Turkey: Currency collapse, nepotism, and the portent for gas

[Jan van Eck + 7,558]

Turkey, the perpetual suitor for EU membership, is undergoing what was a slow-motion deterioration, and is now rapidly escalating into a full-blown economic and currency crisis.  Let’s take a look at how this developed.

Historically, Turkey has been a more-or-less secular State, being the physical bridge country between an Asia with wrenching conservative Muslim thinking and a quite secular Europe.  Notwithstanding its deep roots as a Christian continent, and having official State religions, Europeans today are not church-goers to any great degree.  The majority of Europeans declare no religion and do not attend church, even in deeply Catholic countries such as France.  Instead, Europeans have embraced the Administrative State as their government model, which requires a secular platform to operate. 

Meanwhile, Turkey, in attempting to meld itself with the winning economic format of the West, detached itself from a religious descriptive and also became a largely secular State.  That did not sit well with some Muslim factions, and in yet another coup,  Recep Erdogan became the President and de-facto dictator.   Erdogan had a daughter, Esra, whose husband had no job; that fellow promptly became the government’s Minister of Energy.   Nepotism?  But of course.  Yet there is some precedent for this, even in the USA, where President Kennedy appointed his brother Robert to be the Attorney General and in charge of the Justice Department.  So nepotism is not exactly unknown outside of the Middle East, we do that also.  The son-in-law,  Berat Albayrak, was subsequently promoted to Minister of Finance, a job for which he seems manifestly unsuited.  

Turkey’s promise to the EU was two-fold: a continuing source of labor for Europe’s factories, especially in Germany under the Gastarbeiter program, and a source of semi-finished goods from Turkish plants, relatively cheap materials under the exchange rate of two lira for one Euro.  In order to finance expansion of Turkish manufacturing, those plants took on debt – which was denominated in Euros.  And that’s fine, but implicit in that scenario is the idea that the exchange rate, which determines the ability of the borrower to eventually repay the debt, remains stable.  The inherent risk in foreign-currency debts is that the exchange rate kilters, typically due to current-account imbalances and galloping inflation.  When that happens, you end up looking like Argentina, and you default.  

Now Mr. Erdogan proceeds to jail an American evangelical pastor, on some bizarre charge of espionage.  This is ludicrous, of course, and it reflects an unstable mind of the President.  Couple that with structural problems in the Turkish Government – the brazen nepotism and over-staffing – and you start down the road of instability.  First up, the US places Sanctions on Turkey.  That immediately pushes up the inflation rate. 

A mild inflation is not necessarily a bad thing.  It tends to stimulate the economy by convincing the consumers holding cash to spend it today, as it may have less purchasing power “tomorrow” – where “tomorrow” is interpreted as being months or years down the road, to any significant degree.  Very rapid inflation, however, badly distorts markets, as nobody wants to hold cash and that acts as a transactional barrier, thus throttling the economy and resulting in a drop in GNP. 

The warning signs for Turkey start to pile up, and Erdogan is more interested in suppressing Kurds and instituting a theocracy than he is in sovereign debt management, infrastructure, a reformed civil service, and smooth relations with the Americans.  That gets you into trouble fast.  In his confrontation with the Americans, Erdogan is stubborn (and stupid), and gets hit with Sanctions.  That makes it difficult for both his government and his factories to manage their debt borrowings, and the curtailment of external credit pushes the printing of money in-house.  To no surprise, the Turkish Lira starts to devalue. 

The fight over the Pastor leads to the steel and aluminum tariffs of 25% and 10%, respectively, to include Turkish materials and semi-finished goods.  The Lira collapses by ten percent in one morning.  The son-in-law is incompetent to do anything.  

Turkey now is on the edge of the precipice. It has these foreign creditors, not only in the government bond market, but in corporate debt.  Those debts have to be paid in Dollars or Euros.  The debts cannot be paid, as they were taken out when the exchange rate was 2:1, and today it is at 7:1.  So that is hopeless.  Widespread corporate bankruptcies loom.

Incomes and buying power are collapsing.  The measure of this is Gross Domestic Product per capita – what has sunk by ten percent since 2016.  Inflation has risen to 18% per annum. The net result is that the population is rapidly losing purchasing power, cannot buy imported goods, and is getting poorer, in both relative and absolute terms.  Remember particularly that Turkey imports both food and fuel, two elements that all households need an irreducible minimum of.  When the household budget gets whacks like that, civil unrest and revolution is around the corner.

All this is pushing capital flight.  The coffers of Turkey are being stripped bare, as foreign capital leaves.  The result is that Turkey cannot find the currency reserves to make purchases of imports or pay the sovereign debt.  This has led to increasingly strident and irrational proclamations from Erdogan, about having the citizens exchange their Euros and dollars at the bank for Lira  (which are inflating away, so not much success in that idea), and about “the West” ganging up on Turkey to wreck the State  (a preposterous notion, entirely paranoid, the product of a delusional mind). 

Inflation now pushes up the domestic price levels, and for imported goods (and Turkey has to import both food and oil, remember), those get astronomically expensive when paid in Lira.  Life is getting very expensive for the citizens.  Meanwhile, Turkey suffers from that current-account deficit, of at least 6%, as more is imported than exported.  But the sellers will not accept Lira for those goods, only Euros, putting even more strain on cash reserves, decreasing imports, and pushing down the total level of economic activity inside Turkey.  It gets into a cycle of “stagflation,” a disastrous combination of economic stagnation (no purchasing power) and inflation (a currency with rapidly declining value). 

Finally, the Erdogan government with its erratic fundamentalism and drift into theocracy will turn off secular Western States, their governments, and lenders.  Turkey is headed for a world of hurt. 

How does this affect oil and gas?  Well, if you were a prospective pipeline builder, would you want to take a chance on spending many billions on building some transit pipeline through a country that is headed for civil war, invasion from fundamentalists on the borders,  and theft of your product as it moved through that line?  You tell me. 
 

[TraderTate + 186]

I'd like to hear more about your theory of 'civil war'. I personally don't see this part of the equation playing out, but would be interested to hear how you think it might be possible. Erdogan has pretty much quashed the Gulen-ites inside the country, and the last 'coup attempt' failed miserably. 

To my mind, the biggest problem facing the Turkish economy is the independence of the Central Bank, which is now--for all intents and purposes--controlled by Erdogan and doing his bidding via son-in-law. That is killing investor confidence, and obviously since Erdogan believes that interest rate hikes are pure evil, I don't see how it will improve. 

[TraderTate + 186]

I see Turkey just raised interest rates and the lira got a big bump.