A simple lesson from Turkey for investors: rising authoritarianism is bearish

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Yesterday, the Turkish central bank cracked.

The Turkish lira has been collapsing in the past month or so, for reasons we’ll discuss in a moment.

In an effort to defend the currency, the Turkish central bank raised interest rates by three percentage points, from 13.5% to 16.5% (imagine paying that on your mortgage!).

Will that stop the slide? And if it doesn’t, what comes next?

Turkey’s currency woes

The Turkish lira has fallen by nearly 20% against the US dollar so far this year. It’s near a record low. And really that’s just the latest leg of a long decline. One US dollar will now fetch you more than 4.5 Turkish lira. Four years ago, it was less than 2.5. A year ago, it was around 3.5.

In short, the lira has fallen a long way in a pretty short space of time.

In the short-term though, the most recent havoc has largely been driven by Turkish president, Recep Tayyip Erdogan. He is up for re-election next month.

Erdogan has an odd grasp of monetary policy. He has said, consistently, that high interest rates cause inflation, which even the most contrarian analyst would be hard-pushed to argue. And as a man in the running for an election (even one that he is bound to win), he’s promising to spend more money.

Inflation is already running at 11%. More public spending plus a reluctance to raise interest rates would mean even higher inflation. That in turn tends to mean a weaker currency (because “real” – after-inflation – returns are low or negative) and the higher inflation goes, the higher the risk of full-blown economic crisis.

It also doesn’t help that Erdogan’s constant railing against interest rates and apparent desire to “take more responsibility” for the economy, makes investors worry about the central bank’s independence (which is a laughable idea in an authoritarian state in any case).

Hence the massive flood of money leaving the country.

Now the crash in the lira has got bad enough for the central bank to take action. The leap in interest rates yesterday followed an emergency meeting.

The lira briefly rallied, but this morning it has slid back again. And this is the problem.

If you remember earlier this year, Argentina had a similar issue. The peso was collapsing because investors were losing confidence in the central bank and the government’s willingness to make hard decisions.

As a result, interest rates were raised sharply. But the first move wasn’t enough. Argentina finally raised rates to 40%, and the government made an appointment with the International Monetary Fund. That’s what it took to stop the slide in the peso.

So don’t be surprised if the Turkish central bank needs to take more action before the market stops calling the country’s bluff.

The real lesson from Turkey – investors need to be wary of authoritarianism

What Turkey demonstrates more than anything else is the importance of governance.

In the developed world, we tend to take good governance for granted (perhaps less so these days in some quarters). When I say “good governance”, I don’t mean that our politicians are especially shining examples of public officialdom, or that we don’t spend lots of time moaning about them.

I mean that we take a certain level of civic standards for granted. Things like property rights – no one can take what’s yours without facing legal consequences. Low levels of public corruption – there might be a lot of bureaucracy, but you don’t have to slip anyone a backhander to get stuff done (not these days, anyway).

A right to a fair hearing in court, should that end up being necessary. The right to have the opportunity to vote on the people who are leading your country every so often. The basics of a free society.

We like to think that we’ve developed safeguards against these freedoms being eroded. We spend a lot of time worrying about that, and rightly so.

In developing markets, these elements of good governance are much more fragile, if they exist at all.

The past few decades have been good for globalisation. As a result, markets have been lulled into a sense of confidence that politicians will act in an economically “rational” manner. But the trouble is that the level of economic freedom required to operate as a functional part of a globalised economy is basically incompatible with authoritarianism.

Authoritarians and authoritarian regimes don’t like anyone telling them what to do. They’re obsessed with control: the economy, the weather, their fellow human beings.

Look at the comments sections on websites when anyone writes ill of an authoritarian regime – Russia is best known for this, but the same happens with many others, Venezuela in particular. The space under the article will rapidly fill up with defensive comments of varying inarticulacy.

The sheer amount of effort that goes into patrolling the internet to protect the egos of dictators is insane. It probably consumes enough energy to fuel a bitcoin-mining operation (which would be a lot more profitable). And it’s a complete waste of time.

That’s the problem with a craving for control. These are all incredibly complex systems. Even if you can force one bit to do what you want for a short period of time, then another bit will start freewheeling out of control.

That’s why the most authoritarian regimes in the world end up being entirely closed, dysfunctional economies. North Korea. Venezuela (described in 2014 as “socialism in action” by shadow chancellor John McDonnell, and now consigned by him to the dustbin full of countries where socialism has failed because it “took a wrong turn”). Cuba.

No single individual can plan an entire economy. So they end up shutting it down. Part of the problem is that they start with the assumption that there’s a fixed amount of pie, and it’s merely their job to cut it up more “fairly”. The pie is not fixed. It can grow. But unfortunately, it can also shrink (again, see Venezuela).

Anyway – my basic point is that authoritarianism makes for poorer economies and volatile markets. So if a country is moving towards authoritarianism rather than away from it, then be very wary of having your money there. And remember that progress away from authoritarianism is fragile and easily reversed – so monitor investments made in “improving” countries very closely.

What does this mean for your investments?

I certainly wouldn’t invest in Turkey just now. Indeed, if you forced me to choose, I’d rather invest in Argentina (although in reality I’d avoid them both).

One region of the world is looking more interesting in terms of opportunities that might arise as a result of a shift from authoritarian regimes – Africa. My colleague Matthew Partridge wrote about this in MoneyWeek recently – you can check out the piece here.