RUTHFULLY YOURS

In fact, if you had invested in the Turkish model (that is, in the Turkish stock market) at the outbreak of the Arab revolts, you would have lost about half your money. If you leave your money in Turkey, you probably will lose the rest of it. Turkey is not a model. It is a bubble, and it is bursting, starting with the stock market and national currency.

Full disclosure: I shorted the Turkish market after I published my obituary for the country’s economic boom (see “Instant Obsolescence of the Turkish model”, Asia Times Online, August
10, 2011). And I was denounced as a Zionist plotter in the Turkish media. As a matter of record, I wish to state that I am shorting Turkey not for any political motivation, but only because the Turkish government’s economic policy is a clown show. I make a point, however, of contributing some of the profits to Zionist causes.

Chart 1: Turkish stock market (TUR exchange-traded Turkey
stock market fund) vs. S&P 500, November 2010 = 100

Source: Bloomberg

Turkey isn’t democratic, as its volatile Prime Minister Tayyip Erdogan reminded the world last week by arresting yet more journalists on trumped-up charges of coup plotting. According to Turkey’s Journalists’ Union, Turkey has jailed 97 writers, more than China, which no-one confuses with a model democracy.

Nonetheless, Erdogan was Time Magazine’s 2011 “Person of the Year”. The designation is not necessarily an endorsement. In 1938, Time’s Man of the Year was Adolf Hitler. In 1939, it was Joseph Stalin. Like Stalin and Hitler, Erdogan’s reputation has been more resilient than the country’s stock market.

The West still believes in its own ability to fix all the problems of the world, and cannot abide the thought that success is to be found anywhere in the Muslim world (not counting Malaysia and Indonesia). Now that Libya and Yemen are immersed in tribal warfare,

Egypt is dissolving into chaos, Syria has dug in for a long sectarian bloodbath, and Iraq prepares for an ethno-confessional civil war, Turkey seems a pillar of stability by comparison. Not for long, if my calculations are correct.

Last year, I predicted that the “Arab Spring” would prove to be a symptom of societal failure rather than regime failure, and that Egypt as well as Syria would suffer a social breakdown. That has now become conventional wisdom, even among news outlets that inhaled the hashish smoke from Tahrir Square and predicted a glorious era of Arab democracy only a few months ago. The subject requires no elaboration here.

Western credulity over Turkey, though, has not quite departed. On January 6, for example, Peter Kenyon wrote yet another paean to the Turkish “economic miracle” for National Public Radio in the United States.

Now I predict that Turkey’s economic crisis will undermine the stability of the Turkish state as well, leaving the Muslim world without a single enclave of stability from the Moroccan-Libyan border to China’s Xinjiang province.

Encouraged by the central bank, Turkish banks increased their lending at a 40% annual rate in 2009 and 2010, financing a flood of imports. Turkey’s trade deficit ballooned to a tenth of its total output – as bad as that of Greece or Portugal. And the country has been borrowing on short-term money markets to finance the import bubble.

Erdogan has the weirdest economic views of any serving head of government. He justified the credit bubble on religious grounds, pledging repeatedly to cut the “real” interest rate (the cost of interest minus the inflation rate) to zero.

“We aim to cut the real interest rate in the long run, so people will increase their incomes through working, not through interest,” he said last April. “Eventually we aim to equalize the interest rate and inflation rate.”

Erdoğan believes that this would fulfill the Islamic injunction against lending for interest; if the real interest rate is zero, he seems to think, the sharia ban on interest is fulfilled de facto. In order words, Turkey provided nearly free money to bank customers. Erdogan’s program set in motion a series of perverse effects. One is a sharp fall in the exchange rate.

Turkey’s currency has been falling for a year, and fell even faster in August and September. Turkey’s central bank had no choice but to raise interest rates sharply last October to prevent it from entering free fall. Even with the sharp rise in interest rates, though, the currency has continued to deteriorate, and the Turkish stock market has continued to grind lower. But the spike in interest rates will have deadly effects on the domestic economy.

Chart 2: Turkish central bank pushes up
interest rates (left scale) to support the currency

Source: Central Bank of Turkey

Chart 3 below shows that happened to domestic interest rates, meanwhile, have risen as the central bank tightened money.

Chart 3: Commercial lending rate
rises as Turkey tries to prop up TRY

Source: Central Bank of Turkey

The result is a vicious cycle: excess credit creation weakens the currency, forcing the central bank to put up interest rates; higher interest rates push up the cost of debt service for Turkish borrowers; Turkish banks lend more money to their customers to finance the higher interest costs, so that credit keeps expanding and the currency keeps weakening.

Turkish banks continue to increase lending at a 40% annual rate, but most of the new lending will finance interest payments on the old loans. In Chart 4 below, we simply multiplied the higher interest rate by the amount of outstanding bank loans in order to calculate the total volume of interest payments.

Chart 4: Interest cost explodes as loan bubble meets
higher rates: Interest payments on Turkish lira bank debt

Source: Central Bank of Turkey, Macro strategy LLC calculations

That leads to another perverse result: the banks cannot slow down their lending. After the credit-and-import bubble of 2010 and 2011, the central bank promised that it would cool down bank lending. Now, it appears, the central bank can do no such thing because the banks need to lend customers the money to meet their interest payments. Capitalizing interest is a very, very bad thing.

Chart 5: Turkish credit growth
year-on-year percentage change

Source: Central Bank of Turkey

Despite its earlier rhetoric from the central bank about the need to restrain lending growth, the central bank continues to finance an extremely fast rate of lending growth from its own balance sheet. Again, this suggests that the central bank has no choice but to capitalize interest, which means the bubble is getting worse by the day.

Chart 6: Turkish central bank credit to banks

Source: Central Bank of Turkey

The central bank pumps money into the banking system at an accelerating pace; the banks increase their loans to customers at a 40% annual rate; the central bank raises deposit rates to prevent the currency from collapsing; and the cost of carrying the debt bubble grows astronomically.

Meanwhile, the current account deficit continues to roar along at 10% of gross domestic product (GDP). Where does Turkey get the foreign exchange to important twice as much as it exports? It seems that the Turkish banks are borrowing the required money on the interbank market. Their borrowings from foreign banks (liabilities) exploded while their loans to foreign banks declined.

Chart 7: Turkish banks: Foreign interbank assets vs foreign liabilities

Source: BIS

As Turkey’s balance of payments deficit ballooned in 2009, Turkish banks became massive net borrowers of dollars from other banks. Those are short-term loans, though, and the slightest shudder could wipe out this source of financing.

A disaster is in the making. Leave aside the economic ills of the southern Mediterranean generally, which will impinge Turkey’s exports (about half of which go to the European community): Turkey’s financial system is reaching the end of the rope. A sudden adjustment in the current account accompanied by large-scale bankruptcies among Turkish businesses and widespread unemployment will make 2012 an ugly year for the Turkish economy, and an even uglier year for Turkish politics.

Spengler is channeled by David P Goldman, president ofMacrostrategy LLC, from whose December 16 report (“Wile E Turkey”) the charts in this essay were taken. He is the author of two books published late in 2011, How Civilizations Die (and Why Islam is Dying Too) and It’s Not the End of the World – It’s Just the End of You.