August rarely disappoints to conjure up an event to trouble global markets and disturb holiday festivities.
This year it falls to Turkey to bring us prematurely back to our desks. Over a few days a fully-fledged currency crisis threatens contagion to other emerging markets, to European banks and potentially to global geopolitics, including the politics of energy.
Could this spoil the capital markets’ long party like other historic summer party poopers such as the collapse of LTCM, Russian debt default, European sovereign debt crisis, or the collapse of the sub-prime market?
Turkish lira currency weakness has been brewing all year as economic imbalances and the degree of president Recep Tayyip Erdogan’s power stranglehold became apparent.
The spat between the US and Turkey – ostensibly over Ankara’s refusal to extradite an imprisoned Evangelical American pastor and the doubling of tariffs by president Trump on Turkish steel and aluminium exports in response – tipped this into a full scale currency collapse for a few days.
Turkey’s domestic imbalances are real and significant. The economy has overheated from artificially low interest rates - Erdogan is a self-declared enemy of interest rates - and heavy public expenditure, including super-jumbo infrastructure projects from airports and canals to suspension bridges.
The trade deficit is high and rising and inflation is pushing towards 20%. Markets are particularly good at exploiting any Achilles Heel, and the high level of relatively short maturity foreign currency debt and loans leaves Turkey exposed to serious currency weakness which has duly been delivered. By the end of July the Turkish Lira had fallen by over 22% against the US dollar since the start of the year – it fell a further 22% by mid-August, fuelling ‘crisis’ fears.
Turkey’s responses so far have been more tit for tat and jaw-jaw than any serious measures to address the underlying issues.
President Erdogan, rejecting economic fundamentals as the cause of the lira's weakness, has said that Turkey is the target of an economic war led by foreign powers.
In this vein he has rallied his people not to ‘give in to the enemies’ and to boycott US goods and convert their currency and gold into lira, backing this up with retaliatory tariffs on a range of US goods including cars, agricultural products and tobacco. The environment minister followed this up by saying that no US products will be used in construction projects.
In terms of contagion, there are reasons to be cheerful. The global economic expansion still has life. Turkey, as the 17th largest economy, is too small to impact this significantly on its own. Eurozone exports to Turkey at €60 billion will require a major collapse to have any serious impact on European economic activity. Turkey’s stock market accounts for less than 1% of the MSCI Emerging Markets Index. In context China accounts for 33%, South Korea 15%, Taiwan 12%, India 9% and South Africa 7%.
However, looking at developments in Turkey from a domestic, geopolitical and regional perspective, this little local difficulty might not go away too easily and could have unintended broader consequences.
President Erdoğan has for some time been shaping a narrative of a country under siege, a victim of foreign powers. This rhetoric has proved popular and fundamental to the passage of the constitutional reforms and the presidential elections that have elevated and cemented Erdogan’s authority. However, it masks the deep and growing divisions within society and comes at a cost of undermining long standing Euro-Atlantic relations.
In reality Ataturk’s secular, reformist, modernised model of Turkey is now a synthetic state under attack from within. Despite the façade of more centralised control and power, Turkey is in fact on a long term path to breaking up into its three core components. President Erdogan represents the political Islamists who have rejected modern Turkey's secular heritage. Fundamentally conservative, undemocratic and increasingly authoritarian, locking up troublesome journalists and others.
In the centre are Erdoğan’s political predecessors, the secularist but divided parties that ruled Turkey, and those who inherited Ataturk’s vision within the army, as well as intellectuals and western looking businessmen and liberals.
And in the East and South East there remains the oppressed but fiercely resolute and armed Kurdish community and their PKK insurgents. Throw in three million Syrian refugees towards whom growing hostility is being voiced, threats imposed by ISIS sympathisers and the exacerbated tensions from events that followed the July 2016 coup attempt and you have a volatile cocktail of explosives that are likely to tear Turkey apart.
In the long term a break up of Turkey cannot be ruled out – if so it is more likely to follow the Yugoslavian model than the more peaceful dismantling of the Soviet Union.
Given its significant position in a strategically sensitive region, the potential fallout goes way beyond yet another country battling with a currency crisis.
When in trouble at home look for enemies abroad. Erdogan seems to have burnt bridges with the US and is turning back the path of reforms required to bring it closer to, and eventually into the EU. Plans to introduce the S400 air defence systems from Russia will only highlight Turkey’s ambivalent relationship with its Nato Allies.
As it looks for enemies, where will Turkey turn for friends? Russia, China, Iran and Qatar – who have already turned up with $15bn as an alternative to any IMF (and therefore US) aid package – will no doubt be courted. In the region, how Turkey will respond to its neighbours as it succumbs to its internal political, social and economic imbalances will also have repercussions way beyond its frontiers.
Energy is shaping regional alliances and estrangements. Due to recent world class natural gas finds and with the prospect of even more to follow, the eastern Mediterranean will soon become the new energy frontier.
Energy cooperation has spawned an emerging Greek-Israeli-Cypriot partnership, leading in turn to cooperation in the field of defence. At the same time disagreements over the exploitation of energy resources in the waters off Cyprus have undermined any progress on reuniting the divided island. With security and reliability of energy supplies a growing issue for western governments, how eastern Mediterranean resources are exploited and delivered to market carry a geopolitical significance well beyond their economic impact.
As you reflect on contagion, risks and opportunities from Turkey’s currency crisis it is important to understand that what we are witnessing is a strategically important, deeply divided, powerful and unhappy nation on a path to serious turmoil, embedded in a region of turmoil. Do not ask for whom the bell tolls…