Could Turkey Trigger the Next Global Financial Crisis?
All eyes are on the Turkish lira, the currency of Turkey. Its decline has been precipitous—it has already lost over 40 percent of its value against the U.S. dollar this year. For Turkey, which has relied upon the inflow of foreign credit, this poses terrible risks. Enormous debt coupled with a vicious attack for political reasons on the Turkish economy by the U.S. government has set Turkey toward the precipice. Will Turkey’s descent take Europe with it and then, certainly, other middle-income countries? Is this the harbinger of a new global financial crisis that would be far more dangerous than the one in 2007-08?
The credit crisis of 2007-08 has not really ended. The problems posed by the collapse of the U.S. housing market and the subsequent debt problems in world banking have not been fixed. Sober recommendations from the Basel Committee on Banking Supervision as well as from the International Organization of Securities Commissions and the International Association of Insurance Supervisors have been substantially set aside. Instead of genuine reform to the financial sector, the United States government held its interest rate near zero and flushed the financial system with U.S. dollars. The solution to a housing bubble in the United States has been to create a massive debt burden in the middle-income countries.
In countries such as Turkey, recently private companies started to take out more dollar-denominated loans from international financial institutions to finance their operations and even speculative investments. A flood of dollars crashed into these countries. Foreign speculators used this money to invest in their local currencies (including in lira-denominated public sector securities in Turkey). The Institute of International Finance showed that this wave continued to crest as recently as the past few years. At the end of 2011, the thirty largest emerging markets were indebted to the tune of 163 percent of their gross domestic product; in the first quarter of this year, the percentage increased to 211 percent of GDP, an increase of $40 trillion in debt of these countries. The exit from the 2007-08 financial crisis was by debt-financed economic growth, with a massive balloon of various kinds of debt inflated over the past decade.
Total global debt is estimated to be $247 trillion. It is a figure that should give us pause. Much of this debt, furthermore, went to finance the expansion of the financial sector rather than develop the productive and socially beneficial sectors. It is a model of economic growth that demands more debt to finance itself. There are few other avenues for this unsustainable model. The trigger that might explode this bubble fully comes in the months ahead as countries such as Argentina, Brazil, South Africa and Turkey will confront the maturation of their $1 trillion of dollar-denominated debt. Will they be able to replace these existing loans with fresh loans? Who will be in line to lend money to countries that seem to be at the end of their rope?
Financial crises are not new to Turkey. Major crises struck this country of 80 million in April 1994 and February 2001. In both cases, the country lost a large part of its GDP and its foreign exchange reserves as interest rates skyrocketed (in 1994, overnight interest rates went from 75 percent to 700 percent, while in 2001 they went from 40 percent to 4,000 percent). Recovery came through a variety of means, namely through an IMF-induced “Transition to a Strong Economy” program. The IMF program pushed Turkey to “capital account liberalization,” a fancy way of saying that its banks were encouraged to borrow in dollars from international capital markets and lend in liras to domestic investors. The entire economy was restructured to rely on lower wages to encourage exports and by the inflow of short-term capital. As this volatile short-term capital rushed into Turkey, the current AKP government used it to fund extravagant, unproductive projects. There was no possibility that Turkey could export enough to finance its significant foreign debt. Massive current account deficits have been vulnerable to the withdrawal of the short-term foreign capital—what is rightly called “hot money.”
In 2011, everything seemed manageable. Turkey was on the threshold of entering the European Union, relations with the United States were on a high and the Anatolian businessmen saw their own manufacturing benefit in the markets from Lebanon and Syria to the Gulf and to North Africa. The war in Syria threw the entire political situation into turmoil. Exports to the Arab world declined, the refugee crisis put pressure on Turkey and its own political stability ended with the government opening up a new war on the Kurds. Turkey’s ambitions in Syria ended and the ruling AKP or Justice and Development Party’s government tried to bring stability by ruthlessly purging any dissenters in the country. Political favors brought incompetent people to take over from those who had been purged. All this brought internal stress into the Turkish economy.
And then came Trump. The tariff policy from the United States—particularly in this case on Turkish steel and aluminium—sent a tremor through the bankers who had lent Turkey money. Higher interest rates in the United States drew money out of places such as Turkey (and other middle-income countries) to rush back to the U.S., where the dollar is “good as gold.” All this hit the lira hard. It did not help that the United States and Turkey are in the midst of a political fight over a U.S. pastor who is jailed in Turkey and over a Turkish cleric who lives in the U.S. Since the attempted coup in Turkey in 2016, tension has existed between the two countries. Now, the U.S. administration has made it clear that even the release of the pastor will not be enough. “The tariffs that are in place on steel would not be removed with the release of pastor Brunson,” said Trump’s spokesperson Sarah Sanders. “The tariffs are specific to national security.” What that chilling phrase means is not clear.
It is an advantage to Trump that the banks with the largest exposure to the Turkish lira are all European—France’s BNP Paribas, Italy’s UniCredit and Spain’s BBVA. The European Central Bank has already indicated its concern despite the fact that these banks say that they are prepared for the worst scenario. The amounts are not small. Turkish borrowers owe Spanish banks in excess of $82 billion, while French banks are owed $38.4 billion and Italian banks are owed $17 billion. Turkey’s private sector debt is substantial—within a year it must pay $220 billion to service this debt. An inability to make these payments as well as a further collapse of the lira could set off a crisis in Europe, which would then have an impact on the global financial markets. Turkey, this time, could be what the U.S. housing market was in 2007.
Turkey’s finance minister Berat Albayrak, who happens to be the son-in-law of President Recep Tayyip ErdoÄŸan, has said that his country has opened discussions with the IMF. He pledged not to put capital controls in place. Capital controls might well be the only option to truly protect Turkey from economic collapse. The AKP party is averse to any radical solution. It will likely conform to IMF policies without going formally to the IMF—to preserve ErdoÄŸan’s faÃ§ade about being anti-Western. The AKP is now governed by anti-Western rhetoric, but pro-Western policies.
On August 15, the Turkish government approached the World Trade Organization (WTO) with a formal complaint about the United States’ tariff policy. The complaint says that the U.S. tariffs are against the General Agreement on Trade and Tariffs (1994), the bedrock framework for the WTO, and that even U.S. law (Trade Expansion Act of 1962) violates the 1994 GATT agreement. Five days later, the WTO circulated this complaint among its members. There will now be a serious discussion based on this document.
Meanwhile, across its border, Iran has suffered as well from the return of U.S. sanctions. China has provided some short-term succor for Iran. Will it offer such protection to Turkey? When Boeing pulled out of its contract to sell aircraft to Iran, the Russian firm Sukhoi offered to do so. Will Russia now make similar concessions to Turkey? Will there be an Asian solution to the Turkish crisis? But can China and Russia, themselves vulnerable to the turbulence of global finance, bail these countries out indefinitely?
Other solutions are necessary, more radical ones.