In 2017, Turkey had the fastest-growing economy among the G20. Now, just a year later, the once-proud nation is on the verge of economic collapse.
Normally, the U.S. government would swoop in to save an emerging-market economy on the brink of destruction, offering aid packages and explaining to stretched-thin U.S. taxpayers that “we’re all interconnected” in the global economy. This is particularly true when the nation in-need is a NATO ally, which Turkey is.
But President Trump, for better and for worse, is not a normal U.S. president.
Instead of offering aid to Turkey, Trump is intentionally trying to inflict greater pain on the country. And there’s a reasonable case to be made that the president is entirely justified.
That’s because the primary motivation for Trump’s tough tack on Turkey is that the Islamic Republic is holding an American Christian pastor on what experts say are trumped-up charges. Trump’s actions may not be constitutional or economically sound; they might even put global peace and prosperity at unnecessary risk; but they do seem genuinely aimed at freeing an innocent and unduly held American citizen.
Regardless of Trump’s justification, global markets have been roiled by the Trump-Turkey dustup, and the Turkish lira’s precipitous drop has sparked fears of contagion affecting the entire spectrum of emerging-market economies. Such a contagion could put downward pressure on precious metals by strengthening the U.S. dollar, or it could send prices of gold and silver soaring to levels they haven’t seen in years.
To determine which is more likely, we need to investigate the specifics of the situation, starting with the captivity of Andrew Brunson.
American Pastor Held on Trumped-Up Charges?
In 2016, opponents of Turkish president Recep Tayyip Erdogan’s increasingly authoritarian rule staged a short-lived and unsuccessful coup. The response by Erdogan’s government resulted in more than 140,000 people being detained, including American pastor Andrew Brunson.
Mr. Brunson, who is originally from North Carolina, lived in Turkey for more than two decades. He and his wife operated a small Presbyterian church in Turkey, which is legal despite laws there that forbid “trying to convert Muslims.” Brunson is charged with that crime, along with espionage and aiding terrorist groups. If convicted, he faces up to 35 years in Turkish prison.
The pastor’s supporters allege that Turkey knows Brunson is an innocent man, but he is being held as a political bargaining chip. Turkey wants the U.S. to deport Fethullah Gulen, a Turkish cleric living in Pennsylvania, accused by Turkey of masterminding the 2016 coup. The U.S. won’t turn over Mr. Gulen, who was initially an ally of President Erdogan but fled one of his purges, because Turkey reportedly hasn’t supplied credible evidence against him.
Speaking of “credible evidence,” Turkey has produced very little, if any, against Mr. Brunson. The charges against him are largely based on anonymous testimony, such as that by someone speaking under the pseudonym “Meteorite,” who appeared in Turkish court via video link with a blurred face and altered voice. Meteorite alleged that some members of Mr. Brunson’s congregation sympathized with the PKK, a Kurdish group the Turkish government considers terrorists, and that Mr. Brunson himself showed some appreciation for the cause of Kurdish independence.
In his own defense, Mr. Brunson told the court that he has “always supported Turkey’s territorial integrity, and PKK’s violence is against my belief.” He admitted to traveling to refugee camps near the Turkish border with Syria on religious and humanitarian missions, and also acknowledged that he sought to ease tensions between Kurdish and Turkish members of his church.
Even more absurdly, Turkish prosecutors present a picture sent by Mr. Brunson’s daughter to her father’s cellphone as evidence. The subject of the photograph: a meat-and-rice dish called maqluba, popular throughout the entire Middle East but especially well-liked by Fethullah Gulen’s followers. Seriously.
The most credible evidence against Mr. Brunson comes from an e-mail he sent five days after the attempted coup. In the message, Brunson seems to lament that the Turkish people weren’t more supportive of the army’s efforts to depose President Erdogan: “The Turkish people have not taken sides as usual for the Turkish military,” he wrote. “Everything is going badly, but in the end, we will be the winners.”
Taken together, the two sentences above seem to implicate Mr. Brunson as a supporter of the coup. But the first sentence – “The Turkish people have not taken sides as usual for the Turkish military” – is simply a fact; and the second sentence – “Everything is going badly, but in the end, we will be winners” – could be independent of the first.
The sheer chaos of the coup attempt could be the everything going badly; and in the end, we will be winners, could merely be a statement of optimism. The “we” could indeed refer to the coup plotters, but it could just as easily refer to the Turkish nation as a whole, or even Mr. Brunson’s congregation in particular.
The e-mail is definitely not a smoking gun. And if the e-mail, anonymous testimony, and a food selfie constitute the best evidence against the American pastor, he could only be convicted by the most ramshackle of kangaroo courts.
Trump’s Efforts Haven’t Worked… So Far
Believe it or not, President Trump was initially cautious in his attempts to free Mr. Brunson. Although his administration began working on the issue shortly after Inauguration Day, the president uncharacteristically chose to offer carrots rather than brandishing a big (“yuge”) stick. He even asked Congress to shelf plans to impose sanctions on Turkey earlier this year.
President Erdogan allegedly reached out to President Trump to help free a Turkish citizen, accused of having ties to Hamas, held in Israel. Trump made a phone call to Israeli leader Benjamin Netanyahu, and the woman was promptly returned to Turkey. Trump hoped this would earn him points with the Turkish president and lead to the release of Mr. Brunson.
Moreover, when Erdogan visited the U.S. last year, his bodyguards beat up several Turkish-American protestors. Trump had charges against 11 of the 15 bodyguards thrown out, in another effort to appease Erdogan and win Mr. Brunson his freedom.
But Erdogan has been obstinate. While still posturing like there is good cause for holding Mr. Brunson, he’s also made it clear he’d be happy to swap him for Fethullah Gulen. Failing that, he’d like to secure the return of a Turkish banker, held in the U.S. for evading sanctions against Iran, to Turkey to finish his 32-month sentence; and he’d like leniency for Halkbank, the company the banker in question worked for. Halkbank is facing crippling fines from the U.S. Treasury department.
Erdogan’s willingness to deal casts doubt on the notion that he or anyone in his government believes Mr. Brunson is a genuine threat to Turkey. It seems the American is, as his supporters allege, being used as a pawn. This is bolstering President Erdogan’s domestic image as a fierce and independent Turkish leader, but it’s putting tremendous pressure on his nation’s economy.
Turkey’s Two Weeks of Total Turmoil
Even before the Trump administration decided to put the screws to Turkey, the country was already in dire straits. Turkey’s currency, the lira, hit a then-record low against the dollar and euro in late March. It dropped another 3.5% after Erdogan appointed his son-in-law as the country’s finance minister and rammed in place measures to curb the Turkish central bank’s independence. Forex investors tend not to like things like that.
The lira was under all of this pressure based on Turkey’s excessive debt-load, much of which is owed in U.S. dollars. With the dollar gaining value on the strength of U.S. economic growth and the Federal Reserve’s interest rate hikes, Turkish debtors are having a harder time paying back their dollar-denominated loans, particularly if the debtors earn their incomes in lira, which most do. Indeed, the bulk of Turkish debt is concentrated in the nonfinancial corporate sector; largely thanks to a loan-guarantee program Erdogan installed in 2017 that helped boost Turkey’s economy to its lofty levels that year.
The lira had already lost 25% vs. the dollar in the first seven months of 2018. Then on August 1, President Trump announced sanctions against Turkey’s Minister of Justice and Minister of Interior, accusing them of “serious human rights abuses” related to the detainment of Mr. Brunson and others. This sent the lira even lower, caused Turkish bond yields to explode, and hammered the country’s stock market.
If Trump hoped President Erdogan would immediately give in, he found out he was wrong. The Turkish leader was defiant in the face of the sanctions, calling the dollar a “missile” launched as part of an economic attack on Turkey, and he threatened to stop using the U.S. dollar in transactions with America’s biggest geopolitical rivals, China and Russia.
President Trump’s response to Erdogan’s threats was to escalate. On August 10, he announced a doubling of tariffs on Turkish steel and aluminum, to 50% and 20%, respectively. This sent the lira to its lowest level ever, while yields on Turkey’s 10-year government bonds soared above 20%.
European banks with outstanding Turkish loans were hit, too. Spain’s BBVA lost 5.2%, France’s BNP Paribas fell 3%, and Italy’s SpA fell 4.7%, all in a single day. This showed that Turkey’s woes might not just spill over into other emerging markets, but possibly the Eurozone, too.
The lira hit a new record low on the evening of Sunday, August 12. As of then, the currency had lost 40% for the year. By the next day, the year-to-date losses had reached 45%.
On August 13, the yield on Turkey’s two-year government bonds soared above 25%, while its leading stock-market index lost another 2.5%. Fears of contagion spread: The South African rand and Argentine peso each lost 2.4% vs. the dollar, which is a huge one-day amount even for third-world currencies. The Mexican peso and Indian rupiah also suffered significant losses.
In an effort to bolster its currency, Turkey’s banking regulators imposed restrictions on the amount of liras banks can swap for foreign currencies. First, the amount of foreign exchange swaps and related transactions was capped at 50% of bank equity, and then just two days later, the amount was cut to 25%.
If the above effort sounds desperate, then what follows may be considered pathetic: Turkey also hiked tariffs on exports from the U.S., including tobacco, alcoholic beverages, cars, cosmetics, rice, and coal. Erdogan even vowed that Turkey would boycott Apple, which is not exactly President Trump’s favorite U.S. company.
Thursday, August 16 saw the lira catch a bounce, but the embattled currency lost another 4% the next day when the Trump administration threatened new penalties unless Mr. Brunson was released.
As Forex traders looked forward to the weekend on August 17, a dollar bought 6.12 lira. By Wednesday, August 22, the lira had firmed a hair so that a dollar bought 6.04, and the currency seems to be holding steady – for now.
Are Contagion Fears Justified?
Turkey could fall off the face of the Earth, and most Americans wouldn’t notice. Even though Turkey’s economy was the fastest-growing among G20 nations last year, its GDP represents only about 1.5% of the global total. But could a Turkey be the Lehman Brothers of countries; the first domino to set off the next global economic panic?
During years of quantitative easing from the Federal Reserve, funds flowed into Turkey and other emerging-market countries at record pace. Low U.S. interest rates made global investors hungry for income, and Turkey and other emerging markets boasted comparatively fat yields. This allowed Turkey and other countries like Argentina, Chile, and South Africa to attract massive foreign investment, boosting their domestic economies.
But it all had to end sometime.
The Fed’s “tapering” of QE was the beginning of the end. Now with the U.S. finally raising interest rates, the chickens are coming home to roost. Or in this case, the fowl in question is Turkey.
The IMF says about $260 billion invested in emerging markets since 2010 is directly attributable to Federal Reserve policy. In the IMF’s latest report on global financial stability, it suggested Fed tightening will reduce flows into emerging markets by about $35 billion a year. This may be an understatement, though: Flows into emerging-market stocks and bonds totaled $59.7 billion for the first seven months of 2018, according to the Institute of International Finance, which was down from $167.6 billion for the first seven months of 2017.
But while other emerging-market nations have taken steps to stabilize their currencies and economies, Erdogan’s Turkey has tried to keep the party rolling. “Some people say ‘too much growth is not a good thing.’ Why? Because they’re jealous. It is nothing else,” Erdogan has said.
When Erdogan became prime minister of Turkey in 2003, the country was two years into an IMF bailout plan. The nation made all of its scheduled payments and implemented some of the IMF’s suggested policies, ultimately exiting the plan in 2008 in pretty good financial shape. Or at least that’s what it seemed like.
In the first quarter of 2009, Turkey’s economy shrank by a shocking 13%. The government then kicked into Keynesian overdrive, encouraging growth-through-debt by easing the restrictions of foreign currency loans. The economy was humming by the end of the year, and a classical Keynesian would have put the brakes on growth to avoid overheating. But Erdogan, like many in the West, is a sort-of neo-Keynesian who thinks there is no downside to government stimulus, ever. Indeed, he calls himself “the enemy of high interest rates” and even suggests that low interest rates can help tame inflation!
Turkey’s situation is admittedly unique. While many emerging-market countries have large current-account deficits, external debts denominated in foreign currencies, high inflation, bad monetary policy, or a weak currency, very few have more than one of the above. Turkey has them all, and very little international goodwill, to boot.
- Turkey’s current-account deficit will be 5% of GDP in 2018, according to the IMF. That’s the highest of all G20 nations.
- Turkey’s external debt (which excludes debts owed to Turkish nationals) is 53.4% of GDP. That’s higher than beleaguered Argentina, Mexico, or South Africa. Worse yet, 53% of Turkey’s debt is denominated in currencies other than lira; mostly U.S. dollars and euros. One-third of that debt is due in less than a year, and 40% of it is floating-rate, which means debt payments go up when interest rates go up.
- Although Turkey’s economy grew by more than 7% last year, inflation will be at least 15% this year. Consumer prices rose by an annualized 16% last month, which would motivate most central banks to raise interest rates. But Turkey’s central bank is not truly independent from President Erdogan and is operating under his crackpot “low interest rates and low inflation go together” theory.
- The lira has lost 41% of its value over the past year, and a staggering 66% over the past five years. Few nations other than Zimbabwe can compete with that dismal record.
And what was left of Turkey’s international goodwill was squandered by President Erdogan’s thuggish response to the 2016 coup attempt. More than 80,000 teachers; 14,000 military personnel; 22,000 government workers; and another 22,000 others have been detained. American Andrew Brunson is only one among many.
But just because Turkey’s situation is unique (and uniquely bad), that doesn’t mean problems in Turkey couldn’t spill over into other emerging markets. Turkish stocks account for less than 1% of the MSCI Emerging Markets Index, but Turkish debt is a much larger component of emerging-market bond funds. And the global bond market is much larger than the global stock market.
One fear is that as Turkey drags down emerging-market indexes, investors will sell mutual funds and ETFs benchmarked to the indexes; and in turn, portfolio managers will have to sell all of the underlying stocks and bonds in the indexes, forcing prices of all emerging-market stocks and bonds lower and cascading until there is a crash.
This idea is being dismissed by mainstream financial analysts, but it may be more plausible than they’re willing to believe.
Turkey’s Impact on Gold, Silver, and the Dollar
Emerging-market stocks and bonds are considered “risk assets.” During boom times, investors have an almost insatiable appetite for risk, but when fear replaces greed as the dominant emotion in the market, the once-hearty risk appetite evaporates and is replaced by demand for “safe havens.” Chief among these haven investments are the financial world’s greatest adversaries: Gold and the U.S. dollar.
Gold and silver prices are highly correlated. The gold price and the value of the U.S. dollar, by contrast, normally have an inverse correlation – when gold goes up, the dollar tends to go down, and vice-versa. This is largely because gold is priced in dollars, so when the dollar is weak, it takes more dollars to buy gold, resulting in a higher gold price.
But both gold and the dollar can go up simultaneously, and an emerging-market meltdown is one such case where that’s a likely scenario.
Gold and silver haven’t caught much investor attention over the past three weeks, even as Turkey’s plummeting currency has stoked fears of a broader emerging-market contagion. Indeed, the pair of precious metals have lost 1.6% and 4.3%, respectively, since August 1; while the U.S. dollar has posted tiny gains of about 0.6% vs. other major currencies over that same time. Is this all much ado about nothing?
Perhaps. But despite the limited action in gold, silver, crypto, and even the dollar, all of the signs of a coming crash are staring investors right in the face. And given the severe, multi-year underperformance of gold and silver, the metals have almost nowhere to go but up.
It’s impossible to predict exactly how this situation will be resolved. Trump is cut from a different cloth than all past U.S. presidents, and Erdogan isn’t the typical world leader, either. Both are incredibly prideful men. Both take actions that fly in the face of conventional political and economic wisdom. And both are facing mounting pressure at home that could cause them to act erratically.
Even if Andrew Brunson is freed, Turkey’s not out of the woods. While the U.S. taking its foot off of Turkey’s throat would give the latter nation a respite, the economic problems it faces will still be daunting.
And even in the event that Brunson is sent home to North Carolina, there’s no guarantee the U.S. will let up on Turkey. As the Washington Post posits, perhaps Trump is the first president to get Turkey right. Maybe the Muslim nation has no business being in NATO, much less the European Union, and not because of the religion of its people but the politics of its government.
Although President Trump was initially cautious and conciliatory, Turkey’s repeated rebuffs have led the U.S. leader to vow “no concessions” for the return of Mr. Brunson. National Security Advisor John Bolton said Turkey made a “big mistake” and called on Turkey to do “the right thing as a NATO ally, part of the West, and release Pastor Brunson without condition.”
Could this situation potentially escalate to military conflict? Mainstream analysts snicker at the notion, but remember that World War I started over the assassination of an Austrian archduke. Stranger things have happened.