A Turkish lira crisis involving dollar-denominated debt, a current account deficit, and foreign-exchange reserves may seem like an arcane Wall Street concern, right up there with bond-market liquidity and congestion at Teterboro Airport. But Turkey’s economic crisis is anything but. It represents the truly scary financial trends that are keeping investment bankers up at night: the weakening of emerging markets that’s threatening to spill across borders, a massive wave of maturing corporate debt that needs to be refinanced, and the ending of an era of ultralow rates We can now add an even scarier trend to the list: President Donald Trump’s willingness to make things worse. While the U.S. government has historically been a supportive force during financial panics, Trump has been treating Turkey’s economic meltdown like a bargaining chip, one more weakness to be exploited. This shouldn’t just scare Turkey. It should scare everyone.
Turkey’s economic troubles long predate the Trump administration. Over the past 15 years, President Recep Tayyip Erdogan has transformed a secular democracy on the cusp of EU membership into an illiberal autocracy, where the judicial, legislative, and executive branches of the government, as well as the media, are all controlled by one man, namely himself. It’s a country where tens of thousands of judges, teachers, police officers, journalists, and civil servants have been fired and jailed on dubious terrorism charges; a country where excessive government spending and excessive corporate borrowing have left the government with insufficient dollars to pay back its debts. Turkey is starting to seem like a less extreme Venezuela, but without all the oil.
Until recently, Wall Street was willing to fund this oncoming train wreck because Turkish debt and equities offered the possibility of much higher returns compared to U.S. and European securities. Sure, investors were troubled by Erdogan’s debt-fueled infrastructure binge and overreliance on foreign financing. But in an era of near-zero interest rates in developed markets, investors were inclined to overlook a lot, even Erdogan’s more eccentric beliefs—such as his unwavering conviction that high interest rates cause inflation (they don’t) and his assertion that Moody’s, the U.S. credit-ratings agency, is part of a plot to undermine his regime. (It’s not.) Then President Trump came along.
In early August, just as the lira was tanking and in desperate need of positive news or supportive actions, President Trump announced that he was doubling Turkish steel and aluminum tariffs. The tariff announcement cited national security concerns, but the increase was more likely a response to Erdogan’s refusal to release the imprisoned American pastor Andrew Brunson or concerns that the plummeting lira would make Turkish exports too competitive, negating the effect of the original tariffs. Whatever the reason, Trump’s decision roiled markets just when he should have been trying to calm them. In the days following Trump’s announcement, the lira fell to an all-time low against the dollar, bringing its year-to-date decline to nearly 40 percent, before it rebounded slightly following a clampdown on short selling and the announcement of $15 billion in Qatari aid. The lira was a veritable ping-pong ball after Trump took to Twitter to mock the currency’s weakness like some kind of schoolyard foreign-exchange bully, disregarding fears that Turkey’s crisis could spread beyond its borders to endanger European banks and other vulnerable emerging market, aka EM, economies.
While there is an utter lack of clarity about Trump’s reasons for taking these steps, his message to Wall Street was perfectly clear: The trade war is on. Wall Street has normally been quick to forgive President Trump’s poor policy decisions—trillions of dollars in tax cuts will do that. But the Trump administration’s proposed tariffs on $200 billion of Chinese goods, its growing tendency to mix geopolitical negotiations with trade policy, and its norm-shattering response to the lira panic are all having a real effect on investor sentiment and investor behavior. EM companies are finding it increasingly hard to issue new debt, many EM currencies are weakening further against the dollar, and, according to a Citigroup survey, 50 percent of EM debt investors now believe a “full-blown trade war will break out” in the near future. Don’t let booming U.S. equity markets fool you: Trump’s weaponized trade policy is hurting the global economy.
This isn’t how the U.S. is supposed to behave. While the U.S. has historically used sanctions and the awesome power of the U.S. dollar system to influence other nations, as the Economist recently discussed, previous U.S. administrations normally prioritized market stability over point scoring, especially when a crisis had the potential to damage other economies. During the Mexican peso crisis in the early 1990s and the Asian financial crisis in the late 1990s, the U.S. didn’t try to take advantage of weakened trading partners. It instead broadcast its support to bolster investor confidence. While the 2014 U.S. and European Union sanctions on Russia contributed to Russia’s severe economic troubles, what mostly caused the ruble’s value to plummet was an unexpected decline in oil prices in late 2014. The Obama administration was certainly willing to pressure countries like Iran and Russia with economic pain to encourage them to come to the negotiating table, but the administration understood the importance of market perception. Wall Street might claim to be objective and data-driven, but it’s often beliefs, expectations, and emotions that really drive behavior, at least in the short term.
Trump, however, does not seem to care about the very real crisis that could be unleashed if his dangerous policies push Turkey into a financial abyss. Turkey remains vulnerable to increasing U.S. interest rates, a stronger U.S. dollar, higher oil prices, and Wall Street’s declining interest in riskier investments—like, say, Turkish equities. But now it’s also vulnerable to aggressive Trump trade policies that involve directly attacking foreign currencies.
It’s possible Turkey’s acute crisis will be contained, at least temporarily. Erdogan is reportedly more pragmatic than he appears and might be stalling until November, believing Trump will become a weaker negotiating partner following disappointing midterms. Erdogan may also soon realize that he will need many more of those $15 billion Qatari checks if his country’s businesses have any hope of meeting their immediate foreign-currency needs. So he could capitulate and turn to the IMF or the German government for help, admitting that he needs to cut spending and restore central-bank independence. But even if Erdogan is able to magically restore market confidence, the damage caused by this episode could have a lasting effect.
In options trading, an investor can buy a “put,” which gives the investor the right to receive a specific price for a specific security, like a safety net. The U.S. government’s commitment to market stability—and investors’ faith in this commitment—has long functioned as a kind of global put, serving to limit the damage caused by many financial crises. But the Trump administration’s recent actions could undermine this faith, forcing Wall Street to reckon with the new reality that the trade war is intensifying, emerging markets are weakening, corporate debt is coming due—and there are few nets in sight.