We interrupt August vacations, the silly season, and back-to-school preparations with news of a modest international financial crisis. Markets today are overreacting because of weekend risk, running to safety now, and these things usually fizzle.
Usually. At this writing the 10-year T-note has fallen to 2.87%, and mortgages have hardly flickered.
A run on Turkey began last night. The immediate precipitate was a Trump-doubling of a tariff sensitive to Turkey to punish the place for not releasing an American pastor accused by Turkey of fomenting revolution. However, Turkey’s finances have been deteriorating for years, its currency crashing this year, pastor or no pastor.
The Turkish lira has lost half of its value in the last year, a fatal illness when in combination with 50% of Turkey’s government debt held outside Turkey. You’d think given Italy’s luck with lira that Turkey might pick another name for its wallpaper. Debt held-inside, held-outside matters. 95% of Japan’s wallpaper is held inside Japan and therefore not at risk to yen movement or vice-versa.
Autocracies have an especially hard time with this stuff because the autocrat has disposed of anyone who would disagree with him, and begun to believe that he can make water run uphill at his command. See Venezuela’s Chavez and Maduro, also Czar Vladimir’s adventures. BTW: the ruble is also crashing in response to new sanctions. Awful Erdogan’s new orders to his people today: “Buy lira.”
Right. Another problem common to autocrats: flight by non-believers. One of the reasons that Xi Jinping was made emperor: fantastic flight from the yuan, anyone with money desperate to get it out of China. Someone had to be made sufficiently powerful to stop the run, which China has, but the jury is out on the rest of his autocratic hat trick: how to keep cash at home where government can steal it, and stop China’s borrowing binge (another form of stealing) while not simultaneously crashing the economy. At the heart of Turkey’s run: get anything you have out of the place, which forces capital controls incompatible with economic growth.
The splendid German word for enjoying the troubles of others is schadenfreude. Lest we get carried away, the autocratic impulses of our own leader are in play.
Turkey’s difficulty can go viral via non-banks, the primary external holders of Turkey’s wallpaper. Same for the new sanctions on Russia, which says that a sanction attack on its banks is an act of war. I have forgotten who-all is now subject to US sanction or tariff. We have been busy.
The standard international response to a financial crisis is oil upon the waters. An IMF loan and strictures for Turkey. Turkey is a NATO member, and the US Treasury Secretary would burn phones to counterparts and the Fed to other central banks. Smother the ignition before it gets going.
Mr. Trump’s business style has been to bludgeon deal partners into a corner until they either give in, or flee, or he moves on to the next deal, or he files for bankruptcy. In global affairs we are stuck with each other. Mr. Trump’s idea of oil upon the waters is to set it on fire.
The US has useful experience as a fire brigade. Secretary Mnuchin knows what to do, as does the Fed, but loons elsewhere in the administration may stand on the hoses. Nevertheless, no matter how many unnecessary fights we have picked in the last 18 months, our allies are still allies and nobody wants to risk suicide by allowing a minor matter like Turkey run out of control.
Back to the US economy and finances, inflation and our own debt.
July CPI up-ticked, not out of control but the year-over-year core rate rose to 2.4%. That pretty much cancels gains in wages but did no harm whatever to US interest rates in one of the most powerful signals available.
Turkey suppressed Treasury yields today, but in the three previous days the Treasury sold at auction $78 billion in new bonds and found eager buyers. The dog that didn’t bark… going back to the first days of big US deficits and borrowing, the late 1970s, one of the easiest ways to make money was to short Treasurys before one of these big bond auctions (expecting rates to rise and prices to fall to attract bidders), and then toward the end of the auction buy bonds (rates falling back and prices rising). It’s amazing to see us borrow with the ease that we did this week, rates not moving at all.
Which is a caution. Autocrats have no domestic brakes on dangerous finance, but markets soon punish them. In the US today, Republicans have joined Democrats in binge-borrowing but not even markets are warning us.
When in sports we accomplish something beyond our talent, human nature is to think, “Damn! I’m better than I thought I was.”
When are effortlessly borrowing ruinous sums it’s a good idea to examine the motivation of the lender rather than to admire our perspicacity. In this world, 2018, if you’re looking for highest quality IOUs to buy, whose do you choose?
The Germans have a budget surplus and don’t sell IOUs. Most other European ones are either trash or embalmed inside the ECB. Japan? Hah. China does not even have a market currency, let alone bonds. Britain? With Europe trying to kill it for escaping?
A process of elimination is not necessarily flattering to the winner. Beware lenders desperate to lend.