Feathers were ruffled this week as Turkish President Recep Tayyip Erdogan vowed to take greater control of monetary policy if he wins elections next month. There are two main issues that confront Turkey; money and power. Turkey is a parliamentary republic and the presidency largely ceremonial, but Erdogan won a referendum to increase his powers and abolish the post of prime minister. Can you say autocratic? That is the power issue. Then there is the recent broad selloff in the Turkish lira against the dollar and others. The lira, which has lost 15 percent of its value in the past three months, plunged to its lowest level ever against the dollar following Erdogan’s remarks. That is the money issue. We will begin here.
The proverbial economic tail is wagging the political dog. In an interview with Bloomberg News, the Turkish president expressed that cutting interest rates would lower inflation. “The lower the interest rate is, the lower inflation will be,” he said. “The moment we take it down to a low level, what will happen to the cost inputs? That too will go down… you will be able to get the opportunity to sell your products at much lower prices…. The matter is as simple as this.” Umm…wrong. As a matter of fact, he knowns nothing of what he is saying. In world banking today, there is an inverse relationship between inflation and interest rates. Maybe Erdogan will be able to understand the following chart, as do most macro 101 students.
It’s like a teeter-totter. When one goes up, the other goes down. Now, why is that? Well, there are many fascinating books on the subject, but let’s try to keep it simple. I couldn’t have said it better if I were Investopedia. “In general, as interest rates are reduced, more people are able to borrow more money. The result is that consumers have more money to spend, causing the economy to grow and inflation to increase. The opposite holds true for rising interest rates. As interest rates are increased, consumers tend to save as returns from savings are higher. With less disposable income being spent as a result of the increase in the interest rate, the economy slows and inflation decreases. Simplified of course, but you get the picture.
This leads us to the second issue; power. If one can dispel the quantity theory of money, and asses blame to the central bank, then one could argue that a change in control needs to be made. But surely the Turkish bankers understand finance. I would image that most of them acquired their Ph.D.’s in the U.S. Like Paul Volcker and Alan Greenspan, the renowned economist Erdogan will run the central bank in the way that any authoritarian leader would. With an iron fist. The ruse of fake-economics may fool the lemmings that will usher him in as president again next month, but not the real financial world. Dietmar Hornung, head of European sovereigns at Moody’s, told a conference in London that the rating agency was “a bit concerned” by the comments. “Centralization of power and interference in the monetary policy is a concern to us,” Mr. Hornung said, according to Reuters. Case closed!