Turkey is grabbing headlines, but its financial troubles aren’t unique.
The underlying driver of Turkey’s economic crisis is not the detention of an American pastor or President Recep Tayyip Erdogan’s opposition to higher interest rates. It’s the steady upward march of U.S. interest rates.
Behind the slide in the lira and pressure on emerging markets, generally, is a lopsided monetary world. The dollar is still the FX superpower. As long as the Federal Reserve keeps raising interest rates further and faster than anyone else, the developing world is going to be pinched. The differences between Turkey and the rest are of degree, not kind.
Don’t expect Fed Chairman Jerome Powell to flag a big change of course at the central bank’s Jackson Hole retreat this week. He may acknowledge difficulties abroad, but his focus is on the U.S., and the strength of the domestic economy doesn’t justify a halt in rate hikes at this time.
China’s rise and global antipathy toward President Donald Trump have done nothing to dent the financial supremacy of the American dollar. Despite perennial predictions of the dollar’s eclipse, it accounts for more than 60 percent of global reserves. The euro, which was supposed to rival the greenback, makes up about 20 percent. China’s yuan, which was added to the International Monetary Fund’s reserve basket with great fanfare a few years ago, is 1.4 percent.
The dollar was on one side of almost 90 percent of foreign-exchange transactions, according to the Bank for International Settlements. The yuan is making progress, but remains under 5 percent.
What does China have to do with Turkey? China is often seen as a proxy for emerging markets and challengers to American financial supremacy. China has made enormous strides and is starting to behave like a stabilizer in world affairs, rather than a disrupter. Its leaders have been careful to respond proportionately and not provocatively to Trump’s trade broadsides. But for all that and all the predictions of China’s ultimate economic dominance, its capital markets are small relative to the U.S. The greenback still rules.
When U.S. interest rates are low or declining, capital generally tends to flow to emerging markets where risks are greater and expected returns are better. When the Fed raises rates and Western central banks withdraw stimulus, emerging markets are vulnerable. That’s the current against which Turkey is swimming.
All this isn’t to say that a unipolar financial world is a good thing. Or that it will last forever. The past decade shows that America’s banks can crash just like an emerging market and be bailed out. (Malaysia’s former — and recently returned — leader, Mahathir Mohamad, was prescient about that.) And for all its strengths, the Fed has made some big mistakes over the years.
China’s influence in capital markets will also grow over time. As its gross domestic product approaches that of the U.S., China will require a financial system and central bank befitting that sheer size.
Until then, the dollar is king.
Source: Bloomberg
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