The Turkish lira is crashing again, back past 6.5 against the U.S. dollar. A one-two punch helped push it back into freefall.
First, Bloomberg reported that the main reason is lack of public confidence in Turkey’s central bank, the TCMB, in its efforts to stem the tide. The bank’s latest move on Aug. 28 was to double bank borrowing limits after previously pledging to print all the money banks needed to stay afloat as of Aug. 13. On top of that, Business Insider reported Moody’s downgrade of 20 Turkish banks and financial institutions.
The causes are complementary and have compounded on each other with the emerging market currency down 8.5% against the dollar since Thursday.
Putting aside the Moody's downgrade, why the lack of public confidence? The latest move by the TCMB is a token acknowledgement in theory that it cannot continue to print lira at will in order to support its ailing banking system and at the same time expect the lira to firm. At bottom, this was a tightening move, theoretically.
So why would the lira fall on the news of monetary tightening?
Because practically, the TCMB’s move may not be a tightening move at all, but actually an easing policy masquerading as a tightening policy.
How so?
It depends on how much lira troubled Turkish banks have actually been borrowing in the overnight market. Since Aug. 13, the TCMB has guaranteed liquidity to the Turkish banking system. Now it says it is pulling that lifeline, but in its place doubling borrowing limits on banks from previous pre-Aug. 13 levels. But what if the amount of lira that the TCMB has been printing since Aug. 13 is less than double the previous borrowing limit? In that case the doubling of the limit would effectively be an easing policy, not a tightening one.
Whether it is or isn’t, is not so much the point as the market – and particularly Moody’s, which exacerbated the recent fall – recognizing the attempted parlor trick, namely the TCMB trying to have its cake and eat it, too, talking out of both sides of its mouth. If it wanted to broadcast true tightening, it should have simply cut off unlimited lira funding and restored the original borrowing limit. By doubling the limit, the market saw through the attempt for what it was – an attempt to restore confidence without actually dealing with the inflation problem.
More about the hard numbers as to how this move is affecting the bottom line lira supply will be known in a month when the numbers for Turkey are published. It is known that from July to August, the Lira supply jumped 4.4%, which is remarkable considering that in a currency collapse, what needs to be done is the constricting of the money supply so as to support exchange rates. Of course, constricting the supply of lira would endanger banks, so Turkey must choose. It can’t have both.
Like everything else in economics, it all goes back to supply and demand. Increase the supply, in this case by printing Turkish lira, and all else being equal, price goes down, in this case the lira per U.S. dollar exchange rate. Cutting off unlimited funding for its banks while restoring the original borrowing limit would have most likely strengthened the beleaguered currency, but it would have been a painful move.
Turkey is looking for a way out of its currency crisis without stressing its banking system. But just like physics cannot operate outside of its own laws, neither can economics. In order for the lira to strengthen, the rate of the expansion of the lira supply must slow compared to the rate of expansion of other currencies. There is no other way out.
One data point to consider on this: Since November 2017, the lira supply has expanded by 22%. That the lira is falling so fast now is simply basic supply and demand catching up to numerical realities.
Disclosure: No positions.
