As if war wasn't enough

 

The February 6 earthquakes threw financial markets into chaos in Turkey. They undermined demand for the Turkish currency, the lira, weakening its dollar value.  Turks holding lira became poorer in dollars. They couldn’t afford to buy many things from other countries.

But at least Turkey has a technically competent central bank, which manages the supply of lira. The President of Turkey, Recep Tayyip Erdogan, just won’t let the bank do its job, that’s all. 

Now consider neighboring Syria, which also suffered from the 7.8-magnitude earthquakes as well as from a 6.3-magnitude aftershock on the border February 20.  Far from having technical prowess, the Central Bank of Syria doesn’t even have a Web site that works.  In 2020, the United States Treasury sanctioned the Bank for its “deep banking ties” to a sponsor of terrorism, Iran, choking off its dollars.

Without dollars, the Bank cannot back up the value of the Syrian pound. The pound slid against the dollar throughout late 2022, plunging to its record low of 6,850 pounds in late December, despite the central bank’s attempt to fix the exchange rate at 3,015 pounds on December 6.  Back in 2011, before the civil war, 47 pounds had traded for a dollar.  Thus the dollar value of the Syrian pound had fallen 99.3%.  It was virtually worthless. The average monthly Syrian income, of 130,000 pounds, came to less than $19. Average annual income, expressed in dollars, had fallen by nearly 92% since 2010, according to my calculations (see the Notes).

And this was weeks before the earthquakes.  As in Turkey, the decimation of homes and roads will sharpen the demand for hard-to-find shelter and food. Prices will skyrocket.  Inflation in Syria was 139% in 2020, if you can believe Trading Economics, which does not explain its methods.  The Syrian pound can no longer buy many goods; Syrians who saved pounds will find them more useless than ever.  People will lose their homes and starve.

But now Syria’s story diverges from Turkey’s -- in a way that it hadn't before the civil war broke out in 2011. At that time, Syrian President Bashar al-Asad had looked like the reformist son of the repressive late ruler, a young, Western-trained eye doctor who would modernize his homeland. The economy was growing 3% or 4% per year -- not great but not bad -- and inflation was only about 4%. 

Arab Spring, Syrian Storm

But pro-democratic protests, stemming from the Arab Spring in the region, exposed the delusion in those dreams.  At first, Asad made concessions, such as repealing a law that permitted arrests without charges. But when protesters proliferated, he ordered his troops to attack them. So began the war.  It has killed more than 300,000, according to United Nations estimates -- and by some media reports more than half a million.  It has also deprived millions of their homes.         

Turkey can hope for dollars from the West.  Syria cannot.  Its President is waging a war that the West abhors and sanctions:  In 2012, 130 countries recognized the opposition Syrian National Coalition. Asad's main support is from the Kremlin.  With friends like that.... 

On top of it all, the central bank of the US, the Federal Reserve, has just cut off the supply of dollars to Iraq, which had sold them to Syria, because of laundering under the table.  The central bank of Syria is up the creek, and the crocodiles are circling.

With dollars, Turkey can steady the lira and stanch the loss of value from lira savings. But humanitarian aid is the most that Syria can expect. With no dollars and no credibility, its central bank can do nothing about the incredible shrinking pound. 

This means that imports from other countries are becoming more expensive. Since Syrians appear to import far more than they export, life is becoming prohibitively costly for them.  Even if the central bank can put its hands on a few dollars, just possibly with Russian connivance, it will probably use them to pay down the government's foreign debt, which the CIA estimated at 95% of gross domestic product in 2017. 

The refugees are thick in Idlib Province, in rebel-held, war-torn northwest Syria, west of Aleppo, the second largest city in Syria (Damascus is largest). See Figure 1.  They live in tents and on humanitarian aid already stretched to the breaking point.  The United States provides $185 million in aid in all to Syria and Turkey for the earthquakes.

Figure 1: Syria and surrounding countries

The Turkish buffer zone is on the border stretching east of the Euphrates Source: Creator: PeterHermesFurian | Credit: Getty Images/iStockphoto. Copyright: PeterHermesFurian 

Figure 2: Rescuers comb rubble in the town of Hamen, in Idlib province, after earthquakes 

Source: Al-Jazeera

It's hard to find good data on Syria.  The World Bank does not report consumer inflation for any year since 2012, when the civil war began. The IMF Datamapper reports no economic data for Syria, period, since 2010. But I crudely and foolhardily calculate that annualized inflation in late December may have hit 110% (see the Notes). It’s undoubtedly higher today. History repeats like a crone, and the Syrians are getting wiped out once again.  --Leon Taylor, Baltimore tayloralmaty@gmail.com

 

Notes

The IMF Datamapper reports 2010 income per capita, expressed in dollars using the exchange rate at that time, as $2,810. In December 2022, average monthly wages expressed in dollars were $19. Times 12 gives us $228, an implied loss of income of 91.9%.

By the quantity equation of exchange, dP/P = dM/M + dV/V – dQ/Q, where P is the price level, M is the money supply, V is velocity (crudely, the rate at which we spend money), and Q is output. The equation says the inflation rate equals the growth rate of the money supply plus the growth rate of velocity minus the economic growth rate.  We have good data on none of these variables.

I assume that spending habits have fixed velocity this year, so dV/V = 0. Average income has fallen 91.9% since 2010, indicating a linearized annual rate of decrease of -91.9 / 12 = -7.6%.

Finally, I assume that the loss of dollar purchasing power in the Syrian pound is due to inflation of the money supply.  The loss rate of dollar purchasing power from December 6 to December 28 was 56% if we assume that the dollar was worth 3,015 Syrian pounds when the central bank set that official exchange rate. The annualized loss rate implied is virtually 100%. So far, the implied rate of inflation is 107.6%. 

Finally, the GDP growth rate is the growth rate of average income plus the growth rate of the population. The Syrian population was 21.4 million in 2010. The civil war killed roughly a half million and sent 6.7 million fleeing to other countries. The implied rate of decrease in the population from 2010 to 2022 was 33.4%, or a linearized annual rate of 2.8%.

In sum, the implied rate of inflation is 107.6% + 2.8% = 110.4%. This is probably an underestimate.

I use a linearized rate of change for income and population, rather than an exponential rate, because the changes, especially in income, are pretty extreme.  The exponential rate of change assumes that the actual rates of change decrease over time: That is, the rate of change in the rate of change is falling. I believe that in reality the rate of change in the rate of change was either constant or increasing. The use of a linearized rate of change is conservative in assuming a constant rate of change in the rate of change.

 

References

Al Jazeera.  Photos: Deadly quake intensifies suffering of displace Syrians. February 6, 2023.  Photos: Deadly quake intensifies suffering of displaced Syrians | Earthquakes News | Al Jazeera

Arab News.   Syrian pound hits new low on black market amid fuel crisis.  December 11, 2022.  Syrian pound hits new low on black market amid fuel crisis | Arab News

ARK News.  The Syrian pound continues to decline.  December 28, 2022.   The Syrian pound continues to decline | ARK News

International Monetary Fund.  Datamapper.  IMF DataMapper

Rick Noack and  Aaron Steckelberg. What Trump just triggered in Syria, visualized.  Washington Post.  October 17, 2019.  Syria in maps: Visualizing what Trump’s pullout has done - The Washington Post

US Central Intelligence Agency.  World Factbook.  Syria - The World Factbook (cia.gov)

US State Department.  US assistance to emergency earthquake response efforts in Türkiye and Syria.  February 19, 2023.  U.S. Assistance to Emergency Earthquake Response Efforts in Türkiye and Syria - United States Department of State

US Treasury Department. Treasury targets Syrian regime officials and the Central Bank of Syria.  Press release.  December 22, 2020.  Treasury Targets Syrian Regime Officials and the Central Bank of Syria | U.S. Department of the Treasury

What's next in Turkey?

 

The February 6 earthquakes, up to 7.8 on the Richter scale, killed more than 40,000 in Turkey and left an estimated two million homeless in a population of 85 million, or 2.2% of the population. An aftershock two days ago of 6.3 magnitude hit Hatay province in southern Turkey near Syria.  And now for the hard part. 

The scramble for scarce food and housing will send prices skyrocketing. Annualized consumer inflation in January 2023 was already 58% (and had been above 80% in November). The domestic producer price index, which measures output costs and thus predicts consumer inflation, was 158%. That's the general picture of prices. Now let's look at shelter and food.

Housing prices were rising swiftly well before the earthquake, by more than 230% from July 2021 to last December, according to the Central Bank of Turkey. Growth in food output has never kept consistently abreast with population growth: The typical Turk is not necessarily getting more to eat over time from local farmers, and actually got less in 2020, as Figure 5 shows.  This lack of abundant food sets the stage for rising food prices.  

Now, with the earthquakes pushing up demand for shelter and food, rates of consumer inflation exceeding 100% seem hard to avoid. The hyperinflation may decimate the savings of survivors, leaving many too poor to eat.

At the heart of the problem is the wobbly Turkish lira.  As Figures 1 and 2 below show, the rate of exchange of lira per dollar was rising steadily even before the earthquakes—from the beginning of 2022, in fact. (The sharp revaluation in December 2021 was probably due to Turkey's sensible new policy of protecting lira deposits against depreciation in dollars. The central bank meant this innovation to counter Erdogan's policy of low interest rates, which had caused the lira to lose fans, and thus value, throughout 2021, as Figure 1 shows.)  

Since the earthquakes, the lira has become much weaker, as Figure 3 shows. This devaluation pushes up import prices (since it now takes more lira than before to buy a dollar’s worth of goods) and threatens to drain the country’s reserves of dollars (since people will prefer to hold dollars rather than lira). Foreign currency reserves already are dropping fast—11% from December to January, according to the Central Bank of Turkey. Now they seem too low to cover even regular imports, which have been rising sharply since October (see Figure 4) -- much less emergency imports.  In January 2023, foreign currency reserves were $67.2 billion, not enough to cover three months of imports at the 2022 rate.  

Cash crash

Scary enough. But in truth, Turkey has less cash on hand than this.  Any country must pay its creditors first if it wants to protect its reputation and thus borrow in comfort later.  (Hello, Argentina.)  On one-year loans and such requiring dollars and gold, Turkey's debt in January rose 3.7% in one month to $32.6 billion. As of February 10, right after the earthquakes, it had increased to $34.4 billion. On longer-term trades in financial values, called "derivatives," Turkey's debt maturing in a month is $37.4 billion.  In short, Turkey's short-run debt is growing even apart from the earthquakes. Not many dollars may remain for buying food and medicine from abroad. (By "dollars," I really mean foreign exchange, including euros and yen. But for Turkey, it's mainly dollars.)

Turkey has $50.6 billion in gold that in principal could pay for nearly two more months of imports.  But one hesitates to dump the sacred stuff at a forced price. And Turkey is obliged to set aside a certain amount of gold in reserves, and to use gold to settle certain debts from derivatives.

On top of it all, Turkey has an eye-popping foreign debt of $2 trillion, which would take nearly two and a half years to pay off if Turkey devoted all its income to it (roughly, gross domestic product, the value of output). And Turkey was scrambling for dollars well below the earthquakes, turning to the Russians for help. With friends like that.... So investors have lots of reasons to dump the lira.

Figure 1: Exchange rates since the beginning of 2021

Source: Central Bank of Turkey

  

Figure 2: Exchange rates since October

Source: Central Bank of Turkey

Figure 3: Exchange rates in recent weeks

Source:  US Dollar (USD) to Turkish Lira (TRY) exchange rate history (exchangerates.org.uk)

 

Figure 4: Turkish import levels over 2022 (millions of US dollars)

Source: Central Bank of Turkey

Figure 5: Growth in food output relative to growth in population

Data source: World Bank

An immediate loan of dollars from the International Monetary Fund could shore up the lira.  But the President of Turkey, Recep Tayyip Erdogan, has thumbed his nose at the IMF for years, and it is not clear to me that he is humble enough to ask for help, particularly as he heads into a June election.  

Humanitarian aid is trickling in.  The United States has pledged $85 million.  But even if all this aid goes into housing, it would provide less than $43 per homeless person. NATO is helping, including with tens of thousands of tents. But the estimates of a business group of total economic damages from the earthquakes run up to $84 billion, or more than 1% of GDP.  This would be 125% of foreign currency reserves.

Murk accompanies the gloom, manifest in the "Net Errors and Omissions" account of the international balance of payments, which reconciles unexplained differences between spending and investment. In 2021, the accountants raised the account by $194 million, said the central bank. This year?  A cool $1.4 billion, more than 1% of GDP.

If Turkey can get through 2023, the new year may look brighter. It has been down this road before. In 1999, an earthquake of 7.9 on the Richter scale killed 17,000. But the economy in the next year rebounded 1.5% thanks to rebuilding. "The boost to output from reconstruction activities may largely offset the negative impact of the disruption to economic activity," the European Bank for Reconstruction and Development (EBRD) said about this year’s earthquakes. But Erdogan must find dollars to pay builders. And his wacky policy of holding down interest rates, allegedly to restrain inflation when in reality it does the opposite, has put off foreign investors. Portfolio investment fell 2.2% over 2022, according to the Central Bank of Turkey. In this year of recovery from the 2020 pandemic, investment should have risen.

The Turkish story is fluid, and my predictions are merely educated guesses, sans the education. But it is hard to avoid the sense of a looming disaster. –Leon Taylor, Baltimore tayloralmaty@gmail.com

Note

This update corrects Figure 1 to show exchange rates rather than imports. I thank Forest Weld for catching my error. The update also corrects an error about the 2021 adjustment of the "Net errors and omissions" account.

 

References

Central Bank of Turkey. Konut Fiyat Endeksi (Housing price index). December 2022. Konut Fiyat Endeksi (tcmb.gov.tr)

Central Bank of Turkey.  Statistics.  tcmb.gov.tr

Central Bank of Turkey. Uluslararasi Rezervler ve Doviz Likiditesi (International reserves and foreign exchange liquidity). February 10, 2023. RT20230210TR.pdf (tcmb.gov.tr)

France 24.  Earthquake sends tremors through Turkey's fragile economy. February 19, 2023. The source of the quote from the EBRD. Earthquake sends tremors through Turkey's fragile economy (france24.com)

Reuters. Turkey extends FX-protected lira deposit scheme for a year.  December 17, 2021. Turkey extends FX-protected lira deposit scheme for a year | Reuters

Sune Rasmussen.  NATO pledges earthquake aid to Turkey.  The Wall Street Journal. February 16, 2023.  NATO Pledges Earthquake Aid to Turkey - WSJ

World Bank. World Development Indicators. worldbank.org

 

Turkey, inflation, and the sages of The New York Times

Turkey’s glacial response to the two earthquakes of February 6 has spotlighted its sputtering economy.  In October, well before the earthquakes, the rate of inflation was already 85%. Now shortages of housing and infrastructure will send prices soaring. About the President of Turkey, The New York Times writes:

“Adding fuel to the fire is Mr. [Recep Tayyip] Erdogan’s insistence on lowering interest rates in defiance of a broad economic consensus that inflation should be contained by raising them.

“Although that approach has helped stabilize the lira’s free fall — a dollar now buys nearly 19 lira, compared with 13.50 a year ago — it has come at a high price. Today, over two-thirds of households are struggling to pay for food and rent, and more than half of workers earn wages worth less than the equivalent of $300 a month because of the lira’s devaluation...”

Hmmm.  Despite The Times's claim, cutting interest rates certainly hasn’t steadied the lira. A fall in terms of dollars of 29% purchasing power in one year, even before adjusting for inflation, is no jest. The decline has occurred in part because lowering interest rates cuts the rate of return to investors of holding lira rather than dollars. So they become more likely than before to sell lira and buy dollars. This fall in demand for lira decreases the amount of a dollar that a lira can buy. In other words, Erdogan’s policy of holding down interest rates is exactly why the lira has devalued, boosting the prices paid by Turks.

The lira fell sharply from 14 lira per dollar to 18 last year from February to August, when it leveled off…not because the central bank kept cutting the interest rate but because it finally held it constant. For a while.

The Times continues:

“Mr. Erdogan has tried to offset the pain by increasing salaries for public-sector employees, raising the minimum wage twice last year and boosting fixed pension payments. But those measures have largely been gobbled up by inflation….”

Inflation rises in part because Erdogan raises minimum wages and pension payments. Firms must raise product prices to pay the higher wages and pensions, fueling inflation. A classic example is Israel, where inflation rose from 13% in 1971 to about 400% in 1984 largely because worker contracts automated pay raises to cover spiraling living costs.  Inflation fed upon itself.

The Times adds:

“...$24 billion in funds of unidentified origin helped to finance half of a record deficit that Turkey racked up last year from importing more goods and services than it exported. Some of that mystery money, reported in 2022 data published by the government last week under the obscure heading ‘Net Errors and Omissions,’ is thought to be of Russian provenance….”

Maybe it’s not such a mystery.  My $1 payment to you is your $1 receipt, which you can spend only on things denominated in dollars. The same is true in international transactions.  If you spend 10,000 tenge on a novel from a bookstore in Baltimore, the bookstore must spend the tenge on Kazakhstani assets.  Sorry, the MacDonalds in Linthicum Heights, Maryland, won’t take tenge for a Big Mac. Believe me, I've tried. Similarly, Russian exporters must invest lira in Turkish assets (including lira reserves).  Granted, the Russians are not celebrated for their transparency.

Another source of “mystery money” is simply that we don’t record all international transactions in the twinkling of an eye. Temporary imbalances between inflows and outflows may show up in “Net Errors and Omissions,” which, far from being obscure, is one of the most thoroughly studied categories in the international accounts. 

The Times seems to suggest that secret Russian funds financed something like half of Turkey's trade deficit (presumably Russia would want political favors in exchange).  But Turkey racked up a trade deficit with Russia of only $3.2 billion.  That is, the Russians had $3.2 billion in lira from trade to invest. The suggestion of $24 billion in secret funds, relative to the known trade deficit, strikes me as unbelievably large. More evidence, please.  –Leon Taylor, Baltimore tayloralmaty@gmail.com

 

Notes

A year ago, the exchange rate was 13.5 lira for one dollar, so the dollar value of a lira was $1/13.5 . Now the exchange rate is 19 lira per dollar, so the lira’s value has fallen to about $1/19. The relative loss in purchasing power is ( $1/19 - $1/13.5 ) / ( $1/13.5 ), or -.29.

      

References

Liz Alderman.  Turkey’s reeling economy is an added challenge for Erdogan.  February 19, 2023.  New York Times.  Turkey’s Reeling Economy Is an Added Challenge for Erdogan - The New York Times (nytimes.com)

Central Bank of the Republic of Turkey. Web page at tcmb.gov.tr

Stanley Fischer and David Osmond.  Israeli inflation from an international perspective. 2000. International Monetary Fund Working Paper. 

Monetary digitalis

The National Bank of Kazakhstan is getting ahead of the game.  In a joint seminar a few days ago with the Caucasus, Central Asia, and Mongolia Regional Development Center of the International Monetary Fund, the central bank announced plans to launch the digital tenge over three years.  Ideally, it would eventually account for 10% of gross domestic product, the value of what the economy produces each year, but in reality would hit just 5% or 6%, according to the Bank’s simulations.  No matter. It’s still a revolution. But every revolution has its skeptics.

Cash attracts us for its anonymity.  I can buy Lady Chatterley’s Lover with physical tenge without anyone being the wiser. For that matter, I can buy a handgun with too few questions asked.  Digital tenge, on the other hand, can be tracked. How can we make digital tenge as anonymous as the real McCoy?

Another practical question: Commercial banks worry that as the depositor expects inflation to weaken the tenge, he will sell it for digital tenge, leaving the banks with fewer tenge to lend out at interest. One solution, as the National Bank sees it, is to prevent the digital tenge from substituting for the real one in loans. You could use the digital tenge only to buy and sell things; you could not hold it as an asset.  Exactly how would the Bank keep anyone from holding the digital tenge for a long time?

The Bank says that it verified the likely success of the digital tenge as strictly a buy-and-sell instrument. In its survey of 3,000 respondents in Kazakhstan, 60% said they were willing to try the digital tenge. No surprise, considering that card payments in Kazakhstan increased tenfold from 2017 to 2020, according to the Bank’s white paper.  And the Bank declared victory in a five-day experiment of the tenge in sales and purchases conducted with Eurasian Bank. 

But there may be several problems with this experiment. First, given its history with the National Bank, Eurasian Bank is hardly a random choice. The Bank canceled the license of a Eurasian unit in 2016 and may wish to give it a second chance. That would be admirable, but it would not be objective statistics. (One notes with interest that Eurasian Bank will have a significant advantage over other banks in digital experience.) The Bank should have chosen its partner with a roll of the dice.  More important, five days is not enough time to determine whether people will try to hold the digital tenge as an asset rather than the physical one.

Even more serious problems may loom. To keep the digital tenge from supplanting the real one, the Bank proposes to hold constant the supply of all tenge, physical and digital. But inflation is usually accompanied by an increase in the supply of the inflated money—in this case, the physical tenge. For example, during inflations, people saving tenge will spend them now while they’re still worth something, increasing the total circulation of tenge. Since the total supply of tenge is held constant, the number of digital tenge must diminish. But this will make it more scarce, and hence more valuable, relative to the physical tenge, than before. People will try to sell physical tenge for digital ones, weakening the purchasing power of the physical tenge.  Prices will rise, and the vicious cycle may recur indefinitely, until the physical tenge is driven out of existence.

 

Running like rabbits

 

The Bank insists that its digital tenge would not cut the ground under the commercial banks.  The Bank’s new instruments would appear in the market only, and they would be available to all banks. But that’s not the question. Of course the Bank would be impartial.  But the fact that it is introducing a digital tenge signals to the public that the new currency will have advantages, at least in some situations. It is not a perfect substitute for the physical tenge. Commercial banks that fail to recognize the digital tenge’s occasional superiority could get blown away. Rather than soothe the timid, the Bank should ready them for the future.  

The digital tenge is the future -- it's so easy and quick to use. The Bank proposes to protect the physical tenge by prohibiting interest to be paid on the digital one. However, the rate of return on holding the physical tenge is negative -- minus the rate of inflation, since it loses value at this rate. If the Bank plans to hold the return to the digital tenge to zero, by adjusting its supply, people will still prefer it to the physical tenge. Zero is better than minus 20.7%. We could be in for a wild ride.  –Leon Taylor, Baltimore, tayloralmaty@gmail.com

 Notes

I thank Forest Weld for catching a typo.

 References

National Bank of Kazakhstan.  (2021).  Digital tenge project: White paper on project results.

Report on the Results of the Digital Tenge Pilot Project White Paper.pdf

S&P Global Market Intelligence.  (2016). Kazakh regulator terminates license of Eurasian Bank's unit | S&P Global Market Intelligence (spglobal.com)