The Global Default: How Turkey Could Trigger the Next Debt Crisis
It appears you can have one fifth of your country’s assets in gold and still go broke…
That’s the precarious position Turkey finds itself in.
In the past year, Turkey has purchased 205 tonnes of gold to add to its foreign reserve tally.
It now sits on 582 tonnes of gold worth nearly AU$34 billion. As of last month, 22% of Turkey’s total AU$153 billion foreign reserve was in gold.
That’s fairly impressive by international standards.
But there’s a problem. It turns out you can have all the gold you want and still default on your debts.
Let me explain…
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Even though the Turkish government has spent the past year accumulating large amounts of gold, even this may not be enough pay back hundreds of billions in US dollar-denominated debt.
In 2015, Turkish President Recep Tayyip Erdogan encouraged citizens to buy gold and ditch the US dollar.
The appeal to nationalism worked. Citizens across the country swapped over 2.47 tonnes of gold for gold-based Turkish bonds.
A well known anti-US dollar proponent, Erdogan then told his people to cash in their euros and dollars, swapping fiat currencies for gold and Turkish liras.
Again, it worked. People dumped their foreign currencies in favour of gold and lira. It spurred private gold buying too. Gold imports jumped 688% over the course of 2016, amounting to AU$17 billion.
The patriotic appeal bought the country some time. It enabled the government to strengthen the banking system without having to buy physical gold itself.
By 2017, however, Erdogan was singing a different tune.
The Central Bank of the Republic of Turkey began buying gold by the tonne once more. Although this time the government claimed it was a diversification policy — a way of ditching the US dollar. Erdogan explained that gold was worth more to Turkey than fiat dollars ever would be.
But this plea was short-lived. By the middle of 2017, his tune changed again.
There was now a ‘worry’ that there was not enough gold to support all the paper gold products — some AU$10 trillion worth — operating in the markets.
And, on the quiet, the government slowly began to repatriate its gold. Turkey repatriated some 220 tonnes of gold stored at the New York Federal Reserve Bank.
Defending a bankrupt country
Turkey’s 2017 gold buying spree shouldn’t come as a surprise.
The sudden increase in gold purchases has happened before.
Beginning in 2012, Turkey nearly quadrupled its holdings over three years.
But the reasons weren’t because gold was more important than fiat currencies. It was a purely strategic decision to keep the international banks lending to Turkey.
It didn’t help matters…
By 2014, German banks were reducing funding for Turkish loans.
This move annoyed Erdogan, as German banks are the second largest loan providers to Turkey.
Germany was, and is, still a key source of funding for the Turkish private sector. The Turkish economy relies on two things to keep it afloat: tourism and foreign funding. Without either, the country is in very serious trouble.
Erdogan needed German funds to stave off a recession at home. Yet the Germans banks’ hesitation in lending to the Turkish private sector was understandable.
From 2009 to 2014, the Turkish lira had fallen 33% against the euro. Meaning more and more lira was needed to pay back the already growing debts. Germans were understandably becoming nervous about how Turkey would pay back this debt.
As a result, Erdogan bought gold as a way of assuring Germany it had a strong banking system with large gold stores. Yet today, the lira is almost worthless. Since 2009, it’s down 62% against the euro and 71% against the US dollar.
All the gold buying from the Turkish central bank and citizens has done little to stop the lira’s freefall.
The global default
The official reasons behind Turkey’s gold buying spree in 2017 vary. Everything from a mistrust of the international monetary system, lack of interest in the US dollar, gold being more important than fiat dollars to Turkey, and wariness of the paper gold market — all have been used as reasons to explain the buying.
If the country was economically sound, they’d be valid too.
Yet at no point has the Turkish government addressed its mounting US dollar-denominated debt.
Since 2009, Turkey’s US dollar-denominated loans have grown from AU$200 billion to a whopping AU$448 billion. Furthermore, as the lira weakens, more of it is needed to meet these growing US dollar debt obligations.
Bloomberg reports that for every 1% depreciation in the lira, another five billion liras are needed to cover the cost of international loans.
In short, Turkey is in serious trouble.
The gold buying spree makes the country look fiscally responsible on paper. But buying all that gold has done nothing to support the value of the lira.
However, it’s the sudden and barely noticed gold repatriation that should be setting off alarm bells.
Bringing home its gold is less about the desire to keep it within its borders. Rather, it suggests that Turkey is getting ready to default on its near AU$500 billion debt.
There is a chance that Turkey may use its gold to sell on the open market. However, if it was going to do that, it would have made sense to leave it in storage in the US. That way the allocation of the gold to a new owner would have been easier.
However, repatriating the gold means that Turkey can’t be held hostage by the US. Having the gold nearby at its own central bank enables the government to default on its debts and keep the gold safely within its vaults.
Don’t be surprised if Turkey triggers the next wave of global debt defaults.
Editor, The Daily Reckoning Australia