Alan Shaw
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  • Alan's Blog

  • Nov 18th 2022 at 3:09 AM
    Turkish Monetary Experiment

    The US economy has experienced 40-year high inflation for almost a full year now. Prices for food, electricity, and other staples have climbed higher and higher, which ultimately forced the Federal Reserve to take action.

    This action has arrived in the form of interest rate increases and attempts at quantitative tightening. Why? The widely held belief is that raising interest rates helps to destroy demand, which in turn will decrease spending and the velocity of money, which ultimately brings down inflation.

    Someone forgot to explain this to President Erdogan of Turkey though.

    For three months in a row, the President has been cutting interest rates despite Turkey experiencing over 80% year-over-year inflation. Yes, you read that correctly. Turkey’s central bank is decreasing the cost of capital at a time when inflation is out of control. This morning Turkey announced a 150 basis point decrease in interest rates.

    Before we analyze why this is happening, and whether Erdogan knows something the rest of us don’t, it is important to call out that Erdogan is not the President of the central bank. He is the President of the country. But Erdogan is essentially running monetary policy at this point, which surfaces all kinds of challenges and complexities.

    Imagine President Biden overseeing his day-to-day duties and also managing monetary policy of the US dollar.

    Back to Erdogan.

    His thought process is that raising interest rates are “the mother of all evil” and rather than bring inflation down, it appears he wants to exclusively focus on increasing growth and export competition. Through that lens, Erdogan’s actions may not be as crazy as they initially appear.

    Decreasing interest rates is a widely accepted method to increase growth and investment. You would be hard pressed to find an economist to disagree on that. But the bigger question is whether it makes sense to pursue a growth strategy with inflation at more than 80%. Additionally, Turkey’s currency has lost approximately 50% against the US dollar this year. Brutal.

    What is interesting though is that Turkey’s debt-to-GDP is only about 42% — very healthy compared to the United States’ debt-to-GDP of nearly 140%.

    You can’t argue that Turkey is worried about bankrupting their country with high interest rates because of an unsustainable debt load. You can’t argue that there is historical precedence for aggressive, loose monetary policy taming runaway inflation.

    The only thing you can argue in my opinion is that President Erdogan has accepted the fact that his country will have to live with high inflation. Rather than try to fight the inflation, he has given up on that problem. Turkey lost the battle. Erdogan is going to focus on driving economic growth and exports. The local currency may be devaluing at an insane pace, but if he can get some growth (and profits) into the hands of his citizens then hopefully they are smart enough to get out of the currency.

    This seems like a fairly crazy gamble. I have no clue what is going to happen, nor how the various aspects of an economy will react to this counter-intuitive action. But we are all about to find out. The “pursue loose monetary policy in the face of insane inflation” experiment is being run in Turkey — let’s see what happens.

    Hope each of you has a great day. Alan...

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