Fed holding the key needed to save Turkey’s banks

Political reasons may explain why the U.S. Federal Reserve does not act as a saviour for Turkey’s debt-addicted fragile economy, as it did in 2008 for Europe, economics correspondent Jeff Spross said in The Week. 

The Turkish lira has dropped by more than 40 percent against the dollar since the beginning of 2018, while Turkish companies are saddled with more than $220 billion in unhedged, long-term foreign currency loans, according to central bank figures. 

According to Spross, there is no reason for America’s central bank not to save Turkey now, since as the lender of last resort, the Fed can always offer more dollars to countries struggling to repay their foreign currency commitments so as to improve their balance sheets. 

Similar acts of solidarity have happened between central banks before, Spross recalled, when, during the Great Recession, European banks intervened to ease the American housing bubble, pouring $6.5 trillion in credit into American mortgages and other financial instruments.

In 2008, when crisis hit European banks, the Fed launched its quantitative easing programme; the central bank purchased government securities or other securities from the market in order to lower interest rates and increase the money supply. 

The Fed also created currency swap lines in 2008, Spross said. “Basically, the Fed agreed to sell a foreign central bank a certain amount of U.S. dollars in exchange for their currency. Simultaneously, the foreign central bank also agreed to buy back its own currency at a future date, plus some interest,” he said.

The Fed could create similar currency swap opportunities for Turkey, Spross said, and this would neutralise the risk arising from exchange rate changes, as "the swap agreements preset the exchange rate at which the swap will be paid back,” while, if the Turkish central bank starts unilaterally lending in domestic currency, this would drive the value of lira even lower.

But Turkey has also engaged in a diplomatic row with the United States, over the detention of American citizens in Turkey. The U.S. government imposed sanctions on two Turkish ministers, while doubling tariffs on Turkish aluminium and steel. 

The two allies are also at odds over several other issues, such as the struggle against Islamic State in Syria, where U.S. support for Kurdish forces threatens Turkey’s security according to Ankara, and renewed sanctions on Iran. 

The reason why the Fed does not offer an easy way out for the Turkish economy is politics, Spross said, as “even at the height of the 2008 crisis, the Fed was picking and choosing who to rescue.”

“So why won't the Fed save Turkey? We may never know. Because as is, the Fed's massive powers remain hidden in a kind of black box, guided by a small group of technocrats for often obscure reasons, loaded with potential, but rarely used,” Spross concluded.