Turkey's Political Nuclear Option

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Includes: TKF, TUR
by: Albert Goldson
Summary

Investors should brace themselves for escalating US sanctions and tariffs on the Turkish economy.

Turkey has arrived at a critical economic and political tipping point, perhaps of no return, in which they have a choice to de-escalate or escalate the crisis.

A cornered Erdogan may consider a veiled threat at leaving NATO for negotiating leverage which would shock global markets.

Turkey is the world's 17th largest economy facing a debilitating, self-made crisis which threatens an already brittle investor confidence not only for Turkey but for emerging markets and beyond because of its highly integrated economic relationships with Europe.

According to Al-Monitor's 6 August 2018 article Turkey's Economy Deals with New Political Reality, Turkey is heavily integrated with the Western market with a high dependency on foreign trade. The figures:

  • Turkey's foreign trade is half its GDP of $880 billion.
  • Foreign assets in Turkey are estimated at $650-$700 billion.

With respect to debt, according to the Bank for International Settlements during the next 12 months Turkey's foreign debts to private non-financial institutions to repay or rollover is $66 billion and to foreign-owned subsidiaries $148 billion. The total debt to country-specific banks include: Spanish ($83 billion), French ($38 billion) and Italian ($17 billion).

Additional economic headwinds include US tariffs. According to the 12 August 2018 Wall Street Journal Turkish Crisis Rattles Global Markets Amid Escalating Spat the US intends to double steel and aluminum tariffs on Turkey to prevent them from taking advantage of considerably weaker Turkish lira (TL). Last Friday the TL established a record-setting low to the US dollar at 6.43, a 41% drop since the beginning of 2018.

Any IMF bailout would undoubtedly come with strings attached such as greater transparency and respect for human rights that may be deal-breakers for Erdogan if he should ever consider this option.

Turkey's Options

The Turkish Central Bank continues maintain interest rates which has only accelerated the TL's freefall. In the meantime according to the 8 August 2018 Al-Monitor article Turkey Steps Up Effort to Shun Dollar Turkey has been selling hard-currency to purchase gold. To quote, "Turkey's gold reserves reached 546.8 tons in February, up from 116 tons in September 2011. The huge increase put Turkey in 10th place among the countries with the largest gold reserves." Interestingly this strategy makes their reserves increasingly illiquid.

Erdogan's Political Nuclear Option

The "preacher for preacher" exchange that would supposedly resolve the crisis is a myth. Presidents Trump and Erodgan are strong-willed leaders who tend to double-down when the going gets even tougher. At this point in time the options for "saving face" for Erdogan are almost non-existent, which is why I think he will push this matter into a dark place, specifically a veiled threat to leave NATO.

Turkey, a NATO member for 65 years, is NATO's 2nd largest military after the US which protects NATO's eastern flank. Turkey seeks to purchase the Russian S-400 anti-aircraft missile system which is not only incompatible with NATO systems, it's a direct threat to the US' cutting-edge F-35 fighter which Turkey wants to purchase yet the US has refused approval based on multiple factors of the crisis. In other words, Erdogan wants a win-win result, the best of both worlds. Because he has been politically and economically cornered he may seek to escalate this crisis by threatening to limit or eliminate US military operations on Turkish soil or even threaten to leave NATO.

With respect to non-western military and security alliances, according to Al-Monitor's8 August 2018 article Following Deals with Russia, Turkey Expands Military Cooperation with China, there has been considerably greater high-level Turkish-China military defense and security cooperation one which links nicely with China's Belt & Road initiative in the region.

Turkey is the critical buffer between Western Europe and a volatile Middle East. Factor in record global debt, rising interest rate and escalating trade wars, this US-Turkish rupture could be the proverbial economic straw that breaks the camel's back.

Recommendation

I believe that the rattling of the global markets and subsequent contagion will initially originate from geopolitical security risk rather than crumbling economic fundamentals.

As a follow-up to my recently published SA article 6 August 2018 Post-Election Turkey on the Road to Economic Perdition I recommend than investors continue short selling Turkey including EM indices such as MSCI Emerging Markets Index (MSCI) and FTSE Emerging Index in anticipation of potential contagion.

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.