How the American troika created the EM crisis

Trump, the Fed, and Moody’s together made Turkey’s problems worse. Now contagion is spreading to other emerging markets.

At the height of the euro crisis, Greece was in constant conflict with the “troika”.

The troika referred to the European Commission (EC), the European Central Bank (ECB), and the International Monetary Fund (IMF).

The troika parties insisted they were doing everything they could to keep Greece from drowning. From the Greek point of view, the troika hung a millstone around its neck to make sure it would sink.

Thanks to (or in spite of) the troika, Greece received the last of its bailout money a month ago.

The euro is saved. Greece is saved. And the vultures can stop circling the Hellenic islands.

But they may not have to fly very far to find new prey.

No sooner had the European troika left the stage than a new troika emerged. This new “American” troika is putting the screws on Turkey.

The European troika managed to avoid Greece dragging down other countries like Spain and Portugal with it.

The American troika may already be too late. Contagion in emerging markets (EMs) is spreading like wildfire.

American troika

When Greece was in trouble and threatened to break up the Eurozone, three institutions formed a task force to keep that from happening.

A decision group was formed with representatives from the EC, the ECB and IMF. It was to decide on the fate of the Greeks and became known as the European troika.

Like three horses together pulling a Russian carriage (the original meaning of “troika”), three US bodies have now teamed up to bend an autocratic leader to their will.

This American troika consists of the US government, the Federal Reserve, and credit rating agency Moody’s.

The Turkish economy was already reeling when President Trump picked a fight with his Turkish counterpart (or President Erdogan picked one with his US colleague).

This fight with the world’s biggest power didn’t do the Turkish economy any good. Investors became even more alarmed.

Moody’s then piled on Turkey’s woes by downgrading Turkish debt.

New York Times columnist Thomas Friedman explained the impact of such a move back in 1995:

“You could almost say that we live again in a two-superpower world. There is the US and there is Moody’s. The US can destroy a country by levelling it with bombs; Moody’s can destroy a country by downgrading its bonds.

“Moody’s rates the investment quality of countries today just as it rates companies. Those that get their economic house in order will be rated AAA and be able to sell bonds at low interest. Those that that don’t will be rated C and have to pay pawnbroker interest rates.”

Credit rating agencies are political institutions like any other. Good or bad ratings can be given out depending on who’s asking.

Finally the Fed had begun hiking interest rates again. This posed a problem for Turkey in two ways.

One, it made debt denominated in US dollars more expensive. Emerging markets like Turkey happen to have a large amount of foreign debt and a lot of it is held in dollars.

Higher US rates make that debt harder to pay off. Investors get spooked, take their money and run.

The second way this hurts Turkey is because the Fed is giving investors a place to run to.

Bottom-rate interest doesn’t attract a lot of investors. They seek their fortune elsewhere (like emerging markets) to get a better return on their money. Higher US interest rates make the “safe” US market more appealing to investors again.

You could argue that the Fed is primarily concerned with the US economy and should act what benefits the domestic market, but that tunnel vision leads nowhere.

The fact is the US is a global superpower and the dollar is a global currency. Whatever the Fed does has an impact on the whole wide world.

If the Fed only considers what’s good for the US and pays no attention to the rest of the world, that head-in-the-sand attitude could come back to haunt it.

Turkey as the first domino

So to sum up…

The Turkish economy recently ran into trouble.

That situation wasn’t helped when Presidents Trump and Erdogan entered into a pissing contest, which led the US government to double tariffs on Turkish goods.

Not long after Trump had directed his ire at the Turks, Moody’s downgraded Turkish bonds. This caused even more investors to take their money and leave the Turkish market.

And the Fed hiking interest rates has made the debt of Turkish corporations held in US dollars more expensive.

That’s how the American troika worked together to exacerbate Turkey’s problems.

I’m the last person to defend a corrupt autocrat like President Erdogan. He’s not exactly blameless in the Turkey crisis. It’s a crisis of his own making.

But when Turkey started floundering, the American troika didn’t exactly throw the country a lifeline. It pretty much ducked it under water.

That may have been a mistake. Emerging markets are now submerging one by one.

Turkey’s currency, the lira, has already lost 45% of its value against the dollar this year. The Argentinian peso has fallen by 50%.

Now investors are selling any currency that starts with an ‘r’. Rupee, rupiah, rand, real, and rouble are all losing ground.

People in India, Indonesia, South Africa, Brazil, and Russia are rapidly becoming poorer in relative terms.

Reminds you of something?

In the late 1990s emerging market trouble quickly spread from Asia to Russia to Mexico.

Many other EMs, for example Argentina and Brazil, were affected as investors dumped the currencies of up-and-coming markets and fled to safe currencies like the dollar.

Investors tend to see emerging markets as a group, which leads to contagion. If one EM goes down, other EMs become particularly vulnerable to a capital flight.

It’s that infamous domino theory. If Turkey is the first domino and investors see it’s about to drop, they’re not sticking with the dominoes that are next in line.

The vultures that were circling Greece have now crossed the Aegean. How long before they’re headed our way?

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