How Has Turkey Been Going?

Turkey has been home to one of the most turbulent major economies in the world over the last two

decades. When we last explored the country, we found an economy with incredibly strong

fundamentals that were completely undermined by some unusual macroeconomic decisions.

Inflation has been the headline issue in the country for the past five years,

with the Turkish lira having lost 96% of its value against the World Reserve

since the currency was first introduced in 2005. This is especially concerning considering that the

reason the country introduced a new currency in 2005 was to replace the old Turkish lira,

the currency that itself failed due to hyperinflation. So it's easy to see why economists and

regular participants in the economy are starting to see this as a bit of a systemic issue.

The current value loss of 96% is also compared to the US dollar, which itself has lost about 40%

of its purchasing power over the same time period. So yeah, inflation in Turkey has been severe and

consistent. But on a brighter note, there is news that could indicate that things are starting to

turn around. The country was stubbornly keeping interest rates low, which was only further

accelerating inflation, but in the last few months they've finally started raising rates,

which should, in theory, stabilize the value of the currency and by extension the rest of the

economy. The problem is, it doesn't look like it's working, at least not yet.

This might just be the case of too little too late, but really the biggest challenge with the

currency now is getting people to use it instead of just doing business in other more reliable

foreign currencies. After two decades and two failed currencies, it's hard to convince a highly

intelligent population that this time will be different. The tragedy of this all is that outside

of these wacky numbers, Turkey is a highly promising economy. It has a huge and talented

workforce, a wealth of natural resources and natural beauty, and above all else, it's a masterful

and essential global bridge between economic factions that are drifting further apart. The

art of good business has been a good middleman, and Turkey could play a very valuable role in the

new global economy if only it got its own situation under control. So, how has the economy of Turkey

been going since we last explored it? Why has it been unable to control inflation? And finally,

what realistic solutions does it have left to stabilise its economy?

So a quick refresher to Turkey's situation is probably overdue. In the mid to late 2000s,

Turkey was one of the fastest growing economies in the world thanks to a variety of factors.

The country up until that point had consistent issues with inflation, but new laws gave more

power to the central bank to take an active hand in price stability and a new currency was finally

starting to control inflation. The idea of a central bank that is independent to set its own

monetary policy is that if inflation gets too high, it can raise interest rates, which makes it

simultaneously more expensive to borrow money and more lucrative to save it. This, all other things

been equal, should reduce the amount of money in active circulation, which should encourage

businesses to lower prices to fight for the fewer dollars or bleerer that are in circulation.

Higher interest rates are very politically unpopular though because they do inflict

a lot of financial pain. They make debts more expensive and they slow down businesses, which

usually leads to unemployment, so the independence of a central bank gives them the ability to make

these unpopular, but often essential decisions. Giving its central bank independence signaled

to the Turkish economy that it was taking price stability seriously, which not only gave a level

of confidence to the local population, but also to potential international investors.

Replacing the old currency at a rate of 1 million to 1 also helped bring the Turkish

lira back in line with other global currencies. If a billion euro investment exchanges to a

quadrillion Turkish lira, it just makes things difficult to deal with and also inherently

destroys a bit of trust in the economy's financial system. So even though replacing

the currency might not do anything in real terms, it did do a lot to instill a sense of

confidence in the new system. Now for a while, this worked. Between 2001 and 2013,

the country's economic output more than quadrupled and it made big investments into industry,

education and international trade. Turkey sits geographically as a bridge between the consumer

markets and advanced industries of Europe and the natural resource wealth of the Middle East and

Russia. Even back then, Turkey was accommodating energy infrastructure and playing the role of

a mediator between these two markets, which was a win-win for both sides, but an even bigger win

for Turkey, who made reliable and sustainable revenues by accommodating this trade. During

this time, the country shifted away from agriculture into industries like medium to high in manufacturing,

construction and finance. Finance, especially under the old Turkish financial system, would have been

next to impossible, but for a while this industry thrived, especially learning money to households

to take advantage of this meteoric economic rise the country was experiencing. The government

itself was able to oversee this growth without taking on too much debt itself, which meant in

theory it could step in and help out the economy if it ever needed a bit of a boost with the old

money printer. But of course, this didn't last forever. Turkey's annual output peaked in 2013

before starting a slow decline for the rest of the decade and it has to date not achieved that same

level of output since. The problem was that the new independent central bank had a very difficult

trade-off to make. After being given independence in 2001, they hiked up interest rates to stabilise

inflation, but they slowly lowered them over time to encourage local business activity.

Even over the time of rapid economic growth in the country, the value of the currency continued

to decline, but the central bank didn't want to raise rates because it could stifle that growth.

A devalued currency often isn't the worst thing in a growing economy anyway because it makes

exports more competitive and imports more expensive, encouraging people to consume domestically. But

if the slide of the Turkish lira became too extreme to the point where it outpaced the overall

growth of the economy, then the country would find itself back in the same position it was during the

hyperinflation crisis of 2001. At the same time though, interest rates in Europe and the USA were

at all time lows to combat the sluggish economic recovery from the GFC. So what a lot of Turkish

investors did was go and borrow money in these currencies at rates approaching 0% and then use

that to speculate in Turkey with its record levels of growth. This created a situation where a

majority of the country's private sector debt was denominated in foreign currencies and that

eventually needs to be paid back, which usually meant exchanging Turkish lira pushing down its

value. There wasn't much international demand for the currency either because Turkey was still

a net importer of goods and even though its interest rates were much higher than the west,

after the devaluation of the currency, they were lower. So by keeping money in lira,

people were losing money compared to their home currency. If foreign investors wanted exposure

to the Turkish market, normally that would be a problem that they would have to accept and factor

into their calculations. If an Australian wants to buy a house in the USA, they would need to trade

their Australian dollars for US dollars to buy that house which should, all other things been

equal, push down the price of the Australian dollar and push up the price of the US dollar.

In doing this, Australian investors also accept a level of exchange rate risk. If their property

doubles in price but the US dollar halves in value compared to the Australian dollar,

then the Australian investor is really no better off overall. Of course, in reality one person

isn't going to be able to move enough currency for this to make a tangible impact on the exchange rate

but if enough investors only start flowing money one way, then it will move the price.

Now in Turkey during this time, foreign investors didn't have this problem. They could just use

their own currency to avoid the foreign exchange risk since so much of the country was taking out

loans in foreign currencies anyway. This meant that there were very few people buying lira but

a lot of people selling it to pay for imports or to cover repayments on foreign loans. The central

bank was also unable to raise rates too quickly to compensate for this because that would just

encourage more foreign borrowing if domestic loans became any more expensive than they already

were. To make that worse, most of this investment was going towards unproductive assets like real

estate rather than building out industries that could generate cash flows to service these payments

like factories, ports, training or other infrastructure. It was also a situation that

strongly encouraged wild speculation which did pour fuel onto the fire of economic growth

until it all came crashing down. The catalyst for the slowdown is hard to pinpoint but it

certainly wasn't helped by an attempted coup in 2016. Following this display of political instability

and the retaliations that were made by the government in response to it, the level of foreign

investment into Turkey slowed dramatically because people weren't as sure about its future.

A year later in a referendum motivated by the coup attempt, the country changed its constitution

to give far more power to its head of state which indirectly meant that the new president

could wield much more control over things like interest rates. That's where the devaluation

of the lira went from a slow issue primarily impacting industries operating internationally

to an all-out crisis of extremely high inflation. Now that crisis has been well covered and we've

even made an entire video on it two years ago as it was fully unfolding so as always we don't want

to repeat too much here. In brief, ideological motivations caused the government to put pressure

on the central bank to keep rates low. They did this by firing any central bank chiefs that raise

rates leading to spiralling inflation that hit as high as 80% on an annualised rate. At that

extreme level it was having very tangible impacts on working class people in the country that didn't

have the resources to move their wealth into foreign currencies. The argument was that a

currency worth less would make Turkey a more competitive exporter because the price of their

goods would be artificially deflated. Now this wasn't totally unfounded, some countries,

China in particular, have controlled the value of their currency to make their goods and services

more competitive in countries with more valuable currencies which contributed to their export

dominance over the past three decades. But the Turkish plan missed a lot of nuance. Just having

a currency with a face value lower than another currency doesn't automatically make their goods

cheaper. Japan isn't 160 times more competitive than the USA because its currency has a face value

160 times less. It's really about purchasing power. If $10 could buy one hammer in the USA and

the equivalent of roughly $1,600 yen could also buy one hammer in Japan then there is no inherent

benefit of importing that hammer from Japan. But if the Japanese government intentionally let their

foreign exchange value slip by lowering their interest rates or by selling a lot of their

currency in foreign exchange markets then that $10 US dollars might be able to buy $3,200 yen which

would be able to buy two hammers in Japan making it worthwhile to import those hammers. Now eventually

as import is convert their dollars into yen to buy Japanese hammers that will push the value of the

currency back up and eventually Japanese businesses will realise that they can charge more for their

hammers but that can take a very long time and in the interim Japan has benefited from a huge

boost to its domestic hammer manufacturing industry. Now this is of course an extremely

over simplified example but the problem for Turkey is that it isn't a major export economy.

It actually has a pretty large trade deficit so all this really does is make its imports more

expensive stifling domestic industries. Turkey would be able to add much more value by acting

as an importer exporter given its fantastic geographic position and its ties east and west

but a currency that nobody wants to deal with makes that role very challenging to fill.

Turkey also attempted to restrict the use of foreign currencies in the country in response to

the problems that foreign borrowing caused but again that only really further hurts the real

economy because it makes Turkey more difficult to deal with as a finance and trade partner.

The other argument for keeping interest rates low was even more ideological.

The president and his government have said that interest is usurus and immoral.

That's an argument well outside our area of expertise but it is denying the country a vital

tool to address one of its most pressing problems. Either way that was then and this is now.

Gradually the government was either willingly or unwillingly walked back a lot of these decisions

and the central bank is once again raising interest rates which as of the time of making

this video now sit at over 50%. Unfortunately it's not looking to be having much of an effect as at

the same time the country is printing record amounts of its currency and pushing it out as

loans through its banks mostly to businesses. The businesses are happy to take out these loans

even at extremely high interest rates because inflation is still outpacing the interest on

the loans which means they're effectively getting a negative interest rate or put another way they

are indirectly been paid to borrow money. Another mechanism that was supposed to alleviate inflation

has actually caused it. The Turkish people had no incentive to save their money because it was

losing value so fast. Instead they tried to spend it as quickly as possible which further

increased inflation. To combat this the government announced a special savings account that would

be hedged against the falling value of the lira. Cash kept in the account would be awarded a special

interest payment equal to the decline in the value of the currency on top of the regular

interest payment so that savers would be rewarded for keeping money in the bank instead of just

spending it as soon as they got it. The problem this caused is that it acted as a feedback loop

of money creation. If inflation in a year was 50% these savings accounts would pay their account

holders an extra 50% on their savings which would just increase the money supply even further

pushing up prices which required even bigger bonuses on these accounts. Unsurprisingly the

government quickly ended this scheme after the last election so it seems that everything it does

is just making it worse which is why it's probably more productive to ask if there are any solutions

left for Turkey. The country has been here before this current economic timeline effectively started

after the country lasted a major reset from hyperinflation but the solutions will not be as

pleasant and realistically it will require a major political shift and a reset of the currency

alongside the institutions that manage it. The financial gains of moving bigger and bigger

numbers around in accounts has very tangible impacts on the real economy. The currency is

supposed to be a store of value and a medium of exchange and if nobody inside or outside of the

country trusts it to do that then the economy is denied a very basic yet essential tool to operate.

Running an economy without a reliable currency is like running an engine without oil.

Eventually things cease up. This is a real shame because something that most outlets

failed to mention including ourselves when we last covered the country is that outside of headline

grabbing monetary shenanigans Turkey has a highly promising economy. Its population is large,

well educated and young. It's in a perfect position to capitalise on its labour force that is more

cost competitive than its European neighbours to the west but more skilled than its resource rich

neighbours to the east. Turkey also has huge potential as a tourist hotspot. Even with all of

the very public and very well reported challenges the country has been dealing with over the last

decade it's still one of the most popular tourist destinations in the world which has in the past

been a vital source of foreign currency inflows as tourists bring along their own money to spend.

The country is also extremely popular for medical tourism, a highly lucrative form of tourism since

people spend a lot more on skilled services to get hair transplants than they do just getting

a few cocktails at a hotel. If the country could display a level of stability and peace to the

world then there's no reason that this couldn't become a major growth industry in and of itself.

The country could also keep on being a global middleman and start to benefit from the trend

of French shoring. Turkey is part of NATO but it also maintains close relations with Russia.

It's culturally close to many major powers in the Middle East but it's also part of the EU

customs union. As these groups pull further apart from one another there is going to be a

lot of money to be made on either side as the one person that is friends with everybody or at

least is willing to say the right things to keep the money flowing. Nobody can predict the future

least of all economists but the OECD projects that Turkey will be the fifth largest economy in the

world by purchasing power parity in 2060. That would also make it the largest economy within

Europe and the largest economy within the Middle East. It's a huge economic machine that has been

denied the lubricant it needs to run smoothly. A real shame given its real potential. Now another

country that has had a seemingly endless struggle with inflation is Argentina. We made a video on

that country a few months ago which we'll also be doing a follow-up on soon but for now you should