Turkey: Money Flows, Investment, Inflation And Recession Risk

Includes: TUR
by: Alan Longbon


Prime Minister Erdogan makes a valid point with his criticism of the central bank driving inflation.

Turkey has a negative private sector balance, and the national government needs to spend more to stave off a recession.

Only private credit creation is driving aggregate demand at present and filling the spending gap.

Turkey has been in the news lately with central bank policy changes, an upcoming national election and the Prime Minister's criticism of its central bank and its role in controlling inflation.

The purpose of this article is to look at the macro sectoral flows and assess whether Turkey is a good place for investment. Change of any sort can present opportunities.

Prime Minister Erdogan has made a connection between central bank rate policy and inflation.

It is the Prime Minister's contention that the high central bank rates are the cause of the inflation. His view is correct, though not mainstream, and there is plenty of evidence to support his view.

We have seen globally that as soon as a central bank lowers or lifts rates, inflation moves in the same direction. This makes logical sense, as a rise in borrowing costs increases the price of products and services that have a finance or credit component in their cost structure.

If increasing interest rates strengthen a currency, then the Argentine peso would be the strongest currency in the world. But it is not.

The Canadian inflation rate was bumping along the bottom until they raised rates.

The US inflation rate was bumping along the bottom until rates were raised.

Russian inflation is moving with central bank rate movements.

What I am asserting is that the Fed and the mainstream have it backwards with regard to how interest rates interact with the economy. They have it backwards with regard to both the current health of the economy and inflation, and, therefore, their discussion of appropriate monetary policy is entirely confused and inapplicable.

- Source: Warren Mosler

Mr. Mosler, a self-made multi-billionaire and grounder of the modern money movement, makes the following points with regard to central bank interest rates.

The mainstream is wrong in their presumption that low rates are supportive of aggregate demand and inflation for the following reasons:

  1. Lower rates do not encourage borrowing to spend at the macro level. Rate cuts directly reduce government spending and the private sector’s net interest income from government debt.
  2. Lower rates do not increase inflation expectations or inflation. The currency itself is a simple public monopoly; as a point of logic, the price level is necessarily a function of prices paid by the government when it spends (and/or collateral demanded when it lends), and not inflation expectations. And the income lost to the economy from reduced government interest payments works to reduce spending, regardless of expectations. The reverse is true - inflation in the USA has started rising only after the Fed moved away from its zero rate policy. Japan and Euroland still have zero rate policies and below-expectation and guideline inflation levels.
  3. Lower rates do not provide support through the foreign exchange channel. Currency does not depreciate and make exporters more competitive via lower real wage costs, nor do inflation expectations rise for importers facing higher import prices. Higher rates have so far weakened the USD, and low rates in Japan and Euroland have made them relatively stronger.

Turning to Turkey's lira, we have seen that higher rates have not led to a stronger currency, as the chart below shows.

This has an influence on GDP as measured in USD in the chart below:

Thanks to a volatile lira, Turkey's GDP, expressed in USD, appears to fall. However, in reality, GDP has been growing strongly, as the above chart shows.

A balance of sectoral flows model was used after the work of British economist Professor Wynne Godley to assess Turkey.

In 1970, Professor Wynne Godley moved to Cambridge, where, with Francis Cripps, he founded the Cambridge Economic Policy Group (CEPG). In early 1974, Godley first apprehended the strategic importance of the accounting identity - which says that, measured at current prices, the government's budget balance, less the current account balance, is by definition equal to the private sector balance.

GDP = Federal Spending + Non-Federal Spending + Net Exports

As a percentage of GDP, all three sectors sum to zero.


By definition, the stronger the private sector balance is, the stronger the private domestic economy and markets within it.

The following formula can express a nation's balance of accounts:

Private Sector [P] = Government Sector [G] + External Sector [X]

The community, business and the stock market are located in P. For P to expand, it needs the balance of inputs from G and X to be positive. A negative balance causes P to contract.

When one adds all three sectors together, it equals the GDP for that year. One sector's loss is the other's gain, and if they all go down, so does GDP.

When one does a sectoral analysis, one finds the following...

Sectoral Balance Analysis

The charts below show the key information required to calculate the sectoral balances:

One can calculate the private sector balance by adding the current account balance and the government budget and expressing it as a percentage of GDP. As an accounting identity, this must sum to zero overall as a percentage of GDP.

Recent, current and projected annual sector balances are shown in the table below:

Private Sector


External Sector


Government Sector




-3.8 %






2018 #




(Source: Trading Economics, FRED and author calculations based on the same)

# Forecast based on existing flow rates and plans.

The private sector balance is negative due to the drain from the current account and the meager input from the government sector. To fund what is in effect a private sector deficit, the private sector must be going into debt or running down its stock of existing wealth.

The private sector balance is also reinforced by private credit creation from private banks. One can say that aggregate demand in any period is GDP + Credit. The chart below shows the private credit trend:

Private credit creation added 3.6% of GDP in 2017 to the economy and money supply each year. This makes up the "gap" between the current account and government spending, and enables the private sector to keep on spending. 2018 is tracking to be the same.

The flow of credit adds to the stock of private debt shown in the chart below:

(Source: Professor Steve Keen)

Private debt is about 80% of GDP, which is low by developed world standards.

Professor Steve Keen, an expert on private debt, says that 150% of private debt-to-GDP is the point at which most economies tend not to take on any more debt. It is a natural barrier.

Turkey could add a further 70% of GDP to its private debt before meeting this natural barrier.

Conclusion, Summary and Recommendation

One can see then that the private sector has a negative sectoral balance of over -3.5% of GDP. This is one of the weakest in the world, and but for credit creation fuelling aggregate demand, Turkey would be in recession.

Turkey joins a growing list of countries with negative private sectoral balances lining up for a recession as shown in the table below:

(Source: Trading Economics plus author calculations from the same)

Investment in the country is not recommended unless the government engages in expansionary spending to reverse the negative private sector balance.

This is the situation the US was in before the dot-com crash and before the GFC. That is a negative private sectoral balance with growth fuelled by credit creation that eventually runs out of borrowers and the whole thing reverses. Then, to make matters worse, western economies turned to growth through austerity policy, which mathematically cannot work.

The prime minister believes the central bank is causing the inflation in his country, and he is right. The same trend is occurring in other countries as well.

Central banks are independent of government; however, they are not independent of the finance industry. The finance industry is an organization that is global, knows no national boundaries and is a law unto itself.

Separating monetary and fiscal control of a country is a mistake. Both are key to the effective governance of a country. We now have a situation is most countries where the central banks are working against the best interests of the country they belong to.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.