The Turkey Crisis: Part I

Over the past few months, Turkey has become a major topic of interest. Recep Erdogan won re-election to the presidency in June 2018. This event was important because a referendum on a new constitution in 2017 gave the office of the president sweeping powers; the previous constitution was based on a parliamentary model which gave more power to the prime minister. According to the referendum, Erdogan could only exercise these new presidential powers after winning a new election.

Even before the election, there were signs the economy was overheating. Inflation was increasing and the central bank was not raising rates in a manner consistent with quelling the inflationary pressure. Since the election, an economic crisis has developed, with falling financial asset prices and a sharp decline in the Turkish lira (TRY). In addition, Erdogan has found himself in a contest of wills with President Trump over Americans detained in Turkey. This has led to punitive trade tariffs and threats of additional sanctions.

The goal of this report is to place the current crisis within the context of Turkey’s evolution and development. Part I will examine Turkey’s geopolitics and history. Part II will discuss economic factors, including the impact of foreign debt on Turkey’s economy and financial system. We will highlight the impact of the 2016 coup and analyze the causes of the current crisis in Turkey. From there, we will offer a discussion on the debt problem and Turkey’s options for resolving the crisis. As always, we will conclude with market ramifications.

Geopolitics and History

The key to understanding the geopolitics of Turkey rests on understanding the region around Istanbul.

(Source: World Atlas)

The original Turks who inhabited the area came from central Asia and settled on the land bridge that separates Europe and Asia. This land bridge straddles the Black Sea and the Sea of Marmara, which empties into the Aegean Sea. The Turks fully gained control of this area in 1453 with the capture of Constantinople (Istanbul).

This land bridge gave the Turks effective control of two seas, the Black and Marmara, along with the Bosporus Strait and the Dardanelles. The core of original Turkey was this land bridge, not the Anatolian land mass that is modern-day Turkey. By controlling the surrounding seas and plains, the Turks put themselves in the middle of regional trade and economic growth. From this base, the Turks pushed east to create a defensible space on the rugged Anatolian peninsula. The region is mountainous, making it hard to invade; at the same time, these characteristics make it difficult to conquer and control local ethnic and religious groups. But, as long as the Turks controlled the commanding heights, they could fend off potential invaders.