Podcast Summary
Turkey's persistent economic challenges: Turkey's heavy dollarization and government measures to discourage domestic savings in dollars have failed to stabilize the lira, leading to high inflation, currency volatility, and significant corrections in the currency, sudden rises in interest rates, and large drops in bond prices.
Turkey continues to face long-term issues that contribute to its frequent bouts of high inflation and extreme currency volatility. Principal Asset Management, as a real estate manager with a 360-degree perspective, recognizes the complexities of such situations and actively seeks out investing opportunities. In the case of Turkey, the country's heavy dollarization and government measures to discourage domestic savers from holding dollars have failed to stabilize the lira. Economist Paul McNamara, an investment director at GAM and a long-time specialist in emerging markets, characterizes Turkey's predicament as a recurring issue. The country's tendency towards high inflation and currency volatility can lead to significant corrections in the currency, sudden rises in interest rates, and large drops in bond prices. McNamara has previously shared his insights on Turkey's economic situation on the Odd Lots podcast. In this episode, he discusses the current measures implemented by the government and offers his perspective on the international investing community's view of the situation.
Turkey's Economy: Political Choices or Structural Vulnerabilities?: Political choices, particularly unorthodox monetary policies, have led to Turkey's economic volatility. However, structural vulnerabilities like a large external deficit, low foreign exchange reserves, and heavy reliance on foreign currency make Turkey more susceptible to external shocks.
The recent volatility in Turkey's economy, which has seen a significant shift between the lira and the dollar, is largely a result of political choices made by the government. The Erdogan administration's unorthodox views on monetary policy and repeated lowering of interest rates despite high inflation have created a volatile environment where people feel the need to react quickly, leading to a volatility-promoting spiral. However, Turkey's structural vulnerabilities, such as a large external deficit, low foreign exchange reserves, and a substantial role for foreign currency in its economy, make it more susceptible to the consequences of such policy experiments. The high amount of onshore debt in US dollars only adds to this vulnerability. While the recent volatility can be largely attributed to political choices, the longer-term structural issues make Turkey more prone to boom-bust cycles. To reverse these factors, a more orthodox approach to monetary policy and efforts to reduce the role of foreign currency in the economy could help build a stronger cushion against external shocks.
Dollarization and Economic Instability in Turkey: High dollarization in Turkey's economy, coupled with macroeconomic instability, can lead to increased volatility and instability, particularly in sectors without a natural source of dollars, such as real estate.
The high level of dollarization in an economy, particularly in the case of Turkey, can lead to increased volatility and instability. This is because when a significant portion of an economy's debt is denominated in a foreign currency, such as the US dollar, the strength or weakness of that currency can have a profound impact on the economy. In Turkey's case, the strong role of the dollar in the economy, coupled with a lack of a natural source of dollars, can create a situation where when the dollar strengthens, it can put borrowers in a precarious position, leading to a vicious cycle of volatility. This is especially true in sectors without a natural stream of dollars, such as real estate. While dollarization is not unique to Turkey, countries have managed to reduce the level of dollarization in their economies by maintaining macroeconomic stability and addressing inflation. However, in the current situation in Turkey, high inflation and a lack of faith in orthodox or unorthodox policy solutions have contributed to the crash in the lira and a perceived lack of options for stabilization.
High inflation in Turkey: Causes and challenges: Turkey's high inflation rate of 36% YoY, driven by lira depreciation, import costs, global economic conditions, and dollarization, poses challenges for economic decision-making. Other emerging markets have managed to mitigate dollarization risks through macroeconomic stability.
The current high inflation rate of 36% year on year in Turkey, with a 13.5% increase in just one month, is a significant concern that makes economic decision-making challenging, even for the short term. The lira's depreciation and import costs are contributing factors, but they're not the only ones. Global economic conditions, such as a buildup of cash balances and a rise in oil prices, are also driving inflation. Turkey's high dollarization and the government's lack of action are making the situation more volatile. However, other emerging markets have managed to deal with dollarization and reduce its associated risks through macroeconomic stability, which includes keeping inflation in check. Turkey appeared to be on this path, but recent events have derailed its progress.
Factors contributing to economic stability for a currency: Low inflation, safe banking sector, and stable government debt lead to economic stability, making a currency a preferred unit of account, while uncertainty and instability lead to preference for foreign currencies.
Economic stability is crucial for a currency to appreciate and for people to prefer using it as their unit of account. Factors contributing to stability include low and persistent inflation, a safe banking sector, and a stable government debt. When these conditions are met, people prefer the certainty of their domestic currency over foreign currencies, even if it means missing out on potential gains from a stronger foreign currency. However, when there is uncertainty, such as frequent changes in monetary policy or government interference in the central bank's independence, people may seek the safety of foreign currencies, leading to currency volatility and instability. In Turkey's case, the government's desire for low inflation, growth, and favorable financial conditions for certain sectors, coupled with a reluctance to acknowledge the trade-offs in economics, has contributed to economic instability and a preference for foreign currencies among the population. The government's efforts to protect the lira without encouraging dollar purchases have been met with skepticism, as they have not addressed the underlying causes of the instability.
Turkish government's lira deposit guarantee: The Turkish government's plan to guarantee deposits in lira and compensate depositors if the currency weakens is a risky strategy that could lead to contamination of the government balance sheet if the lira weakens significantly and the government can't afford the compensation.
The Turkish government's plan to pay depositors in lira and compensate them if the currency weakens could be seen as an attempt to stabilize the economy and banking system. However, it also resembles the Irish government's decision to guarantee its banks during the financial crisis, which turned out to be a costly and unsustainable solution. The Turkish government's plan could be considered as writing a valuable put option on the lira for free, but the concern is that if the lira weakens significantly, the Turkish government may not be able to afford the compensation, potentially leading to contamination of the government balance sheet. The success of this plan relies on the assumption that the guarantee will never have to be used and that it won't make everyone's credit worse. This is a risky strategy, and the Turkish government's ability to afford the compensation is a major concern. The discussion highlights the potential dangers of such guarantees and the importance of considering the long-term financial implications.
Central Banks Using Promise to Backstop Debt as Crisis Prevention Tool: Central banks can prevent financial crises by promising to backstop debt, but underwriting dollar debt without the ability to print dollars could lead to a dollar-lira spiral and potential crisis.
Central banks, such as the European Central Bank (ECB) and the Federal Reserve, have effectively used the promise to backstop debt as a tool to prevent financial crises. This was seen with Mario Draghi's Outright Monetary Transactions (OMT) in Europe and the Fed's promise to support municipal bonds in the US. However, the Turkish Central Bank's attempt to offer similar stability through locked accounts for lira conversions into dollars raises concerns. Since the Central Bank of Turkey cannot print dollars, it is effectively underwriting a dollar debt, which could lead to a dollar-lira spiral and potential crisis if not enough people convert their lira. The analogy given was that of an insurance contract, where the insurance may make a crisis less likely but make it worse if it does occur due to the contamination of the sovereign balance sheet and potential for excessive lira printing.
Turkey's economic stability relies on monetary discipline and controlling credit growth: Turkey's economic stability depends on internal policies to control credit growth and external factors like the pandemic and inflation. Principal Asset Management offers expertise to help navigate these complexities and find opportunities.
The economic stability of Turkey, particularly its currency, hinges on monetary discipline and domestic credit growth. The Turkish Central Bank's intervention in the lira market can temporarily improve valuations, but sustainable stability requires a focus on controlling credit growth. Additionally, external factors such as the pandemic's impact on tourism and global inflation also play a role in Turkey's economic situation. Turkey's reliance on external energy sources adds another layer of complexity to its economic challenges. Principal Asset Management, with its 360-degree perspective and expertise, is well-positioned to help clients navigate these complexities and uncover opportunities in the global market. For businesses, tools like the American Express Business Gold Card can provide flexibility and financial benefits to help manage cash flow during uncertain times.
Identifying inflection points for Turkey's economy: To invest in Turkey's economy, focus on identifying inflection points that consider both external factors and economic sustainability, and look for a stable lira and half of deposit base in local currency.
While high oil prices and inflation in countries like Turkey are significant challenges, relying solely on external factors for resolution is not enough. Turkey, specifically, needs to improve its policy mix to avoid a potential crisis. Inflection points, which indicate a change in direction, are crucial in identifying buying opportunities for economies experiencing rough times, such as Turkey. Valuations alone do not determine these inflection points, as external factors and economic sustainability are also important considerations. The lira's stabilization is a key indicator of a sustainable footing for Turkey, as long as half the deposit base remains in lira, the currency's volatility is unsustainable. Looking ahead to 2022, the ongoing pandemic adds another layer of complexity to the economic landscape, but identifying inflection points and focusing on sustainable economic situations will be essential for investors.
Fed's stance and global growth key factors for EM landscape: The Fed's hawkish stance and the global economic growth situation outside the US are crucial factors shaping the EM landscape in 2023.
The strength of the US dollar and the hawkish stance of the Federal Reserve are making it challenging for emerging markets (EM) to prosper. The Fed's determination to raise interest rates and the resulting stronger dollar are making it difficult for countries with weaker economies to compete. The ideal situation would be a significant growth recovery outside the US, which would help counteract the strong dollar environment. During the discussion on Odd Lots, Paul McNamara, an EM expert, emphasized the importance of the Fed's stance and the growth situation in developed countries outside the US as key factors to watch in the EM landscape. The podcast also featured differing perspectives on Turkey's economic situation, highlighting the complexity of the government's ability to encourage domestic saving and stabilize the lira relative to the dollar. Overall, the consensus is that the Fed's actions and the global economic growth situation will significantly impact the EM landscape in 2023.
Exploring the World of Finance with Matt and Katie's Money Stuff Podcast: Learn valuable insights into the financial world and stay informed on the latest trends and developments through Matt and Katie's popular Money Stuff Podcast, available on Apple Podcasts and Spotify.
Every Friday, Matt and Katie bring you the latest in Wall Street finance and other intriguing topics through their podcast, Money Stuff. This podcast, which is based on Matt's popular newsletter, is available for listening on popular platforms like Apple Podcasts and Spotify. By tuning in, you'll gain valuable insights into the financial world and stay informed on the latest trends and developments. Whether you're an investor, a business owner, or just someone interested in finance, Money Stuff is a must-listen for anyone looking to expand their knowledge and understanding of the industry. So, make sure to add it to your weekly listening schedule and join Matt and Katie on their journey to explore the world of finance.
