August 13, 5:00 pm EST
We have a currency devaluation in Turkey that is shaking up markets. Let’s talk about what’s happening and why (if at all) it matters for the big picture outlook.
First, here’s a look at the Turkish lira chart (orange line moving up means a stronger U.S. dollar, weaker lira)…
Now, the problems in Turkey aren’t new. The country is economically fragile. But the collapse in the currency probably has more to do with its leadership – and the erosion of democracy in Turkey.
There are a lot of people comparing Turkey’s currency crisis to the Thai Baht devaluation in 1997 — which ultimately ignited a currency crisis in Asia, which culminated in a sovereign default in Russia. That’s the fear: a currency crisis turning into a contagion of sovereign debt defaults.
But Thailand was about economic policy – specifically, the Thai currency policy. Speculators attacked to close the valuation gap between the central bank managed currency and its economy.
This Turkey issue looks more like the collapse in the Russian Ruble in late 2014. That was geopolitically driven. Back in 2014, Putin was forcing his way into Ukraine – an affront to the Western world. This was viewed as a proxy war against the West. That led to capital flight out of Russia and speculative attack on the currency.
With this chart on the Ruble (the orange line going up means a stronger dollar and weaker ruble), Russia was quickly made vulnerable and on a sovereign debt default watch.
But like Turkey, the contagion risk was driven by Russia’s foreign currency denominated debt (primarily euro denominated debt owed to European banks).
With that said, the world wasn’t “normal” in 2014, nor is it now. Remember, the European Central Bank remains in quantitative easing mode. That means, we should expect central bank (or policy) intervention (if needed) to quell any shock risks that could come from European bank exposure to Turkish debt. So the ECB’s “ready to act” commitment of the post-financial crisis era should calm fears of contagion.
As for Turkey, the crippling effects of the currency attack should put pressure on the freshly re-elected Ergodan (i.e. should make him vulnerable to an uprising).
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