Autocrats and markets don't always get along.
After all, for every Lee Kuan Yew of Singapore, who embraced export-led growth with whatever's stronger than religious fervor, there's been a Nicolás Maduro of Venezuela, who has tried to muzzle markets the same way he has his own people out of the misguided belief that this would make his underlying economic problems disappear.
In between these two extremes, though, is someone like President Recep Tayyip Erdogan of Turkey: a head of state who doesn't like that economic reality doesn't always conform to his wishes, who intermittently rages about this fact with a mix of ignorance and bravado — interest rates beyond his control are “the mother and father of all evil,” he mused recently — but who has nonetheless begrudgingly acceded to things when he has had no other choice.
Well, at least until now. Which is to say that while Turkey's lira has been the second-worst performing currency this year, it might have a lot further to fall if Erdogan follows through on his promise to take even more control of the country's economic policymaking. Bad fundamentals and worse governance are not, it turns out, a good combination.
This story really started 10 years ago. That's when zero interest rates across the developed world sent money pouring into emerging markets in search of anything resembling a return. This made their stocks and bonds and currencies all go up, but it came at the cost of making their economies so dependent on these inflows that they were vulnerable to the inflows' going into reverse. Indeed, all it took was then-U.S. Federal Reserve Chairman Ben Bernanke saying that they might start printing less money soon — meaning there wouldn't be as many dollars looking to be invested overseas — for the most fragile emerging markets to sell off sharply five years ago. Those were the ones that were still borrowing heavily from abroad and didn't have big rainy-day funds of dollars.
That was the wake-up call those countries needed to start shoring up their positions, and, to their credit, most of them did. Turkey was an exception. Sure, it cut its foreign borrowing a bit, but that's still a substantial 5.5 percent of its economy right now. Nor are its dollar reserves big enough to be much of a buffer, either.
It's no surprise, then, that its currency has come under a lot of pressure now that the U.S. central bank is not only raising rates — sucking money out of emerging markets now that investors can get a better return at home — but is also looking as if it might be doing so more than expected now that U.S. unemployment it down to 3.9 percent. The result, as you can see below, is that the Turkish lira is down 14.6 percent against the dollar since the beginning of March.
To the extent that it was overvalued before, it's not that big a deal that the lira is falling today. A cheaper currency will help it export more; exporting more will give it more money to save; and more savings will mean it won't have to rely so much on borrowing overseas. Problem solved! Or at least it would be if Turkey's banks hadn't borrowed a lot of dollars and made a lot of loans in lira that are now worth a lot less than before. That means the lira's plunge isn't as benign as it might seem; if anything, it's the opposite.
The normal response to this kind of situation is to raise interest rates until investors are so enticed by the returns they can get that they move their money back into the country and, in the process, push the lira back up. That would save the banks from potentially defaulting on their dollar debts at the expense of causing much slower growth.
But Erdogan doesn't want that. He has elections coming up, and even though he has stacked the deck in his favor as much as possible by jailing journalists, turning the courts into a rubber stamp and intimidating the opposition, he's still worried about having the economy as healthy as possible leading up to the vote.
Not to mention that Erdogan subscribes to some, let's say, unconventional economic theories. He has long said that he thinks higher interest rates cause higher inflation, rather than the other way around and has attacked what he calls the foreign “interest-rate lobby” for allegedly trying to hurt Turkey's economy by using its double-digit inflation as an excuse to call for, yes, higher rates.
Never mind the cognitive dissonance here — Erdogan seems to understand that higher rates cause slower growth but incongruously claims that they make prices rise faster, too — the point is that he has made it hard for his central bankers to do their job when that involves things he doesn't like. They're still independent enough that they eventually did raise rates aggressively in 2014 and less so in 2016, the last time they faced this kind of problem. And they maintain that they will take all “necessary steps” today. But they might not be for long.
Erdogan, you see, has now gone so far as to say that “the central bank can't take this independence and set aside the signals given by the president.” His remarks have made investors worry that this time really might be different, that Erdogan might not be carried kicking and screaming to a rate hike even if his economy desperately needs it. And so, the lira keeps falling.
He's the captain now.