The history of currency markets tells us that where there is turmoil, there is opportunity for wise investors to make money; whether by speculating on short-term corrections, or by playing the long-game by analyzing macro trends in the economic and geopolitical movements of a country, currency crises create investment opportunities.  The Turkish Lira crisis of 2018 serves as an excellent case study to analyze the opportunities presented when the value of a country’s currency is in turmoil.

In the first 8 months of 2018, the Turkish Lira plunged 40-50% in value, falling to roughly 7 Turkish Lira to a US Dollar in August – just one of many currency crashes around the world.  This dramatic plunge in a currency’s value presents traders with unique opportunities to earn a profit, and by analyzing relevant indicators, we aim to shed some light on how to evaluate the trading opportunities presented when this type of crash occurs.

There are two key things to consider when looking at a particular crash: the long-term trends of a market, whether a crash is expected to continue, or whether it has reached its trough and is expected to rebound; and the short-term fluctuations resulting from policy measures, institutional framework, political climate, and even aspects of culture that can act to reinforce the downward pressure, or cushion a fall and help stimulate recovery.  Markets are unique, and the better people understand the economic, social, and political intricacies of a country, the better equipped they will be to speculate.

Is the Turkish Lira going to continue to fall, or is now a safe time to buy?  There is a broad consensus that the currency plunge is part of a much larger banking-and-debt crisis, even a sign of much deeper economic instability, and looking at the country’s banking system, its public finances, trade-deficit, the general flight of private capital, and rampant institutional corruption, it is not hard to be pessimistic about the state of the Turkish economy; there are no signs of a recovery any time soon, and this means that any long-term plays hoping for a rebound in value are unlikely to pay off within a realistic time frame.

Turkey’s banking system is highly fragmented, a hodge-podge of quasi-privatized state-banks and extensions of conglomerates that branch into finance – most are undercapitalized and poorly managed, generally serving related or vested interests.  Enticed by low interest rates, banks had been borrowing from abroad and lending, rather carelessly, to domestic clients; consequently, they were highly exposed and unprepared for a plunge in the Lira, and lacking any access to capital, they are likely to struggle immensely in the coming years.

At the same time, the country’s public finances were out of control at the time of the crash.  Massive infrastructure projects over the past few decades were aimed at sustaining population growth and urbanization, and money was thrown at social programs in order to retain popularity, but this frivolous spending left both public and private coffers dry – many projects were mostly debt financed through bank-lending or more creative instruments (BOTs or JVs), but this only served to further expose the country to a crash by coupling private and public finances.

The plunge in the lira also served to exacerbate the country’s trade deficit, a pre-existing condition.  Turkey had previously worked to embrace open trade, deluding itself that it had the export capacity to liberalize imports.  With a relatively overvalued currency, the economy quickly grew dependent on these imports, even on essential items like grains and other foods – products that are now made unaffordable by the currency plunge.  The export capacity was an expression of domestic pride; however, even at now devalued prices, it is hard to see how the country could increase its exports to ease this pressure.

Furthermore, Turkish citizens had acquired the right to transfer their money abroad, a practice that was common before the crash, but would become a major problem when currency began to flood out of the country in response to the crash.  As the Turkish Lira started to plunge, in anticipation of yet worse to come, the more astute among the wealthy were quick to stuff their foreign currency accounts, preferably off-shore.  Calls for “patriotism” fell on deaf ears, failing to persuade the citizenry to keep their money in Lira, and this is likely to continue unabated as the secular elite are worried about increasing market uncertainty.

Conventional wisdom calls for austerity measures and higher interest rates; however, the cost of tightening the public purse strings is losing popularity among voters, and the country refuses to go to the IMF for monetary aid, fearing this would be an inescapable remedy.  Turkey has instead vowed to pursue a home-grown solution, and this is likely to stall out the crises for years to come.

In view of all this, can the Lira avoid a further free-fall?  A long term decline is inevitable but not without upticks along the way; and while there is not much hope for long-term investors to begin earning a profit as Turkey’s economy recovers, there is still ample opportunity to earn money by playing off short-term fluctuations, like the one from 7.2TL to the dollar in August to the subsequent recovery to 5.5TL.

While it is impossible to identify a precise algorithm to profit off of these swings, there are some things to keep an eye on in order to better inform your decision: firstly, understand the political dynamics of Turkish governance, and see that they will pull every trick in the book to disguise the depth of the crisis and display illusions of recovery; and second, be on the lookout for short-term relief efforts, like the gesture by Qatar, that are offered in exchange for political favor in the region.

The Turkish government is adept in playing nationalist and Islamist sentiments in their favour, and will even go so far as to call all patriots to purchase domestic products and to buy Turkish Lira.  These short-term tricks often work to create minor upticks in their currency, and can be used to earn speculative profits: follow the president’s speeches as closely as possible, and expect his charisma to affect the market in a very real way.

Qatar’s loan was made primarily for geopolitical reasons to gain Turkey’s favor; regardless, it served to provide a relatively modest lending facility that helped the Lira recover 10-15% within a matter of days.  In the crazy political power games of the Middle East, we are bound to see more such deeds, lending a false sense of confidence to the Turkish economy.  Do not expect any of these patchwork fixes to actually correct the faltering economy, but do not be surprised if they stimulate short windows of recovery that provide speculative opportunities.

These kinds of efforts will trigger periods of short-term relief, thus present opportunities to dump the Lira for those who had caught the low points to buy.  However, the underlying fundamentals will continue to exert downward pressure on the Lira for the foreseeable future.  Wait for signs of healthy economic growth before expecting an actual turn in the currency crisis, but be on the look-out for the short-term opportunities presented as the market fluctuates toward its trough.

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