All foreign exchange traders are aware of the current financial crisis in Turkey, especially traders who trade currencies in emerging markets, such as the Turkish lira. Lira has fallen into free fall lately.
It has lost about a third of its value this year, and the decline has accelerated dramatically in recent weeks. Earlier this week USD / TRY was trading just under 7 according to my broker. It fell below 6 during the week, while Turkey’s central bank intervened by raising interest rates by 1.50%, but jumped back by the end of the week. We’ll see how the Turkish lira behaves next week, as we are forex traders and like to distinguish between basic and technical data, but things don’t look so good from now on. Here the elementary students do all the damage to Lyra.
So what’s going on and more importantly, will this last?
To answer a more important question: it will last. Why? We will explain below. Although one of the reasons for this, which probably made the situation worse, is the fact that Erdogan is a bit of a master of the country and does what he wants. He removed all economists who had warned him of the financial and economic problems that might lie ahead. He got rid of all the opposition in financial circles in Turkey and left only those who agree with him in everything. He even appointed his son-in-law as the head of the central bank. Erdogan even instructed his son-in-law not to keep interest because that would weaken the lira. It doesn’t make sense, but let’s put that aside because that’s not what hurts Lear.
One of the things is the tariffs imposed by US President Donald Trump on the world, including Turkey. But Turkey and the US are not on good terms, as Donald Trump tweeted on August 10th. Turkey imprisoned the American pastor and refused to release him, while demanding the extradition of former opposition leader Gylen from the United States. So relationships are not good. In the same tweet, Trump said U.S. import duties on Turkish steel and aluminum would double to 50% and 20%, respectively. Lira dived even faster after that Trump tweet.
Turkey exported about $ 1.2 billion worth of steel products to the U.S. last year, and with those tariffs, exports will fall dramatically. Although, with a trillion-dollar economy, Turkey should not face such problems. It is not that Turkey is dependent on raw material exports like other countries like the Gulf countries and Russia. But it was a blow at a time when Turkey was in decline and still is.
The real problem lies elsewhere. The Fed and other large central banks such as the ECB, the Bank of Japan and the Bank of England have begun to expand their balance sheets by buying bonds and pumping money into their economies and the global economy. Interest rates in developed countries have long been close to zero, and on some occasions, such as Switzerland and Japan, rates are negative, and growth in these economies has been very weak. As a result, a large amount of money flew abroad, especially to emerging markets such as Turkey, India, South Africa, Indonesia, Vietnam, China, etc ..
The Turkish economy recorded very strong growth in this period. The money was coming in, the business was great, and the tall buildings were mushrooming. The return from construction and real estate is quite large when the economy is doing well – the prices of homes and office buildings are rising enormously. As a result, everyone tried to get some action during this gold rush. But buildings and real estate are not something that brings real value to the economy in the long run, unlike factories or the IT industry. Many liberal economists have tried to warn Erdogan, but the slogan in Turkey’s last decade has been “Love it or leave it.” My colleague from the profession tells me that many of these economists left when Turkey became more and more dictatorial.
Erdogan had his way, and now this is coming. These people tried to point out the naked king, but no one heard it. Now that the big central banks are starting to shrink their balance sheets and return the money by selling bonds, especially the Fed, money problems are emerging. Turkey has a large external debt, amounting to 53.3% of the country’s nominal GDP for that year and is likely to increase this year. This means that the interest they have to pay is quite high and they have to be paid in foreign currency, especially in US dollars.
The dipping is barely visible
This increases the demand for foreign currency to pay interest and settle debt. In addition, money is flowing out of the country as the Fed begins to shrink its balance sheet, which is a real problem. If you look at the chart above, you can see that the line is starting to go down. That is a very minimal drop. The Fed’s balance sheet stood at $ 4.8 trillion until less than a year ago, meaning trillions of U.S. dollars have boosted the world economy, especially emerging markets.
It is now starting to shrink, and only such a small drop is causing chaos in Turkey. Imagine when the line falls to 2010 or worse, to the 2008 level, which would mean a reduction in the balance below $ 1 trillion. Of course, not all emerging market economies are so dependent on US dollars, but Turkey seems to be dependent. How bad will it get? No one knows exactly.
I hope that Turkey will act together, but foundations such as the reduction of the Fed’s balance sheet and Erdogan’s old-school policy point to major problems for Turkey and the Turkish lira.