An economic crisis in any one country generally offers cautionary lessons for other countries. The current Turkish economic and financial market debacle would seem to be no exception to that rule.
Drawing the right lessons from that crisis might prevent other countries, including the United States, from repeating at least some of the many policy mistakes that have led Turkey to its current desperate economic state.
The basic source of Turkey’s present financial market meltdown, which appears to go from bad to worse on a daily basis, is that for all too many years, its government allowed the country to live way beyond its means.
It did so by adopting highly accommodative monetary and fiscal policies in pursuit of an unsustainably rapid pace of economic growth that might gain short-term favor with the public at the ballot box. It also did so by neglecting to rein in excessive borrowing, especially in U.S. dollars, by its corporate sector.
Overly easy macroeconomic policy over many years manifested itself in a dangerous widening in Turkey’s external current account deficit. It also resulted in an undue build up in corporate-sector borrowing and to a marked pickup in inflation.
Turkey’s growing economic imbalances did not get the country into trouble during the years when the world’s major central banks were flooding the world with liquidity through their aggressively unorthodox monetary policies.
However, when the music began to stop, once the Federal Reserve started raising interest rates and reducing the size of its bloated balance sheet, the Turkish lira began to swoon.
It did so as foreign capital, which had earlier flooded into the country in search of higher yields than those that were being offered at home, headed for the door in search of safer havens for their investment.
Adding fuel to the crisis is the fact Recep Tayyip Erdogan, Turkey’s increasingly powerful and arrogant president, is widely perceived by the markets as someone who believes that the Turkish economy is not subject to the usual laws of economics.
It has not helped matters that as the Turkish lira swooned and as inflation accelerated, Erdogan has kept insisting that high interest rates cause inflation rather than cure it.
Nor has it helped that as the markets were looking for signs that Turkey would do something serious to reduce its external imbalances, Erdogan has kept promoting ambitious government spending projects.
Among the more important lessons that can be learned from the ever-deepening Turkish economic and financial market crisis is that years of ultra easy monetary policies by the world’s major central banks can have serious adverse consequences.
Had global liquidity conditions not been as ample as they had been over the past several years, Turkey would not have been able to run the outsized external imbalances that it has managed to run, nor would its corporate sector have been able to incur as large a U.S. dollar denominated debt as its corporate sector has built up.
Turkey’s current desperate economic situation, along with that of Argentina, might also serve as a warning to the world’s major central banks about the risks of being too hasty in their desire to normalize monetary policy.
Turkey and Argentina are all too likely to be the canaries in the coal mine about excessive borrowing by other major emerging market economies, like Brazil, that have major economic imbalances.
Closer to home, Turkey’s present economic debacle might remind us that there comes a day of reckoning for reckless macroeconomic policies. This would seem particularly pertinent in the current U.S. context where a massive unfunded tax cut together with public spending increases are expected to give rise to budget deficits in excess of 5 percent of GDP for as far as the eye can see.
It would be fanciful to think, as the Trump administration seems to do, that these budget deficits will not lead to a widening in the U.S. external current account deficit or that these deficits can be financed indefinitely without a dollar crisis at some point.
Yet another cautionary lesson that Turkey’s painful experience might hold out for the Trump administration is that it is dangerous to pressure the central bank to keep interest rates artificially low.
By undermining investor confidence that policy is being run in a responsible manner, such interference with central bank independence can lead to very untoward financial market consequences.
Hopefully, a silver lining in Turkey’s current economic crisis is that others might draw the right lessons and not repeat the same mistakes as Turkey did. Sadly, however, experience teaches that each country seems to think that it is different and that what is happening in Turkey could not possibly happen at home.
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.