11 Trillion Dollars in Debt and Counting
The International Currency Crisis Affecting the Global Economy
Currency crises are abound. In many states, they are brought about by a number of factors, mainly, poor economic policies by the government coupled with heavy borrowing. Another factor is “debt trap economics”, a strategy used by states like China or the U.S. to take advantage of underdeveloped or developing states in need of capital. The borrowing state is led into a vicious cycle of borrowing and re-borrowing on their initial loan payments because they are unable to afford the scheduled payments on the principal of the loan. On top of the original loan, interest rates are usually high and are in relatively short term. This results in a decline of value for the states currency. The devaluation of the currency has a negative effect on a state’s economy by destabilizing the exchange rates. This means that the revenues generated in domestic currency are no longer as valuable compared to the dollar. For example, currently, 39.39 Argentinian pesos equal one U.S. dollar. This forces the state to dig into the foreign reserves to stabilize the currency or in a worst-case scenario, ask the International Monetary Fund (IMF) for a loan.
The Bigger They Are, The Harder They Fall
With several currencies like the Turkish lira plunging to new depths, several emerging economies are beginning to buckle under pressure. What is happening to the lira however is not only restricted to Turkey. Several economies across South America like Argentina, Brazil and Chile are under immense pressure to avoid the fate of a free falling currency. Global credit levels especially U.S. dollar denominated debt is at an all time high.
As a formidable economic power with 466 billion dollars in external credit, Turkey had borrowed heavily to fund its construction initiatives and bolster the states infrastructure. Today, Turkey’s debt to Gross Domestic Product (GDP) ratio is nearly 53%. About 18% is in Euros and 78 % is in U.S. dollars. A third of the total debt is scheduled to be paid off or refinanced by 2019, yet over the years the debt severely increased due to the imprudent actions of President Erdoğan.
Paired with the criticism surrounding Ankara, foreign investment in the country stagnated and the lira steadily decreased in value. Subsequently the decline of the lira made the loans even more costly to pay off and also made imports and services more expensive. This in turn affected the trust of the financial community and further depreciated the domestic currency. Policy makers in Turkey secured external loans in foreign currencies to compensate. This cycle of currency debt is nothing new and during these difficult economic periods a state needs strong leadership. Unfortunately, in Turkey this occurred in early August 2018 when Erdoğan stepped in and inadvertently added fuel to the fire. This was the bi-product of self-inflicted legislation that contributed to the fall of the currency.
When Erdoğan stepped in, the lira’s fall accelerated, and inflation skyrocketed into the double digits. The task of mitigating the inflation was taken on by the central bank. They had immediately promised to raise interest rates and pump as much liquidity into the system as necessary which allowed the lira to largely correct itself. The conditions that enabled the crisis are very much alive and well. In fact for Turkey, things will get worse before they get better as Washington is manufacturing newly imposed sanctions against Tehran. Many Turkish banks and firms have significant deals with their Iranian counterparts and are likely to face secondary sanctions.
These developments will further depreciate the lira, although Erdogan has wide range of economic and political options at his disposal to try and stabilize the currency most of the available measures have their own drawbacks to consider. For instance, raising interest rates is a good short-term solution, while placing capital controls as some internal officials have Suggested will greatly hamper the activity of the private sector. Another possible solution is the IMF whose bailout packages are codicillary in nature and often violate the sovereignty of a nation.
Opportunity or Trap?
Yet perhaps the most anticipated option is for Turkey to acquire new loans and investments from other nations. Qatar had already planned to invest 15 billion dollars in Turkey. Furthermore, China is looking to invest heavily in Ankara. Turkish and Chinese policymakers are working on the deal to issue Chinese-yuan denominated bonds for the first time in Turkey’s history. Moreover, as Turkish firms start to rely on Chinese funds, China’s state-owned companies will begin to expand into Turkey’s private and public sectors. This practice has been seen in Africa many times as it becomes a new strategy to “colonize” a state.
This move would make sense for both nations especially since Turkey is a link between European and Asian marketplaces. In turn, this will play a critical role in China’s belt and road initiative. The Belt and Road initiative, a long-term economic investment policy is an ambitious program created by China to dominate the global economy. However, Turkey still needs more than 200 Billion in the next year to pay off it’s short term credit, this will no doubt greatly test Beijing’s commitment to Turkish investment.
An even larger global trend has contributed to the decline of numerous domestic currencies all around the world. Since the start of 2018 the Indian rupee and Iranian rial have dropped to a record low against the dollar, even the Russian ruble briefly fell to its lowest level against the US dollar in more than 2 years. Meanwhile in Argentina, the peso is down more than 60% this year. This is causing an economic crisis that forced President Maurcio Macri to seek a loan from the IMF worth 50 billion dollars. The deal with the IMF is subject to board approval, in return the government promised to quickly formulate solutions to mitigate the current fiscal deficit. They also have plans to sell $500 Million worth of reserves to halt the pesos freefall. Still these measures have failed to stop the depreciation of the currency.
On the other hand, Argentinian authorities are foreseeing decreased or even stunted growth and increased inflation in the coming years. These developments might lead to another crisis in South America, seemingly similar to that of Venezuela. Other major South American economies, like Brazil and Chile have also seen a decline in their currencies 20% and 10 % respectively. Brazil’s public finances are set on an unsustainable and unstable path. The current budget deficit is over 8 percent of GDP and to add fuel to the already growing fire, it also has a public debt-to-GDP ratio of 85%.
Moving to the hyperinflation in Venezuela, the current humanitarian crisis is taking a toll on both Peru and Ecuador, this creates a dangerous cocktail that puts a great strain on already developing states. Also, in recent weeks, similar currency related issues have even emerged in South Africa. All of these global economic meltdowns have one thing in common, each of these countries holds large amounts of U.S. dollar denominated debt. To add insult to injury the United States has moved towards higher interest rates and a stronger dollar has put increasing pressure on the domestic currency. The mountain of U.S. dollar denominated debt started in the 1990s when emerging nations sought to overhaul their economies by borrowing cheap credit to boost their Financial Growth. At the time it was a sound plan and as long as their own currencies remain strong against the dollar, the credit was relatively risk free.
However as new governments succeeded the previous administrations the new policy makers continued this pattern without considering the long-term prospects, as such as U.S. dollar denominated debt increased exponentially from $642 Billion in 1990 to over 22.17 trillion dollars in the next decade. In the following years as U.S. dollar denominated debt increased, many of the currencies of the indebted countries fell in value against the dollar especially as Washington increased its interest rates.
However just like in Turkey, the bonds and loans needed to be paid off on a regular basis. Yet as the domestic currencies weakened the debt became even larger than the initial loan and became harder to pay back. Correspondingly, many governments failed to live up to their financial commitments and acquired even more loans to pay off their original loans. These measures however only aggravated the model. As of late 2017 interest in U.S. dollars outside United States reached a staggering 11.4 trillion dollars. That is a record amount of debt in the documented history of the financial community, it’s not hard to imagine how this debt bubble exposes nations that lack monetary policy options. That is precisely what happened in Turkey as well as in Iran, Russia, Argentina, India, South Africa etc. The U.S. dollar denominated debt accounts for a disproportionately large share of the external debt in these countries for instance, in Turkey the credit in U.S. dollars is about twice as high as the country’s total foreign reserves. Other countries that are particularly vulnerable include Mexico, Chile, Argentina, and Indonesia.
In Chile, the government has a U.S. dollar denominated debt of $100 Billion which equals 36% of the states GDP. However, Chile’s reserves sit at 37 billion dollars, that means that the country is nearly three times debt than total foreign reserves. Another excessive example is Mexico, which holds two hundred 271 billion dollars in debt, this is one of the highest sums U.S. dollar denominated debt in the world so far, the Peso has remained steady, but the ongoing dialogue between Mexico and the U.S. could end up depreciating the Mexican peso as bad as the Turkish lira. The point is that even though many of the indebted governments are likely to blame Washington for economic warfare and rightly so, yet they must also look to blame the person in the mirror for equally contributing to their economic downfall.