Turkey’s lira crashed by 13.7% last Friday, plunged by 21% over the week and 41.1% in 2018. As a sign of the deterioration of the US-Turkey relationship, US President Donald Trump’s recently imposed sanctions on the Erdogan government. The crashing lira represents the “first currency crisis of the floating era”, according to a popular economist.
Say what? A currency crisis in the era of floating exchange rate regimes?! Have floating exchanges not been the Holy Grail?
How about foreign reserves? Have they not been designed to function as a shield against a currency crisis?
To stanch the lira’s hemorrhage, Turkey’s central bank has raised policy rates by a stunning 975 basis points in May and in June. Unfortunately, such aggressive rate hikes haven’t calmed the crashing lira.
That’s because Turkey’s money supply growth has exploded. A surge in debt levels fueled money supply's double-digit growth for years. Short-term external debt has grown faster than foreign reserves.
Turkey had been previously acclaimed for its infrastructure based ‘economic miracle’: an economic miracle that had been propped up by money supply growth through massive debt expansions.
Today it suffers from a currency crisis. It may be Turkey’s time to pay the piper.
Turkey’s predicament has not been in isolation.
Currency pressures have emerged and have been intensifying in emerging market currencies: Argentina’s dollar, Iran rial, the Russian ruble, the South African rand, Brazil real et.al as shown by the weekly chart above. The Chinese yuan also fell.
Will Turkey’s currency crisis morph into a banking or debt crisis? Will it spread to the emerging market sphere?
How will this impact Turkey’s major creditors, mostly European banks with some exposure by US and Japan banks? How will such dynamic impact external trade with Turkey?
Will Turkey’s currency crisis highlight the periphery to the core transmission?
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