Turkey Maneuvers to Escape Its Dollar Trap

Geopolitical Diary

So far, President Recep Tayyip Erdogan’s plea for Turkish citizens and businesses to convert their foreign currency holdings, mostly dollars, into lira appears to be working. The value of the Turkish currency has climbed against the dollar this week. (CHRIS MCGRATH/Getty Images)

In Turkey, patriotism appears to be running deeper than profit motive. A number of major Turkish companies in the past few days have announced that they will heed President Recep Tayyip Erdogan’s behest announced Friday to convert their U.S. dollars to lira. The switch may help to shore up the Turkish currency, but it does not make a great deal of purely commercial sense. The list of businesses so far supporting Erdogan’s call by conducting some transactions in lira include the Defense Ministry’s Industry Support Fund, Turkish Airlines and various telecom operators. The experiment, which has also involved Turkish citizens, has resulted in, at least during the past three days, a sharp reversal of fortune for the lira, which has strengthened against the dollar to end a monthslong streak of depreciation.

The source of Turkey’s economic woes, along with various political and security issues, can be traced to its exposed position in relation to the U.S. dollar. Many Turkish companies hold dollar-denominated debts, which become more expensive as the dollar’s value climbs. And the course that Turkey is trying to set is being driven by necessity as the world’s reserve currency continues to gain strength. Several other countries have found themselves in a similar position, but perhaps none are as blessed as Turkey to have private sectors so flush in foreign money or so willing to spend it on bolstering the weakening national currency.

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With this in mind, the Turkish experience could be seen as something of a test case for how exposed countries might be expected to cope with the dollar storm if and when it hits them. Turkish officials have revealed that capital controls — limits on the movement of capital in or out of the country — which were the savior of Iceland in 2008 and various Asian countries during their 1997 crisis, have been discussed but discarded, at least for the time being. Another potential solution to Turkey’s conundrum, a sharp rise in interest rates, looks highly unlikely given Erdogan’s passionate aversion to tight monetary policy, a feature of his speeches on an almost daily basis.

Another of Erdogan’s suggestions has attracted much global interest, especially considering Turkey’s possible role as bellwether. On Dec. 3, Erdogan suggested that Turkey should conduct trade with Russia, China and Iran using their currencies. This would appear to be an attempt to wean Turkey’s economy off its addiction to the dollar — one it shares with the rest of the world, where the dollar holds almost complete dominance. The three countries featured in Erdogan’s proposal supply 25 percent of Turkish imports and account for 6.6 percent of its exports.

The dollar’s identity as the global reserve currency means that the world largely keeps its wealth as dollars. A decision by a country such as Turkey to turn its back on the dollar would thus come with immediate costs. Moving trade into the ruble, the yuan and the real would, by extension, increase the proportion of Turkish foreign exchange reserves that would have to be held in those currencies. Unlike the dollar, the ruble has a recent history of sharp devaluations, while the yuan is also on a depreciating course. A shift to local currencies increases the risk of a rapid loss of national wealth should those currencies collapse.

For a single country, or just a small group of countries, a move away from the dollar would create inefficiencies inherent from being outside the main pool of interactions that dollar trade represents. The calculations shift, however, if a large number of countries were to follow this path. The greater the number of countries that use their own currencies to conduct interactions, the less overwhelming the dollar’s power becomes, thus shrinking the pool from which those countries are excluded.

If that kind of movement were to pass a tipping point, a clamor might grow for an alternative currency to rise as the global reserve. Right now, however, there are few candidates that could supplant the dollar. The yuan is weakening and the trend in China is toward increased control over its currency, hardly propitious grounds for further internationalization. The euro was the favorite in 2001, but the odds that it will even exist in a few years are shrinking. The Japanese have never pushed the use of the yen, and the British pound’s best days are behind it. New technologies could provide alternatives, such as those based on digital ledger systems such as the blockchain, but those solutions cannot be adopted in the imminent future. In fact, if a large enough quorum of countries got together with the intent of ditching the dollar, the likeliest solution would be a renovation of the International Monetary Fund’s unit of account, the SDR (Special Drawing Rights), which could be rebooted as a global currency to replace the dollar.

That is the thought experiment, anyway: the playing forward of Turkey’s currency strategy not only to meaningful fruition in itself, but also through adoption by a sufficient number of other countries to change the global picture. Sizable barriers stand in the way of this outcome, not the least of which is the substantial resistance that could be expected from the United States, which undoubtedly would go to great lengths to preserve the dollar’s role. An immense amount of force would be necessary to overcome the inertia and evolve toward an alternative reserve currency. Still, the concept is another thread to be watched and considered as the global economy continues to shift.