Turkey in Freefall
The Lira Continues to Face Rampant Inflation
Nureddin Nebati gave a solemn message when speaking to the economic community. Turkey would face 40% inflation in the coming months, and the Lira would continue to fall in the face of other currencies.
And the worst part? This was the good news. The inflation rate wouldn’t go over 50%, Nebati predicted, and the economic community hoped that inflation would peak at 40%, instead of languishing above that.
But how did we get here? How did Turkey become one of the faces of high inflation, taking its place among Argentina and Venezuela as fragile developing economies?
And more importantly, what, exactly, is President Recep Tayyip Erdoğan doing to solve the issue?
Turkey has always faced a serious problem — low savings rate. The country has massive expenditures, and huge current accounts deficits that require massive financial inflow to correct. In essence, Turkey needs billions to enter the country, or else the whole economy may go bust.
These massive current account deficits are partially fueled by Erdogan’s massive spending programs. The Turkish government increased R&D and education spending significantly in the late 2010s, and these gains failed to materialize in any way. The return on investment that Erdogan needed to dig himself out of his hole never came, and the costs kept mounting.
But Turkey still had one ace up their sleeves — as long as foreign investors were still confident in the country’s growing industrial and manufacturing sector.
All Erdogan needed to do was stay on good terms with other countries who provided this inflow, and keep Turkey’s internal economy running smoothly without much instability.
Which obviously means that the Erdogan would spend the next few years picking fights with the countries that were keeping Turkey functioning.
NATO’s opinion on Turkey has quickly soured, as the country changed from a friendly, open force in the middle east — promising to make nice with historical foes and work to increase the stability of the region — to one that consistently causes rifts with Europe on the whole. Erdogan’s foreign policy has quickly changed him from a Pentagon darling to a national security threat that the United States intelligence community was loathe to trust. It was a dramatic about-face, and the Turkish invasion of Afrin in Syria in 2018 did nothing to help their public image. They were no longer a European ally in the middle east, but a hostile nation, with whom many major investors were wary to work with.
And internally, Erdogan continued to destabilize investor trust. Following a coup attempt in 2016, the government began to seize assets of many people, some of whom were not related to the coup in any sizable regard. This move spooked investors, and inflow began to decrease, slowly, while the country’s account balances didn’t follow suit.
One of the factors investors take into account is a stability of a country. Turkey, for years, was coming closer and closer to Europe, and the country remained stable. Erdogan’s crackdowns, the country’s slide back away from the policies that almost made it an EU member, and the disassociation from NATO organization has turned Turkey into an unstable nightmare.
Enter, Economics 101. Or at least, Erdogan’s disastrous misunderstanding of Economics 101.
If you’ve read any of my other articles, you’ve probably heard of a link between interest rates, and inflation. That’s something Erdogan denies, and it’s lead to policy that does not line up with the rest of the world. Erdogan wants to keep interest rates low, keep credit easy to access and flowing fast, and keep spending to grow faster, grow more, and grow larger.
Except, if you grow too fast, to the point where you’re outpacing your capabilities, then suddenly, there’s a whole lotta money and not that much to buy.
So when Erdogan slashed interest rates to keep money flowing, interest rates began to spike, and the Turkish Lira continued to tumble.
The situation is dire. The value of the lira is inherently tied to the cost of imports. A cheap lira is good news for foreign investors, whose currency can now command larger prices in Turkey, but wipes out the wallets of Turkish buyers as their imports suddenly spike in price. The lira fell from .086 in late 2021, to .074 in late January of 2022, a net decrease of 14% against the US dollar. Looking at the currency in a one year period, the Lira lost over 45% of its value against the US dollar since last January. In a country that uses over 30% of its GDP in imports, changes like that can, and were disastrous.
Electricity, housing, and other day-to-day costs have increased upwards of 50% in the last year, leading to protests, demonstrations, and crisis for Erdogan’s government. While some plans were unveiled, temporary bringing up the price of the lira considerably, those plans fizzled, and Erdogan has been reduced to begging people keep their hands on lira instead of converting it to gold.
With annual inflation increasing rapidly, the world’s economists have proposed a simple solution: hike interest rates. Decrease the availability of easy to access funds, and tamp down on the money supply. It’s reminiscent of policy put in place in the US during the 70s and 80s, and it follows simple principles — decrease the total amount of money in circulation in order to decrease inflation.
But Erdogan refuses. His party has based itself on support from both the lower classes, and his policy has been incredibly generous for them. Cutting their benefits would be politically disastrous, and the middle class, for whom taxes and costs have only continued to increase, are tapped out.
With Turkish inflation continuing to remain high, investor confident in the country falling, and Erdogan’s balance sheets remaining dangerously lopsided, there doesn’t appear to be any plan for Turkey short of their production catching up to their inflation.
And who knows how long that will take…
