Doug Noland: Turkey (Nudged Over the Cliff)

[Turkey] The situation has evolved into a full-fledged crisis of confidence, which typically foreshadows the violent end to a country’s existing financial and economic structure. 

…As I have posited repeatedly and expounded in more detail last week, the global Bubble has been pierced at the “periphery.” I also believe the backdrop is now conducive to contagion at the “periphery” (finally) gravitating toward the “core.” The Turkey-induced risk aversion that erupted this week in European equities (bank shares!) is an important escalation in “Periphery to Core Crisis Dynamics.” 


The Turkish lira sank 13.7% in chaotic Friday trading. The lira’s 21.0% “worst week in 17 years” collapse pushed y-t-d losses to 41.1%. Turkish 10-year yields spiked to almost 21%, before retreating somewhat. After beginning the year at 155, Turkey sovereign credit default swaps (CDS) spiked 166 bps during Friday trading (up 199 bps for the week) to 437 bps (high since Feb. 2009).

EM Contagion Effects gained momentum this week. Friday trading saw the Argentine peso hit 3.8% and the South African rand sink 2.7%. For the week, the Argentine peso fell 6.6%, the South African rand 5.5%, the Brazilian real 4.0%, the Hungarian forint 2.2%, the Romanian leu 2.1%, the Polish zloty 2.2% and the Mexican peso 1.8%. On the (local) bond yield front, 10-year yields in Brazil jumped 66 bps, Russia 40 bps, Hungary 15 bps and South Africa 13 bps. As global “hot money” frets faltering liquidity and the next shoe to drop, Brazilian equities sank 5.9% (as Brazil sovereign CDS jumped 24 bps to 237 bps).

August 10 – Bloomberg (Lionel Laurent): “Turkish President Recep Tayyip Erdogan has been standing firm as investors dump his country’s assets at an alarming pace, saying: ‘They have got dollars, we have got our people, our right, our Allah.’ European banks with substantial investments in Turkey will hope some of that divine providence rubs off on them, too, after sticking with a bet that has gotten more perilous over time.”

Fears of contagion this week were not limited to the emerging markets. With significant exposure to Turkey, European bank stocks were slammed in Friday trading. Unicredit sank 4.7% and ING Groep fell 4.3%. The big German banks, Deutsche Bank and Commerzbank, dropped 4.1% and 3.5%. European Banks (STOXX600) fell 1.9% Friday.

August 10 – Financial Times (Claire Jones, Ayla Jean Yackley and Martin Arnold): “The eurozone’s chief financial watchdog has become concerned about the exposure of some of the currency area’s biggest lenders to Turkey – chiefly BBVA, UniCredit and BNP Paribas – in light of the lira’s dramatic fall… According to cross-border banking statistics from the Bank for International Settlements, local lenders, including foreign-owned subsidiaries, have dollar claims worth $148bn, up from $36bn in 2006 and euro claims worth $110bn. Spanish banks are owed $83.3bn by Turkish borrowers, French banks are owed $38.4bn and Italian lenders $17bn in a mix of local and foreign currencies. Banks’ Turkish subsidiaries tend to lend in local currency.”

The above FT article was written prior to Friday’s currency collapse. As Contagion gathers momentum at the “periphery,” the “core” is indicating heightened vulnerability. European fragilities are again rising to the surface. Italy’s MIB 35 stock index dropped 2.5% in Friday trading. Germany’s DAX fell 2.0%.

Safe haven bund buying saw German 10-year yields fall six bps to 0.31%. Italian 10-year yields jumped 9 bps Friday to 2.98%, as the Italian to German 10-year yield spread widened 15 bps. For the week, this spread widened 16 to 268 bps, the widest since the May spike to 290 bps (which was the wide since 2013). Elsewhere in the European “periphery,” Greek spreads (to bunds) widened 22 bps (to 387 bps) this week and Portuguese spreads widened nine bps (to 146 bps).

August 10 – Financial Times (Daniel Dombey): “Some analysts have long seen Turkey as a ‘quantitative easing play’ – a country that benefited from developed economies’ huge asset purchase schemes. But as US and eurozone quantitative easing becomes history – at least for this economic cycle – the funds that Turkey needs are getting harder to come by. Those funds are far from negligible. An ABN Amro report on Thursday said investors were worried Turkey would not be able to finance its annual external financing requirement of about $218bn – which includes funds needed to maintain Turkish companies’ foreign-denominated debt as well as the country’s hefty current account deficit.”

Turkey is the poster child for systems that have for a decade luxuriated in abundant cheap global liquidity. Once again, dysfunctional global finance furnished plentiful rope for economies to hang themselves. A spectacular Turkish borrowing binge fueled a formidable Bubble. A spending boom, ongoing low savings and persistent Current Account Deficits (surpassing 6% this year) have been for years financed with cheap international (chiefly dollar) finance. Turkish corporations have more than doubled foreign-denominated borrowings since the crisis to over $200 billion, approaching 50% of GDP.

Turkey now faces funding requirements (current acct deficit and maturing debt) of over $200 billion over the next year in the face of an acute “hot money” exodus. It’s untenable. The situation has evolved into a full-fledged crisis of confidence, which typically foreshadows the violent end to a country’s existing financial and economic structure.

In ways, Turkey’s crisis resembles previous bursting EM Bubble episodes: too much cheap international “hot money” financing an unsound boom, replete with excessive spending and malinvestment. The protracted nature of Turkey’s Bubble ensured deep structural maladjustment. Today, the Turkish “economic miracle,” as many before it, is exposed in harsh terms. The reversal of speculative flows has illuminating latent fragilities and an unsound currency. The banking system and scores of corporate borrowers of dollar-denominated debt are at the brink of insolvency. Suddenly, the whole Bubble is coming crashing down. Similar scenarios recurred in absolute dismal fashion throughout the nineties.

August 10 – Xinhua (China’s official state-run press agency): “Turkish President Recep Tayyip Erdogan urged on Friday his nation to change all savings in U.S. dollar and gold into Turkish lira. [The] Dollar will not block our way. Let’s respond them with our national currency,’ Erdogan said in his address to crowds… ‘Change your dollars and gold under the mattress to the local currency,’ he added. The Turkish president described the campaign as a “national struggle” in response to ‘those who declared economic war’ against Turkey. Meanwhile, Erdogan ascribed the current ‘economic problems’ to ‘artificial financial instability waves’ stoked by foreign actors, rather than structural issues involving employment or the banking system. He also blamed foreign meddling in Turkey’s economy because of ‘some bilateral disagreements,’ hinting at the tension between Turkey and the United States.”

I fear Erdogan’s pinpointing sinister foreign forces behind Turkey’s problems will garner adherent elsewhere – with measures from the U.S. administration stoking conspiracy suspicions. Calls for Turks to sell dollars and gold to support the lira recalls South Korean citizens donating their gold to help the government stabilize the Korean won (and service an IMF loan) back in 1997/98. We’ll see if Turkey’s population can match the extraordinary patriotism demonstrated by the South Koreans – and if they do, whether it will even matter.

Typically, market expectations would have Turkey immediately commencing negotiations with the IMF (didn’t take Argentina long). Yet these are neither normal times nor is Recep Erdogan a typical head of state. In this age of the strongman leader, bowing to the demands of an institution domiciled in Washington (while backing down to Trump) may be unacceptable in Ankara and throughout Turkey.

From the FT (Ayla Jean Yackley and Demetri Sevastopulo): “Mr Erdogan urged Turks to stand firm and defend their currency. ‘If there is anyone who has dollars, euros or gold under the pillow, he should go and convert this at the bank,’ Mr Erdogan said. He also held talks by telephone with Russian president Vladimir Putin to discuss economic and commercial ties.”

Putin will lend a sympathetic ear. For some time now, the strongman Russian president has assailed U.S. dominance over global financial and economic institutions and arrangements. Putin’s outrage was surely further elevated this week with the imposition of additional U.S. sanctions.

August 10 – Politico (Emily Goldberg): “Russian Prime Minister Dmitry Medvedev warned Friday that his nation could retaliate against the United States’ newly issued economic sanctions, saying it would consider any action against its banks an act of economic war. ‘I would not like to comment on talks about future sanctions, but I can say one thing: If some ban on banks’ operations or on their use of one or another currency follows, it would be possible to clearly call it a declaration of economic war… And it would be necessary, it would be needed to react to this war economically, politically, or, if needed, by other means. And our American friends need to understand this…'”

The Russian ruble declined 1.4% Friday and was down 6.4% for the week (down 14.8% y-t-d). Russian 10-year (ruble) yields increased eight bps Friday and surged 40 bps for the week to the high since December 2016. Russian dollar-denominated yields jumped 32 bps this week to multi-year highs (5.14%). Moscow must be feeling under assault – and increasingly bereft of patience.

To have the strongmen of Turkey and Russia speaking the same language (“economic war”) in the midst of currency and market turmoil is noteworthy, to say the least. A three-way conference call with China’s president Xi would be only fitting. Might as well bring in the Iranians and others.

Donald J. Trump – 5:47 AM – 10 Aug 2018: “I have just authorized a doubling of Tariffs on Steel and Aluminum with respect to Turkey as their currency, the Turkish Lira, slides rapidly downward against our very strong Dollar! Aluminum will now be 20% and Steel 50%. Our relations with Turkey are not good at this time!”

Those are fighting words. Teetering at the edge, a presidential tweet nudges Turkey over the cliff. I cringed. Leaders around the world surely recoiled. Does President Trump appreciate the consequences and ramifications of a destabilizing currency crisis in a world of lurking financial, economic and geopolitical fragilities? Our President is tough, enthralled with disruption and clearly sending a message. But does he appreciate the extent to which he is playing with fire?

The world order is fraying before our eyes – and, for many, the impulse is to revel. Careful what you wish for. I’ll assume recent events push forward the move to develop financial and economic institutions outside of the U.S. sphere of influence. In recent years, Putin has surely been preaching to his comrade Xi Jinping that the U.S. is a hostile and untrustworthy rival. At least publicly, Beijing had remained non-aligned, content to foster a non-adversarial relationship with the U.S. Much has changed. The world is now on a trajectory that will shatter pretenses – the façade is being unmasked.

Bloomberg Friday headline: “Trump Embraces Market Pain With Little Concern for Contagion.”

The dollar index gained 1.2% this week to a 13-month high. With Turkey now in full-fledged crisis, the unfolding EM de-risking/de-leveraging dynamic attained important momentum this week. Meanwhile, the U.S. vs. China trade war further escalated. President Trump admitted that playing hardball is “my thing.” The Chinese invoked the “American trade blackmail”; “waving the stick of hegemony everywhere”; “playing double-faced tactics” and “mobster mentality” (to name only a few). Perhaps heightened global market instability will have the Trump administration backing down from their hardline approach with China. I seriously doubt that the U.S.’s unilateral actions in dealing with Turkey, Russia and Iran will inspire a softening in Beijing’s resolve.

Turkey, a nation of 80 million, is a long-time U.S. ally and NATO member. The U.S. Air Force has significant operations at the Incirlik Air Base, and Turkey was a staging ground for major U.S. military operations including the two gulf wars and, more recently, in Syria. I see the unfolding financial, economic and geopolitical crisis in Turkey as an ominous development for a region sliding into an intractable geopolitical maelstrom.

Despite Friday’s decline, the S&P500 ended the week a little more than 1% below all-time highs. With Treasuries enjoying safe haven demand – and visions of jittery Fed officials glued to Bloomberg screens, longing to conclude rate hikes – there’s still little worrying the bulls. But the global backdrop is now in a state of transformation – and not for the better. And on various fronts this became increasingly apparent this week.

When I began posting the CBB almost twenty years ago, my focus was on “money” and Credit and the U.S. boom. I didn’t anticipate geopolitical developments would some day play a role in my analysis. But I also never contemplated a global Bubble of today’s dimensions and characteristics.

I never imagined how an explosion of government debt and central bank Credit would be used so recklessly to inflate intertwined Bubbles spanning the globe. Never did I contemplate how this new age global “system” – already highly unstable two decades ago – would be nurtured, backstopped and resuscitated into today’s monstrosity. I never could have envisioned how the U.S. would run huge Current Account Deficits for another 20 years and still maintain such command over a dollar-based global financial apparatus. Who would have believed a global financial arms race was even possible – amidst such escalating animosity and hostility?

This is a strange period. It’s strange here at home – in society, in politics and in the markets. It is strange globally. The unprecedented nature of what we see at home, abroad and in the markets provides a lot of leeway with interpretation and analysis. Somehow, there’s a dominant contingent that believes the U.S. is on the right course – that the economic boom will accelerate, markets will, as they always do, continue to rise. The future is bright, all the polarization and social angst notwithstanding. Markets offer unassailable confirmation.

It would be great if the optimists were right. But this was a week that corroborated a much darker interpretation of developments. A decade of unrelenting easy “money” and booming finance has masked a metastasis of festering issues – financial, economic, social and geopolitical. And we’re now only a more general bursting of the global financial Bubble away from having to simultaneously face a bevy of very serious issues. As they tend to do, developments can seem to move at glacial pace – and then, rather suddenly, they can be more akin to lava.

As I have posited repeatedly and expounded in more detail last week, the global Bubble has been pierced at the “periphery.” I also believe the backdrop is now conducive to contagion at the “periphery” (finally) gravitating toward the “core.” The Turkey-induced risk aversion that erupted this week in European equities (bank shares!) is an important escalation in “Periphery to Core Crisis Dynamics.” “Risk off” is gaining a firm foothold, and global financial conditions now tighten by the week. Market pundits expect cooler heads in Ankara and Washington to prevail over the weekend. If not, it could intensify what was already a particularly long and hot summer.



Original Post 11 August 2018


TSP & Vanguard Smart Investor

Categories: Doug Noland, Perspectives