Trade Deficit Is the Last Fundamental Problem

Submitted by David Ryan (United States), Dec 31, 2021 at 00:28

Inflation is too much money chasing too few goods. This is usually caused by government deficits covered by issuing more currency in response to government needs rather than economic need. Turkey ran government deficits through 2020 before austerity measures brought a surplus in 2021. That is a step in the right direction.

Interest rates are used to move currency between savings and circulation. A surge in inflation in 2018 led to raising rates from 8% to 24% which had some impact in lowering inflation by taking money out of circulation. The problem then moves to government deficits soaring to pay more interest. But high interest rates only hide inflation while damaging economic growth.

Lowering interest rates moves money from bonds to currency. This "unhides" inflation from previous government spending. This can be disrupting in the short run. Turkey's big problem is that there is no government debt in lira but almost $450 billion denominated in US dollars. Lira devaluation makes this debt harder to service and pay. And it is all foreign debt from decades of trade deficits.

The US controls its inflation in the longer run by exporting US dollars in trade deficits and getting other countries to hold that money out of circulation by paying higher interest rates than they do. Turkey can't do that because its foreign debt is in dollars, not lira. So Turkey can only use local holdings to control the value of its currency, which makes for wide swings on small changes.

Erdogan has been right in cutting spending and running Turkey's first surplus. That done, he is probably right in the long run to lower interest rates to normal levels and "unhide" baked-in prior inflation. The final step is to reduce the trade deficit. This has been going on unevenly for 20 years. In the last month the trade deficit plummeted. So Erdogan may be on to something if he can make it through some short term pain and maintain fiscal discipline afterward so it isn't for naught.

Data referenced:
https://tradingeconomics.com/turkey/indicators

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