Turkey found relief due to the recent actions of the Federal Reserve Bank. Today’s troubles, in the same way, will be because the Bank will alter its course of action.

The other day I had an hour-long conversation with a fund manager. He wanted to talk about the Turkish economy. But it did not turn out to be a full-fledged talk on economics. He had one simple question: “Would Turkey prefer a sharp depreciation in lira or a sharp increase in interest rates?” Choosing between a rock and a hard place. He did not ask what the Central Bank would do. He knew the score. Rather he asked what the government would do. That was his only question. Would you quietly watch the depreciation of the lira, or wimp out and immediately raise interest rates? He did not understand Turkey’s sensitivity about a rapid depreciation in the lira’s value. What was the reason for this unreasonable and non-economic sensitivity when price adjustments could settle the disequilibrium?

I have been thinking about this issue since our chat. Why does no one have confidence in Turkey’s economy? Why does no one like Turkey?

These days, we all have fixed our eyes on the exchange rate. The lira is depreciating against the dollar. Investors in Turkey that hold lira are racing to exchange them for dollars. The demand for the dollar is increasing, that for the lira is decreasing. As a result, the lira is depreciating against the dollar. Everyone seems to be a little nervous. But we have known since Seneca that it is fate that kills the gladiator, no matter how well trained he is. If you reveal that you are afraid, you will be heading for a fall.

Remember, just a short while ago we were worried about the appreciation of the lira. Unlike today, everyone was trying to exchange their dollars with liras back then. The demand for liras increased while that for dollars decreased. Under the free exchange rate regime, people who believe that the boiler can give birth, as in the Hodja Nasreddin story, also should be ready to believe that it can die, too. There used to be liquidity abundance in dollar terms. That is no longer. The US economy used to perform poorly; today, it is recovering. The abundant liquidity used to park in Turkey. Now it’s about to leave the parking lot. Turkey enjoyed the fruits of the global climate, but it is all over now. The boiler has died.

But why do people no longer have confidence in Turkey in this new climate? For starters, they never had it. Let me cite a figure. For a second, forget about the current account deficit to GDP ratios and take a look at the absolute deficit figures. You will see that Turkey, together with India, is among the top five in the world in terms of absolute current account deficit. The seventeenth biggest economy in the world has the fifth highest current account deficit in absolute terms. Here lies the cause of Turkey’s structural challenge. The US has the highest current account deficit, at around $750 million. India is third with $155 billion. Turkey is fifth with $100 billion. The US is in no hardship today. Turkey and India are.

People have confidence in the US, not Turkey. How is the US able to finance its current account deficit? It is because everyone invests in the US dollar and assets. Eighty-five percent of the US dollars in circulation are held outside the US. This is how the US reaps foreign savings. In the early 1990s, 50 percent of the dollars in circulation were 100 dollar bills. In the first decade of the 2000s the ratio reached 67 percent. Lately, it has increased to 78 percent due to the crisis. The entire world has confidence in the US and the US dollar. But not in Turkey or the Turkish lira. They therefore switch from the lira to the dollar.

To solve the current account deficit problem, Turkey first must give confidence. Second, when you check the international investment position, you will see that more than 50 percent of Turkey’s foreign exchange liabilities are composed of short-term funds while in 2009 the share of short-term funds was one-third.

Why would an investor prefer to make a lira investment under a short-term contract? Evidently to renegotiate the terms and conditions of the investment contract easily. The short-term fund is an investment method that has high maneuverability and bargaining power. If the confidence in an economy is weak, it is only natural that investors prefer instruments that will further thier bargaining power.

A change in the direction of the Federal Reserve Bank of the US will increase global uncertainties and increase global price volatility. Turkey found relief due to the recent actions of the Federal Reserve Bank. Today’s troubles, alike, will be because the Bank will alter its course of action. There is no need to be upset. Price adjustment takes place, though a bit tumultuously. There is a structural issue considering the short-term. What is to be will whether you melt down your reserves or insistently raise interest rates. Price adjustment is good, indeed.

This commentary was published in Radikal daily on 23.08.2013