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Unworthy Currency

In this week's FinMail we take a detailed but simplified view at the currency crisis that has been going around in Turkey.

The Story

"People are bringing their savings and are always looking to buy dollars. When will it end, where will this go? People are panicking, and are using the money that's under their mattresses."

These are the words of Hulya Orak who's a currency exchange office worker in Turkey.

"If I buy the coat, we won't have anything to eat for the rest of the week," says Emine Cengizer who wanted to buy her teenage daughter a winter coat but couldn't.

If you are confused about what you just read, let us jump straight to the point. Turkey's facing a currency crisis and it's huge. Turkey's Currency - Lira has been on a falling spree. It has so far lost 40% of its value in less than a year, the inflation is out of control in the country, people are lining up to buy US Dollars and all of it is being blamed on one man - the President of Turkey; Recep Tayyip Erdogan.

What's Happening in Turkey?

There's an economic emergency going on in Turkey with its domestic currency Lira, as mentioned above, has been losing its value against other currencies and especially against the USD and the Euro.

For reference, 1 Turkish Lira could fetch 14 cents of USD in March 2021 and now it can fetch only 7.2 cents of USD. In the same way, if you were to convert the Turkish Lira against INR in March 2021, you'd have to pay ₹10 to get 1 Turkish Lira while as of now you'd have to pay only ₹5 for the same. Turkish Lira has lost 40% of its value in less than a year which is not normal. It is now in the line with the worst-performing currencies in the world.

As a result of the devaluation of the Turkish Lira, inflation rates have shot up and families living in Turkey are struggling to meet their basic needs. The food vendors in Turkey have started to sell half bagels as people are not even able to afford a single bagel. As per the official records, the inflation in Turkey is 20% which in fact is much higher as compared to other nations and a matter of concern itself. But that's just not it, if the experts are to be believed, the on-ground inflation is much higher than the official records; could be in the range of 40%- 50%. So what the heck is actually going on which has led to inflation rates all spiked up?

The Cause of Inflation

When we try to explore the causes of inflation in a particular country more often we find a series of reasons that leads to a particular situation but believe it or not, the cause of such high inflation in Turkey is one single man - the President of Turkey, Recep Tayyip Erdogan himself.

Contrary to the popular belief that keeping low interest rates for a long period of time can lead to high inflation in the economy, President Erdogan is of the belief that high-interest rates are "the mother of all evil" and cause high inflation and hence he has been guiding (a little less harsh word for ordering) the central bank officials to keep reducing interest rates even when the country's inflation has supposedly gone out of the control.

Now, for a context, it is necessary for an economy to have low interest rates to maintain ample liquidity and promote economic growth but up to a certain limit only. With the rising money supply into the system, it becomes easier to get loans as the interest rates would be low and so would be deposit rates, hence, a motivation for not keeping money with the bank and rather spending or investing it. But after a certain point, the same thing becomes the cause of inflation as money is easily available.

We have seen in India that the government has reduced the interest rates to increase the money supply during the pandemic and the interest rates are still low as the inflation is well within the control of the central bank, RBI. While on the other hand, US is on the route to increasing interest rates and has already started cutting down the supply of money as the inflation in US is rising. But here in Turkey, Mr. Erdogan believes that low interest rates (regardless of how low they are) would not cause inflation, but instead bring down inflation by leading to an increased supply of goods in the economy.

And seems like the President is such a fan of low interest rates that he has removed 3 central bank chiefs who tried to control inflation and stop the devaluation of the Turkish currency by raising interest rates. But now the current chief of the central bank is believed to be a close supporter and follower of the President and is expected to follow the President's commands uhm, we mean suggestions.

How is Inflation devaluing the Turkish Lira?

Valuation and Devaluation of currency might seem one mountain of a topic to understand but in reality, it just boils down to demand and supply, really. Currency is a medium that we use to purchase products or services. We use currency as "value" to pay in exchange for the value we receive in the form of a product or service. Any currency's valuation depends on how scarce or how (available/common) it is just like goods and services. Consider currency just like a good. If you have an ample amount of supply available for a good then it is but obvious that its price or value will be less. Similarly, if a currency is available in ample supply, its value will go down.

In terms of Turkey, due to the regime of low interest rates for many years, the central bank had to keep pumping the Turkish currency into the market which increased the supply of Turkish Lira; thereby decreasing its value. As per World Bank Data, Turkey's money supply rose by 300% between 2014-2020 as compared to a 50% increase in US's money supply.

As the money supply of the Turkish Lira has increased, foreign investors who are invested in Turkey are also not particularly interested as their investment value is also decreasing with the devaluation of the currency and they are redeeming their investments and converting them back to dollars which further increases the supply of the Turkish Lira into the market, further diminishing its value. And that's just not it, the citizens of Turkey are also converting their savings into USD and Gold to protect themselves from devaluation which again leads to the devaluation.

(Note: The job of the Central Bank is to regulate the supply of money in such a way that it is not too much and not too little - Perfectly Balanced; as everything should be. And when the central bank is told not to do that, you know that the economy is in trouble.)

What happens when one centralised authority tries to regulate the whole system?

It's necessary that the decisions for governing the country or even managing a company shall be made by a qualified respective authority which is expected to have the required expertise of the undertakings of their own field/department. One department/person in charge can not have the qualities to perform all the tasks and even if they are equipped with it, it becomes impossible to take care of everything at a higher scale.

And if you notice that is the same reason, governments around the world have different ministries and companies have separate departments to undertake and manage different tasks. Together they form the large entity accountable to one authority. But what if the same authority behaves like one supreme power and tries to micromanage or even instructs to follow its suggestions? That would be problematic, right?

Turkish president in this case has been acting as a central authority and making decisions that are supposed to be made by the chief of the central bank.

History has been a spectator of events such as economic failures of countries as their so-called governments or the person in command was not capable of performing their tasks. It happens when too much power lies with a single authority/entity/person which in many cases is misused.

We have seen many countries witnessing economic disasters due to currency devaluation and hyperinflation. During these economic events, citizens of a particular country discard their very own currency and shift towards some other country's currency which is economically strong, USD or Euro. Or either they start storing their value in commodities such as gold or silver as it carries physical inherent value.

So what's the possible solution? Go back to using commodities? Not really.

The Solution

Austrian economist and Nobel Laureate Friedrich Hayek in his book Denationalization of Money argued that a government’s monology over money is just as undesirable as any other monopoly. He further goes on to propose that private institutions should be allowed to issue their own currencies. (yup, you read it right.)

If we look into it, isn't it a fact that the government has total control over our currency just like a monopoly? A monopoly without any reign on it, red flags!!!

Theoretically (or even practically) government has a right to print currency without any limit. And if it does, then the whole country takes a hit and further, it takes decades to completely recover from that situation.

So what if there were other currencies as well co-existing in a country and provide it's citizens with a choice to accept currency in which they trust. Well, you might be thinking that he is pointing towards the cryptocurrencies but... wait for it.

The book was written 45 years ago!

That's it for this week's FinMail. We hope you liked this tweaked version of FinMail. Keep reading, keep learning. Spread love and not Covid and we will hopefully see you in the next week.


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