I have noticed a lot of Internet traffic about Modern Monetary Theory (MMT) and the situation in Turkey at present. Apparently, as the narrative goes, MMT is finally being revealed as a fraud because Turkey’s economy is going backwards and its currency is depreciating rapidly. The logic, it seems, is that if a nation enters rough economic waters and the financial markets sell its currency (although remember someone has to be buying it simultaneously) then that proves MMT is false. An extraordinarily naive viewpoint if you think about it. This viewpoint has somehow missed the train on understanding what MMT actually is and seems to think that MMT economists have seen Turkey as a policy model. In this blog post, I consider some aspects of this naivety. It won’t silence the critiques, but it, hopefully will educate those who are interested in the topic and are learning about MMT.
First, the discussion will also talk about ‘starting points’.
Too often I read commentary on, for example, exchange rate movements, where it is immediately assumed that a depreciation indicates a movement to a worse outcome.
That assessment, of course, requires the commentator to make a judgement about what constitutes a desirable state.
I am not talking about changes or rates of changes here. At any level, a rapid change in any direction can be destabilising because it imposes adjustment costs.
Second, and I have written this before but it still seems to evade a lot of commentators who seem to continually be on the lookout for some ‘gotcha’ moment on which to declare the poverty of the body of work known as MMT.
MMT is not a policy regime.
The fact that the Turkish central bank has very high interest rates, or has cut them under direction of the President, or that the government deficit is rising, or that the President just announced the minimum wage would rise by 50 per cent to maintain its USD value has nothing at all to do with MMT.
MMT is a system of understanding how modern monetary systems work and the capacities of the currency-issuing government.
It also allows us to understand the consequences of using that capacity or giving up the currency sovereignty altogether.
So trying to conclude that the Turkish dilemma is an example of what happens when a government applies MMT policies is nonsensical and reveals the ignorance of the person drawing those conclusions.
This is tied in with the stupid conclusion that MMT can be summarised as saying that governments should just ‘print money’ and ignore the size of the fiscal deficit.
There is nothing in MMT that would allow such a conclusion.
There is nothing in MMT that says that a nation cannot hit skid row or that the external financial markets might get edgy about a currency and sell it off to bargain hunters at lower prices – thus depreciating the currency.
A depreciating currency simultaneously being recorded with a fiscal deficit tells us nothing interesting.
To appreciate these points is crucial to getting to stage 1 of your MMT education.
Turkey tells us nothing about MMT.
But MMT tells us a lot about why Turkey is in the situation it is in.
This is what the fuss is about.
The Turkish lira has depreciated sharply over the course of 2021. But it hs been depreciating for some years – since about September 2013, when it breached the 2 lira per USD level.
How should we judge this shift?
What is the appropriate rate?
How we answer this question goes to the heart of what we think interest rates should be.
The President thinks that rates should be lowered to help farmers etc.
Mainstream economists everywhere think that rates should rise because that will help shore up the currency and stifle demand, which they claim will reduce the inflationary pressures.
An MMT understanding suggests that the mainstream analysis is wrong.
To comprehend that statement, one needs to ask whether the level that the currency is depreciating from was a sustainable level given what else was going on.
Were there imbalances that allowed a rate, of say 2 lira per USD to persist for a while, which are finally revealing themselves to be unsustainable?
That is more in line with my thinking.
This, of course, then leads to the question of interest rates.
The mainstream approach is that the high interest rates are necessary to attract speculative capital, which provides strength to the lira, which in turn, eases the inflationary pressures that they see arising from the impact of the depreciation on import prices.
The President thinks the high interest rates actually contribute to the inflation via their impact on business costs.
Another plausible view is that the high interest rate regime has been protecting the privatised banking sector, which is heavily exposed to external borrowing denominated in foreign currencies.
So by running high rates, the lira is propped up and the solvency of the banks is boosted.
Now, ask the question: if the banks are engaged in a sort of speculative frenzy fuelled by foreign capital (which they are), then is it in the long-term interests of the population to prop them up with very high interest rates?
And the corollary is whether the propped up lira value is sustainable and/or appropriate for the long-term welfare of the citizens?
These questions thus relate to the first point I made – what starting point or benchmark are we going to use.
Sure enough, the lira is depreciating and that causes disruption.
But if the value it has been depreciating from was just part and parcel of these major imbalances in the economy that were themselves part of the short-term grab by the financial elites then that puts the shift in a different light.
Perhaps by reducing rates and exposing the debt of the banks, the government will eventually restructure the economy away from this dependence on hot money denominated in foreign currencies.
The short-term grief thus puts the economy on a more sustainable footing.
IMF stamp all over it
The other point to understand is that Turkey is now where it has been. In 2001, it took a major change in policy direction towards the standard IMF export-led, privatisation, deregulation agenda.
This agenda has finally come home to roost and the structural imbalances it created will have to be addressed as part of the new strategy to stabilise the economy (reregulation, curbs on foreign currency debt, etc).
After a major financial crisis in 2001, the Turkish government floated the lira on February 22, 2001.
The IMF released a press release on May 15, 2001 – Press Release: IMF Approves Augmentation of Turkey’s Stand-By Credit to US$19 Billion – after the Turkish government sent the IMF a – Letter of Intent – on May 3, 2001 outlining its plan to reduce inflation, stabilise the currency and engage in widespread structural changes of the economy.
They promised the IMF a primary fiscal surplus (and to get there they need a 9 percentage point cut in net government spending between 2000 and 2002).
They claimed their approach would reduce external debt exposure.
Their strategy was IMF-par excellence – cutting the public sector contribution to growth, replacing it with an export boom, particularly in tourism and cutting domestic costs (wages) to enhace international competitiveness.
They also rationalised (privatised) large swathes of their banking system, which had carried massive debt, in addition to recapitalising many private banks.
In general, they embarked on what they called an “ambitious privatization agenda” to allegedly “reduce the stock of public debt”, with the implication that foreign debt exposure would be transferred to the private sector.
Key state enterprises (Turk Telekom, Petroleum refineries, Turkish Airlines, Sugar and Tobacco, Electricity generation and distribution, etc) were put up for sale.
They specifically targetted “private capital … to participate in restructuring the banking sector.”
And, importantly, they continued to sell Treasury debt in foreign currencies to help them “rollover … external debt.”
The IMF’s response in its press release approved the plan and increased the nation’s debt exposure even further.
So if you ask an MMT economist what they might expect to happen, you would be told that with so much external debt denominated in foreign currencies, and a program aiming to free up the banking sector and allow it to expand foreign liquidity into the economy, it would be likely that the nation would eventually reach an unsustainable point.
Turkey – External debt
Here is the external debt history since 1990 for Turkey (data is from the excellent CBRT portal).
It is clear that since the IMF program was agreed that the foreign debt has escalated significantly and the proportion of short-term debt has also risen from 12.1 per cent in the March-quarter 1990 to 21.6 per cent in the June-quarter 2021.
The short-term debt tends to be speculative in nature rather than FDI, although in recent years (since 2018) a rising proportion of the short-term external debt exposure has been from CBRT borrowing to maintain foreign exchange liquidity.
The next graph shows the long-term external debt situation since the March-quarter 1990.
Long-term external debt accounts for around 72 per cent of the total gross debt and its evolution reflects the massive changes that Turkey has gone through as part of its relationship with the IMF programs and the rise of neoliberalism.
The more recent increase in public sector long-term borrowing is due to the CBRT actions noted above.
Once the nation (both public and private sectors) are borrowing in foreign currencies, the exposure to insolvency increases.
The nation has to maintain its export revenue in order to earn the foreign exchange necessary to ensure the debt can be serviced.
If export markets blip, then the nation enters a ponzi situation – it has to borrow more externally just to service its existing exposure.
Investors know this is a slippery slope and will respond to that exposure risk in the way that we are seeing in Turkey now.
Thus, no-one should be surprised that the foreign exchange traders are in sell mode.
The central bank of Turkey (CBRT) has also been trying to defend the currency level in recent years by selling foreign exchange – a fixed exchange rate strategy really designed to slow down the pace of change.
The problem with that strategy is that the traders know it is finite and their bets become self-fulfilling.
Living beyond a nation’s means
The IMF’s agenda that Turkey succumbed to, was like a magnet to the global financial speculators.
They suddenly had an advanced economy that they could use as a gambling token and the government played along with that.
Historically, Turkey has run an external deficit on the current account.
In a sectoral balances framework, we can see the external deficit as being driven by the gap between domestic saving and investment.
It has 2.3 per cent of GDP since 1980 but rose to 4.3 per cent after 2003.
After the IMF agenda began, the private saving rate started to fall and the access to foreign credit for households and firms increased substantially as part of the lax supervision of its banking system.
The low saving ratio was, in part, due to the young population, which encourages consumption over capital accumulation.
Business investment steadily grew on the back of foreign currency denominated debt.
The fiscal drag that the IMF agenda created also squeezed private domestic sector liquidity.
An economic growth strategy (and Turkey did experience strong growth) based on private debt accumulation to drive domestic expenditure and dependency on imported energy (as well as other things) is unsustainable in the medium- to long-term.
Eventually, the reliance on foreign currency credit destabilises the local economy and the currency is targetted.
That evolution has also seen income inequality rise in Turkey over the time that the IMF agenda was being followed.
The next graph shows the Pre-tax national income shares in Turkey from 1980 to 2020.
It was clear that before the crisis in 2001, the bottom half of the income distribution was increasing its share while the top 10 per cent (and the top 1 per cent, as shown) were receiving a reduced share.
On the new agenda kicked in, that tendency has been reversed.
The crisis tells me that Turkey has relied extensively on capital inflows to drive growth with fiscal policy largely dragging on growth (except for the last few pandemic years).
The private domestic sector spending boom has exposed the economy to global financial markets and there is a limit to that exposure before things get ugly.
Reliance on foreign currency loans is a highway to hell.
That means that a stable growth path has to be less ambitious and better develop the local resource base.
Note also: I haven’t mentioned the US-imposed sanctions on Turkey as a result of th elatter’s choice to deploy Russian military equipment.
I also haven’t mentioned the flight to US government debt during the pandemic which has distorted the gambling markets against the Turkey lira.’
I also could talk about exchange rate pass through impacts to the domestic price level.
At some point, I will also return to this topic and talk about what needs to be done in Turkey based on my understanding of MMT.
As a hint, I covered these sorts of issues in these blog posts (among many):
1. Tunisia is a classic example of the failed IMF/World Bank development model (August 4, 2021).
2. There is no internal MMT rift on trade or development (January 10, 2019).
3. Timor-Leste – challenges for the new government – Part 3 (May 24, 2018).
4. Timor-Leste – challenges for the new government – Part 2 (May 16, 2018).
5. Timor-Leste – challenges for the new government – Part 1 (May 15, 2018).
Trying to tie in the body of knowledge known as MMT with the difficulties that Turkey is facing at present is the work of scoundrels or dopes.
MMT is not a set of policies.
What has been happening in Turkey does not provide a blueprint of what an economist with an MMT understanding might or might not do about policy.
What is clear, an MMT understanding leads one to worry intensely about a nation that has built a growth strategy on vast amounts of foreign currency debt and expanding exports. The two arms of this sort of growth strategy leaves a nation highly vulnerable to changes of circumstances in world export markets.
Add in a central bank that is also borrowing foreign currencies and showing it intends to use their stores to defend the lira.
Add in a deregulated banking sector that is flooded with foreign debt to maintain profits.
Result: disaster pending.
It is only a matter of time.
That is enough for today!
(c) Copyright 2021 William Mitchell. All Rights Reserved.