Outbreak: Turkey’s Financial Crisis Could Spread to Europe
If you’ve been following along with Venture Society the last few weeks, you’ve probably started to see some themes emerge.
I’ve written about Europe printing huge amounts of money to fight knock-on effects of COVID-19…
We’ve talked about how China is manipulating its trade data to mask bigger problems.
Some articles discussed how we’re seeing the effects of these economic events in strong precious metals prices…
… and how those effects sometimes need a good long while to develop.
Yet at other times, they can ramp up strength rather quickly.
The thing to really take home, though, is that for every unexpected problem that arises, people – individuals, governments, corporations, etc. – will react in what they think is a rational fashion.
And those reactions – usually monetary or fiscal ones – have consequences…
…some of which could be serious.
My Venture Society colleague Marin Katusa calls these consequences “financially transmitted diseases” – or “FTD’s”.
And once we lay out just how tangled the international financial system actually is, that description will start to make a lot of sense.
Because we almost unraveled from these consequences once before. It started in such an unassuming place that the world wasn’t prepared to prevent it.
And believe it or not, we’re still feeling its effects today.
Erdogan to Talk About History, But I’m Gonna
The event I’m describing above is, of course, World War I – set in motion by the assassination of Archduke Franz Ferdinand by Yugoslav nationalist Gavrilo Princip.
It was largely believed at the outset of the conflict – and laid out in the London magazine United Empire – that the war’s length and human cost would be determined by “the amounts of coin and bullion in the hands of the Continental Great Powers at the outbreak of hostilities”.
In other words, these great nations would never be able to continue fighting each other if they didn’t have secured funding.
As Pulitzer Prize-winning author Liaquat Ahamed put it in his fantastic book Lords of Finance, the “experts seemed to have forgotten that among the first casualties of war is not only truth but also sound finance”.
That phrase is as true today as it was then, and the conflicts currently raging around the world are eventually going to prove it correct – come hell or high water.
And the one conflict on which I’m keeping a really close eye is taking place in Turkey, where the personal ambitions of Turkish President Tayyip Erdogan appear to be at odds with the country’s economy.
Interestingly, those ambitions all tie back into retaking land ceded by the Treaty of Lausanne – which carved out the Republic of Turkey at the end of World War I.
In other words, Erdogan ultimately wants to recreate the Ottoman Empire.
Turkey Shooting
The primary reason – other than personal and patriotic glory – that Erdogan wants to do this is because much of the land ceded has religious and monetary value beyond just its territory.
The area – circled in blue on the map below – is incredibly rich in oil and gas.
Source: JODI
The British took control of Mosul and Kirkuk (now part of Iraq) in 1921 – a move that the Treaty of Lausanne made permanent a couple years later.
And with Kurdish forces in northern Iraq now weakened by nearly two decades of US occupation and battling ISIS, Erdogan has seized the opportunity to attack, flying sorties over the region on a regular basis.
In addition, Erdogan struck a deal with Libya’s Government of National Accord, or “GNA”, led by General Khalifa Haftar that gave Turkey grounds to block the construction of natural gas pipelines planned to connect Greece, Cyprus, and the Eastern Mediterranean with the rest of Europe.
In exchange, Turkey promised to provide military aid – potentially boots on the ground – to the GNA, currently mired in a Civil War with the Libyan National Army, which controls the eastern half of the country.
Source: InvestigativeJournal.org
The problem is, that has drawn sharp criticism from other neighboring countries – Greece and Egypt in particular, as the claim laid out above encroaches on both nation’s Exclusive Economic Zones (EEZ).
Complicating matters further, the opposing Libyan National Army’s forces are backed by Egypt, France, UAE, and Russia – with the last one providing on the ground military personnel and equipment.
That’s a lot of countries to fight with.
And if we learned anything from both World Wars, it’s that fighting gets expensive… fast.
So, while Erdogan would certainly like access to these oil-rich assets – and the US Dollars that would accompany them – it’s not clear that Turkey can afford it.
At the start of April, the country had $172 billion in debt payments coming due over the next 12 months.
Gross foreign currency reserves, however, stood at just $89.6 billion.
And that even includes all the gold reserves Turkey had purchased on the open market since Q3 2017.
Source: Central Banks, ICE, IMF, World Gold Council
Worse, a large portion of Turkey’s debt is denominated in US Dollars. And without an active swap line with the Federal Reserve – not to mention a serious COVID-related slowdown in trade – there’s no way the country can access that much in foreign currency reserves that soon.
Source: Bank of International Settlements
That shortfall will have to be financed by someone, however.
And given that Turkey has flat-out refused direct assistance from the International Monetary Fund, exactly zero people have a clue as to who that is going to be.
As the Lira continues to weaken versus the dollar, the likelihood of a sovereign default rises exponentially.
Source: Bank of International Settlements
You know, kind of like the pandemic.
Infection Detection
So, Turkey’s sovereign debt is in an enormous amount of trouble – that’s just a given at this point.
But the important thing we need to realize now is that every lira or dollar of debt that Turkey issued is owned by someone else – be it a person, a bank, a hedge fund, a PE shop, etc.
And one day soon, that someone else is going to wake up and realize that debt is completely worthless.
And while all those “someone elses” will be spread all over the world, there’s one place where they are far more likely be located.
Europe.
Source: Bank of International Settlements
Moreover, this crisis is evolving at an incredibly curious time for “the Continent” – and for currency markets – as hedge funds currently register the largest speculative net long position on the Euro in history.
Source: CFTC, Hedgopia
Because of that, when this virus of a debt bomb finally goes airborne, it is highly likely to unwind this trade… and I want to be there with my catcher’s mitt when that happens.
I’m going to do that by picking up another ¼ stake in ProShares UltraShort Euro ETF (NYSEArca: EUO), as well as a ¼ tranche in Proshares Ultra Gold (NYSEArca: UGL) which corrected a little this week.
In addition, we can go ahead and sell the ½ stake of Teucrium Corn Fund (NYSEArca: CORN) we picked up on Tuesday. The WASDE report showed stellar crop yields as expected, but the storm moving through the Midwest did a ton of damage, and shares are up a little under 5%… not bad for two days.
In the meantime, I’ll likely spend the weekend gearing up for what is sure to be an interesting next week, as we get a deluge of economic data releases.
Hopefully, those results for consumer sentiment, manufacturing, housing, and mortgage delinquencies will show us that the global outbreak of financially transmitted diseases has slowed.
But given how most of 2020 has gone, let’s just say I’m setting the bar pretty low.
That way, at least I can access the bourbon easier (ba dum, tsssss…)!
All the best,
Matt Warder
