The global economy is again becoming financially fragile. Financial fragility is an indicator of increasing likelihood of the eruption of a major financial instability event–i.e. stock crash, bond market implosion, housing-commercial property price deflation, sovereign debt defaults, etc. (see my Systemic Fragility in the Global Economy, 2016, book for detailed theoretical analysis). Chapter 3 of the book described ‘The Emerging Markets Perfect Storm’, which explained how emerging markets economies would be destabilized and precipitate the next global economic contraction. The causation of the destabilization would lay in US and other advanced economies raising interests rates and would in turn cause the US dollar to escalate and emerging market currencies to plummet. That would provoke EME capital flight, to which EME central banks would respond by raising domestic interest rates that, in turn, would drive their economies into deep recession. That analysis, scenario and prediction was made in January 2016 in the book.
Global and US events delayed the process at that time. Fed rates stayed low and so did the dollar. In the past year, however, the scenario has begun to emerge, with Fed rates rising, dollar escalating, and an increasing number of EME currencies in turn crumbling and collapsing.
The current case of Turkey’s economy is at the center of this process, its currency having plummeted 40% to the dollar just this year. (It has temporarily stabilized this week, but the decline will soon continue once again).
But Turkey isn’t the only indicator, Other EME currencies are also in sharp decline at various stages: Argentina, Brazil, South Africa, Indonesia, and India. Russia’s Ruble is deflating and China’s Yuan, the strongest, nonetheless pushes against its lower band within which it too has deflated by 6-10%, prevented from falling further only due to China’s central bank massive intervention in money markets to prop up the value of its currency to prevent further devaluation.
Rising global financial fragility is rising due to obvious increasing contagion effects. The Turkish LIRA crisis is spilling over to other EME currencies, causing a further decline in those currencies in addition to the already significant forces driving down those currencies. Turkish dollarized debt payment obligations to Italian, EU and US banks are being noted in the business press. Italian bank debt is especially exposed, when Italian banks already sit on $500 billion in non-performing bank loans. The transmission mechanism to a broader European bank crisis might easily occur from Turkey to Italian banks to the general banking system. US banks like Citibank are also exposed to Turkish debt. Other indicators of growing potential contagion from the Turkish fallout are the global currency speculators (hedge funds, vulture investors, etc.) now plowing into short selling of the LIRA, further depressing its price, the rising interest rates on Turkey government and private bonds. The response of other EME central banks in raising their interest rates to try to stem the outflow of capital as their currencies follow the LIRA down. (Argentina being the worst case, as its central bank raises rates to 45%–thus ensuring that country’s current recession will collapse into an even more serious contraction, perhaps even depression). The first phase of the general contagion effects of the LIRA collapse have now occurred. A second ‘shoe’ will inevitably fall within weeks. Financial fragility is rising in the global economy–and will eventually impact the US economy in 2019, thus further ensuring a US recession sometime in 2019 that this writer has been predicting.
The following is an excerpt verbatim transcription of my August 10, 2018 Alternative Visions Radio Show, during which I stated my early analysis of the Turkey currency crisis now underway. A follow up print article is pending. (To read my analysis in 2016 of the now unfolding crisis, go to my website, for a complimentary copy of the Chapter 3: ‘The Emerging Markets Perfect Storm’, at http://kyklosproductions.com/articles.html. Reviews of the broader book, ‘Systemic Fragility in the Global Economy’, which addresses financial fragility in Europe, China, and elsewhere at the time, are available at that website as well at http://kyklosproductions.com/reviews.html.
HERE’S THE VERBATIM EXCERPT on TURKEY CRISIS from my August 3 Alternative Visions Radio Show:
Let’s take a look at some of the more important trends that have occurred in the past week here, in the US and global economy.
[05:18]
Well, what’s really erupted on the global economy stage has been the collapse of the currency in Turkey. Yeah, it’s getting a lot of news, particularly in the last day or so. What’s going on there? Why is the Turkish currency, called the lira, why is it in free fall? And yes, it is in free fall. It’s down 38% since March, 38% collapse of the currency. You know we’ve been talking about the importance of currencies in assessing the status, the ability of the global economy. And just to repeat my fundamental argument, the dollar is the driving currency in the world. And when the dollar rises, the currency exchange rates are always one currency in relationship to the other. If the dollar goes up other currencies are going to go down, all things equal.
[06:25] (dollar rising)
And of course, the US dollar has been rising, you know, it’s pulled back a little bit, but it’s been rising, and the dollar is rising because the Federal Reserve is raising interest rates. That drives up the value of the dollar. Why? Because, investors elsewhere in the world see rates rising in the US, and they want to buy into those Treasury Bonds and other US securities. So they sell their currencies which increases the supply of their currencies on the market, global money markets, which drives the prices of their currencies down. When they’re buying dollars it drives the demand for the US dollar up, and raises the dollar. So the dollar goes up, their currencies go down when interest rates rise in the US. And that’s what’s been happening, and will continue to happen according to the Federal Reserve. We’re going to get at least two more rate hikes, here, from the Federal Reserve this year, and maybe three next year.
[07:26]
We’re already at 2%, the benchmark federal funds rate, which drives all the other interest rates. When that rate goes up all the others go up. And, if they raise it two more time at .25%, or what they call 25 basis points each time, that’s two and a half. I’ve been saying for some time that once you hit two and a half percent in the benchmark rate that you’re getting close to a credit crunch. I do not believe that the Fed can raise much more than two and a half percent, maybe not even that. But if it does, not much more without precipitating a credit crunch, which means recession.
[8:18]
That’s why I’ve been predicting recession late next year, if the Fed continues raising rates. Which by the way is about half what it raised rates in 2008. Yeah, the Fed clearly raised interest rates to 5.25% in 2007-8 right into the obvious recession that was coming. And then of course, the financial crash exacerbated that, big time. Yeah, 5.25%. It won’t even get anywhere near that and the same thing’s going to happen this time. Because of changes in the economy and the overhang of massive debt, particularly corporate debt that exists in the US economy.
[9:00]
Ah but the Fed is pushing it (raising rates). Why is the Fed pushing it? Well because it’s got to attract borrowers for US Securities in order to finance the trillion dollar annual deficits that Trump has created because of his massive tax cuts, defense hikes, and other policies. The Fed is raising rates to fund the deficit and the debt. Which is going to be over $10 trillion dollars over the next decade, on top of the $21 trillion we already have. That’s why the Fed is raising rates. That’s why the dollar’s going up. That’s why Emerging Market Economies (EME), are going, their currencies are going down. And of course, Turkey is at the forefront of this collapse, 40%.
[09:54]
But there’s other country’s currencies that are not too much further off. You know Argentina down 30 some percent, forced Argentina to go get a loan from the IMF. Well, Turkey doesn’t want to get a loan, because if you get a loan from the IMF, the IMF says, “Okay, it’s austerity time, go squeeze your work force and your small businesses and average folks, hmm, raise your interest rates, create a recession.” Well, Argentina’s already in a recession, its GDP collapsed 6% the latest data. But they don’t care because these are the financial speculators under Macri government there, who took over that government with the help with the US, you see. And they’re just enriching themselves.
[10:48]
Okay, so it’s not just Turkey, you know, there’s Argentina, there’s South Africa, there’s Brazil, other major economies, Indonesia, India showing trouble with their currencies.
[11:06]
So raising interest rates in the US has this major impact on currencies. And that includes, China. Although the impact of the rising dollar under China is not as serious as on these other economies. But nonetheless, its forced the Chinese currency, the yuan, the renminbi, whatever you want to call it, uh, out to the edge of the band in which China allows its currency to fluctuate. In other words the devaluation edge of the band. And uh, Chinese central bank, The People’s Bank of China has been buying up the yuan/renminbi in markets, global markets, to keep it from devaluing further.
[11:57]
Well, as rates continue to rise it’s going to be harder and harder for The People’s Bank of China, its central bank, to continue purchasing, to prevent a devaluation. And at some point that devaluation is going to break out of the band. When that happens, the psychological awareness of,”Uh-ohh, even China’s currency is devaluing,” not just Turkey, Argentina, and so forth, that’s going to have a big psychological effect around the world.
[12:27]
A currency war. Yes, it will precipitate a currency war. I recently written on that, check out my blog, jackrasmus.com. And, what may push it over the edge there in China is Trump’s trade war with China. He’s trying to bully China like he’s done with all the rest of the trading allies, and they’ve pretty much conceded, and come hat in hand to Washington. He’s getting what he wants from them. Including Mexico and Canada very soon before the election, I predict.
[13:04]
But China’s another story. He’s not going to have it so easy. And China’s doing a tit-for-tat tariff response. But uh, China can only do so much tariff response because it doesn’t purchase that much from the US, compared to the US purchasing from China. So China’s gonna have to, if the trade war continues, if Trump keeps driving the trade war with China, China’s going have to respond in other ways. And I predict it’s #1 way is just let its currency devalue. You see, it doesn’t have to declare a devaluation, it just as to stop intervening in global market to keep the yuan from further devaluing. They say, “Well you know, this is global markets, we’re following the markets. We want to be a market society here, US, and there’s a, you’re putting pressure on us to follow the markets, that ‘s all we’re doing.” You see so, all they have to do is not intervene and the yuan will devalue. And then all these other currencies will devalue and faster.
[14:12]
But, let’s get back to Turkey, alright – 38% collapse. Well, is that all attributed to the dollar? No, the dollar’s a big part of it, set if all off. But global speculators pile in, you see, financial foreign exchange currency speculators. You know, hedge funds, and all those guys. Whenever they see a significant move in a price of any kind, and this is a price of a currency, the exchange rate, they jump in and they short it. In other words, they bet that it’s going to fall even further. Which drives it down even further.
[14:57]
And that’s what’s happening here. Global speculators are jumping in now and shorting the Turkish lira, which is causing it to decline even further and faster. On top of that Trump is fanning the flames of the whole thing. Well, how’s he doing that? Well, he just put more tariffs on Turkish steel, and I don’t know if they have aluminum, but uh, more tariffs on that (steel). And uh, in the press what you see is, “Oh, he’s making this demand that Turkey release this, uh, Christian pastor.” I forget his name, back to the US, release him. What Trump is doing is using the crisis in Turkey and its currency, is to leverage some political domestic appeal with the evangelicals in the United States. They want that pastor released, so, he’s willing to create a foreign relations issue in order to pander to the evangelicals in the US
[16:11]
But you know what’s really behind it is the US is sending a signal to Turkey, “Ah, you’re getting too close to Russia. You know you’re buying Russian, Russian military goods, you know, anti missile missiles, and uh, we don’t like that, you gotta buy it from us.” Well, Turkey says, “Russia’s cheaper, and besides, your CIA tried to throw me under the bus, pull off a coup, so why should I buy it from you, I’m going to buy it from Russia.” The US says, “Well, we don’t like that, and you’re getting too close to Iran, Turkey.” Erdogan is the president there, “Erdogan, you’re getting too close to Iran, we don’t like that, and you’ve gone to China to borrow from China, no, no, you’re supposed to borrow from the US, even if it costs more, you’re supposed to borrow dollars.” Well they have been borrowing dollars, and that’s part of Turkey’s problem. Most of their debt is rolled up in dollarized debt. They’ve been borrowing from the west, particularly US banks and European banks in order to finance their economic development. Which has been pretty aggressive. But they’re loaded up with debt right now, you see, dollarized debt.
[17:31]
Those Emerging Market Countries that are heavily, heavily exposed to dollarized debt, borrowing in dollars, are those whose currencies are collapsing the fastest. Because the dollar is rising. You see, when you have debt, and the value of the, the cost of the debt rises, right, and your currency is falling, you gotta spend even more of your currency to service that dollarized debt. In other words, service meaning paying the principal and interest. The cost is going up, but your ability to pay for it, in your own currency, is going down as your currency declines. So, what you gotta do is borrow even more to pay the old principal and interest. You know, and if the US doesn’t like your policies they simply prevent you from borrowing more, and then your economy collapses. And whoever is in power politically collapses.
[18:37]
That’s one of the ways, one of the many ways that the US exercises economic imperialism. The dollar is a weapon, a big weapon, and global interest rates that influences is a big weapon. Trade is another weapon, and the US employs these weapons very cleverly. And that’s what’s going on in Turkey, here. So this big global geopolitics behind this, uh, release this pastor appeal to the evangelicals, where Trump gets two bites of the apple then, right? And he fanning the flames, and the global speculators, hedge fund guys are jumping in and fanning the flames of the currency collapse. And then if the currency collapses, well then, inflation rises. Because most of these other Emerging Market Countries have to buy, in other words through imports, many essential staples. And if the value of their currency is down, well then, the cost of those staples goes up. You know, often times this is food stuff, this is medical supplies, etc.
[19:54]
You can see the very extreme impact of this in Venezuela. Where the US has essentially, for several years now, shut off Venezuelan access to dollars, and inflation has gone through the roof. That’s all part of destabilizing that economy there, which has really been destabilized significantly. But it’s all, you know, it’s about the US manipulating currency and so forth. Because the dollar is the global trading currency. You can buy anything with dollars, right. I mean, who wants to take Argentine pesos for their shipment of medical supplies to Argentina when Argentine pesos are collapsing in value. Well, you’ll just take a loss if you sell and allow them to buy in pesos. But uh, “Okay, Argentina, you want the medical supplies, well then you pay in dollars.” Well then, Argentina has to go out and buy the dollars with a collapsing currency, hmm. And if it doesn’t have enough dollars, what does it do? It goes to the IMF and says, “Give me some dollars, IMF.” And the IMF gave Argentina $50 billion. But, only with the understanding, it impose austerity, “Squeeze, and you pay us back, you squeeze it out of the rest of your populace.” And if you’re, you know, if you’re a big financial business man running Argentina, “Oh, that’s okay, as long as you don’t squeeze us.”
[21:27]
Okay, so Turkey perhaps has become the most indebted in terms of the most external dollar debt, than all of these Emerging Markets. Its borrowing dollars. Now that’s the key, because where did it borrow it from? Ah, from European banks and US banks. Banks got the dollars, that’s where they borrowed it. And, heavily from Italy, and Italian banks. Yes, the UniCredit, BVB, and a couple others there are really exposed to loans to Turkey. And if Turkey cannot pay the principal and interest on those loans then those Italian banks, UniCredit and others are in deep trouble. Well, they’re already in deep trouble, the Italian banks. They already have a half of a trillion dollars of non-performing bank loans from the crisis since 2008. A half a, $500 billion of non-performing. Non-performing means, they gave out these loans, usually to Italian companies and other companies, and they’re not paying it. Whoever borrowed it is not paying the principal or the interest, or both. So, they are non-performing they say.
[22:51]
Well, a lot of those loans from Italian banks, also were made to Turkey. So if Turkey collapses its currency, then it can’t pay its principal and interest on its Italian bank loans. Well then, what happens to Italian banks? Well, they’re in trouble, and the signs of their trouble is the collapse of the stock values of the Italian banks. And that’s going on right now!
[23:21]
So, this thing in Turkey, if it continues, and gets worse, will result in defaults in the big Italian banks. And that can have a bigger contagion effect. We’re talking about contagion effects in this Turkish situation. Now it spills over to European banks. Well you see European bank stocks declining here, and European stock market, and US stock market to some extent to. Because, probably City Group is exposed here. Alright, so other European banks, you see, the financial system is linked. They are all linked together. That’s why you get such contagion in crisis situations. One node in the contagion network, here, can’t service his debt, and that means the debt and losses are transferred to whoever it can’t pay. And then they can’t pay somebody else, and they can’t pay somebody else, you see, it just spills over.
[24:40]
The key problem here is the massive amount of dollarized debt that Turkey borrowed from the US and Europe that has to be repaid in dollars with a currency, the lira, that is collapsing. And it’s all traceable back to the Federal Reserve, the US Federal Reserve raising interest rates.
[25:09]
Now Turkey has, you know, massive, hundreds of billions of dollars in dollarized external debt, that has to be repaid, and with a collapsing currency. And one third of this debt that Turkey is due for payment next year – roll over. It has to be rolled over. In other words, rolled over means, you borrow even more to pay the old principal and interest on the old debt. That’s what they mean when they say ‘roll over.’ Hmm. Well, what banks, global banks are going to give Turkey anymore money to pay off its own debt when its currency’s collapsing? Not many. But that forces them to go to, IMF. Ah but, Turkey doesn’t want to go to the IMF. Turkey did that, went through that ringer about 15 years ago, as a lot of countries did, after 2001, and got stuck with IMF. And had to give up much of its national production to pay off the IMF. They don’t want to get stuck in that.
[26:20]
Now the Argentine, the Argentina finance capitalists, they don’t care, you know. As long as they protect their interests and value of their investments, they’ll squeeze the Argentinians, which they are doing. Same in Brazil. You know, they’re a bunch of bandits. They destroy their own economies, but they don’t care.
[26:44]
So in order to borrow more money, Turkey has to raise what it will pay in terms of interest, and, right now its bond rates are at 20%. In other words, buy Turkish bonds and Turkey will pay you 20% interest. As the currency collapses the bond rates go up and that’s when the speculators jump in, you see.
[27:20]
Turkey’s external debt, as we call this, the dollarized external debt, is 53% of its GDP. As I said, 1/3, has to be repaid next year. Well, Argentinas is 37%, South Africa 50%, Brazil 33%. That’s why these are the currencies that are collapsing, you see. Because interest rates are rising. The debt they borrowed, the massive debt they borrowed has to be repaid in dollars, and their currencies are declining. And that forces them to raise interest rates, and that causes them, domestically, that causes a deeper recession, you see.
[28:05]
So, you can trace this thing all the way to Trump. US deficits, a trillion dollars per year, gotta raise interest rates. Raise the interest rates, dollar goes up, currencies elsewhere go down. They have to raise their interest rates – deep recessions. And it all begins in Washington. Trump is depressing the rest of the world economically.
Dr. Jack Rasmus @drjackrasmus
Jack Rasmus 
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