Will Turkey trigger a banking collapse?

Will Turkey trigger a banking collapse?

Emerging markets won’t survive this time.

That’s the latest analysis from the Bank of International Settlements (BIS).

That’s right.

The world’s go-to ‘get out of jail free’ card — the International Monetary Fund (IMF) — doesn’t have the resources to bail out several emerging markets at once…

What does that mean for investors?

Buckle up and brace for impact, my friend.

The ghost of troubled markets past

This stark warning isn’t just me being gloomy and doomy.

Oh no.

Today’s warning comes direct from the money bosses.

Just yesterday, BIS chief Agustin Carstens issued this warning at a conference with the French central bank:

This leaves us with the problem of having inadequate resources and having to improvise in times of crisis. The mission of the fund is there.

If the Fund [IMF] cannot do it others will have to do it otherwise the economic costs will be huge.

Essentially, Carstens is telling the world that the IMF — the lender of last resort — can’t print more money to save China and the other heavily indebted emerging markets.

Is this a case of the BIS and IMF just passing the trillion-dollar buck?

Maybe.

Perhaps it’s the kick up the behind investors need to prevent them sleepwalking into a crisis…

Perpetual debt

A little over a year ago, my favourite ‘will it or won’t it collapse?’ emerging market, Turkey, dominated the headlines.

Then Trump launched his trade war against China.

And the crumbling Turkish economy wasn’t front page news anymore.

Make no mistake. The problems with the Turkish economy haven’t gone away.

Changing headlines doesn’t fix the problems.

As I’ll show you below, Turkey today could trigger a systemic banking collapse…

And the threat of contagion is about to get bigger…

Turkey imports twice as much in value as it exports. And this AU$1.2 trillion economy relies on tourism to keep the country growing.

The Turks’ official savings rate is low — although they are big buyers of gold — and as a result, banks and private corporations rely on international banks to fund local lending.

In other words, because the Turkish people invest in gold more than cash, the banks need to borrow from overseas lenders to ensure there’s money for lending locally.

This is all very normal banking business these days.

This cycle of debt can continue for years.

That is, until something goes wrong.

And we are on the precipice of something going very, very wrong.

Keeping up appearances

On the surface, the Turkish economy doesn’t actually look unstable.

Gross domestic product (GDP) is increasing every year. While it slowed last year, the Turkish economy still grew 3.5%.

And the country’s tourism-heavy sector is showing no signs of slowing down.

Plus, President Recep Tayyip Erdogan openly encourages citizens to hold gold.

Not only that, but Erdogan directed the Central Bank of the Republic of Turkey to increase the amount of physical gold it holds. The country has more than doubled its gold reserves, from 116 tonnes in 2017 to 261 tonnes by the end of 2018.

In a world awash with fiat dollars and cheap credit, that’s just financial smarts, right?

In this case, no.

Erdogan pretends to be an advocate for buying gold as an alternative to the US dollar or euro. But the problem is, buying gold is a politically strategic decision, not an economic one. Bumping up the gold stash is more about buying time than prudent money management.

We’ve seen this before…

Back in 2012, Turkey also doubled its gold holdings. Physical gold stores went from 121 tonnes to a massive 302 tonnes by early 2013.

What looked like a sound financial decision turned out to be nothing more than a ploy to convince Turkey’s major international lender (at that time, Germany) to keep those loans coming.  

Not only that, but the gold-buying spree happened before Erdogan made several decisions to weaken the value of the lira.

As the value of the lira dropped throughout 2013, German banks reduced their exposure to Turkey.

We can see this in the middle chart below. The pink line represents the proportion of German funding over the past five years.

As you can see, it didn’t matter how much gold Turkey’s central bank bought… Germany still reduced funding by as much as US$10 billion that year.

Breakdown of Turkish debt

Source: Bank of International Settlements

Turns out, it didn’t matter how much gold Turkey bought, the Germans still reduced their funding.

Back then, buying gold was to ensure Erdogan could keep Turkey’s lines of credit open.

It had nothing to do with diversification. Less than a year after doubling the gold reserves, some 171 tonnes of gold was sold off by the central bank. It left the Turkish central bank with 131 tonnes.

It was a trick German banks saw right though…

The result?

They dropped their exposure to the country.

Hundreds of tonnes of gold…and Turkey will still default

Today, Turkey is sitting on an impressive pile of gold.

Yet the Turks’ gold stash doesn’t even come close to the US$300 billion pile of international debt the country rests on.

When German funding scaled back in 2012, Spanish banks stepped in and tripled their lending to the country.

Today, almost every other nation has slowed down its lending to Turkey, except Spain.

But the reality is that since 2012 — when Turkey began its yo-yo gold buying and selling transactions — the Turkish lira has fallen 70%.

This makes Turkey’s huge debt pile increasingly difficult to pay back.

The more the Turkish lira weakens, the more lira is needed to pay off the debt.

High risk of contagion

The real concern for markets isn’t if Turkey goes bankrupt. The piling up of debt and the increasing worthlessness of the local currency makes a bailout ever more likely.

However, as we’ve seen before in past crises, we’ll never understand the impacts of a default until it happens.

Something that appears to be contained to one country could actually cause a default on debt owed to numerous counterparties spread throughout the world.

German banks may have cut back on funding Turkey.

But just how exposed are the Spanish banks?

To complicate this further, who is funding them…other European banks?

Whatever the fallout of a Turkish default, the international banking sector is interlinked. There’s no way that Turkey is the only country at risk here.

But as the BIS warned overnight, there’s no bailout this time.

The real risk is how Turkey could trigger a banking system meltdown.

Considering global debt has only increased since the GFC, any systemic contagion could make the panic of 2008 look like a tea party in comparison.

If you’re not preparing yourself yet, that’s okay. Next week, I’ll release my new report on how you can get started…

Kind regards,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia