In less than a week, the Australian dollar has fallen nearly two US cents against the US dollar as Donald Trump’s decision to impose higher tariffs on Turkey’s steel and aluminium exports to America has destabilised an already-vulnerable economy and sent shockwaves throughout emerging markets.
Those waves have also had an impact on developed world economies as investors have defaulted to a cautious, "risk-off" stance while waiting to see whether developments within Turkey - an economy that represents only about one per cent of global GDP - really do have wider and threatening implications.
It might seem incongruous that global markets might be so concerned about the state of an economy that barely registers on international investors’ radars, and to which international investors have a very modest exposure.
There are a number of strands to the reason why Trump’s imposition of tariffs – as leverage to force Turkey to release a US pastor accused of backing a coup attempt against Turkish president Recep Tayyip Erdogan two years ago – should roil markets well beyond that struggling state.
A key reason is that Turkey’s underlying economic problems – high debt levels, high inflation and soaring interest rates – were being exacerbated by its exposure to short-term foreign currency-denominated debt even before the Trump move.
And it wasn’t alone. Since April, the US dollar has appreciated by about 8 per cent against its major trading partners. Over that period, the Australian dollar has fallen nearly US6 cents.
Super-charged by tax cuts
That surge in the greenback is probably due to a number of factors. One is the strength of the US economy, super-charged by the Trump tax cuts. Another is the tightening of US monetary policy, via both steady rate rises and the shrinking of the US Federal Reserve Board’s balance sheet.
The Trump administration’s use of tariffs as a multi-purpose weapon and the impact it is having, or might have, on China and the emerging economies and resource economies that are part of China’s supply chain has been layered over factors that by themselves would have resulted in a stronger US dollar.
A stronger greenback, even as the Fed is accelerating the unwinding of the legacy of its buying of US government bonds and mortgages during the financial crisis, means the US currency is becoming both more expensive, and less available.
That’s a particular problem for emerging market economies whose governments and/or private sectors borrowed heavily, and ultra-cheaply, in US dollars in the post-crisis era when the Fed was hosing the globe with cheap dollar-denominated liquidity.
The economic crisis that has developed in Turkey has added to the concerns about the dual impact of escalating global trade tensions and a stronger US dollar on emerging market economies. The currencies of Argentina, Thailand, South Africa, Indonesia, Brazil, Mexico, Poland, Russia and India have come under selling pressure as investors, fearing a form of contagion, have retreated to the perceived safe haven of the US currency.
Ripples from Turkey
In the last 24 hours or so, with Erdogan’s Treasury and Finance minister – who's also his son-in-law – pledging to defend the Turkish lira, there has been some respite for both the lira and other emerging market currencies. The lira is, however, down about 40 per cent for the year against the US dollar and had been down 25 per cent in a week before a slight recovery on Tuesday.
The extent to which the ripples from Turkey’s challenges can be felt around the world highlights the potential destructive force to economic and financial stability coming from the combination of a global economic recovery which isn’t synchronised and the Trump "trade war on everyone".
The US is much further along that path than other major economies and its monetary policy is being normalised even as Europe and Japan maintain crisis settings.
That has resulted in an interest rate differential that will continue to widen (and be exaggerated by the blow-out in the US government’s deficits and borrowing requirement as a result of the Trump tax cuts and spending increases).
In turn, that will continue to push up the relative value of the US dollar, imposing pressure on economies with large exposures to US dollar-denominated debt.
It is an issue that has pre-occupied some of the global financial agencies, who have been concerned about the potential for an emerging market financial and economic crisis because of the divergence between conditions in the US and developing economies.
While most of the concern about Turkey’s developing crisis relates to its global implications, there are some potentially more direct and tangible impacts on the wider European Union.
Italy’s biggest bank, UniCredit, Spain’s BBVA and France’s BNP Paribas all have substantial interests in Turkish banks. There are a lot of foreign currency loans in Turkey’s banking system and therefore a risk that the collapse in the lira could cause a wave of loan defaults.
Given that the European banking system isn’t as robust as, say, North America’s (or ours) – the Europeans didn’t respond as decisively to the crisis as other systems – there is some potential for the problems in Turkey to be exported through the EU system, although neither that potential nor its impact on the EU should be overstated.
Stephen is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.