What we learned from the collapse of the Turkish pound

By Mike O’Sullivan

One of the most shocking changes in asset prices in 2021 was the collapse of the Turkish lira. A development undermined by poor fiscal policy, the downgrading of state institutions by Turkish President Tayyip Erdogan and incoherent monetary policy. The recovery of the pound The days before Christmas may have offered some temporary relief, but that does not mean that the quality of monetary policy in Turkey has improved.

Turkey will remain vulnerable financially, economically and – possibly – politically, but it is worth focusing on its case for all that other countries can learn from this crisis.

In the economic field, Turkey offers two interrelated lessons both to the US and to the rest of the world. First of all, Turkey is a prominent phenomenon in the history of “the rise and fall of states”. Since the early 2000s, when economist Kemal Dervis corrected the misconceptions of the domestic banking system and paved the way for European integration, Turkey has made significant progress. Lately, however, this trend has stalled, as policy-making, the quality of institutions and the rule of law in the country have degenerated.

I make the connection with Edward Gibbon’s “History of the Decline and Fall of the Roman Empire”. Gibbon, who tried to explain why the Roman Empire disintegrated, believed that Rome rested, institutions weakened, and Roman public leaders lost their sense of political virtue (what Machiavelli later called simply “virtu”). “good for democracy” or “common good”).

Why the quality of institutions is important and the need to shape a state ethic is reflected in other books that examine the rise and fall of states, such as Acemoglu and Robinson’s work “Why Do Nations Fail?” [“Why Nation’s Fail?”].

Acemoglu – like Dani Rodrik – is one of the world’s leading economists and a Turk. I am sure that both of them are saddened by the course of their country. Both would have clear solutions – at the policy level – to get it back on track. Both are based in Boston. I inevitably think that their work, like Gibbon’s, should be read in Washington.

Maybe they should read it on Wall Street too, because – as Turkey shows us again – political risk is increasingly affecting markets. Usually – especially in periods of quantitative easing (QE) – political or geopolitical risk does not have a significant impact on the markets of developed economies. However, the behavior of Turkish bonds, the Turkish pound and the money market – over the last three years – teaches us that – at least for emerging economies – political risk is now a dominant factor in the markets.

Read also:

* Turkey: Lawsuits against former central bankers for manipulating the pound

* How “Erdonomics” plunged Turkey into chaos

* New losses for the pound: Concerns grow, enthusiasm for Erdogan’s announcements drops