Trouble ahead? Easy money vs. Turkey 1:0

by Andreas Hoffmann

While the US, Japan and Europe slashed interest rates to unprecedented low levels, growth remains sluggish. Dealing with debt problems and supporting the recovery, the ECB provided money to quasi-finance the euro area problem children. Similarly the Federal Reserve is trying to jump start the economy and has been flooding markets with money so that they have no idea about what to do with all the liquidity.

But – wait – there are emerging markets. They are booming from Brazil to Turkey. Hence, investors target emerging market asset markets until there is something to gain at home. As a consequence Poland and Brazil just raised interest rates to fight inflationary pressure in goods and asset markets. On the contrary, while inflation picks up (expected rate for 2011 is 5.9 percent), Turkey LOWERED interest rates and raised reserve requirements.

This might seem odd?

But it makes sense: Turkey has a history of severe crises (1994, 2001) and turbulence (1999, 2006) over the last two decades caused by sudden capital flight and depreciation. And again, an economy that is growing at rates of eight percent, faster than any European economy, is the natural target for speculative investment. “Can it happen again?”, asked the Turkish Prof. Onaran  in 2006. The Turkish authorities seem to think so:

In my opinion, this unorthodox measure shows not only that Turkey’s primary fears stem from hot money inflows, but also that the country is already preparing for a possible crisis. As higher interest rates might attract more speculative capital inflows due to appreciation of the lira, this is not seen as a wise option to fight inflation. The policy answer of the Turkish central bank makes a lot of sense: First, lower interest rates. In a second step, raise reserve requirements. Raising reserve requirements increases interest rates back to where they were or even more. But then banks are better prepared to deal with possible capital flight.

Unfortunately this unorthodox policy has shown that it might already be too late. Easy money investment is already very sensitive to devaluation. After the Turkish central bank lowered rates (19.Jan. 2011), financial stocks lost about 20 percent as the depreciation of the currency led foreign investors to sell out their portfolio. Therefore it seems that Turkish authorities have nothing to stop easy money inflows without risking severe disinvestment. They are trapped.

But what is worse: this immediate market turbulence signals that the risks taken by investors in emerging markets around the world might be very high and trouble may be ahead. Once the major economies return to a more moderate monetary policy stance, it is likely that emerging market asset market booms go bust. The longer they wait, the worse it will be. Let us hope the Turkish turbulence is just a small cloud on a clear sunny sky!

8 thoughts on “Trouble ahead? Easy money vs. Turkey 1:0

  1. If I may take up a theme long a part of the “Austrian” critique of government interventionism (including monetary interventionism), once the government introduces various price interventions in one (or some) sectors of the market(including interest rate and related monetary manipulations), this soon generates (unintended) spill-over effects on other inter-related markets.

    Then to counter-act these “undesired” and possibly “dis-equilibrating” secondary effects, further interventions must be introduced. And the process continues, generating more unsustainable and imbalanced distortions in a growing number of segments of these inter-related markets. With government control or intervention expanding its reach.

    And what Andreas is tracing out is another current example of what we might call “Mises’ Law” of the cumulative distorting affects arising from individual interventions that reduce the range of free market activities in the society that are outside the reach of the political authority.

    Richard Ebeling

  2. Dr. Ebeling makes an important point. Hot money does not flow in and out of an economy for no reason whatsoever. Governments need to understand why they money comes in and why it leaves. The search for higher rates of return bring in the new money, but those rates of return are related to risk. When investors discover the extent of corruption and state interference in the economy, the money leaves very quickly.

  3. The big international financial organizations are extremely good at making world wide arbitrages. They make shot term, portolio investments, which are very sensitive to international economic conditions and hence very volatile. The central banks and regulatory authorities in smaller emmergent countries, often faced with conflicting multiple problems of their own, can’t do much.

  4. I want to offer another point of view on the same topic:
    By Steve Bryant

    (Updates with economist comment in fourth paragraph, bonds in sixth.)

    Feb. 1 (Bloomberg) — Turkey’s inflation rate probably fell to the lowest in four decades in January, supporting the central bank’s surprise decision to cut the benchmark interest rate in the last two months.

    Consumer price inflation may slow to 4.6 percent from 6.4 percent in December, according to the median estimate of nine economists in a Bloomberg survey. That would be the lowest rate since July 1970 and about half what it was 11 months earlier.

    An inflation rate lower than the central bank’s goal of 5.5 percent will help Governor Durmus Yilmaz’s case for a monetary policy mix that combines lower rates with higher reserves for banks in a bid to prevent a credit bubble and stem short-term capital inflows that widen the current account deficit.

    Easing food and clothing prices could help achieve “an all-time low in the modern economic history of Turkey,” Tevfik Aksoy, Morgan Stanley & Co.’s London-based chief economist for Turkey, the Middle East and North Africa, said in an e-mailed report. “There’s no doubt this will strengthen the credibility of the central bank.”

    The slowdown in Turkish inflation comes as the European rate rose to 2.4 percent last month from 2.2 percent in December. Inflation in the U.K. may climb toward 5 percent in the coming months, Bank of England Governor Mervyn King said last week.

    Yields on benchmark Turkish two-year lira bonds declined 7 basis points to 8.16 percent at 5:17 p.m. in Istanbul.

    The Turkish central bank has cut the benchmark one-week repo lending rate by three-quarters of a percentage point to a record low of 6.25 percent in the last two months. It’s raised banks’ reserve requirements twice since the start of December.

    The central bank forecasts a “pronounced” slowdown in the inflation rate in January, according to the minutes of its meeting on Jan. 20. The statistics agency will announce January inflation figures on Feb. 3 at 10:00 a.m. in Ankara.

    Inflation in Istanbul fell a monthly 1 percent in January, taking annual inflation to 4.9 percent from 8.7 percent in December, the city’s chamber of commerce said on its Web site today.

    Editor: Mark Bentley

    To contact the reporter on this story: Steve Bryant in Ankara at

    To contact the editor responsible for this story: Mark Bentley at

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