Among
all the dumb things said about the so-called Arab
Spring last year, perhaps the dumbest was the idea
that the new democracies of the Arab world might
follow the Turkish model.
In fact, if you
had invested in the Turkish model (that is, in the
Turkish stock market) at the outbreak of the Arab
revolts, you would have lost about half your
money. If you leave your money in Turkey, you
probably will lose the rest of it. Turkey is not a
model. It is a bubble, and it is bursting,
starting with the stock market and national
currency.
Full disclosure: I shorted the
Turkish market after I published my obituary for
the country's economic boom (see "Instant
Obsolescence of the Turkish model", Asia Times
Online, August
10, 2011). And I was
denounced as a Zionist plotter in the Turkish
media. As a matter of record, I wish to state that
I am shorting Turkey not for any political
motivation, but only because the Turkish
government economic policy is a clown show. I make
a point, however, of contributing some of the
profits to Zionist causes.
Chart 1: Turkish stock market
(TUR exchange-traded Turkey stock market fund)
vs. S&P 500, November 2010 = 100 Source: Bloomberg
Turkey isn't democratic, as its
volatile Prime Minister Tayyip Erdogan reminded
the world last week by arresting yet more
journalists on trumped-up charges of coup
plotting. According to Turkey's Journalists'
Union, Turkey has jailed 97 writers, more than
China, which no-one confuses with a model
democracy.
Nonetheless, Erdogan won Time
Magazine's People's Choice poll to be its 2011 "Person of the Year". Being designated "Person of the Year" is not necessarily an endorsement. In
1938, Time's Man of the Year was Adolf Hitler. In
1939, it was Joseph Stalin. Like Stalin and
Hitler, Erdogan's reputation has been more
resilient than the country's stock market.
The West still believes in its own ability
to fix all the problems of the world, and cannot
abide the thought that success is to be found
nowhere in the Muslim world (not counting
Malaysia and Indonesia). Now that Libya and Yemen
are immersed in tribal warfare,
Egypt is
dissolving into chaos, Syria has dug in for a long
sectarian bloodbath, and Iraq prepares for an
ethno-confessional civil war, Turkey seems a
pillar of stability by comparison. Not for long,
if my calculations are correct.
Last year,
I predicted that the "Arab Spring" would prove to
be a symptom of societal failure rather than
regime failure, and that Egypt as well as Syria
would suffer a social breakdown. That has now
become conventional wisdom, even among news
outlets that inhaled the hashish smoke from Tahrir
Square and predicted a glorious era of Arab
democracy only a few months ago. The subject
requires no elaboration here.
Western
credulity over Turkey, though, has not quite
departed. On January 6, for example, Peter Kenyon
wrote yet another paean to the Turkish "economic
miracle" for National Public Radio in the United
States.
Now I predict that Turkey's
economic crisis will undermine the stability of
the Turkish state as well, leaving the Muslim
world without a single enclave of stability from
the Libyan-Algerian border to China's Xinjiang
province.
Encouraged by the central bank,
Turkish banks increased their lending at a 40%
annual rate in 2009 and 2010, financing a flood of
imports. Turkey's trade deficit ballooned to a
tenth of its total output - as bad as that of
Greece or Portugal. And the country has been
borrowing on short-term money markets to finance
the import bubble.
Erdogan has the
weirdest economic views of any serving head of
government. He justified the credit bubble on
religious grounds, pledging repeatedly to cut the
"real" interest rate (the cost of interest minus
the inflation rate) to zero.
"We aim to
cut the real interest rate in the long run, so
people will increase their incomes through
working, not through interest," he said last
April. "Eventually we aim to equalize the interest
rate and inflation rate."
Erdoğan believes
that this would fulfill the Islamic injunction
against lending for interest; if the real interest
rate is zero, he seems to think, the sharia
ban on interest is fulfilled de facto. In order
words, Turkey provided nearly free money to bank
customers. Erdogan's program set in motion a
series of perverse effects. One is a sharp fall in
the exchange rate.
Turkey's currency has
been falling for a year, and fell even faster in
August and September. Turkey's central bank had no
choice but to raise interest rates sharply last
October to prevent it from entering free fall.
Even with the sharp rise in interest rates,
though, the currency has continued to deteriorate,
and the Turkish stock market has continued to
grind lower. But the spike in interest rates will
have deadly effects on the domestic economy.
Chart 2: Turkish central bank
pushes up interest rates (left scale) to
support the currency
Source:
Central Bank of Turkey
Chart 3
below shows that happened to domestic interest
rates, meanwhile, have risen as the central bank
tightened money.
Chart 3: Commercial
lending rate rises as Turkey tries to prop up
TRY Source: Central Bank of
Turkey
The result is a vicious
cycle: excess credit creation weakens the
currency, forcing the central bank to put up
interest rates; higher interest rates push up the
cost of debt service for Turkish borrowers;
Turkish banks lend more money to their customers
to finance the higher interest costs, so that
credit keeps expanding and the currency keeps
weakening.
Turkish banks continue to
increase lending at a 40% annual rate, but most of
the new lending will finance interest payments on
the old loans. In Chart 4 below, we simply
multiplied the higher interest rate by the amount
of outstanding bank loans in order to calculate
the total volume of interest payments.
Chart 4: Interest cost explodes
as loan bubble meets higher rates: Interest
payments on Turkish lira bank debt
Source: Central Bank of Turkey, Macro
strategy LLC calculations
That
leads to another perverse result: the banks cannot
slow down their lending. After the
credit-and-import bubble of 2010 and 2011, the
central bank promised that it would cool down bank
lending. Now, it appears, the central bank can do
no such thing because the banks need to lend
customers the money to meet their interest
payments. Capitalizing interest is a very, very
bad thing.
Chart 5: Turkish
credit growth year-on-year percentage
change Source: Central Bank of
Turkey
Despite its earlier
rhetoric from the central bank about the need to
restrain lending growth, the central bank
continues to finance an extremely fast rate of
lending growth from its own balance sheet. Again,
this suggests that the central bank has no choice
but to capitalize interest, which means the bubble
is getting worse by the day.
Chart 6:
Turkish central bank credit to banks
Source: Central Bank of Turkey
The central bank pumps money into
the banking system at an accelerating pace; the
banks increase their loans to customers at a 40%
annual rate; the central bank raises deposit rates
to prevent the currency from collapsing; and the
cost of carrying the debt bubble grows
astronomically.
Meanwhile, the current
account deficit continues to roar along at 10% of
gross domestic product (GDP). Where does Turkey
get the foreign exchange to important twice as
much as it exports? It seems that the Turkish
banks are borrowing the required money on the
interbank market. Their borrowings from foreign
banks (liabilities) exploded while their loans to
foreign banks declined.
Chart
7: Turkish banks: Foreign interbank assets vs
foreign liabilities
Source: BIS
As Turkey's balance of payments
deficit ballooned in 2009, Turkish banks became
massive net borrowers of dollars from other banks.
Those are short-term loans, though, and the
slightest shudder could wipe out this source of
financing.
A disaster is in the making.
Leave aside the economic ills of the southern
Mediterranean generally, which will impinge
Turkey's exports (about half of which go to the
European community): Turkey's financial system is
reaching the end of the rope. A sudden adjustment
in the current account accompanied by large-scale
bankruptcies among Turkish businesses and
widespread unemployment will make 2012 an ugly
year for the Turkish economy, and an even uglier
year for Turkish politics.
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