The Turkish Tragedy | Financial Times

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Türkiye and emerging countries

Recep Tayyip Erdogan believes that interest rate cuts will help stabilize the Turkish currency and control inflation. He's wrong. Here is the lira against the dollar since 2014, the year he became president of Türkiye (this and the following charts use data from Bloomberg):

The red circle shows Turkey's recent currency crisis, which follows the central bank cutting interest rates to 15 percent (up from 19 percent in September) and Erdogan giving a combative speech on Tuesday that devastated global finance.

This is how investors in Turkish stocks behaved in lira and in dollars:

Given the lira's devastation, it is remarkable that hard currency investors have lost only half of their money in Turkish stocks. But the situation is desperate for the nation and something must be done. A central bank statement on Tuesday suggested the government may intervene in foreign exchange markets to support the lira, but it does not have the reserves to do so on a significant scale.

Edward Glossop, emerging markets economist at Abrdn, told me that the basic options currently are interest rate hikes and capital controls, but Erdogan's belligerent tone suggests that rate hikes are unlikely. “Soft touch” capital controls, such as: Other steps, such as converting hard currency deposits into lira within a certain time frame, can be the next step. Edward Al-Hussainy of Columbia Threadneedle, however, argues that interest rate hikes are becoming more likely by the day.

The good news – for everyone but Turks – is that the crisis was caused primarily by bad policies unique to Turkey, and there are few channels for it to spread elsewhere. As Capital Economics' Jonas Goltermann summarizes, Turkish imports are not so important globally that their collapse would cause major external damage; foreign investment in Turkey has become a small part even in emerging market-focused portfolios; and the chaos in Turkey is unlikely to make investors fearful of possible crises in other markets, because everyone knows how uniquely bad Ankara's policies are and how uniquely vulnerable its currency is.

But that's not all, as the stronger dollar and the prospect of US monetary policy tightening are making the situation worse. Over the last decade, the value of EM assets (stocks, bonds and currencies) has become increasingly sensitive to capital flows from developed countries and therefore to the looseness of developed countries' fiscal policies. Here are 10 years of the MSCI Emerging Markets Stock Index compared to the Goldman Sachs US Financial Conditions Index, which tracks interest rates, dollar strength and stock market valuations:

This is a strong relationship. What is notable, however, is that US financial conditions have eased this year and EM assets have not strengthened. This is due to two factors: inflation and the chaos in China, which accounts for about a third of the MSCI EM index. Here are the S&P 500, the MSCI EM Index and the MSCI EM Index with China deleted last year:

In the first half of this year, emerging markets excluding China outperformed U.S. stocks; Reflation and the associated increase in raw material prices provided a seemingly ideal environment. But in June, when inflation really heated up, the ex-China index started trending sideways, and last month, as the dollar strengthened, U.S. stocks surged.

Emerging market central banks cannot afford to deal with inflation the way the US can. They need to smother it quickly by increasing the growth rate, and outside Turkey most have done so.

US monetary tightening comes at a terrible time for Turkey – and a bad time for emerging markets in general. Not surprisingly, EM assets are underperforming. What remains a bit of a mystery, however, is the behavior of risky assets in developed countries. With the exception of a few super-speculative stocks, they act as if tighter policy won't hurt them at all.

Bitcoin ETFs: a terrible product that's doing well, thanks

Unhedged is not a fan of the Bitcoin exchange-traded funds. They are opaque and expensive. The Securities and Exchange Commission's Fraud Concerns Mean Bitcoin ETFs Are Really BitcoinFuturesETFs incur high “rollover” costs as expiring futures contracts are sold and expensive new ones are purchased.

It didn't take a genius to see this when the products debuted, and now it's brutally obvious. As Steve Johnson reported in the FT on Monday, only three Bitcoin futures ETFs have actually launched, compared to about a dozen that have filed with the SEC. Invesco ETF boss Anna Paglia said the following after Invesco shut down its own Bitcoin offering:

"We ran a number of simulations and the cost of rolling the futures created resistance of 60-80 basis points [a month]. We're talking some big numbers, 5-10 percent annualized. It wasn't a simple vanilla replication of the [bitcoin] index."

On the other hand . . . who cares? Bitcoin! About $1.6 billion has flowed into the first three Bitcoin ETFs - ProShares ($1.5 billion), Valkyrie ($57 million) and VanEck ($3 million):

We asked Valkyrie CEO Leah Wald what's going on. She told us that demand comes from both institutional and retail investors, but for different reasons.

For institutions, an ETF provides tax-free Bitcoin exposure through retirement accounts where it is impossible to hold Bitcoin yourself. The ETFs also help investors avoid having to deal with hassle cryptocurrency exchanges or custody issues. We think this is bad – simplicity masks risk – but it is logical.

When asked why retail investors shouldn't just buy from Coinbase or Robinhood and avoid the rollover costs, Wald pointed out the costs associated with trading crypto directly, including:

• Potential tax events with each purchase or sale of a cryptocurrency (tax policies are ambiguous here);

• Blockchain transaction fees;

• exchange withdrawal and transaction fees;

• Custody and/or wallet fees.

According to Wald, some of these costs are not transparent and could be baked invisibly into the spread of a Bitcoin trade. So, savvy Bitcoin investors can assume that the ETF route is actually more cost-effective than buying spot Bitcoin.

Even if you buy this line (we're not sure), this isn't a positive pitch - it's just an argument that owning physical Bitcoin is also costly. The success of Bitcoin ETFs, if sustained, amounts to a nasty criticism of Bitcoin itself (Ethan Wu).

A good read

OK, OK, maybe Team Permanent is right about inflation.