Why The Worst Is Still Ahead For Turkey’s Bubble Economy

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“Unfortunately, like most emerging market nations, Turkey’s economic boom has devolved into a dangerous bubble that is similar to the bubbles that caused the downfall of Western economies just six years ago. Though Turkey has received significant attention after its currency and financial markets fell sharply in the past year, there is still very little awareness of the country’s economic bubble itself and its frightening implications.

The emerging markets bubble began in 2009, shortly after China pursued an aggressive credit-driven infrastructure-based growth strategy to boost its economy during the global financial crisis. China’s economic growth immediately surged as construction activity increased dramatically, which drove a global raw materials boom that created a windfall for commodities exporting countries such as Australia and emerging markets. Emerging markets’ improving fortunes began to attract the attention of global investors who were seeking to diversify away from Western nations that were at the epicenter of the financial crisis. As the bubble progressed, even developing countries that were not significant commodities exporters (such as Turkey) began to benefit from the growing interest in this investment theme.

Rock-bottom interest rates in the U.S., Europe, and Japan, combined with the U.S. Federal Reserve’s multi-trillion dollar quantitative easing programs, encouraged a $4 trillion torrent of speculative “hot money” to flow into emerging market investments over the last several years. A global carry trade arose in which investors borrowed at low interest rates from the U.S. and Japan, invested the funds in high-yielding emerging market assets, and pocketed the interest rate differential or spread. Soaring demand for EM assets led to a bond bubble and ultra-low borrowing costs, which resulted in government-driven infrastructure booms, alarmingly fast credit growth, and property bubbles in numerous developing nations.

Like many other emerging nations, Turkey’s economic boom since the financial crisis has been heavily predicated upon a combination of foreign “hot money” inflows, ultra-low interest rates across the yield curve, rapid credit growth, and soaring asset prices. The charts of Turkey’s benchmark interest rate and three-month interbank rate show how they were cut to all-time lows in the years following the financial crisis:

Turkey Benchmark Interest RateTurkey Interbank Interest Rate

Turkey’s idiosyncratic monetary policy of the past half-decade was responsible for these unusually low interest rates: Recep Tayyip Erdoğan, Turkey’s Prime Minister, believes that a zero real interest rate policy is the best practical implementation of sharia law’s ban on usury, or lending for interest, for modern Islamic societies.”

By Jesse Colombo

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