We were supposed to correct a debt bubble…What we did instead was create more debt”.[x]

There isn’t anything intrinsically wrong with high debt levels. The problem in the GFC wasn’t debt; it was the quality of the debt. Low quality debt was being sold as ‘quality high yield’ debt securities without much qualification. The issue in Turkey is whether:

  1. The lender can sustain those levels of debt from income
  2. The lender can sustain rises in interest rates, or whether there is any prospect of higher interest rates. You can’t simply project ‘higher rates’ because rates rose in the past.
  3. The lender is under stress because of falling asset prices, and whether those exposures are systemic.

The problem with the GFC was not ‘excess debt’, it was inadequate responsibility. There is no problem moving forward, because as Japan showed, it is too easy for governments to simply print money. There is no fear of inflation throwing through to inflation expectations.

“[With higher interest repayments] coming due, Turkish borrowers, like those in other developing countries, may not have the dollars and euros to pay them back”. [xi]

In actual fact, the emerging markets are actually growth fairly well. The issue is that there are isolated economies which will need to absorb some bad debts. The only issue is whether the lender sells off the distressed asset, or the host government socialises the project.

“The Fed is raising interest rates in the midst of a healthier US economy. The stronger dollar – along with the sinking lira – makes it increasingly expensive for Turkish borrowers to repay their dollar debts. Paying off a $100,000 loan at the start of this year would have required 379,000 lira. Now, that same loan would take more than 660,000 lira”. [xii]

It is fair to say that such exposures become more appealing for American investors. So the risk is only to the underlying project sponsor.

Tim Lee, economist, Pi Economics: “The free money is going away”, who has been warning of a potential Turkish crisis since 2011. [xiii]

Well, a crisis for some project sponsors, but as is indicated, the emerging markets are still growing, and the US economy is relatively strong. This is not ‘treacherous times’ for most markets. On the contrary, this type of situation paints a rosy picture for investing in these specific markets, if you can be comforted by the prevailing political situation in these nations in the wake of those failures.

“The situation could grow even more perilous. Money is fleeing Turkey and similar markets precisely when many of the loans their companies took out in recent years are coming due. Globally, a record total of up to $10 trillion in corporate bonds must be refinanced over the next five years, according to McKinsey”. [xiv]

Rolling debt is a standard practice. The fact that debtors will roll debt doesn’t necessarily present a problem. Certainly there is no reason to project a problem beyond Turkey. The risk lies only with those lenders reliant on local revenue streams to finance foreign-denominated debt. Those businesses will fail, and the banks will recoup their money from asset sales.

“Moody’s cut its credit ratings on 20 Turkish financial institutions. The ratings agency cited ‘a substantial increase in the risk’ that banks would struggle to finance normal operations. The prospect of a new debt crisis is striking because the world has already seen two in the past 10 years”. [xv]

This suggests a systemic risk for domestic businesses that rely on discretionary spending. There are not likely to be many of those. The types of businesses likely to be vulnerable are car dealerships, construction companies tied to real estate.

Authorities in the United States and Europe took steps after the 2008 crisis to avoid a repeat episode. US regulators required banks to hold significantly more emergency reserves. US consumers whittled down their debts. In Europe, authorities forced overspending governments to embrace austerity programs. [xvi]

The reality is that people have curtailed ‘consumer debt’, and it is ‘investment debt’ which has bourgeoned.

“Yet debt has grown furiously and is almost 2 1/2 times the size of the global economy”.[xvii]

It is a normal thing for ‘debt’ to overshadow the economy, any economy, and no more is this a positive thing, than at a time of low interest rates, where there is an expectation that interest rates (or the underlying inflation) will remain low. Much depends on your capacity to service that loan, i.e. You need to be able to retain a job, or you need to be able to generate revenues to grow the asset whilst servicing the loans. In this market, there are successors and failures. Banks need to know the difference, but there is no risk of systemic failure for at least 10 years.

“As banks in recent years have faced tougher regulatory scrutiny, they have increased their global corporate lending by only a small amount. Cash-hungry corporations increasingly have turned to the bond market. Chinese borrowers have been the most active among developing markets, but 95% of corporate bonds in China are issued in yuan, minimising the financial dangers, according to McKinsey”. [xviii]

So there is every reason to think that if there is a financial stress in China, that the government will step in and ‘socialise the bond debt’. This is actually a sensible time for companies to carry ‘bond debt’. Moreover, Chinese savings levels are exceptionally high, so Chinese vulnerability is overstated. It is true that those savings are not ‘well-invested’, but you would hardly construed ‘high savings as a problem’ in ‘good times’. They are a wasted opportunity. China could be investing in ‘quality assets’ rather than US treasuries.

“[For riskier than China] emerging markets that borrowed in dollars and euros, rising interest rates will make it more expensive to borrow new money or refinance existing debt. That could trigger a wave of defaults by corporate borrowers, with problems spreading far beyond Turkey and ultimately into the United States”. [xix]

This is hardly a systemic risk. Turkey is not a country that the West would have excessive exposure to, and it, as a market, is dwarfed by these developing markets. It is only the local sponsor who stands to lose a lot.

“Among the chief casualties from Turkey’s plight will be European banks, especially Spanish institutions that have loaned Turkey more than US$82 billion”. [xx]

Spain is already in a state of vulnerability; however it is safe to say that not all of the Spanish debt exposure will be in jeopardy. There is however a systemic vulnerability.

David Rosenberg, chief economist at Gluskin Sheff, a wealth-management firm: ‘The rising USD will erode the sales that major US companies book overseas, which amount to roughly 40% of revenue for members of the Standard & Poor’s 500-stock index’. [xxi]

So the argument is that the USA will experience a loss of exports because of a strong USD, even though:

  1. Many emerging markets currencies are pegged to the USD
  2. The USD is partially rallying because of a strong US economy
  3. The US is fighting a trade war
  4. The US is likely to benefit from higher interest income??? Aren’t they a debtor? They are, but they are denominated in USD, and they are a big financial intermediary.

Adam Posen, President, Peterson Institute of International Economics: ‘Factors such as the financial health of lenders, the borrowers’ ability to raise cash by selling assets quickly and central banks’ willingness to raise interest rates all matter’. [xxii]

This is a great deal of scope for lenders to augment a sale of distressed assets, or to assume some of the equity in a project, to ensure that these types of investments are supported. There is no party interested in jeopardising the underlying asset. There is just a question of pricing the debt and equity. The debt holders are actually in a strong position, and they will make money from the ‘opportune’ collapse of the lira.

Adam Posen, President, Peterson Institute of International Economics argued that Brazil, Mexico, Russia, Indonesia and India are well positioned to remain stable through this period of uncertainty. [xxiii]

Their stability is destined to arise from the fact that they are likely sitting on large asset reserves, and they can raise money locally to repay USD debts if they are big companies. One of the rationales for tapping foreign markets is to access ‘cheap debt’, but the other is to demonstrate to local lenders that you meet ‘foreign standards’ for borrowing. It becomes a ‘good deal’ for the local investor, at the expense of the original project sponsor.

Susan Lund, a co-author of the McKinsey study, concluded that the global economy is unlikely to suffer a deep downturn akin to the 2008-2009 recession. Not seeing the debt vulnerability as “a general pervasive problem”. [xxiv]

Clearly the issues in Turkey relate more to the economic fallout of Turkey’s political administration, where President Recep Tayyip Erdogan has waged an “economic war against the entire world”, and this is having an impact upon the lira, and debt holders with debt denominated in USD or Euro. The president has cultivated Turkish nationalism, with the “authoritarian leader calling for a boycott of US products such as Apple’s iPhone”. His supporters have even resorted to “burning USDs in the streets”. [xxv] The president, having resorted to Turkish nationalism to defend his reign, has only served to undermine the economic fortunes of his country. He is in a strong position to defect responsibility upon the United States because:

  1. The US is important to the fortunes of every country, as a trading partner, and because the banks and financial credit rating agencies are US-domiciled.
  2. The US projects itself as the international policeman
  3. Trump has quarantined the US from Muslim countries
  4. He holds a commanding position in the media and Arab culture to deride foreigners in general, and the US in particular, given its importance.
  5. Trump took the unilateral decision to announce the doubling of US tariffs on Turkish steel and aluminium import to the USA, which culminated in a plunge in the lira, though it had already been falling for months.[xxvi]

Turkish President Recep Tayyip Erdogan has accused the US of sabotaging his nation’s currency.[xxvii]

This action however serves President Recep Tayyip Erdogan in another way. He can align himself with powerful economic interests in Turkey to secure the assets of those companies impacted by the lira depreciation, and then profit from their association with the president, to orchestrate a recovery in the lira, after the president concedes. Erdogan’s mates then profit from a ‘staged recovery’. This is how oligarchs profit from a close association with government, who possess this arbitrary power. It is why authority cannot be arbitrary or centralised, as it is in all democracies. Western centralised media is no less concerning than Turkey’s. Free expression is less important that ‘popularised expression’, as a lone wealthy voice articulating an unpopular message is a risky proposition when a media monopoly is ‘overtly political’. Of course it doesn’t help his political sustainability, but in an autocracy, ‘legitimacy’ is a lower standard.

The Turkish president is in the fortuitous position of being ‘in control of his nation’s future’, even if that means conceding to US concerns about his regime, or the country’s economic settings. Consider that ‘Turkish government debt is not large, so the government is in a strong position to socialise any private sector debt, much of which is already guaranteed by the government. For an emerging market, the assumption of this debt need not be a problem. Much depends on how the president wishes to proceed. One of the reasons why Turkey is able to carry ‘low debt’ is simply because it is not readily able to tap into debrt markets, and this is true for the government as well. For this reason, the Turkish government resorts to ‘printing money’, and as a consequence, Turkey has a persistent problem of high inflation, which is projected to reach 22% by the end of 2018. The global ratings agency is projecting that this will drive the Turkish economy into recession for the first time in a decade.[xxviii] It is readily apparent that this crisis is not going to be ‘sustained’. The Turkish president will be forced to capitulate, but not before his corporate oligarchic friend’s profit from the collapse. There is no reason to project such a ‘crisis’ upon all emerging markets. Erdogan is one of a few autocrats who have been ‘quarantined’.

Susan Lund, a co-author of the McKinsey study: [Markets have] depended on emerging markets to raise global growth, partially on the back of a credit boom. “This is going to take a bite out of growth, which will affect the US, Europe and the entire world economy”.[xxix]

It is true that the Us has launched a ‘broader trade war’ beyond Turkey, but the scope of this trade war is rather limited.

References

[i],[ii],[iii],[iv],[v],[vi], [vii],[viii] “Soaring global debt has analysts predicting next big crash” by David J Lynch, Washington Post & NZ Herald, website, 4th Sept 2018.

[ix] “Asian Financial Crisis: Causes and Development” by Richard Wong, Hong Kong Institute of Economics and Business Strategy, The University of Hong Kong, website, 2000.

[x],[xi],[xii],[xiii],[xiv],[xv],[xvi],[xvii],[xviii],[xix],[xx],[xxi],[xxii],[xxiii],[xxiv],[xxv],[xxvi],[xxvii],[xxviii],[xxix] “Soaring global debt has analysts predicting next big crash” by David J Lynch, Washington Post & NZ Herald, website, 4th Sept 2018.

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