Notes From Underground: Will He Or Won’t He? (Only His Son-In-Law Knows)

On Monday, Rick Santelli and I unpacked a great deal in the few minutes we were allotted on CNBC. The Turkish story remains a key to the global financial markets. The U.S. equity markets interpreted that as all-clear, and the narrative of a dynamic U.S. growth story sustains itself.

(Click on the image to watch me and Rick talk Turkey.)

The National Federation of Independent Business (NFIB), which reports on the sentiment of small businesses issued its monthly index. It reflected a continued optimism evoked by a strong economic outlook. Lower taxes and less regulation are the drivers of the growth in small business increased profits. Small businesses biggest complaint continues to be the lack of qualified personnel.

The U.S. equity markets continue to be a story of strong data begetting strong data that results in higher profits. The question everyone wants to know: Can the U.S. remain the repository for capital inflows for global investors seeking returns? This is a classic feedback loop propelling asset values higher and higher. Weena, what does that siren mean? It’s all clear. (You don’t need a time machine to be reminded of ITS ALL CLEAR.)

The question facing capital markets is whether President Erdogan will invoke FOREIGN EXCHANGE CONTROLS to halt the outflow of dollars and euros in an effort to alleviate the selling pressure on the TURKISH LIRA. It is the threat of exchange controls that drives the global financial system apoplectic as the current system relies on the free flow of money in a borderless financial system. Money flows to the cheapest labor, which is the breast milk for ever-increasing profits and establishes the significance of global supply chains. Every pundit on the visual media diminishes the possibility of Erdogan delivering a nuclear blow by inhibiting the flow of capital out of Turkey.

I would URGE caution as I believe that President Erdogan will follow the policies of another strong Islamic leader, Mahathir Mohamad, who, as leader of Malaysia in 1998 defied conventional wisdom and embarked upon a program of tight capital controls in an effort stem the speculation against the Malaysian Ringgit. Prime Minister Mohamad put stringent time constraints on inflows/outflows of capital from the Malay financial system. It was the first economy to escape the Asian contagion. The IMF and other Western financial institutions decried the actions of the Malaysian authorities but Mohamad established his own course of action.

If the Turkish lira remains under great pressure Erdogan will follow the Malaysian policy and lock in massive amounts of foreign capital. The Turkish president has spoken out against the use of the IMF playbook that involves raising interest rates and cutting fiscal spending in an effort to shrink the current account deficits. If Erdogan invokes exchange controls, western lending institutions will be forced to raise capital in an effort to shore up balance sheets. The favored narrative is that Turkey is just a small part of the emerging market valuations and therefore its impact on the global economy will be minimal. But it is not the percentage of market indices but rather the fear of exchange controls that will most affect global markets.

Remember, President Erdogan has been a disruptor of conventional wisdom for more than a decade. When an autocrat is suffering from domestic problems history shows that the international arena becomes the target in an effort to build nationalistic support. Erdogan’s son-in-law is the Minister of Finance and Treasury so embarking upon an effort to control capital flows will not be met with any cabinet dissension. It is of extreme importance to be aware of Turkey following the Malaysian playbook rather than the U.S.-dominated IMF. Erdogan has been vociferous in distaste for high interest rates as an instrument to halt the outflow of foreign money. Many analysts will rightly point to the country’s low public debt-to-GDP ratio (28%), but that is not the relevant issue for a leader looking to punish foreign institutions for the benefit of domestic political consumption. No time to be complacent.

***This is the key question plaguing global macro: How is it that the weakest equity markets are also the ones with the weakest currencies? Typically weak currencies beget rallies in strong exporting economies. The weakness in the German DAX coupled with a weak EURO, a weak Chinese equity market coupled with a weak YUAN, and a weak EURO STOXX 50 with a weakened EURO. These correlations are divergent from the patterns over the last several years.

The biggest divergence may be the U.S. equity markets rallying with a strengthening dollar, which has been seen as a negative for U.S. foreign-based profits. I’m open to a discussion about this important correlation gone awry. Yes, I know the issue of the U.S. as the ultimate haven. Proceed.


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19 Responses to “Notes From Underground: Will He Or Won’t He? (Only His Son-In-Law Knows)”

  1. Stu f Says:

    Rancid Turkey was consumed by the the EUuuuuuuuuuuuuu


    • yraharris Says:

      Stu–except that in 2012 Nicholas Sarkozy was adamant that Turkey would not become a full member of the EU–interesting that so many people forget these when they think of things gone awry in the EU—Erdogan was none too happy about Sarkozy’s efforts to block Turkey–this current problem has a long way to go to be resolved

  2. Bellino Says:

    The triffin paradox must in here, somewhere.

    • yraharris Says:

      Bellino–it never seems to leave the discussion

    • Chicken Says:

      Except in the case causality (being in the denominator) dampers the paradox itself.

      Undiscovered imaginary components, the wildcard, bears watching.

  3. judd Says:

    Great Post..I’m out for a few days so I know it will get wild

  4. asherz Says:

    Turkey Lira collapse is not a solitary phenomenon, as contagion spreads in EM. What seems to be a paradox is the 17 month lows in gold and silver at the same time. With safe havens being sought in all these regions, wouldn’t gold and silver be one of the primary ports, and historically THE safest of the havens?
    The answer to me is obvious but has not given much credence on this blog, is the interference in the PM markets by the central bankers and the BIS. Again the motive is obvious, as QE and alchemy requires it.
    We have seen the absence of free markets in other areas, notably the bond markets (“Whatever it takes” and QEs) so why is it so surprising to hide from what some see as the obvious?
    I have previously posted a transcript of the 1974 Kissinger/Enders exchange. Here is a Zero Hedge piece worth reading for the agnostics.

    • yraharris Says:

      Asherz—you know I have great respect for your thinking and your posts certainly reflect that[even higher respect for you as a person].As you point out I have not given much credence to the market manipulation of gold by central banks but I have respected Paul Volcker because he raised rates in an effort to deflate gold as a signal of FED strength and responsibility.I have great respect for the Kissinger/Enders exchange although not for Kissinger for his interference in other countries elections.Having read Jacque Reuff several times I understand the need for the U.S. to do whatever it takes to sustain the reserve role of the dollar.But with the massive monetary creation over the last 31 years gold has certainly gained status as a monetary mechanism.The Russians and Chinese certainly have stockpiled the heavy metal as an alternative to U.S. economic hegemony which is why that GOLD/YUAN chart may be the real tale of the tape.I don’t know but my anti-conspiracy stance is based on my sense that it takes too many people to sustain the conspiracy.The interesting take away from the Zero Hedge piece is the perceived role of the IMF which makes me understand why the lap dogs at the IMF would never move to begin the issue of GOLD backed bonds but I would certainly love to see the Chinese officially monetize gold by offering gold backed bonds–it seems an easy response to U.S. fears and certainly its monetary irresponsibility for the last 50 years

      • Asherz Says:

        Yra- I actually expect the Chinese to issue Gold backed bonds at the time they deem it to be most propitious and effective in challenging the dollar as the world reserve currency. When is anyone’s guess but I would say by 2030 when their GDP equals ours.
        The battle for global supremacy by the eastern power vs. the western power is a long struggle. The financial arena is only one of the areas of combat.
        Trump’s courting of Putin is part of this currently Cold War.

  5. Stefan Jovanovich Says:

    Bagehot claimed that 5% would draw money from the moon. The IMF and others take that same “fact” for granted even though, as Yra notes, experience offers few examples where their attempt to mimic the BofE has actually worked. In Bagehot’s world offering higher interest rates on loans of bullion stopped runs by foreign counter-parties because they knew that the BofE would never fail. Its borrowings loans would always be repaid – in specie. The BofE and its pound sterling could be considered a safe haven, even in the midst of domestic bank runs and failures because no one anywhere in the world ever considered refusing its pound notes or no bank or counter-party would insist of a greater discount than the one the Bank itself was using.

    That world of Lombard Street died in August 1914 – when, in fact, the BofE not only had to suspend domestic redemption of its notes but also had to default on clearing of its foreign IOUs – something it had not done even during the Napoleonic Wars. (Those of us who would happily piss on Woodrow Wilson’s grave blame him for allowing the British (and French) to pretend that they did not default in 1914. Without that massive fraud, the Great Depression is impossible.)

    There are no “safe havens” now. A higher exchange rate for the U.S. dollar is likely precisely because the dollar is the one currency that is still broadly and actively exchanged independent of its own central bank’s discounting. The Fed is now what the Morgan Bank once was; the people to trust in a country that continues to swallow up other people’s capital and use it to buy (and make) more and more guns. When foreigners trusted the Morgan Bank as much as they trusted their own domestic central banks and did not trust the U.S. Treasury, it was because the Morgan Bank never, ever closed its cash window. To foreigners wanting to withdraw domestic deposits and take them across the border to another currency jurisdiction, the ECB’s sovereign subsidiaries (i.e. the Bank of Italy), BOJ, PBOC and (I would guess) even the BofE no longer have cash windows. (How else can one explain their near panic at the thought of being decoupled from the ECB?)

    Erdogan may have had no choice, as Yra suggests, but to end the bank run by limiting the payout of foreign exchange; but he – and others – are failign to find a clearing House that foreign counter-parties will trust. The greatest of all the present ironies of this market is that Trump’s MAGA hat is the only one out there that holds that magic financial rabbit.

    Trump’s tariffs will be the permanent wall of worry for those of us foolish enough to be buyers in the U.S. stock and Treasury/corporate bond markets. Even as Trump avoids the twin follies of trade quotas and exchange controls, the world will continue to bemoan what he is doing to trade/finance/order/peace/spiritual harmony/civility et. al.

    • yraharris Says:

      Stefan–this is a very good post–thanks.The additions to the discussion today by all have been a method in raising the financial IQ and political economic knowledge of all the readers of Notes From Underground—

      • Stefan Jovanovich Says:

        Thx, Yra. I think the point I am trying to make can be summarized as this: If Chicago – i.e. the futures markets – trades the currency, the risks and potential rewards are being actively discounted. If Chicago does not have a contract, the amount of actual money at stake cannot be successfully measured. The numbers “the markets” are dealing with are the global equivalents of the market caps of companies whose shares are only quoted in the pink sheets. There are no broad domestic dollar, Euro, pound or yen savings at risk in Turkey; if there were, Chicago would have a lira contract.
        I harp on this with you and Mr. Santelli precisely because you all do not see what you have created – a discounting mechanism that does not have its prices set by diplomatic conference. You and your fellow traders have quite literally revived the commercial discounting market of bills of exchange that developed in London and Amsterdam and grew to become the world’s pre-1914 money market. The international “crises” that now occupy far too much of the conventional financial history books were headlines precisely because – like Turkey today – they were transactions that existed outside of the money market. They were the deals that required the British, Dutch and (later) French and (much later) German, Italian, Austrian and Japanese merchant and deposit banks to use their political influence to get gunboats to do their collections. Precisely because these were the foreign loans in the post-Napoleonic world that only traded by appointment among the firms themselves, it was a “crisis” that offered the Army and Navy a rationale for their continuing existence. What the IMF and NATO say and do about the Turkish crisis is relevant to the pretense of their continuing importance; but their pronouncements have no more sustained importance to the markets that Chicago discounts than the speeches by Abdülhamid II had for the London-New York-Paris-Berlin-Vienna money market.

    • Yra Says:

      stefan–beautifully laid out and i am laughing about discounting the bills of exchange as I am reading right now Manias,Panics and Crashes–the sixth edition [Kindelberger and aliber ] which updates through the Lehman crisis.There is so much discussion about what have elegantly written–thanks

  6. Pierre Chapuis Says:

    These guys here offer a yield on gold, paid in gold. The metals are leased to companies that use gold. From what I understand plans for a gold back bond in the future may be possible to companies that are involved in commodities with some kind of arbitrage between the gold and such commodity they are involved with. Don’t ask me any more than that =). I’m not trying to sell this, just thought it may be something interesting to add to the conversation.

    • yraharris Says:

      Pierre –it is very interesting and coupled with my recent reading of American Default even more so.The Asherz post is full of very good reading material to gain a further understanding

  7. Arthur Says:

    Yra, have you ever thought about writing a book?

    • yraharris Says:

      Arthur–nobody has ever approached me but first I would like to get a half hour weekly show or an hour to present analysis of global markets

  8. A.M. Look 8/15/18 | Says:

    […] buyers! Yra’s Notes went over this in last night’s blog. […]

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