WEBVTT - Understanding Turkey’s Bold Plan To Stabilize the Lira 0:00:10.920 --> 0:00:15.040 Hello, and welcome to another episode of the Odd Lots Podcast. 0:00:15.080 --> 0:00:20.040 I'm Joe Wisenthal and I'm Tracy Halloway. It's pretty incredible, 0:00:20.120 --> 0:00:22.720 how like every you know, for the last several years, 0:00:22.760 --> 0:00:26.119 maybe five, six, seven years, I feel like there's this 0:00:26.280 --> 0:00:30.240 rhythm where, maybe like every nine months or every year, 0:00:30.720 --> 0:00:34.040 the world really turns its focus to what's going on 0:00:34.120 --> 0:00:38.000 with Turkey, what's going on with Turkish monetary policy, and 0:00:38.040 --> 0:00:41.280 what's going on with the Lira. Yeah, I know what 0:00:41.400 --> 0:00:43.599 you mean. It does seem to pop up like at 0:00:43.680 --> 0:00:46.479 least once a year and suddenly everyone's very focused on it, 0:00:46.560 --> 0:00:49.080 and then within a month or two people seem to 0:00:49.080 --> 0:00:51.000 have forgotten it, or at least it's moved out of 0:00:51.080 --> 0:00:54.480 the limelight. But I have to say we're recording this 0:00:54.600 --> 0:01:00.200 on Christmas Eve, December, and this week in particular or 0:01:00.280 --> 0:01:02.760 has been one of those weeks where everyone wakes up 0:01:02.800 --> 0:01:05.400 and decides that they all have opinions on Turkey and 0:01:05.440 --> 0:01:07.720 what's going on there. And to be fair, we have 0:01:07.880 --> 0:01:12.679 seen this enormous amount of volatility in the lira. So 0:01:12.959 --> 0:01:16.240 I think the lira was up something like twenty five 0:01:16.440 --> 0:01:21.039 per cent on a single day this week after are 0:01:21.120 --> 0:01:25.400 to Wan announced a new mechanism to try to stop 0:01:25.400 --> 0:01:28.600 its halt, and before that it was down. I think 0:01:28.600 --> 0:01:31.119 it had lost like half its value over the past 0:01:31.200 --> 0:01:36.320 three months. So just crazy moves in the currency. Yeah, right. 0:01:36.360 --> 0:01:38.600 There are a lot of e m s which see 0:01:38.920 --> 0:01:42.480 significant currency volatility. You know, we see it in Brazil 0:01:42.600 --> 0:01:44.640 from time to time, we see it in South Africa 0:01:44.640 --> 0:01:47.119 and so forth, but there seems to be nothing quite 0:01:47.319 --> 0:01:50.960 like the volatility that we see in the Lira, and 0:01:51.200 --> 0:01:54.520 it's incredibly volatile. And as you mentioned, and you said 0:01:54.640 --> 0:01:57.920 there a day I think it was up like thirty 0:01:57.960 --> 0:02:00.920 five from the lows of that day, because I think 0:02:01.240 --> 0:02:03.520 in the morning it was down ten percent. But as 0:02:03.560 --> 0:02:08.360 you mentioned, President Radwan having instituted a new mechanism to 0:02:08.480 --> 0:02:11.359 attempt to stem the decline, and we'll get into how 0:02:11.400 --> 0:02:13.880 that works. I think it was up thirty like truly, 0:02:14.960 --> 0:02:17.720 any sort of like macro tourist and what is interest 0:02:17.800 --> 0:02:21.080 in currencies, monetary policy, etcetera, had to be sort of 0:02:21.120 --> 0:02:26.200 like jaw dropping at that move that day, right. And 0:02:26.360 --> 0:02:29.360 the other thing going on with Turkey, of course, is this, 0:02:30.120 --> 0:02:34.760 I guess, rejection of economic orthodoxy. So when it comes 0:02:34.760 --> 0:02:37.680 to emerging markets, I think there's often a perception that, 0:02:38.000 --> 0:02:41.000 you know, e M s are different to developed economies 0:02:41.000 --> 0:02:44.200 for a variety of reasons. But there's always concern about 0:02:44.560 --> 0:02:48.679 fiscal discipline and whether or not they're going to be conservative, 0:02:49.040 --> 0:02:52.680 whether or not they have the institutional strength to you know, 0:02:52.919 --> 0:02:56.120 keep the economy in check and keep it stable. And 0:02:56.160 --> 0:03:00.600 then when it comes to Turkey, we've seen just I guess, 0:03:00.639 --> 0:03:04.400 an extreme version of these concerns, where are Doowan is 0:03:04.840 --> 0:03:09.960 rejecting economic orthodoxy. He keeps lowering interest rates and that's 0:03:10.000 --> 0:03:12.919 leading to inflation and that's causing the currency to fall, 0:03:13.000 --> 0:03:17.720 and no one really knows how to interpret it. I guess, yeah, 0:03:17.760 --> 0:03:19.960 I think that's exactly right. And you see it from 0:03:20.000 --> 0:03:23.160 time to time that various e M s will say, 0:03:23.360 --> 0:03:26.160 have a central banker who is very steeped in a 0:03:26.360 --> 0:03:30.880 sort of neoclassical economics, and whether the sort of measures 0:03:30.880 --> 0:03:33.160 are successful or not, there's always this sort of there's 0:03:33.320 --> 0:03:37.680 often this sort of portrayal to foreign investors of like 0:03:38.120 --> 0:03:43.640 fiscal discipline in central bank independence and macroeconomic orthodoxy. And 0:03:43.680 --> 0:03:45.960 I think, uh, you know, people look at Turkey and 0:03:46.000 --> 0:03:50.000 they see an example of a country and a system 0:03:50.040 --> 0:03:53.400 that very much not playing by those sort of like 0:03:53.560 --> 0:03:56.040 the standard playbook, and then they see the volatility and 0:03:56.080 --> 0:03:58.120 they say, oh, well, this is what happens when you 0:03:58.200 --> 0:04:00.640 don't when you don't follow the rules laid out by 0:04:00.640 --> 0:04:05.800 the University of Chicago Economics department. Yeah, that's one way 0:04:05.840 --> 0:04:09.000 of putting it. Yeah, anyway, but I still, you know, 0:04:09.080 --> 0:04:10.960 I again I sort of edgine, like, you know, we're 0:04:10.960 --> 0:04:13.760 all so many like tourists look at Turkey, and I 0:04:13.760 --> 0:04:16.800 don't think we have like a truly deep understanding of 0:04:16.800 --> 0:04:20.320 what is going on in the economy, approach to monetary policy, 0:04:20.480 --> 0:04:22.320 what is going on with the leer and so forth. 0:04:22.640 --> 0:04:25.200 So I'm very excited about our guest today who is 0:04:25.240 --> 0:04:28.520 going to help us understand everything about how the Turkish 0:04:28.520 --> 0:04:31.640 economy and monetary system works. We're gonna be speaking with 0:04:31.720 --> 0:04:34.800 Lutfla Bingo. He's an economist at a bank in Istanbul 0:04:34.839 --> 0:04:38.599 al Baraka Turk Lutfala. Thank you so much for joining us, 0:04:39.000 --> 0:04:43.039 Thanks for having So why don't we start? I mean, 0:04:43.520 --> 0:04:47.440 would you say it's I mean, it's a fair characterization, 0:04:48.040 --> 0:04:51.440 this idea that in this very Turkey, in a very 0:04:51.440 --> 0:04:55.279 sort of overt sense does not sort of make the 0:04:55.360 --> 0:04:58.480 same I guess that. Yeah, I want to play by 0:04:58.520 --> 0:05:03.919 the same playbook as many emerging markets typically attempted. There 0:05:03.960 --> 0:05:08.920 are some similarities with some periods with some countries, but 0:05:09.080 --> 0:05:15.440 Turkey has some very unique fundamental conditions. Some of these 0:05:15.480 --> 0:05:18.279 are issues, and some of these are strengths, and the 0:05:18.440 --> 0:05:22.279 Turkey Turkish economy is of course bound by these. That 0:05:22.520 --> 0:05:28.320 is why sometimes Turkey makes different choices than the rule book. 0:05:29.440 --> 0:05:33.200 I'm not even sure a proper rule book exists for 0:05:33.400 --> 0:05:37.360 emerging markets, but that will be one of my arguments today. 0:05:38.120 --> 0:05:41.640 There is no rule book for what Turkey goes through 0:05:41.640 --> 0:05:46.560 it and there will be one if this instrument works. 0:05:47.960 --> 0:05:51.400 You're talking about the attempt to stabilize the lerou that 0:05:51.440 --> 0:05:53.640 was announced this week. But before we get to that, 0:05:54.080 --> 0:05:56.839 can I just ask a really basic and I guess 0:05:56.839 --> 0:05:59.680 this is the obvious question, but you know what is 0:05:59.720 --> 0:06:03.159 where all the interest rate cuts? Like, where does the 0:06:03.240 --> 0:06:07.719 refusal to actually raise interest rates come from? And what's 0:06:07.720 --> 0:06:12.320 the rationale for going in that direction? To answer that question, 0:06:12.680 --> 0:06:15.799 I'm going to have to provide an entire framework, which 0:06:15.880 --> 0:06:18.039 I was planning to do anyway. Ship So who should 0:06:18.040 --> 0:06:21.360 I go and do that? Ye? Sure, please go for it? First, off. 0:06:21.360 --> 0:06:23.320 It's going to sound like a cliche, but I do 0:06:23.400 --> 0:06:27.360 not believe in structures or you know, claims. I believe 0:06:27.360 --> 0:06:31.520 in incentives, and for various reasons I'm going to talk 0:06:31.560 --> 0:06:37.039 about today the central bankers goal of price stability and 0:06:37.760 --> 0:06:41.880 the policymakers goal of you know, having growth providing jobs. 0:06:42.680 --> 0:06:45.440 Those are two conflicting goals in the case of Turkey, 0:06:45.560 --> 0:06:49.120 and that is for precisely one reason, because there is 0:06:49.640 --> 0:06:54.040 a huge amount of dulverization. And that is precisely why 0:06:54.400 --> 0:06:57.720 I do not see this week's move as just the 0:06:57.880 --> 0:07:01.120 short term measure to you know, stabilize the er. I 0:07:01.160 --> 0:07:04.880 see it as a crucial structural reform. I begin this 0:07:04.920 --> 0:07:12.280 week extremely pessimistically. I had almost no hope, but now 0:07:12.320 --> 0:07:17.120 I'm rather hopeful because what they announced it tells me 0:07:17.480 --> 0:07:22.480 that they diagnose the problem right, and if the mechanisms 0:07:22.520 --> 0:07:26.080 announced work, we won't have that problem anymore. So for 0:07:26.200 --> 0:07:31.200 the first time in probably Turkish history, after the end 0:07:31.280 --> 0:07:35.360 of you know, Breton Woods, perhaps we will have a 0:07:35.480 --> 0:07:39.800 proper alignments of incentives. So I think I will have 0:07:39.960 --> 0:07:45.920 answered the question why the policy makers you know, add 0:07:45.960 --> 0:07:50.560 fuel to the fire whenever there is a global USD 0:07:50.640 --> 0:07:55.520 cycle downturn. Whenever fed heights interest rate, you see central 0:07:55.520 --> 0:07:59.000 bank independence and Turkey disappear. I will try to explain 0:07:59.040 --> 0:08:01.320 why is that? So, what do we get it? Just 0:08:01.360 --> 0:08:05.600 get give us this sort of basic argument for because 0:08:05.840 --> 0:08:09.960 I think from a sort of like foreign perspective, the 0:08:09.960 --> 0:08:14.680 typical story is air do Wan is pushing this sort 0:08:14.680 --> 0:08:18.400 of like very heterodox, unusual policy. It's not out of 0:08:18.440 --> 0:08:21.440 the central anchor playbook. It's bad. We get to the lira, 0:08:21.680 --> 0:08:25.000 people flee to dollars and so forth, and it leads 0:08:25.000 --> 0:08:28.880 to inflation and price instability. It sounds like your argument 0:08:29.080 --> 0:08:32.160 is that it's something much deeper and much more structural 0:08:32.200 --> 0:08:34.560 with the Turkish economy, and that it can simply be 0:08:34.840 --> 0:08:39.160 attributed to these sort of idiosyncratic policy choices. So before 0:08:39.160 --> 0:08:42.400 we even get into the mechanism, and we'll talk about that, 0:08:42.480 --> 0:08:45.560 of course, what is it about the structure of the 0:08:45.559 --> 0:08:51.280 Turkish economy in your view, that creates these cycles? There 0:08:51.280 --> 0:08:56.200 are three types of flows that are inconsistent with each other. 0:08:56.400 --> 0:09:01.760 So you have dollarization, you have the current account balance, 0:09:02.000 --> 0:09:06.480 and you have the foreign capital inflows and outflows. There 0:09:06.600 --> 0:09:11.040 is no single interest rate that can balance all three 0:09:11.040 --> 0:09:14.440 of these in the case of Turkey, so whatever you do, 0:09:15.040 --> 0:09:19.440 you'll sacrifice something. And in the case of Turkey, if 0:09:20.280 --> 0:09:23.880 given this structure, if you don't change anything, you take 0:09:23.880 --> 0:09:28.199 this is given if you aim for price stability, and 0:09:28.440 --> 0:09:31.839 the global central banks, especially FED, is hiking interest rates. 0:09:31.880 --> 0:09:35.240 So you do not have that much capful flows, you 0:09:35.320 --> 0:09:38.160 do not receive that much capital flows, there is no 0:09:38.240 --> 0:09:41.040 way you can grow. Basically that that will be my argument. 0:09:41.080 --> 0:09:45.559 And any policymaker anywhere in living in a democracy wants 0:09:45.600 --> 0:09:50.920 the economy to grow and if something is standing in 0:09:50.960 --> 0:09:54.600 the way of that, that that thing will be run over. 0:09:54.920 --> 0:09:58.320 That that that is what's happening in Turkey, and if 0:09:58.440 --> 0:10:02.760 dollarization issued, it's result I think you'll see are gone 0:10:02.840 --> 0:10:21.600 talking about interest rates a lot less. Can you, just 0:10:21.640 --> 0:10:24.959 before we move on, can you talk about how dollarization 0:10:25.440 --> 0:10:28.640 became such a thing for the Turkish economy, because of course, 0:10:28.679 --> 0:10:31.280 there are a lot of emerging markets that have dollarization 0:10:31.400 --> 0:10:35.280 to some degree. They have people who you know, don't 0:10:35.360 --> 0:10:38.080 necessarily trust the local currency and want to shift into 0:10:38.120 --> 0:10:40.960 something that they perceive as more safe, or they have 0:10:41.160 --> 0:10:44.000 a lot of you know, trade that's denominated in dollars, 0:10:44.080 --> 0:10:47.160 things like that. But in Turkey, as you just laid out, 0:10:47.280 --> 0:10:49.760 it seems to be extreme or it seems to be 0:10:49.840 --> 0:10:52.600 more of an issue because of the structure of the economy. 0:10:53.040 --> 0:10:58.000 So how did that happen. It started with a very 0:10:58.120 --> 0:11:02.360 premature capital account of done by the late President Turkados 0:11:02.360 --> 0:11:06.600 All In with that kepital account opening, he also let 0:11:06.640 --> 0:11:11.800 people have FX deposit accomps in local banks, So that's 0:11:11.800 --> 0:11:14.880 how it started. And throughout the nineties there was this 0:11:15.000 --> 0:11:18.080 predictable pattern whenever, whenever there was something wrong with the 0:11:18.120 --> 0:11:22.319 Turkish economy you know USD Lira exchange, it blew up. 0:11:22.880 --> 0:11:25.920 So if you are a you know, household, if you're 0:11:25.920 --> 0:11:30.720 a person observing this pattern, this means you have now 0:11:31.160 --> 0:11:36.320 access to a put option. That's pretty much it's in 0:11:36.360 --> 0:11:39.880 the case of Turkey, I argue the main reason for 0:11:40.000 --> 0:11:46.600 dolorization is that that's the only tail events hedge household 0:11:47.040 --> 0:11:54.319 has access to. And that's what makes this problem hugely pernicious, 0:11:54.360 --> 0:11:58.080 because if you treat it like some sort of simple 0:11:58.160 --> 0:12:01.120 portfolio choice and tried to solve it that way, it 0:12:01.200 --> 0:12:05.720 doesn't work. And I'll tell how they treated that way 0:12:06.120 --> 0:12:10.080 and it didn't work. And now for the first time, 0:12:10.880 --> 0:12:15.480 diagnosing the problem right that you know, dollarization, households holding 0:12:15.520 --> 0:12:21.080 dollars is a tail event hedge, and unless you completely 0:12:21.160 --> 0:12:24.480 replicate the payoff structure of that tail event hedge, there 0:12:24.559 --> 0:12:28.120 is no way you can prevent dollarization, you know, borring 0:12:28.400 --> 0:12:32.360 capital controls or something. So this is the first credible 0:12:32.360 --> 0:12:36.640 attempt to do that. I think that That's what I 0:12:36.679 --> 0:12:40.160 meant by they seem to be diagnosing the problem, right. 0:12:40.679 --> 0:12:43.319 What do I mean by you can't solve this problem 0:12:43.360 --> 0:12:47.079 by treating it as a simple portfolio choice issue. If 0:12:47.120 --> 0:12:51.320 this is another risky asset, what do you do? You 0:12:51.440 --> 0:12:57.559 hike interest rates, right, you make the alternative more preferable. 0:12:58.320 --> 0:13:01.920 You should be able to solve your problem. Right, But 0:13:02.240 --> 0:13:04.960 that does not work in in the case of Turkey. 0:13:05.000 --> 0:13:10.600 Whenever you hike interest rates, if other uncertainties are still their, 0:13:11.200 --> 0:13:15.719 households do not just go ahead and buy lira. They 0:13:15.760 --> 0:13:20.040 hold onto their dollars, and they buy even more if 0:13:20.080 --> 0:13:24.480 the uncertainty is extreme. And another issue is if there 0:13:24.600 --> 0:13:29.559 is saying momentum in the US the Lira exchange eight, 0:13:30.160 --> 0:13:34.000 you see households buying more. That is typical for the 0:13:34.040 --> 0:13:38.000 case of a put option. But if it was a 0:13:38.120 --> 0:13:41.240 simple sort of portfolio choice. There is a chance you 0:13:41.320 --> 0:13:44.280 might observe that, but it should not be this predictable. 0:13:44.400 --> 0:13:48.320 So I think one major difference is let me give 0:13:48.320 --> 0:13:54.440 you an example. Let's say Tesla wants to know dissuade 0:13:54.559 --> 0:13:58.439 put option buyers and it's stock from buying put options, 0:13:58.559 --> 0:14:03.120 and to do that, fits increased it's dividends. Would it work? 0:14:04.040 --> 0:14:08.280 I think not, because the put option is a tail 0:14:08.360 --> 0:14:13.920 event hedge and increasing dividends does nothing to that. I mean, 0:14:14.440 --> 0:14:18.800 it would weaken Tesla's balantie it would it would, yes, 0:14:19.280 --> 0:14:21.920 I mean that was one of the things that happened 0:14:21.920 --> 0:14:25.280 in Turkey as well. They would do nothing to Tesla 0:14:25.400 --> 0:14:30.000 put buyers. So if you want folks from you, if 0:14:30.000 --> 0:14:32.040 you want to prevent folks on buying Tesla puts, you 0:14:32.080 --> 0:14:36.760 have to somehow replicate that payoff structure or remove on 0:14:36.880 --> 0:14:41.200 certainty completely. But removing on certainty completely means you can't 0:14:41.960 --> 0:14:45.400 grow either, and I'm not sure if that's something you want. 0:14:45.440 --> 0:14:49.160 I mean, providing a stock that is completely you know, 0:14:49.200 --> 0:14:52.080 treading with a fixed price would solve that issue, But 0:14:52.440 --> 0:14:55.160 would you want that? I think not. So I think 0:14:55.200 --> 0:14:58.800 that's that That's a good example of what we're dealing 0:14:58.840 --> 0:15:01.160 with here we where we go on. I just wanna 0:15:01.560 --> 0:15:04.920 clarify this because I think this is important to understanding 0:15:05.080 --> 0:15:09.160 your argument. So in a typical sort of like portfolio channel, 0:15:09.280 --> 0:15:11.960 you're like raise the interest rate and that creates some 0:15:12.040 --> 0:15:15.880 sort of like marginal incentive to hold lira. But if 0:15:15.880 --> 0:15:18.520 people are holding dollars as a tail risk hedge, then 0:15:18.520 --> 0:15:21.480 it really doesn't solve the problem. Can you just explain 0:15:21.520 --> 0:15:24.800 a little bit further this idea, the tail risk hedge 0:15:24.840 --> 0:15:28.680 against what And you sort of mentioned the premature opening 0:15:28.800 --> 0:15:31.680 of the capital account in the late eighties, But what 0:15:31.920 --> 0:15:36.560 is the impulse to hold such a strong um tail 0:15:36.640 --> 0:15:41.880 risk hedge and how is this not previously appreciated by policy? 0:15:42.080 --> 0:15:45.320 This is the dynamic of that previously appreciated by policymakers. 0:15:45.920 --> 0:15:49.880 Let me describe what happened when they tried to hide 0:15:50.000 --> 0:15:53.720 rates to solve this issue. And for a while it 0:15:53.760 --> 0:15:57.120 looked like they solved this issue. After the two thousand 0:15:57.200 --> 0:16:00.760 and one crisis in Turkey, there was this im stirchial 0:16:01.120 --> 0:16:04.560 program and you know the primary objective of that program, 0:16:04.600 --> 0:16:09.200 it was to decrease inflation, you know, control inflation, and 0:16:09.720 --> 0:16:12.640 to do that you have to provide some sort of 0:16:12.640 --> 0:16:17.960 currency stability, and one of the major roadblocks in front 0:16:17.960 --> 0:16:21.600 of that was dollarization. And it did something else as well. 0:16:21.720 --> 0:16:25.240 It dollarization weakens the monetary transmission mechanisms. So you're they 0:16:25.320 --> 0:16:30.119 hired the dollarization your montree policy works, you know, whereas 0:16:30.480 --> 0:16:33.440 hiking the interest rates a lot, providing a huge amount 0:16:33.480 --> 0:16:38.720 of real interest rate to savers should have done the trick, 0:16:38.760 --> 0:16:40.960 and for a while it did. I mean, after the 0:16:40.960 --> 0:16:43.520 two thousand and one crisis, at the dollarization rates in 0:16:43.560 --> 0:16:47.840 Turkey was around sixty percents and in two thousand and 0:16:47.840 --> 0:16:53.040 twelve it was down to so it seemed like it 0:16:53.560 --> 0:16:57.520 resolved issue, right. It didn't. It created a huge and 0:16:57.760 --> 0:17:02.640 various structural issues the Turkish economy is still dealing with today. 0:17:02.880 --> 0:17:05.240 One of the things that it did it was, you know, 0:17:05.560 --> 0:17:10.480 by the way, for about ten years, Turkish economy offered 0:17:10.640 --> 0:17:15.920 twenty points of real interest ring. It is prohibitively expensive. 0:17:17.000 --> 0:17:20.399 That that's why I said, you know, fixing the price 0:17:20.440 --> 0:17:24.320 of Tesla indefinitely would solve the issue of put buyers. 0:17:24.560 --> 0:17:28.440 That that's pretty much what happened. It was so expensive 0:17:29.600 --> 0:17:32.600 that it removed almost all volatility, so it did not 0:17:32.720 --> 0:17:36.720 make sense statically, not dynamically to whole dollars, so it 0:17:36.960 --> 0:17:43.520 decreased tolarization, but it also created another issue. And for 0:17:43.640 --> 0:17:46.600 us to understand what, you know, how this issue emerged, 0:17:46.680 --> 0:17:48.800 I'm going to have to talk about the incentive structure 0:17:48.840 --> 0:17:52.240 of the economy. So the policymaker would want the economy 0:17:52.280 --> 0:17:55.400 to grow, right, because that's how you create jobs, and 0:17:55.520 --> 0:17:59.000 if you create jobs, you get reelected. And for you 0:17:59.160 --> 0:18:02.119 to grow the economy, there two things you can do, 0:18:02.200 --> 0:18:05.440 you know, on an accounting identity based basis, you can 0:18:05.480 --> 0:18:10.199 either increase liabilities or you can increase equity. And you can, 0:18:10.280 --> 0:18:14.120 in the Turkish case, you can increase liabilities in Turkish 0:18:14.160 --> 0:18:18.520 lira or some other foreign currency. And if you want 0:18:18.560 --> 0:18:21.639 to do this, if you want to grow sustainably, you preferably, 0:18:21.680 --> 0:18:23.960 you know, want to do this in Turkish later because 0:18:24.040 --> 0:18:26.760 you are not able to print the foreign currency. But 0:18:27.560 --> 0:18:31.399 let's say a bank issued a new loan denominating in 0:18:31.440 --> 0:18:35.440 Turkish lira. If this was a closed economy, completely closed, 0:18:35.440 --> 0:18:38.919 no exports, no importonal capital flows, there's and there's a 0:18:38.960 --> 0:18:44.160 single bank, no no reserve requirements or some sort. If 0:18:44.200 --> 0:18:47.679 there is one lira of loan issued, you have to 0:18:47.760 --> 0:18:52.400 have one lira of deposits. Right, it's it's it's an identity. 0:18:52.440 --> 0:18:56.280 There's no way there's money could escape, so there is 0:18:56.320 --> 0:18:58.960 no chance of a bank run apart from the you know, 0:18:59.520 --> 0:19:03.160 uh sure to risk here something like that. So fractional 0:19:03.240 --> 0:19:07.879 reserve banking this is not you have complete matching events 0:19:08.000 --> 0:19:11.679 is liability in currency. The problem is there might be 0:19:11.800 --> 0:19:14.600 some bleeds in the structure. So let's see you issue 0:19:14.600 --> 0:19:20.240 it a loan. It might turn into dollar deposits by households. 0:19:20.280 --> 0:19:24.719 It might go to dividend and net dividend and interest 0:19:24.800 --> 0:19:29.439 rate payments abroad. It might pay for your imports. You 0:19:29.560 --> 0:19:33.480 might get influence from exports. This adds too, there's this 0:19:33.720 --> 0:19:37.040 issue for capabling flows and out flows. And I include 0:19:37.560 --> 0:19:41.200 f d iron here as well. So if you notice 0:19:41.280 --> 0:19:44.520 what I described, the last four or five components of 0:19:44.640 --> 0:19:48.680 this equation is precisely the balance of payments equation. So 0:19:48.840 --> 0:19:52.280 that means if you issue a little loan and you 0:19:52.840 --> 0:19:57.000 burn reserves, you will have fewer lit deposits than you 0:19:57.119 --> 0:20:00.639 have little loans. And there are three bonus of this 0:20:00.720 --> 0:20:04.280 bouncier payments equation, and in d M there are only two. 0:20:04.359 --> 0:20:07.760 That matters. You have foreign capital inflows and outflows, and 0:20:07.840 --> 0:20:10.560 you have imports and exports. In the Turkish case, there's 0:20:10.600 --> 0:20:13.920 a crucial third component that is dollarization. I'm going to 0:20:13.960 --> 0:20:17.480 explain how these two are impossible to balance. At the 0:20:17.520 --> 0:20:21.080 same time. Some folks are calling this the fear of floating. 0:20:21.560 --> 0:20:24.720 I think, I mean they're presenting it as a choice. 0:20:25.040 --> 0:20:28.080 I'm arguing that this is not a choice. This is 0:20:28.119 --> 0:20:33.120 simply a result of this structure. If you have this structure, 0:20:33.200 --> 0:20:36.320 you have no other choice, then you know, go for 0:20:36.440 --> 0:20:39.720 fear of fear of floating. So let's say you want 0:20:39.760 --> 0:20:42.800 to solve the issue of dollarization, and to do that, 0:20:43.000 --> 0:20:45.439 if you want to go the way of fiking interest 0:20:45.520 --> 0:20:48.840 rates like Turkey did in two thousand and twelve, you 0:20:48.920 --> 0:20:52.800 have to increase it by a lot, untoven twenty points 0:20:52.800 --> 0:20:56.040 of real interest rates. When you do that, currency stabilizes, 0:20:56.480 --> 0:21:01.560 so that that's that's good, all right. Foreign capital probably 0:21:01.600 --> 0:21:05.200 flows in because you're paying a huge amount of money 0:21:05.280 --> 0:21:09.680 for them to do that, but your exports and imports 0:21:09.720 --> 0:21:13.680 are not going to match because you now made your 0:21:14.000 --> 0:21:19.560 exports hugely expensive for others and imports hugely cheap for 0:21:19.640 --> 0:21:22.639 your own consumers. So if you try to solve with 0:21:22.880 --> 0:21:26.879 dollarization by congrades, you'll have earrant account issues. If you 0:21:27.000 --> 0:21:30.720 try to solve euarant account issues, you know, by devaluing 0:21:30.800 --> 0:21:36.480 your currency, then you'll have dollarization issues and form capital 0:21:36.920 --> 0:21:42.159 netflorm capital issues. Capital will flow out because there's momentum, 0:21:42.240 --> 0:21:46.720 and instability breeds instability. There will be dollarization. If you 0:21:46.760 --> 0:21:49.800 want to solve form capital and flow out flow issues 0:21:50.359 --> 0:21:53.400 with let's say you hide interest rates again, you will 0:21:53.480 --> 0:21:56.879 have the problem with Guarentt account. What I'm trying to 0:21:56.920 --> 0:22:00.479 say is if you want to take the structure given 0:22:00.800 --> 0:22:04.840 and acts as among Montrey policy maker, there is no 0:22:05.000 --> 0:22:09.280 way you can do policy growth policy based on lyra. 0:22:09.600 --> 0:22:13.520 If you want to solve dollarization, you can't grow by 0:22:13.800 --> 0:22:17.200 issuing lira loans. Issuing lieral LANs with the structured will 0:22:17.240 --> 0:22:20.240 breed instability. So what did the Turkish policy makers do 0:22:20.720 --> 0:22:23.840 to grow? They took the structure as given an act 0:22:24.280 --> 0:22:27.760 in accordance with that, so they preferred foreign capital. If 0:22:27.800 --> 0:22:33.480 you can't issue lira loans, you can get lira sorry, 0:22:33.520 --> 0:22:37.479 foreign currency loans from abroad and invests in consume with that. 0:22:37.760 --> 0:22:41.280 And that's precisely what happened, and Turkey was able to 0:22:41.320 --> 0:22:44.679 grow on average seven percent every year in the first 0:22:44.920 --> 0:22:48.080 five six years of that period after the two thousand 0:22:48.119 --> 0:22:51.960 and one prices. The problem is, this only works when 0:22:52.160 --> 0:22:56.160 the global USD cycle works in your favor, and it 0:22:56.240 --> 0:22:58.560 did work in Turkey's favor at the time. There was 0:22:58.640 --> 0:23:03.919 this lot of us D liquidity and that kept on 0:23:04.040 --> 0:23:07.560 going until the taper tension of two thousand and twelve. 0:23:08.320 --> 0:23:12.120 And that was the reckoning because until that moment, everybody 0:23:12.280 --> 0:23:16.919 was praising the Turkish economy. You know, Montree policy is independent, 0:23:17.359 --> 0:23:19.720 but they are still able to grow and they solve 0:23:19.760 --> 0:23:22.119 the issue of dollarization and there is no inflation. This 0:23:22.520 --> 0:23:25.840 is a successful economy, they were saying, and it did 0:23:25.920 --> 0:23:30.080 look that way. The problem is, once that global USD 0:23:30.160 --> 0:23:34.159 cycle reckoning came, this old structure king trumbling down because 0:23:34.200 --> 0:23:38.360 now you can't get effects loans from abroad as well, 0:23:38.480 --> 0:23:42.920 you have a huge issue with form capital flows and 0:23:43.400 --> 0:23:46.120 because of this structure, you are not able to grow 0:23:46.280 --> 0:23:50.000 by issuing literal loans in a sustainable manner or either. 0:23:50.440 --> 0:23:53.760 So after that point you started to see Mr President 0:23:54.160 --> 0:23:58.120 getting more anxious, getting more restless about the Montree policy. 0:23:58.280 --> 0:24:00.919 That's why I in the beginning said I you know 0:24:01.000 --> 0:24:04.680 look at incentives. I do not I tried to analyze 0:24:04.680 --> 0:24:08.560 incentive because it is completely a result of the incented structure. 0:24:09.080 --> 0:24:11.520 So can I just jump in here? And so just 0:24:11.600 --> 0:24:16.960 to recap, so Turkey has the stollarization problem. It's difficult 0:24:17.119 --> 0:24:19.879 for it to adjust interest rates in the way it 0:24:19.920 --> 0:24:24.480 needs to without causing some sort of current account issue. 0:24:25.359 --> 0:24:27.639 And that wasn't a problem for a while, but then 0:24:27.680 --> 0:24:30.320 we had the Taper tantrum and we had a retreat 0:24:30.359 --> 0:24:34.720 of dollar liquidity, and suddenly this issue of dollarization really 0:24:34.760 --> 0:24:38.399 comes to the four Could you maybe walk us through 0:24:39.400 --> 0:24:43.240 what exactly are Dowan announced this week when it comes 0:24:43.320 --> 0:24:47.879 to the new um effex mechanism, this new program to 0:24:47.920 --> 0:24:51.840 try to halt the slide in the lira, and how 0:24:52.359 --> 0:24:57.159 it anticipates trying to solve that problem of using the 0:24:57.200 --> 0:25:01.520 dollar as a tail risk hedge as you described. I mean, 0:25:01.840 --> 0:25:07.280 the most popular press covered this ethics deposit instrument the most, 0:25:07.320 --> 0:25:10.400 but there were two other things in there as well. 0:25:10.840 --> 0:25:14.760 The main piece in that package was an instrument that 0:25:14.840 --> 0:25:20.159 completely replicates the payoff structure that tailhage. So if you 0:25:20.320 --> 0:25:26.639 deposit your money and through this new instrument and the 0:25:26.720 --> 0:25:31.560 US de lira exchange rates does not depreciate more than 0:25:31.800 --> 0:25:36.200 the prevailing central bank interest rate, you're gonna receive the 0:25:36.359 --> 0:25:39.600 central bank interest rate. But if it literally depreciates more 0:25:39.640 --> 0:25:43.199 than that interest rates, you're going to be paid for that. 0:25:43.359 --> 0:25:48.160 So if literally depreciates eight and the interest rate prevailing 0:25:48.160 --> 0:25:52.919 interest rate is fourteen percent, either the Treasury or the 0:25:53.000 --> 0:25:58.879 CBRT will cover your air quotes loss. There as I 0:25:58.920 --> 0:26:02.240 said it, it is a free call option on US 0:26:02.359 --> 0:26:06.920 de leer exchange. If you are getting into this instrument 0:26:07.680 --> 0:26:11.720 from your usc deposit accounts, you're going to be dealing 0:26:11.760 --> 0:26:16.240 with cb r T and CBRT will be covering your loss. 0:26:16.840 --> 0:26:20.479 And if you have already a lirac condition you put 0:26:20.560 --> 0:26:23.400 your liric account money to into this new instrument, you're 0:26:23.400 --> 0:26:25.640 going to be dealing with the Treasury and they will 0:26:25.680 --> 0:26:30.200 be covering the losses. And why did they do this 0:26:31.040 --> 0:26:35.040 Probably because you know, if it's already a USD deposit, 0:26:36.160 --> 0:26:40.800 dealing with the CBRT directly is easier. It becomes a 0:26:40.840 --> 0:26:47.040 CBRT reserve dat amounts. And if you have a Lira accounts, 0:26:47.080 --> 0:26:49.680