Turkish bankers try to drag Erdogan toward monetary sanity to no avail

Turkish bankers try to drag Erdogan toward monetary sanity to no avail
© Getty Images

According to an old proverb, whom the gods want to destroy they first make mad. Evidently, Recep Tayyip Erdogan, Turkey’s president, is blissfully unaware of this old warning.

Otherwise he would not be allowing his illusions of grandeur to lead him down the path of misguided economic policy decisions that could prove to be both the Turkish economy’s and his own ruin.

More than 10 years in power and with some economic success to his credit, Erdogan now seems to entertain the dangerous delusion that somehow Turkey is immune from the usual laws of economics.

ADVERTISEMENT

One clear instance of Erdogan’s loss of touch with economic reality is his eccentric view on interest rates and inflation. He now entertains no doubt that high interest rates are the cause and not the consequence of high inflation.

 

Never mind that practically every central banker and every trained economist around the world would think that such a view is akin to a doctor saying that chemotherapy is the cause rather than the consequence of cancer.

Another instance of Erdogan’s irrational behavior is his making very ill-advised decisions at a time of economic crisis that any sane person would see as likely to seriously add fuel to the crisis.

At a time that both domestic and foreign investors would like to be assured that Turkey will address its serious inflation and external imbalance problems, Erdogan chose Berat Albayrak to be the country’s new minister of finance. He did so even though it seems that Albayrak’s only qualification for the job is that he is the president’s son-in-law.   

It also would not seem to help matters that at a time that markets are concerned about the erosion of the central bank’s independence, Erdogan chose to do everything to confirm the market’s worst fears. He's done so by announcing that he will now have the power to appoint the governor of Turkey’s central bank and of hundreds of other senior officials.

Erdogan’s idiosyncratic approach to economic policy would not bode well for the Turkish economy in the best of times. However, these are hardly the best of economic times for his country’s economy.

Turkey is already in the grips of a currency crisis that has seen the Turkish lira lose more than 20 percent of its value since the start of the year, giving it the dubious distinction of being the world’s worst performing currency this year.

It is also occurring at a time that the Turkish central bank has been forced to hike interest rates to 17.5 percent to help support the currency, despite Erdogan’s kicking and screaming.

It should come as no surprise that the Turkish currency is receiving the harshest of treatments from the markets considering that, even before the current international oil price shock, Turkey has been running one of the world’s largest external current account deficits and is suffering under a large burden of short-term external debt.

In addition, Erdogan would seem to be making a major mistake in his misreading of the global credit cycle.

In particular, he seems to be overlooking the fact that after many years of extraordinarily easy monetary policy by the world’s major central banks that made the global economy flush with liquidity, the Federal Reserve is now raising interest rates and reducing the size of its bloated balance sheet.

He also seems to be overlooking the fact that an expansive U.S. fiscal policy at this late stage of the economic cycle is all too likely to force U.S. interest rates and the U.S. dollar ever higher.

In a less-benign global liquidity environment, one must expect that foreign investors will continue to repatriate capital from the emerging markets in general and from countries with weak economic fundamentals like Turkey in particular.

With U.S. Treasury yields now approaching 3 percent and with the dollar appreciating, foreign investors will no longer be willing to turn a blind eye to Turkey’s many economic weaknesses when they can get a good return on a safe U.S. asset.

Turkey is of course no stranger to currency crises resulting from a sudden stop in international capital flows. This strengthens one’s reason to think that Erdogan’s current actions fueling Turkey’s currency crisis and thereby raising the risk of a deep economic recession is the clearest indication that the gods wish to destroy him by first making him mad. 

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy Director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.