If He’s Correct, the Rest of the World is Screwed

Unless you are a politician running for reelection, we are in a recession.  So is the rest of the world.  And most of us—at least those who live outside of Washington D. C—know that one of the prime reasons for the recession is a mounting rate of inflation.

The causes of inflation have been long known: there is too much money available in the market for the current level of production.  Simply put, there are too many dollars chasing too few products.  (Or as Milton Friedman put it, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”)

Most countries, including the United States, have a central bank that attempts to counter inflation by reducing the amount of money available, and while there are several ways to accomplish this, one of the most effective means of doing so is to raise the prevailing interest rate, making it harder to borrow money.  Given time, this will bring down inflation.  It is what our Federal Reserve is doing now, it is what the Bank of Japan is doing now, it is what the Swiss National Bank is doing now…. It is what almost all of Europe is doing. 

If this sounds confusing, picture an auction where everyone bidding has exactly a thousand dollars in their pocket.  Will the bidding go higher or lower if everyone in the audience suddenly has two thousand dollars?

There is one country in Europe that has a different idea.  Turkey is not only not raising its interest rate, Central Bank of the Republic of Turkey is lowering it.  Despite the Turks’ calling themselves a republic, since Turkey elected President Recep Erdoğan, he has been increasingly autocratic, ignoring both the desires of the central bank and the nation’s Supreme Court…And Erdogan has some “unusual”, contrarian ideas about economics.

Erdoğan received his primary education at a private Islamic academy and  claims to have graduated from a Turkish university, although no official record of his attending the university exists.  His unique theories about economics seem to be all his own creation.  The Turkish president firmly believes that the correct method of fighting inflation is to lower interest rates—repeatedly—until inflation returns to the generally accepted target range of 2-3%.

If Erdoğan is correct, the economies of the rest of the Western World will crash and Turkey is about to enter their Golden Age of Prosperity.  President Erdoğan will win a fistful of Nobel Prizes and have chapters in textbooks named after him.  If he is wrong—and I’ll bet money on it—Turkey is about to get flushed down the economic toilet while Erdoğan will get added to the long list of crackpot dictators like Idi Amin (though Uganda was landlocked Amin made himself an admiral of the Ugandan Navy) or the Congo King who imposed a tax on his subjects each time his hat fell off. 

Despite criticism from damn near everyone—that is, everyone who lives outside of Turkey—that this is the economic equivalent of trying to put out a forest fire with buckets of gasoline, Erdoğan insists on doing the exact opposite of what the World Bank and the International Monetary Fund insist is sound economic policy.  Just yesterday, he ordered his Central Bank to lower the rate, again.  Naturally, the bankers followed his mandate while praising his sage advice.  (That is good policy, since people who don’t do what Erdoğan wants tend to be arrested.  Or worse.)

Lowering interest rates will make borrowing money much easier and those rising prices will definitely make borrowing more money an attractive idea to businesses struggling to meet their obligations.  And the more money that is in the economy means prices will continue to spiral upward, making Turkish products more expensive on the world market, leading to a trade deficit and a lower exchange rate for the Turkish lira.

Erdoğan would say that everything in the previous paragraph is exactly backwards and I’m wrong.  I’m not sure what he would say if I pointed out that Turkey currently has an annual inflation rate of 80%, that the Turkish Lira has declined in value 28% against the dollar so far this year and has declined three times that amount over the last five years.

He might just say that his monetary policy simply needs more time to start working.

Unfortunately, time is not on Turkey’s side.  As the dollar rises and the lira falls, Turkey is burning through its cash reserves faster than a drunken sailor on shore leave.  (That may not be a fair comparison, since a drunken sailor will stop spending after running out of money, but Erdoğan won’t.). Since most of Turkey’s foreign debts are dollar-denominated, it will become increasingly hard for Turkey to meet its financial obligations.

Erdoğan got a brief, small reprieve via an influx of foreign currency when tourists returned to Turkey at the end of the pandemic.  The reprieve was brief because the tourist season is ending, and the reprieve was small because most of the tourists were from Russia—Turkey happens to be just about the only place that the Russian tourists could go because of the various sanctions placed on Russia in response to the war in Ukraine.

If I were to consult my crystal ball, I would predict that the next step in this drama will be for Turkey to add a night shift at the Treasury Department in order to print more lira to keep up with the rising costs.  With just a little effort, Turkey can easily move from high inflation to hyper-inflation.  Then, after a couple of years of this, Erdoğan will announce that all Turkish citizens have to exchange their “old” Lira for New Lira, that are printed in the same denominations but with a handful of zeros lopped off at the end.

As the recession gets worse, so will unemployment.  Taxes will rise, the cost of living will skyrocket, personal savings will be wiped out, and the country will undergo significant capital flight as anyone with more than pocket change will try to move their assets out of Turkey.  

Eventually, Erdoğan will probably remove the last vestiges of democratic rule and try to restart his own private version of the Ottoman Empire, as well as likely also leaving NATO in the process and realigning himself more closely with Russia.

Or the Turkish people might remove President Erdoğan while there is still time to correct what will otherwise become a snowballing economic nightmare.  Because if there is one thing I am certain about, it’s that lowering interest rates will never end inflation…anywhere.