When it comes to diplomacy, the Trump administration has a far more cordial relationship with some of the world’s most notorious autocrats than it does with traditional American allies in Western democracies. That’s a surreal state of affairs befitting of the surreal times in which we live.
The President’s almost childlike affinity for strongmen is disconcerting for all manner of reasons, not to least of which is that implicitly slapping the White House stamp of approval on autocratic regimes undermines democracy as a political ideology on a global scale.
The problem for Trump, though, is that people like Xi Jinping see the U.S. President for what he is: an empty suit and a hapless demagogue masquerading as an authoritarian. “His remarks remind me [he’s] a political layman”, Kim Jong-Un said last September, adding that Trump “is unfit to command a country, and he is surely a rogue, rather than a politician.” Obviously, that’s the pot calling the kettle black, but it speaks to the fact that the authoritarians of the world only take Donald Trump seriously to the extent they believe he might accidentally stumble the U.S. into a war. The presence of John Bolton in the President’s inner circle doesn’t do much to alleviate those concerns.
But when there’s no risk of imminent military confrontation, these dictators don’t seem to have much patience for Trump. China has generally tolerated his bombast on trade for the last six months, but Beijing’s willingness to strike back with reciprocal tariffs and currency depreciation speaks to the fact that Xi isn’t going to be a pushover. Friday’s news underscores that contention.
Meanwhile, Trump seems to have collided with another largely immovable object in Turkish President Recep Tayyip Erdogan. Trump has attempted to cozy up to Erdogan on several occasions over the course of the last year (he actually fist-bumped the Turkish dictator last month at the NATO summit while explaining to America’s European allies that Erdogan “does things the right way”) and there’s a bizarre backstory involving Michael Flynn that’s worth your time to investigate. But the administration seems to have underestimated Erdogan’s penchant for belligerence when it comes to North Carolina evangelical Christian pastor Andrew Craig Brunson, who stands accused in Turkey of conspiring with Erdogan’s arch nemesis Fethullah Gulen and, for good measure, is also being investigated for having ties to the Kurdistan Workers’ Party (the PKK).
We’ve spent a ton of time documenting this ongoing drama and those who want the long version complete with some context on Gulen, can find it here. Trump and Vice President Mike Pence appear to be convinced that sanctioning two Turkish ministers is going to be sufficient when it comes to securing Brunson’s release, but anyone who knows anything about Turkey could have told them that while Ankara might ultimately cave, the idea that Mike Pence was going to intimidate Erdogan by talking tough on U.S. television (which is what Mike did late last month) was laughable in the extreme.
Erodgan tried to make it clear to Washington that there would be “no weakness!” (to quote Trump) last Sunday when he declared that Turkey would not bow to sanctions threats. Two days later (so, on Tuesday), a Turkish court rejected an appeal by Brunson’s lawyers to have him released and for his travel ban to be lifted.
After the U.S. moved ahead with sanctions on Turkey’s Minister of Justice Abdulhamit Gul and Minister of Interior Suleyman Soylu who the Treasury accuses of “play[ing] leading roles in the organizations responsible for the arrest and detention of Pastor Brunson”, the Turkish lira fell to fresh all-time lows. The currency is of course beset with problems, not the least of which is Erdogan himself, whose decision to install his son-in-law as economic czar following the farcical June 24 “election” raised fresh concerns about central bank independence. Those concerns were validated just weeks later when CBT failed to raise rates to combat spiraling inflation.
The lira depreciated past 5.10 on Friday before paring losses on “better” than expected inflation data. This is a currency crisis, plain and simple:
Note that I put “better” in scare quotes above when describing the inflation numbers that hit on Friday. The 15.9% YoY headline print was better than expectations (economists were expecting 16.3%) but it’s still a horrible situation and the core index surged to 15.1% YoY – that was actually worse than anticipated.
Turkey desperately needs rate hikes, but Erdogan (the self-styled “enemy of interest rates”) isn’t likely to allow that, which means either fiscal policy will need to tighten or else things risk spiraling completely out of control.
“In our view, the policy adjustment required to address high levels of inflation will come through the fiscal/quasi-fiscal sphere, rather than through further rate hikes”, Goldman wrote, in a note dated Friday, before cautioning that “the lack of credibility in economic policy making, de-anchored inflation expectations and the Lira’s volatility are all likely to make any adjustment more challenging.”
“Turkey is now firmly stuck in a vicious cycle: currency declines are causing high inflation and elevated prices are begetting lira depreciation”, Bloomberg Economist Ziad Daoud remarked.
10Y yields in Turkey rose above 19% this week.
On Friday, while speaking in Ankara, Erdogan did exactly what you would expect Erdogan to do in this situation – he blamed an international conspiracy and implored Turkish citizens to convert any dollars and euros they have to liras.
“Engage in this national resistance”, he said, before reiterating comments he made earlier this year about what he imagines is a large store of “under the pillow” dollars and euros that could potentially be converted to local currency in a show of defiance against U.S. sanctions.
Fast forward to Saturday and Erdogan was at it again and let me tell you something, he was in rare form. “The decision to freeze assets of Turkish justice, interior ministers in the US is illogical”, he said, speaking again in Ankara. Here’s what he said next:
We were patient until last night but I gave instruction to freeze all assets of the U.S. justice and interior ministers, if they have any.
With apologies to Pastor Brunson and all those caught up in the middle of this farce, that is hilarious and it’s classic Erdogan. He would go on to call the U.S. sanctions “disrespectful” before saying (literally), that if the U.S. thinks it can make Turkey “take a step back by resorting to threats and absurd sanctions, it proves that they don’t know Turkey” – and by “Turkey” he of course means “Erdogan.”
He went on talk about Halkbank and Atilla. According to reports out on Thursday, there was a deal in place between the U.S. and Turkey that would have called for Mehmet Hakan Atilla to be shipped back to Turkey from a U.S. jail. Atilla was convicted earlier this year for his role in a plot to avoid American sanctions on Iran and was sentenced to 32 months in prison in May. The case, profiled in these pages in great detail, grabbed national headlines when Erdogan was implicated by gold trader Reza Zarrab. As part of the deal for Brunson, Halkbank – which was at the center of the U.S. court case – would get off with a “lenient fine” for its role in the oil-for-gold scheme. With that apparently off the table, the shares came under renewed pressure.
“The US sanctions announced against two Turkish ministers on 1 August are largely innocuous in practice, in our view, but highly significant symbolically”, Credit Suisse wrote on Friday. “The key question for investors remains whether Turkey’s state-owned Halkbank will be subject to US sanctions and/or large penalties in the coming period against a backdrop of difficult relations between the two NATO allies”, the bank continued.
For the Trump administration, this should serve as a crash course in what happens when you try to use strongarm tactics on a strongman. Again, Erdogan may well be forced to relent if for no other reason than to remove one of the factors weighing on the lira. More to the point, it’s entirely possible he could see releasing Brunson as preferable to an out-of-cycle rate hike when it comes to giving the lira a short-term boost.
As for asset allocators, let this be another reminder that the only thing that matters for Turkish assets is Erdogan. Period. As long as you’ve factored that in, well then by all means take a flyer, but make no mistake, it’s just that: a flyer.