Dec. 29, 2021

E5: Bombing the Turkish Economy - Part 1

This is Part 1 of a 2-part episode on the Turkish economy and its ongoing currency/debt crisis. In this part, we will discuss the merits of theory and how they do or do not apply when exposed to reality. We will explore the advice of classical economic theory given to President Erdoğan and the reasons for why he does not follow it, religious aspects notwithstanding.

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Henri (00:00:00):

Today, we are going to kick off part one of what is going to be a two-part episode where we'll talk about the current economic crisis that's going on in Turkey and the controversy surrounding president Erdoğan's comments about his interest rate policies. In today's part we're gonna set the stage by delving into how competing economic theories attempt to explain the situation that's going on in Turkey. And then in part two, we'll explore what happens when these economic theories clash with the reality of the situation on the ground. To start off, though, let's listen to a succinct summary provided by Deustche Welle and their reporting on the current crisis. Let's have a listen.

DW Reporter (00:00:40):

Double-digit inflation and a crashing currency are turning the income and savings of millions of Turks to dust. The Lira has lost 50% of its value against the dollar since the beginning of the year, more than almost any other currency. Discontent is growing in recent weeks. Demonstrators took to the streets in Istanbul and Ankara, they called for the government to resign. Many lay the blame for Turkey's currency crisis on president Recep Tayyip Erdoğan. Every time he pressures the country's central bank and calls for interest rate cuts, the Lira plummets even further. Economists warn, inflation is spiraling out of control. And Turkish consumers are the ones who literally have to pay the price, but president Erdoğan hold the unconventional view that lower interest rates fight inflation. And despite the Lira crashing, shows no sign of changing his position.

President Tayyip Erdogan in DW report (00:01:46):

What we are doing might be politically very risky, but it's the right plan for our country and our nation.

Henri (00:02:00):

Come on. Don't Bullshit Me!

Henri (00:02:10):

Yeah, the economy slowed down, but you know, it's like telling someone, oh, you need to lose weight, but rather than then going on exercise and dieting, they chop off their legs. It's like, okay. Yeah, you reduced weight, but now there are bigger problems there.

Henri (00:02:25):

Welcome to "Come On, Don't Bullshit Me!", where we peel away the messaging of talking heads to get to the crux of today's issues.

Henri (00:02:45):

So one of the things that they teach us at the academy during military strategic studies is the flow from the academic Ivory Tower, if you will, of theory, the doctrine, to the strategy, all the way down to tactics, and more specifically, how each of them evolves along that chain of events. And there're countless examples of this throughout military history. All the way from Sun Tzu to modern day. But one of the big stories that stands out, particularly at the Air Force Academy is obviously of an Air Force general. And that was general Curtis Lemay, the father of the modern bomber force. And most people today know him as the father of the Berlin airlift, but there is a lot more to him than that in the Air Force. He's considered the father of SAC, the father of Strategic Air Command, which was essentially the bomber mafia.

Henri (00:03:42):

There there's an expression in the Air Force: fighter pilots make movies, but bombers make history. And while World War II was going on, the theory of warfare, which was being constantly tested because, you know, we're in the middle of a world, war was about how bombers should go and run their campaigns, right? So this is where the concept of strategic bombing came in, especially after the battle of Britain because the Germans, the Luftwaffe, pretty much destroyed all of the docks and the war making capability of the Brits after France capitulated. And according to some reports, there was a candid interviews of Churchill after the fact. But basically they were saying, okay, Britain was pretty much ready to capitulate and surrender to Germany right then and there, because the Luftwaffe was so effective in just completely decimating British war making capability.

Henri (00:04:39):

But then during that time, the British did a cursory bombing mission to Germany, and Hitler was obviously pissed off about, how dare the British come and reach out, and touch us, and bomb Germany. So he switched his focus. He ordered the Luftwaffe to, instead of bombing all the factories and the docks -- the British war capability, he said, we're gonna bomb London, the city, and bomb the civilians for their insulins of how dare they bomb the, the Fatherland, or whatever. Which actually allowed the British war making capability to recover. Because the Germans temporarily stopped bombing their factories, they were able to recover their war making capability and continue to fight. And obviously they didn't surrender. And then eventually, obviously the United States came in and tipped the tide. And while this was going on, they're like, okay, well now that the Germans decimated London, well now it's payback time.

Henri (00:05:38):

So the Brits were like, okay, we gotta go bomb Germans, but we need to figure out how we're gonna do this. Because obviously it's a, it's a difficult thing to do. And they tried to do... To bomb specific factories ball bearing plants, because that's the rules of warfare. What the hell are ball bearings, right? But those are the key components, and bombing the ball bearing pants basically grounded the German war fighting machine to a halt, because ball bearings were essential components in motors and engines and whatnot. So, but the Brits realized that their bombs were ineffective, right? Because this was obviously before the days of the GPS. So they were pretty much reliant on flying over a target, dropping the ball and then letting Isaac Newton's law of gravity do the work. And it wasn't really that effective, especially because they were trying to be high up because of the flat cannons and whatnot were a big threat to the bombers. Flat cannons are the AAA anti-aircraft guns. So to avoid or to minimize the damage from anti-aircraft guns, you would try to fly above the flat cannons so that you can get to the German factories. But of course being that high up then it's obviously it's harder to hit your targets. So that really didn't work.

Henri (00:06:57):

So eventually they decided, okay, well we're gonna do nighttime bombing runs, because at night it would be, figured, it would be harder to hit the bombers and, we're gonna be like lows to the ground, and basically instead of targeting factories, we're gonna put like a box if you will, over a city or a town and just bomb the shit out of it. Right? That's why most German cities are pretty modern architecture, because all in the nice ancient architecture with the wooden façade, the old like, you know, from like Hofbräuhaus comics, you know, those, those don't really exist.

Henri (00:07:37):

Except for actually there's interesting... Another side story. There was this one town right on the Swiss border. I forget the name of the German town. But obviously Germany, they're like once they realized this nighttime bombing was going on, they pretty much said, okay, everyone has to shut their lights off, right. But this one German town that was like right on the Swiss border, they actually, left their lights on. And then the Allies thought, oh, well this town has their lights on, so clearly they're not Germany. And like it's right on Swiss border so, oh this must still be part of Switzerland. So they skipped that. And I forget the name of the town, but if you go there now today, you can actually see how Germany looked like, at least German towns look like pre-World war II, because they were saved, because they successfully outsmarted the Allies by saying, oh yeah, we're totally Switzerland <laugh>.

Henri (00:08:26):

But anyway, so the Brits were basically, okay, we're gonna make a square instead of bombing individual factories and, based on the lighting of the towns, dump all your bombers into that square of the village and bomb the shit out of it. Like who cares if it's a factory or a civilian target. This is obviously the dates before Geneva conventions. So the Brits basically leveled entire towns.

Henri (00:08:50):

So the Brits would bomb at night. Fast forward to 1942: America has entered the war. And now there's this big thing where while the Europeans were fighting, the US was obviously neutral and we were doing our own thing. Like testing and R&D. So we developed this thing, called the Norden bombsight. It was this really super accurate bombsight where you can dial in your altitude and the wind speed. And then on the bombing ranges in the United States, even though you're like really high up, ridiculously high up based on what would be considered the flat cannon ceiling. And even despite flying above that ceiling with the Norden bombsight, you were like super accurate with the delivery of the bombs.

Henri (00:09:34):

So the Brits were like, Hey US, we're glad that you're part of the war effort, but we've been bombing the Germans, we've got like two years under our belt. We've got a lot of experience. So this is what we're doing, we're bombing at night. And we recommend you do the same thing. And the US being the cocky Americans that we are, we said, nah, screw it, we've got this thing called Norden bombsight. The Brits were like, what is it? Oh, that's classified. That's how, like, even though we shared things like Enigma code, stuff like that, amongst each other and breaking cryptograms and whatnot, the Norden bombsight was so top secret, that we didn't even share it with the Brits, the technology with the Brits. But we were like, yeah, we have this Norden bombsight, it's super accurate and we're not gonna do nighttime bombing. We're gonna do daytime high altitude precision bombing. And we can do that because we have this bombsight.

Henri (00:10:24):

And there's this big argument back and forth between British Air power theorists and the American Air power theories on what's a more effective bombing strategy: low altitude nighttime or high altitude daytime precision bombing.

Henri (00:10:40):

Long story short, Norden bombsight was shit, it didn't work. And we didn't really do that much damage. Because, turns out American, quote, "experience", was bombing ranges out in Arizona or whatever, desert conditions, no one's attacking you, nothing. So, <laugh>, we quickly realized that... Well we actually, we didn't quickly realize, we didn't realize shit. Well, actually we realized it, but we didn't accept it, basically saying, no-no, high altitude daytime precision bombing -- that's the way to do things, and we're gonna do it. And then, you know, post mortem, we figured out that, oh, we actually weren't as effective as we thought we were, because the testing conditions on a bombing range are completely different than actual war over one of the most powerful modern empires of human civilization.

Henri (00:11:32):

Anyway, the other funny thing was that during this whole debate of whether nighttime or daytime was more effective, rather than one side convincing the other of when and how to actually bomb, because both parties couldn't come to an agreement, each side, each party, decided to do their own thing. So we basically took turns: like the Americans would bomb during the day and then the Brits would bomb at night. And then the daytime would come and the Americans would keep going on and on. So the Germans never actually got a chance to breathe, because because of our own infighting, we were like basically constantly bombing them around the clock. Kind of like that.

Henri (00:12:14):

Anyway, other than this being an interesting story, we took these lessons... Well, actually, they weren't really lessons, because as far as we, the Americans, were concerned, daytime precision bombing was totally the best thing and this Norden bombsight was the greatest thing since sliced bread. So we're gonna continue doing this and we're gonna upgrade our B-17s, the flying fortress, which was the main bombing aircraft. And you remember the movie, "Memphis Belle"? The plane that they were fighting in the "Memphis Belle" -- that's the B-17. But anyway, so the new aircraft that they were building was B-29, which was the super fortress.

Henri (00:12:53):

And that one was this upgraded airplane, like the Enola Gay -- the bomber that dropped atomic bomb, that was a B-29 as well. But it was this super fancy aircraft where everything was computerized, computerized fire control system. So rather than having 10 people like in the "Memphis Belle" -- a crew of 10 -- essentially one person could control multiple guns on the bomber, on the aircraft. And the armor was up-armored to a point, where it said, okay, neither the anti-aircraft, nor the German fighters would be able to fire on it. So it was gonna be even more effective than that. And obviously it was going to be bigger and larger, and more capable. So you can even put more bombs on it, and what have you. So, all around, this was a pinnacle of American aviation technology -- the B-29.

Henri (00:13:44):

But by the time we got to be able to field it, well, the Germans already essentially surrendered, or at least there were close to surrendering. So there was not really no need for the B-29. So all that effort was for not. But obviously the Pacific war was still going on. So essentially all those assets were moved over to the Pacific and were used against the Japanese.

Henri (00:14:07):

And this is where Curtis LeMay, this really came about his genius, because basically everyone, at least on the American side, were saying: yeah, it's high altitude precision bombing, we've already verified it. Even though it was completely, you know, not true, but as far as they were concerned at the time, yeah, high altitude daylight precision bombing was the way to go, and that's what we're gonna continue doing. Until Curtis leMay came in and he was like, uh, wait, wait a second, I don't think we should do this. There's something to what the British were doing. And what he did was rather than just listening to the theory, and this is what's important, he looked at what the actual situation was on the ground, because... And this is why, and this is the whole point of the military MSS -- the Military Strategic Studies class at the Academy: it's not just knowing the theory. You have to understand why the theory came about. And in business schools they say, like, all theories or all models are, are lies, but some of them are useful.

Henri (00:15:05):

So he basically looked at this and said, okay, why are we doing a high altitude precision bombing in Germany? Well, because: one, we wanted to get above the ceiling of the flat cannons; and then two, we obviously, we got our Norden bombsight and so we can do a precision bombing there. But more importantly, the German war fighting capabilities were pinpointed in these factories, right? So that was the point to do high-altitude bombing. But in Japan... Obviously we didn't do really strategic bombing in Japan for a long time, because our bombers physically couldn't reach the Japanese Homeland. That's where in the middle of China, we had the bomber base, in Chengdu. But obviously, because back then Japan controlled pretty much the entire coastline of China, even any forces that we pre-positioned out in China were still really far away because the Asian content is ridiculously huge.

Henri (00:16:04):

But this is where we had the island hopping campaign where rather than fighting the Japanese, we just basically bypassed them until we got to a point where we conquered a couple of islands that were within bombing range of Japan. And that's when, when we could unleash on bombers and do massive damage. It's kinda like if you remember in "The Last of Mohicans" where the British and the French were fighting, and then the English were like, oh, we're gonna lose doesn't matter. And Daniel Day-Lewis was like, what are you talking about? And he's like, well, it's only a matter at a time: as soon as they get their artillery within the range of our Fort, it's pretty much game over. So they try to sue for peace and they left and a whole bunch of other stuff happened, and awesome <laugh> theme song, but whatever.

Jack Winthrop, "The Last of Mohicans" (00:16:49):

May I inquired after the situation, Sir, given that I have seen the French engineers from the bridge above?

Colonel Munro, "The Last of Mohicans" (00:16:54):

The situation is his guns are bigger than mine. That he is more of them. They keep our heads down while his troops take 30 yard of trench a day when those trenches are 200 yards from the Fort and within range, you'll bring in these 15 inch waters, lob, explosive rounds over our walls and pound dust to dust.

Jack Winthrop, "The Last of Mohicans" (00:17:10):


Henri (00:17:27):

So once we got our bombers in range, Curtis LeMay, who was in charge of the 8th Air Force and responsible for this bombing of the mainland, he looked at it and said: okay, well, first off with the jet stream, and basically Japan on virtue being an island, Japan was almost always cloudy. It wasn't clear skies like in Germany. So going a high altitude necessitated going above the cloud line, which means obviously you can't really see what you're bombing at. So, that's one big issue. But he also noticed that the Japanese war making machine, if you will, wasn't concentrated in factories like with Germans, but actually they farmed it out, because it was a total mobilization of the population. Basically the entire population, including the cities and towns, were also used for war fighting. So bombing specific targets for precision bombing strike wasn't as effective in Japan as it would've been in Germany, because the Japanese weren't in specific factors or whatnot, they would be at home or in their little town areas, doing whatever it was that needed to be done for the war effort.

Henri (00:18:38):

So the entire cities were contributing to the war effort. So precision bombing really didn't make sense. And the other thing was, unlike in Germany where most of the buildings were stone or metal work, it was all wood and paper, right. So it was highly susceptible to fire. So Curtis LeMay said, okay, you know what? Even though daylight precision bombing worked in Germany -- and that's what the theory says, even though we technically didn't work, but again, that's, besides the point at that time everyone thought it did work -- he said, okay, even though it worked, I'm not gonna go do that, because it doesn't make sense. Because Japan is not Germany, and the conditions in Japan do not apply to the conditions in Germany. So we've got to change the theory. The theory was right for Germany, but when you apply it to Japan -- for a different area -- it doesn't work.

Henri (00:19:27):

So what he said was, okay, we're gonna do nighttime low altitude fire bombing. And that's where you had the whole fire bombing of Tokyo and a whole bunch of other cities. And of course it ultimately culminated with the atomic bomb, but that's a separate story, which is obviously immaterial to Curtis LeMay's decisions.

Henri (00:19:46):

Actually, before this, his whole big genius, if you will, was still, while he was a commander of the 8th Air Force back in Germany, because his whole thing... The fighters normally would accompany the bombers. Also basically when the bombers would roll in through to where they were gonna go bomb, because it was high altitude, the German radar see them, right? Because of the curvature of the earth, it's much easier to see something up higher altitude than it is to see something close to the horizon. So there was plenty of warning. And because we were going high altitude, we'd have our fighter escorts. And when the Luftwaffe would come and try to shoot down the bombers, the fighters would fight, and you have all those zillion different World War II. Films like that scene, that famous scene from Millennium Falcon in "Star Wars", you know, the original "New Hope" where they're fighting the TIE fighters. And like Luke finally shoots down one of the TIE fighters, he is like, ah, I got one! And Han Solo is like, uh, don't get cocky kid, right? You know, 'cause there's more.

Luke Skywalker in "Star Wars: A New Hope" (00:20:55):

Got it. I got him,

Han Solo in "Star Wars: A New Hope" (00:20:57):

Great kid. Don't get cocky.

Princess Leia in "Star Wars: A New Hope" (00:21:01):

There's still two more of them out there.

Henri (00:21:04):

That all was inspiration from all those old World War II movies, because that's kind of like how it was basically: you had these guys just like Han and Luke in their little separate shooting laser pods. You had like 10 guys on a B-17, on the bomber. Most of them, they would've been in their different little gun pods, shooting at the fighters that were flying around. And Germans would try to shoot down the bombers. And then the fighters would try to protect the bombers and yadi yadi yada. And obviously if all the fighters were destroyed, or if they ran out of fuel or whatever, they had to leave, obviously. Then the bombers would be exposed and the German fighters could pick off and destroy the bombers. Right? That was the whole thing.

Henri (00:21:48):

But then LeMay, what he did, what he decided was, okay, we're not gonna have the fighters escort our bombers. What we're going to do, I'm gonna send all my fighters ahead of the bombers. Like, you know, an hour, a half hour ahead of them. And then the Luftwaffe, they're gonna be alerted, because they see all that on a radar, all these, allied aircraft. So they're gonna send all their fighters up. And even if our fighters aren't effective, because they're like half hour to an hour ahead of the bombers, 'cause bombers are in air, right, they're just behind, they're just behind the fighters; the they're gonna do their fighting and everything like that. Hopefully our fighters will basically destroy the fighters. But even if they don't, the German fighters will run out of fuel and they're gonna have to be forced to land. So by the time the bombers actually come on station, there's not gonna be any German fighters there. We either killed and shot them all down, or they had to RTB -- Return to Base. So, and that was the thing.

Henri (00:22:42):

And then, okay, I shouldn't be like completely praising him on this. Because part of this was because with the invention of the P-51 and Mustang, which was the brand new aircraft that allowed him to do this tactic. But still the fact that he even came up with this tactic and said, basically, I'm gonna leave all my bombers exposed, which was back then was unthinkable, because bombers are your most important asset. He said, no, I'm gonna leave them completely exposed, but I'm gonna send this fighter screening ahead of them to basically bait the Luftwaffe. It was kind of ingenious at the time. Now it makes sense. But back then, obviously it was a super genius thing. So he already proved his genius in Germany. So when he came to Japan, he was already primed with credibility of successfully challenging assumptions, underpinning doctrine or theory, or whatever.

Henri (00:23:30):

So I spent all this time talking about how this amazing new aircraft B-29, that was super up-armored and got all these fancy control systems and could carry all these bombs and whatnot. Curtis LeMay was like, well, I see all that fancy armor that we have: we're stripping all that out. Which all the fighter, all the airmen were like, uh, are you serious? You're gonna get rid of all of our armor? But Curtis LeMay, his philosophy was like, okay, we need to end this war, the Japanese aren't gonna submit willingly. So we need to do as much damage as we can to shorten the war. Right? That was basically the theory of almost every single general during that time, because Japanese famously wouldn't surrender. So the only way we can really get them to capitulate is just do maximum carnage, because in a weird mess up way, that's actually gonna save the most lives, if we do the most damage.

Henri (00:24:21):

So he said, okay, obviously we can only carry a certain amount of bombs on the B-29 because of the takeoff weight. But if we remove all the armor, or the unnecessary armor, we can put more bombs on. And obviously the airmen were like, you can't take all our armor. And he was like, no you're gonna do that, because we need more bombs. But to counteract, we're gonna fly at night. Because the Japanese were famously known to be not good at fighting at night. Like their anti-aircraft and their fighters, their airmen -- they just weren't effective at night. So we're gonna go at night. And we're not going to have advantage of the bombsight, but in order to counteract that, we're gonna fly at a low altitude.

Henri (00:25:05):

And that was another reason why you'd want to do low altitude: it was in order to get up to the cruise ceiling of, I think it was like 30,000 feet that takes a lot of gas, right? To get all the way up to station of like 30,000 feet high, drop the bombs, and then obviously you come back. But getting up to that high altitude takes up a ridiculous amount of fuel. So if you just go low altitude, well, then you don't need that much fuel. Which means two things: you can put more bombs on your aircraft, or you can have the same amount of aircraft, but you can fly it from further back. And when you're talking about the Pacific theater being islands, you don't have that many places to fly from. So the range extension is a huge thing. And he did this, even though all the theories and everything that was beaten into his head, from the academics to application and even the public or institutional pressure of the army Air Force were saying, yeah, high altitude daylight precision bombing is the way to go.

Henri (00:26:03):

He said, no, conditions are different. This is the way it is in the Pacific theater. This is what we're going to do. And rather than having all these conventional bombs that were effective against modern earthworks -- the metal and the brick of Germany -- they'd load up with fire bombs and napalm, and phosphorus, or a whole bunch of things that were basically incendiary bombs that would just basically not do so much physical damage, but most of the damage would come from the fire damage. And of course, knowing that the Japanese buildings were basically wood-based, wood and paper based, you knew that that would be more effective than just conventional anti metal bombs. And sure enough, it worked. To devastating effects. Obviously a lot of people today talk about the atrocities of the US committed against the Japanese, when looking at the fire bombing that happened there. And also fire bombing Dresden. Some would even argue that the atomic bombs that we dropped were less destructive than the fire bombing that was done on Tokyo and Dresden.

Henri (00:27:08):

But the fact that we even have this debate just shows you how effective the fire bombing campaign was. That all came about because LeMay went against the conventional theory, because conventional theory was based on different set of circumstances. And he realized that, okay, in this new battlefield, we have to redo our assumptions, based on the conditions of the battlefield.

Henri (00:27:33):

And I won't say "long story short" <laugh>, so long story long, this is a big part of the MSS studies at the academy: talking about not only how Air theory, Air Power theory came about, but also how we have to recognize not just the theory, but understand the assumptions behind every theory, so that we can make our own assumptions and update the theories based on the conditions of the battlefield. Because every battlefield is different. There's that whole famous saying that generals are always training to fight the last war. 'Cause the whatever war we're fighting is gonna be presumably different than the last war. But because the only thing that we know is the last war, everyone trains for the last war, even though that's not necessarily effective.

Henri (00:28:19):

So that's Curtis LeMay. What does it have to do with today? <Laugh> I am finally getting into it.

Henri (00:28:35):

So the main point of this is to address the comments about what's going on in Turkey with the lira depreciation and the inflation, and economic troubles that Turkey is going through right now. Where it's pretty much almost universally stated that Erdogan, the president of Turkey, is being an idiot and he is constantly lowering the interest rates and that's what's causing all these problems. And if we just do what the conventional economics theory states, which is raise interest rates to stop inflation, then everything will be back to normal.

Henri (00:29:11):

Because according to conventional economics, if you have inflation, your economy is running too hot, so you have too much money chasing too few goods -- that's the famous phrase. So what you wanna do is: the Central bank of Turkey, it needs to raise interest rates. And if it raises interest rates, well then what are people going to do? Well with interest rates raised that means, the cost of borrowing is going to be expensive. Which means people that would normally spend money would not spend money, because buying things is gonna be more expensive, because the interest rate on loans is going to be expensive. And Because it's more expensive to borrow, they're gonna borrow less, right? And borrowing presumably would be to spend it into the economy. So because they're gonna be borrowing less, they're gonna be spending less. Right?

Henri (00:29:55):

And also the other side of the coin for raising interest rates means are gonna be paying you more money for saving in your savings account, which encourages savings. So not only are you not spending money in the economy, because it's too expensive to spend the money, but you're also going to save that money, because the banks are going to pay you more money. Or I should say, because the banks are going to pay you more money, it is more advantageous for you to keep that money in the bank and not in the economy, which further cools down the economy. And that means since there's less money chasing the same amount of goods, well then inflation will drop and then you're saved, right?

Henri (00:30:34):

That's pretty much what anyone in high school or first year College economics class would tell you. This is like standard. I'm not saying anything shocking or controversial here. And that's actually why everyone is basically calling Erdogan an idiot, because any high school or a College economics undergrad student is going to tell you, if you have a high inflation, raise your interest rates, everything is good. So that's the thing.

Henri (00:30:59):

And of course Erdogan is like, no, I'm gonna lower the interest rates 'cause interest rates are bad, and I know better, and if you lower the interest rates, that's going to bring Turkey back to prominence. And there's a lot of theories out there, why he's thinking that. All the way from the crazy things from, okay, he's just going in his old age, he's becoming senile, or that okay, well this guy, he's not a secularist politician.

Henri (00:31:27):

The whole thing about Turkey, or should I say the Republic of Turkey, you know, post 1923, is that it came out of the ashes of the Ottoman Empire. And the founder of Turkey -- Mustafa Kemal Atatürk -- said, okay, we're going to be a secular nation, because that's the only way to bring Turkey from the backwards history of the Ottoman Empire days and remove religion as an influence in politics or within the state. And he was educated in Switzerland and also in France. So like code Napoleon La laïcité. You know, la laïcité is different in America: in America we have freedom of religion, whereas in France or La laïcité is freedom from religion. So that was his whole big thing: it's not just religion or freedom of religion is not enough. We have to have freedom from religion. So completely divorce religion from the state. Anyway, we can devote a whole podcast on the ascent of Erdogan, but essentially as far as Westerners are concerned, they considered him a moderate Islamist. Which, and I can get into future reasons why, that's an oxymoron in itself.

Henri (00:32:40):

But the point is, Erdogan, the current president of Turkey, is an Islamist, right? He's big into religion. He's like what George Bush was to Christianity. So Erdogan, being a moderate Islamist, or just plain old Islamist, a lot of his theory of governance comes from his theories on religion. Specifically, his theories on Islamic religion. And one of the things that's said in the Quran is the outlawing of interest rate, of usury, right? Usury is forbidden or its haram. It's a taboo in Islam. So Quran forbids charging interest. It forbids usury. It famously says, Allah permits trade, but he does not permit interest, and charging interest is the way of the Satan, and whoever charges interest will burn forever in the fires of hell. And thing is what you're supposed to do is, you're not supposed to take interest from people, because that's consuming people's wealth unjustly. But instead you're supposed to do is you're supposed to provide zakat. You're supposed to be charitable, right?

Henri (00:33:56):

Because zakat is one of the five pillars of Islam. And its actually really further codified, if you will, after the death of the prophet Muhammad, during the reign of Abu Bakr.

Henri (00:34:08):

Actually a lot of people say, oh, who's the most winningest general in all human history? And people like talk about, oh well Napoleon, he was amazing, or Genghis Khan, or like, you know, Alexander the Great. But actually Abu Bakr, who was the first caliph, or the successor to the prophet Muhammad after his death. And this is actually the kind of the genesis, if you will, of the split between Sunni and Shia, for those who don't know, is that after the prophet Muhammad died, there was no clear line of succession, especially because he didn't have a male heir. So it's kind of like "Game of Thrones"-ish <laugh>. Now I will get nasty comments, because of comparing religion to "Game of Thrones".

Henri (00:34:51):

Anyway, the two main successors to the prophet were Abu Bakr, his father-in-law, and Ali who was his son-in-law and eventually Ali became a caliph. The fourth caliph, but there's a whole bunch of things which would require us to go into a history podcast at this point. But long story short is that, who was going to be the successor, whether it was gonna be Abu Bakr or Ali, was basically the initial cause of the schism, the split, which between Sunni and Shia Islam. But irrespective of all that the fact remains Abu Bakr became the successor to Muhammad. And he started going on this massive campaign of conquering, I wouldn't say the known Arab world, but pretty damn near, at least the entire Arabian peninsula and a bunch of other places. And famously he didn't lose a single war. So when a lot of people say, oh, who's the most winningest general: Genghis Khan or Alexander the Great, or who have you? Well actually it should be clear cut case that Abu Bakr is probably the greatest or most winningest general in all of human history.

Henri (00:36:01):

And during all these wars of Abu Bakr, he basically said, okay, one of the pillars of Islam is zakat, where you have to give 2.5% of your income of your wealth to Allah, right? And because he was the caliph, and it was a theocracy, that was essentially the tax or the charity that you would give to the State. Because the State was speaking directly on behalf of Allah. So from an economic standpoint, without getting too much into the religion, that's what basically financed the Empire, right? And it still stays to this day. One of the things that Muslims do or they're supposed to do, who provide zakat. As Christians would call it, they're supposed to give tithe to their local mosque or whoever. And compare that to Christians, who are supposed to technically give 10%. Maybe that's a higher percentage, but because hardly anyone does that, from an absolute standpoint, it's considerably less.

Henri (00:36:56):

So the obvious question would be: well, if interest is forbidden, then how do all these Arab theocracies or Arab religious countries, how do they have a banking? How do they have a financial system, if they can't charge interest? Well, they get around that by basically giving, quote, "interest free" loans, but they get a stake in the enterprise, that's asking the loan. Which, wink-wink, nudge-nudge, is the amount that corresponds to the interest that they would get, had they been a Christian, Jewish, secular whatever financial institution. And nowadays, if you go to Dubai or Riyad -- a lot of these places where they're trying to bring a lot of FinTech startups, a lot of the big FinTech startups in the Arab world is about how to do Sharia compliant FinTech. Because most FinTech apps are all about how to charge interest, right? That's how you make money. So this is a way you can still make money as a FinTech startup, but you do it in a way that Sharia compliant, where technically you're not charging interest. So it's all, it's all halal, it's not haram. Right?

Henri (00:38:07):

But anyway, long story short, this shapes Erdogan's, view. But because Turkey is obviously a secular country, or at least it's supposed to be, it's institutions, especially it's banking and economic sector, obviously interest is being charged. But Erdogan detests interest. And if he could, he would eradicate it. But there's institutional inertia history there that he can't fully get rid of. But in his worldview, he's constantly trying to lower the interest rate, because it's haram to him in his eyes. That's the story that most people will give you on that, on why he refuses to raise the interest rates. Even though every classical economist under the sun will tell you: obviously just raise interest rates and this thing will all be over.

Henri (00:38:54):

But the thing is, is this actually true? And one of the things I want to do with this podcast as we go forward, is mix and match different things. Whether it's politics, social issues, geopolitical issues, international diplomacy, economics, military warfare, obviously, but constantly do a rotation, so it doesn't really get stale. But we're going to revisit a lot of the things. And one of the things we're going to revisit, well, especially when we have episodes, focusing on economics, is about the flaws of classical economics. And here I'm going to initially say, come on, don't bullshit me! You know, Erdogan is bullshitting us with this lower interest rate. But I'm going to pause here and say, is he really bullshitting us? Because is the classical theory true that raising interest rates reduces inflation?

Henri (00:39:53):

And I'm going to try to take the mindset of Curtis LeMay: all institutional and historical inertia tells you to do a high altitude precision bombing, right? This is the way when Germany is the battlefield, where all military theories are tested, whether they're bullshit or not, it becomes readily apparent. Now you are Curtis LeMay and you're saying, okay, this is what everyone's telling me. Obviously, this is what history's telling me. This is what my rational brain is telling me. This is what to do. But I'm in a different area now, should I still be doing this? And that's what I want to talk about here is that classical economics, for the reasons that we stated it's quite evident clear cut. It totally makes sense. Raise interest rates, which means it discourages spending and encourages savings. And obviously that should decrease inflation. That's not controversial, but we need to understand the theories and assumptions that underpin that chain of thought and see if that actually applies to Turkey, just like LeMay did with Japan. because the theories assumptions in Germany did not necessarily apply to Japan.

Henri (00:41:11):

The assumption from classical economics comes from... One of the big underpinnings of classical economics is the quantitative theory of money: MV = PQ. Which is the amount of money you have -- the M, times the velocity of money (V), how fast it exchanges hands, equals the price level (P) times the quantity of goods that are in an economy (Q). And of course on average, all things being equal, V and Q are constant. So all that's left really is M and P. So if you increase M, if you increase the amount of money, your prices go up, right? And that's kind of like what inflation is, right? Inflation is too much money chasing too few goods. That's the whole thing.

Henri (00:41:55):

But the thing there, and probably you've already guessed by now, is the V and the Q are not actually constant in real life. It makes good for economics 101 and for neat little theories, because the math is pretty straightforward. But that assumption of classical economics implies that the quantity of goods can't increase, which in macro economic standpoint means that you have full employment. Your labor force is completely being used to produce goods.

Henri (00:42:29):

In classical economics we like to talk about comparative advantage. Or they talk about, oh, you're on island and you have bananas and oranges. And your buddy's on another island, and he has bananas and oranges. Your island is bigger than his island, so you have potentially more trees than his island, where he doesn't have enough space for enough trees. But the thing is, his climate is better for oranges, and your climate is better for bananas. So even though you can make more oranges than him, you let him completely focus on doing oranges and you completely focus on bananas. And comparative advantage states that even though you're not doing the thing that you're obviously better at than him, because he's doing it from a relative stand point, he's completely focusing on that, the amount of bananas and orange is total between the two of you actually increases. That's the whole point of comparative advantage. And comparative advantage introduces, the concept that trade is good. Free trades is good, because it, it improves the real welfare if you will, of all citizens, right? But again, the assumption here in that very basic example is that you're using your entire island for bananas and he's using his entire island for oranges. So there's no room to increase the capacity. And that's not a bad assumption, right? Actually, that's what we wanna strive to, because if we have all this potential, we wanna realize all the potential because then we become richer, right? So again, the fundamental assumptions behind classical economics is that you're using all your resources, which makes ideas like comparative advantage make sense. And again, that's a nice thing to have. 'Cause why wouldn't you want to realize all the potential of your land, right? Of your society. And if we're going back to the islands example, why settle for growing four trees, if your island can support six trees, right? Grow six trees to produce the maximum amount of produce, 'cause everyone becomes richer for that. The land can support it, obviously do it.

Henri (00:44:35):

So the underpinning behind classical economics is that you can't increase your quantity of goods, because you're using the maximum amount of goods available. It's a zero sum game, which is why comparative advantage works. Is that for every orange I produce, I can't produce X amount of bananas. So rather than waste my resources on oranges, let my friend, whose island is better at producing oranges, let them use it because zero sum game, I'm losing that land for potential banana production. Because with that land where I can only grow one orange tree, I can grow two banana trees, right? That's comparative advantage.

Henri (00:45:16):

But the thing is, again, using all your resources, while again, that's a very noble utopian concept of classical economics, frankly, that's not true in the real world. Because as much as we like it, we're not using all of our resources. I mean, frankly, using all our resource would be disastrous, because there's no slack. Not to mention economic conservation and all those other random things there. But just even if it was possible in some like Ayn Rand paradise, where everything is being used by Acme Inc. We're not that case. And you can easily point to this, because the mere fact that we have unemployment or even underemployment means there are people not doing stuff, which means that's resources not being used, labor not being used. Things are not being produced. And this is where classical economics breaks down.

Henri (00:46:05):

I'm not trying to say classical economics is wrong or I should say, well, I mean, it is wrong, but I don't want to say classical economics is bad, because we should all aspire to a utopian society, where classical economics is the reality and we're using all the things that God has given us, if you will, and we're not wasting anything. And we're producing the max amount of wealth for our society, for ourselves and for our citizens. But it's just that we're not there. And we have to deal not with what we want, but as Donald Rumsfeld, may he rest in peace, would say, you don't fight with the army you want, you fight with the army you have. So we can't run economics based on theories that we want or that sound nice. We have to run economics based on situations on the ground. Just like LeMay with Japan.

Henri (00:46:54):

And the point here is that unemployment is an issue. It's wasted resources from a sociological liberal peacenik standpoint it's bad, because obviously people don't have money and they're poor and everything like that. But from a pure cold calculated economic standpoint, it's also bad because you're not fully utilizing your resources, which means your Q is not maximum. Your Q is not constant. So in that classical economics equation of exchange, where the Q -- the quantity of goods, goods and services, is not constant. It can move up and down. It can drop, which means more unemployment, or it can rise, which means less unemployment, right, and more stuff is being used.

Henri (00:47:40):

And we'll have other podcasts about this too, but there's also a lot of things, like why crypto coins are bullshit. I'm not talking about blockchain -- there might be some use for blockchain. But the actual cryptocurrencies, or even this whole abolishing the Fed, this libertarian paradise of we're just gonna abolish the fed and go back to the gold standard -- they're all nice concepts in theory. Well obviously they're in good in theory, because that's what theory is -- everything sounds nice in theory. But they are nice in theory, but in reality, they're just at best bad, at worst super malicious.

Henri (00:48:17):

Because the world doesn't work like that. Because people think that money is exchanged like barter. Like it's back during the American Colonial days, where you have beaver pelts and you're trading with the native Americans for some corn, right? Money is not like that. Money is not a medium of barter, it's credit. The economy, even though it's simplistic, simplistic obviously sounds good and it's easier to understand, it doesn't necessarily mean it's right. But from simplistic viewpoint, people think, okay, money it's like barter, right? I give you A and you give me B. And that A happens to be money: dollars, euros, yen, whatever. Or if it's gold standard, and a lot of libertarians talk about: forget about the government, we should go back to gold standard and go back to barter. I give you gold pieces and you can give me, you know, beaver pelts, right?

Henri (00:49:13):

But the thing is, that's not how economics works. Or I should say, that's not how global economics works. Because while between you and some guy, it may appear like barter is working, in reality, the exchange of goods and services, which is obviously the underpinning of all economics, that takes time.

Henri (00:49:31):

There's a time delay in all transactions. And for all the accountants that are listening or anyone who's dealing with corporate finance knows this. You have accounts receivable, accounts payable, and there's a difference between your Income Statement, which is the money that you're entitled to, and your Free Cash Flow statement. Also just in general, if you're an entrepreneur or in charge of a PNL, you know this, that there's a delay between you spending money to acquire resources, whether it's humans, you know, employees, or just working capital, and the time for that working capital to be put into use. And then eventually you produce the good and sell it and then get the money. So there's a time between you spending money and the time that you receive money. That delay contributes to the time delay in exchange of, I would say modern economics, but just even ancient economics. Economics in general.

Henri (00:50:28):

I want to do a podcast about this, about the actual nature of money, but I can't do this now, because this will be another two hours and we're going to go into the Old Testament and a whole bunch of things in there. And you're like, what the hell does old Testament have to do with it? Trust me, it has to do a lot. But I'm trying to keep myself grounded here, so this doesn't become like another AUKUS podcast where it goes over an hour plus. Which it probably will. I don't know, my producer will tell me what the final count is.

Henri (00:50:53):

Anyway, so there's a time delay between money spent and money received. And in order for economics to work, there has to be the financial sectors there to facilitate or to bridge the gap between that time delay. Because I can't just go to a worker who's been working and say, Hey, look, as soon as our customer pays us for the products... Let's just talk about the banana tree, right. As soon as the guy from Orangina Land pays for my bananas... I'm gonna ask you to work on this island and grow all the bananas and you're gonna do it for free, but I totally promise you, that once the guys from the Orange Land pay me money, you're gonna get that money for all the work that you did, growing the bananas, right? It doesn't work like that. So what you need to do is go to the financial sector of your island and the financial sector, what their job is is to say, Hey, look, we know you're good for the money because you obviously have contracts and you're an established business. We're gonna give you a short-term loan for like 30 days or whatever, and you're gonna use that to pay for your workers, right? And then after you get your money from, from your consumer, then obviously then you pay us back, plus interest. That's usually how it goes.

Henri (00:52:14):

And we're not even talking about long-term the investments, because obviously we can further complicate it, talking about savings and investments. And this is actually one of the things that they're talking about with Erdogan and the collapse of the lira is that in order to make an investments, you have to save. But that's actually wrong. You don't save first to have investments. First you make the decision to invest and then you save that money. At least as a business. That's what you do. So it's not that you need savings to invest. It's just savings are the score sheet or the materialization of an ethereal decision to invest. So it's kind of like the accounting mark of investments. So you make the decision to invest first, then you save the money and then when you can actually purchase whatever machine that you're going to do, you obviously pay it all from your savings. From a simplistic standpoint, you say, oh no, that's stupid. You gotta save first. And then you invest. But the point is, again, if you're going into a business or any financial venture, is that the decision to invest always comes first and you either take time to accumulate savings or you take out a bank loan. And this again goes back to the whole point of the time delay of exchange.

Henri (00:53:30):

And in fact, you don't even have to take my word for it. You can go to the IMF or world bank. There's tons of papers out there. And they talk about how the whole point of trade finance is this bridging of the time delay between credit and debit. This time delay of exchange and trade economics, or just economics in general, is reliance on the short-term financing that bridges this time delay of exchange and most business transactions.

Henri (00:54:01):

Like I think it's like over 90% of global transactions take this form. The point is, to bridge this gap, you need this financial sector, because they bridge the gap. They allow the seller to borrow, in economic parlance term it's called working capital, to complete the order that they received so that the purchase can happen. So this either happens through the short-term loans or credit insurance. But either way, again, over 90% of trade in the world falls under this category of this time delay of exchange, where the short-term credit is basically the fuel that drives the engine of international trade.

Henri (00:54:45):

And what does this have to do with barter and gold? Well, the thing is, even if it was, you know, you had gold standard again, you had this libertarian paradise. Well, okay, fine. Well, there's still this time delay of exchange where there's the time where you have to spend to extract the gold to pay people, or hire the work to extract it for you. At that point, you don't have gold, you got to get the gold. And then after that, then you can start paying. But then you're saying, no, no I'm already rich or whatever. I already have gold. Well, okay, fine. You already have the gold. But again, there is another shortcoming of classical economics is that its theories are based on static systems, that it is frozen in time. So then, okay, you have this gold, you paid it in advance. You paid the the workers for the bananas, but you're still waiting on the payment of the oranges. There's a time delay there. And oh, by the way, even after that exchange is complete, well then the next season, you need to acquire gold again to pay the workers for the bananas and then get oranges again. And then so on and so forth and repeats.

Henri (00:55:54):

So because we don't just do one economic exchange in our life and then drop dead. We do multiple things over, hopefully, a long fortuitous life. The economics is dynamic theory. So even if you have an initial capital. Say, you know, you've been blessed with rich parents, like Elon Musk <laugh>. Eventually there's gonna be a point where you have to acquire capital, before you can spend it and realize your economic gains, that classical theory promises us.

Henri (00:56:23):

So that's why this time delay of exchange is important. And you just can't think of things as bartering. And again, 90% of global trade... And when you're actually talking about it on the scale of sovereign nations, which obviously we're talking about that with the case of Erdogan, of Turkey, of sovereign nation, I would say near a 100% of global international transactions involve some form of either credit or some credit insurance, or some sort of guarantee to facilitate the business transactions on a global scale.

Henri (00:56:59):

So, why is this important? Because the thing is, just like with inflation, one of the assumptions in classical economics, when it comes to theory, is that there should not be persistent long-term trade imbalances, all trade should be equalized. And we know that's bullshit, because America obviously has persistent trade deficit, Germany and China famously have trade surpluses, Greece <laugh> has a trade deficits. Trade imbalances, whether it's a surplus or a deficit, are just the common fact of life. And there's no free market voodoo force out there, pulling everything back to the center. And I'll explain why, but first let's run through with the classical theory and to use an example to illustrate the classical theory.

Henri (00:57:52):

Let's use USA and Germany, USA being an importer, obviously, and Germany being an exporter. And to further clarify this, so that there's no confusion about Euro, because it's not really Germany's currency, let's talk about 1990s Germany, right? So we'll talk about the Deutsche Mark and the Dollar. To make things less confusing.

Henri (00:58:13):

All right, so if USA is buying all this stuff from Germany, that Germany is exporting out, then that means, obviously United States or, you know, the world economy, Americans, are trying to sell all their dollars and buy all these Deutsche Marks so they can get all these German goods. And obviously law of supply and demand, you're selling dollars, so the value of the dollars is gonna go down. And you're buying Deutsche Marks, so the value of the Deutsche Marks is going to go up. Well, the more Germany exports and the more US import from Germany, that the value of the Deutsche Mark is going to go up and up and up and up. And the Dollar is going to go down and down, down, down. And all of a sudden there's going to be a tipping point, where all of a sudden now the goods in the United States, because the dollar is so low, it's going to become cheaper for Germans to buy from the Americans, rather than just buying in Germany. And also the Americans are just going to, frankly, just going to stop buying stuff from Germany, because the Deutsche Mark is so valuable, that it's going to be too expensive. They're saying, well, I'm not going to spend all my Dollars converting them to Deutsche Mark, because it's too expensive. I'm just going to buy this stuff in the United States. So there's going to be a shift. And now all of a sudden, Germans are going to start buying stuff from the Americans, so they're going to sell their Deutsche Marks, and they're going to to acquire, they're gonna try to buy US Dollars. And the Dollar is going to start going up. And then the Deutsche Marks are going to go back until the flip. And then back to where we were originally. So there's this constant oscillation, but on average, long-term average, all trades should be balanced. That's what classical theory states and in a barter economy where you're just buying and selling immediately when there's no time delay of trade. That makes sense. That's why it's called conventional economics, because it's conventional. This is what we all believe in. Most of us mostly believe in.

Henri (01:00:03):

But again, we can't ignore in the real world this time delay of exchange. And we don't just do bartering in international trade, because international trade is nothing without international finance.

Henri (01:00:18):

So it's not just that the Americans want to buy stuff from Germany. So they're gonna sell all their Dollars and buy Deutsche Marks, but before we get even a chance for the Americans to sell their Dollars and buy the Deutsche Marks, because of the time delay in exchange, what has to happen is that Germans, obviously, need money first to pay their workers, to actually produce the stuff that's being exported to the Americans. So the German financial system has to create a line of credit of Deutsche Marks, which increases the amount of Deutsche marks in the economy. And then the German manufacturers use that line of credit to pay their workers. Either pay their workers or pay for the investment or the capital goods, whatever, to produce the stuff that's going to be exported to the Americans. And only then they give it to the Americans and the Americans then sell their Dollars and then buy Deutsche Marks to pay them. And of course, then the producer gets those Deutsche marks and then pays back that line of credit to the financial bank. That's actually how it goes. So what classical economic states is that okay, the value of Deutsche Marks should be increasing, because there's a higher demand for it. Well, actually in order for trade to work, the overall amount of Deutsche Marks has to increase, because again, the bank, the financial institution that's extended that line of credit, is increasing the number of Deutsche Marks in the system.

Henri (01:01:48):

So if there's more Deutsche marks, well obviously as we know from, ironically, classical economics, then the more there is of something, the less valuable it is, so that's going to drop down. And because there's a 1:1 exchange, meaning that the line of credit that's being created to produce the export gets immediately wiped out... Well, not immediately, but it gets wiped out after the trade has happened, when the Americans pay for the export, it goes away. So then the Deutsche Mark increases in value again, but that initial drop of value from the line of credit is counterbalanced by the increase in value from the export. But the net effect is that the level of the Deutsche Mark, compared to the Dollar, is the same it's static. So when we extend this to a broader standpoint, that explains why we have trade imbalances in the world, right?

Henri (01:02:37):

And that's why America consistently runs deficits and countries like Germany, China, or whatever, consistently run surpluses. Because for every export, there has to be an additional increase of credit or an increase in monetary vehicles, monetary currency units to facilitate that trade to happen. And because that balances it out, that oscillation theory that we talked about in classical economics doesn't work. That's precisely because of this time delay of exchange.

Henri (01:03:14):

So what does this have to do with Turkey? Well, I was being a little cheeky there, because the thing is, the credit is not a perfect one for one balance, because obviously why would the bank do this? It's not like out of their own pure benevolence, they're good people and they're like, yeah, we will totally give you credit and you do it. They're charging an interest, so they're making money. And because usually this type of trade financing is done under 30 days or what have you, the short-term horizon, so it falls under the short-term rates. Well, what also is the short-term rate that we think about? Oh, the interest rates of the Central Bank of Turkey. Or Central Banks of countries in general, right?

Henri (01:03:51):

Because the thing is interest rates that the Central Banks set are, essentially, the floor, the price floor or the minimum interest that banks will charge, because obviously they're not gonna charge lower because why would they do that if the central bank is paying higher. So if the interest rate in the United States is.. Or right now it's 0%, so that's a bad example. But okay, in Turkey the interest rate is 15%. Then the cost for financing... Again, financing is not something, oh it's a nice to have -- it's the essential, like we just talked about it's the essential lifeblood of trade. Is that for any financing that's going to occur to facilitate international trade with Turkey, the minimum cost of that is 15%. So by increasing the cost of financing for trade, because everyone keeps saying, oh yeah, increase interest rates, because that's going to reduce inflation... Just like there's an extension of credit to the exporter so they can build their goods and what have you, there's also a similar line of credit extended to the importer, to the Americans, so they can actually buy what they have to buy. Because on their side, they also have a time delay of money from whatever resources that they're doing within the United States. And of course that position, likewise, gets closed out at the end of the exchange so that the net result of the movement of currency or the valuation of the currency remains zero.

Henri (01:05:21):

So going back to our comparative advantage lesson, while comparative advantage is a very good thing to learn about in classical economics, because of this time value of credit comparative advantage does not matter. It's not a zero sum game. What matters is the absolute advantage matters, because there can always be an expansion of Q -- of the quantity of goods or financial aspects. There can always be an expansion of financial credit. So more money can always be created or more goods can be created. And because presumably with trade finance that credit doesn't get expanded unless there's actually goods and services to be traded, so from a trade financing standpoint, inflation is not necessarily a concern, because it only appears to facilitate the trade of the real goods and services that comes about.

Henri (01:06:17):

So that's the point here. And this is why these trade imbalances exist.

Henri (01:06:22):

And so when we come back to Turkey, it's that they're saying, oh, well the currency devalued, that means the price of Turkish exports should be favorable. Never mind, there's the economic scene, which will get to, is different. There's no healthy and robust economic infrastructure in Turkey to do a lot of exports and imports. Because in order for Turkey to export, there has to be things that other countries want to buy. Right? And also Turkey has to be able to produce it. But even assuming that that's the case, because of this extension of credit that we just explained to facilitate trade, you can readily see that raising interest rates will not help Turkish situation. If anything, it will harm.

Henri (01:07:10):

I mean Erdogan, well he's wrong. There are reasons why he's wrong. But at the cursory, the end results of actually lowering interest rates is actually a good thing. Raising interest rates is not the thing you want to do, because if right now, if the interest rates in Turkey are 15%, well, that's the cost of financing for the facilitating of trade in Turkey, right? So if you raise the interest rate, then the cost of financing trade, the cost of doing economics, the cost to play the game is going to increase. And you're saying, well yeah, but that's good because you want to slow down the economy, right? You want to get a hold of inflation. That's the whole point. So that's why Erdogan is in the problem.

Henri (01:07:49):

But again, now you're falling into the classical economics assumption trap of that the economy is fully being utilized and when it's being fully utilized, there's a zero sum game: for every give there is a take.

Henri (01:08:03):

But when you consider Turkey having double digit unemployment, well clearly the classical economics assumptions don't stand. There's always room for increase in productive capacity. So it's not a zero sum game. So it's not a question of, okay, all the resources are being used up in Turkey. So like the economy is doing so great, so we've got to raise the interest rates and cool down the economy. The economy is already cold. So raising the interest rates, yes, it's going to cool it down, but it's going to make things even worse.

Henri (01:08:37):

This is kind of like similar to what happened with the Volcker shock in the 1970s in the United States. We had the situation: inflation was high in the United States and Volcker -- the Fed chairman... Well before him, they were trying to raise the interest rates, but inflation was still going up. So hi finally said, screw it, I'm gonna raise the interest rates to a ridiculous point. And sure enough, he finally did eventually get the inflation down, but in the process, unemployment shot through the roof and it completely destroyed the American economy. Fortunately United States is a pretty robust country, so that we rebounded. But if you ask the people back then in the labor force, was what Volcker did good? No, it was not. In fact there were all these protests going on. If you remember back then, there's like news clippings, where there were protests all over the United States. And like even farmers, for example, parked, clogged up the streets of Washington DC by putting their tractors and what have you, and heavy machinery in front of the Federal Reserve building as a protest, because he just completely wrecked the United States economy. It's like, yeah, the economy slowed down, but you know, it's like telling someone, oh, you need to lose weight. But rather than then going on on exercise and diet, they chop off their legs. It's like, okay. Yeah, you reduced weight, but there're bigger problems now there.

Henri (01:10:04):

So that's the thing it's like, yes, you need to control inflation, but you can't do it at the expense of the economic health of your country. And the classical theory of raising interest rates to slow down economy is absolutely correct. And I'm not knocking it at all. But it does it at the behest of reducing consumption, and at the same point, reducing production. Consumption and production going hand in hand there. So if your economy is already shit in the sense of employment, which obviously in Turkey, unemployment is atrocious, raising interest rates to cool down the economy -- well, the economy is already freaking cold. You don't wanna go like absolute zero here.

Henri (01:10:44):

So that's the error that the people are making. So to Erdogan's credit... Well, I don't know if it is to his credit, I don't know if he's actually thinking this, because again, we already talked about his reasons are more having to do with his own religious economic theories. But besides the point, let's just steel-man this. To his credit, he's kind of right: you don't want to raise the interest rates, because inflation is not the end all-be all. The economy, the wellbeing of your citizens is what matters.

Henri (01:11:12):

And to make this more precisely, to bring this argument home, if the economy's like a pizza... Bear with me with the analogy here, it's not perfect, but food is not exactly economics, but okay. You have, you have your base pizza, which is essential to have. I'm not talking about the Chicago deep dish style pizza, I'm talking about real, real pizza. I don't have to say New York style, Brooklyn style. It's fricking pizza. But anyway, so for real pizza, you got your dough and then you got your sauce and your cheese, right? That's your absolute bare minimum for you to have. And then you could add other stuff on it: pepperoni, anchovies... Not pineapples, screw you, pineapples is not a freaking topping. But anyway, put whatever the hell you want on it. And you can put all the fricking toppings on that you want. But at the base of it, you have to have your pizza pie, right? You have to have your base ingredients. Otherwise it's no longer pizza.

Henri (01:12:09):

So with classical economics, assuming slowing down the economy, there's a specific base amount of economic activity that has to happen in a country for the country to function. You have to have water, you have to have at least bread or some basic substance, some food, a cursory amount of electrical energy. Keep the lights on. You have your base level of sanitation, whatever. These have to happen. You can't compromise on them. Because if not, then you basically, you have Somalia. Apologies to the Somalians listening. So everything else, all other economic activities, those are like the toppings on the pizza, right? You can have more, you have less. And that, that can fluctuate, but the country will still move on. People will still live. And this is kind of like what people talk about: living wage versus a minimum wage, and people should be able to live. All the extra economic activity, industry, commerce, whatever that goes on top of it -- that's all good. And you can play around with that because the base level of living of your citizens is still gonna progress.

Henri (01:13:19):

So this is the whole point of the distinction between developed nations, developing nations and underdeveloped nations, and also dysfunctional nations. Depending on who you ask, whether underdeveloped or underdeveloped nations, they don't have the base level of goods and services to provide for the general welfare of their citizens. Developing nations, generally speaking have most of it. And they have some extra economic activity. Developed nations, obviously have all that, plus you know, all that and a bag of chips, they have all the extra stuff. So you can play around with the economic output of the country and not affect the lifestyle or the quality of life of your citizens.

Henri (01:14:01):

So Turkey, obviously, it's not developed nation, but it is considered to be developing nation on the whole, where you have your customary goods and services, whether it's roads, energy, bread, water, et cetera. But obviously there is extra economic activity. But on a whole it's not robust enough to carry on as the main engine of the Turkish economy. The reason why this is important is that while the Americans or Europeans or what have you, Japanese. Hell, even the Chinese to a certain effect, can mess around with the levers of their national economies, Turkey doesn't have that Liberty. Because with the assumption in classical economics mean that, okay, the inflation is too high. Uh, so we need to slow down the economy. Well, if developed economy, okay. Yeah. You can afford to reduce your economic output, because the quality of your life, the essential economy, if you will, the pizza crust of your economy, that part is still going. You're not reducing that part. When using the losing the weight analogy, you're not chopping off your leg. You're, you're exercising, you're getting rid of your belly fat. But with Turkey, they don't have that. Businesses are underwater there.

Henri (01:15:17):

And trying to cool down the economy means that with developed nations definitely, and in most cases, or in some cases, with developing nations, you have a base level of economic activity that has to happen for a generally accepted quality of life for your citizens. Let's called that X. So anything above X you can play around with, and this is why classical economics say, Hey, inflation is too high, raise your interest rates to slow down the economy. And the assumption is that there's a lot of stuff above X. So you can slide the scale up and down still above that X level, that's necessary for quality of life. And that slows down the economy, which brings inflation back under order.

Henri (01:16:02):

But with Turkey, there's not much above the X. And some might even argue there's not even X for a lot of people in Turkey. Again, we got double digit unemployment. That's not even considering the underemployments -- the impoverished people who are technically employed, but don't have enough money for their basic goods and services. And in the population of their young people that unemployment is even higher. I think it's like 46% or something ridiculous like that. It's just insane how their young people are not working. Their most productive age group is not even employed.

Henri (01:16:35):

So cooling down the economy, while from a cold calculated economic standpoint, may definitely slow the economy. It's kind of like the Norden bombsight that was tested over the bombing ranges in Western US: Western US bombing ranges is not 1943 Berlin, you know, with the Luftwaffe and the anti-aircraft shooting at you. It's a real world. And that the laboratory are completely different. And the same thing here with classical economic theory and in this case, Turkey -- a developing nation.

Henri (01:17:10):

So what this means to the shopkeepers is that they still have to produce their work. It's not like your Facebook. And you're like, oh my God, the Fed increased the interest rate, so now I can't sell too many ads, so my economic output is lower. No, in Turkey, you actually have bakers and butchers who are trying to bake bread and meat to satisfy people's dietary needs. And you're saying, oh well, let's, let's increase the interest rates and slow down the economy. Well, people still need bread today and they're gonna need bread tomorrow. And they need meat today, and they're gonna need meat tomorrow. It's not like the economic output is going to decrease, because after a certain point you got rid of all your belly fat. If you keep exercising and running a caloric deficit, your body's gonna start metabolizing your muscles and then your organs, and then that's how starvation happens. So that's kind of like what's happening or that's what people are essentially asking Turkey to do. And even if that were the case, it doesn't work, because they're not gonna stop making bread. They're not gonna stop making meat or whatever.

Henri (01:18:15):

And again, because of the time delay of trade, the businesses are still going to be working. And inflation is already bad. Prices are already increasing. They barely are making ends meet. Increasing the interest rate means increasing the cost of financing, which we've already established is the lifeblood of facilitating trade in the first place, which means you're adding another, an extra artificial cost on an already overburdened economy. Which means the baker now not only is barely making ends meet, because the price of flour has skyrocketed. But on top of that, that short-term financing that he needs to get to be able to sell the bread, buy the flour and sell the bread. That time delay that financing from the bank, the loan is going to increase. So it's going to further burden him. And again, he can't, he doesn't have the option to not sell bread, because this is his livelihood. He doesn't have savings and people need bread. It's not like people are gonna stop eating or the sake of the economy humans have real needs.

Henri (01:19:15):

So that's why while classical theory is sound, I'm not saying classical theory is wrong. It's just, the assumptions are only applicable to a specific narrow case.

Henri (01:19:27):

Again, think like LeMay: what's good for the bombing range is not, not necessarily good for Germany, and it's definitely not good for a bombing campaign in Japan. And the same thing, classical theory might work in the laboratory. It may even work in some isolated cases with, uh, developed nations, but it doesn't work in a developing nation like Turkey, and specifically like with Turkey.

Henri (01:19:50):

And there are test cases of the, where Argentina, for example, they've been constantly increasing their interest rate to slow down their economy. And what's happening is the inflation is still going up and up and up. Japan, on the contrary, they have deflation and they're trying to increase inflation. So again, conventional economic theory says, okay, lower interest rates to have inflation. And they're basically at zero, well, there are negative interest rates now and they still have deflation. They haven't had inflation in almost 40 years now. So if we just get out of our American or Western bubble and see what other countries are doing, you can clearly see that classical economics doesn't work.

Henri (01:20:35):

And again, I'm not saying that classical economics is wrong. It's just, it's only correct in very specific isolated cases, where you have full employment, you have the full use of your economic power or your economic, uh, utility. And also that you have zero time delay in your exchange of goods and services. So if we're going to raise the interest rates in Turkey, the baker is still going to continue baking bread and trying to sell it. But of course, now it's gonna be even less of a profit or, or even at a loss. In companies, or whether it's industrial commercial companies, they still have to produce, because people still need their wages. But their costs, their profits are already low as it is. It's gonna be even lower or even the point where they can't handle. They actually just go under and then people lose their jobs. And in that case, well, okay. Yeah, you do have less money chasing fewer goods, but not because you've healthy, in a healthy manner, reduced inflation by reducing the money supply. What you did was people have been laid off, because companies can't afford to employ them or even worse, companies just shut down altogether, which means no goods are being produced. And if no goods are being produced well then yeah, sure, then by definition the demand is also zero, which means there's no inflation. So I guess, okay, congratulations. You've solved inflation, but at what cost?

Henri (01:22:11):

Going back to the time delay of trade, another interesting anecdote or tidbit on this is that it's kind of funny that if you look back in history or in recent history, a lot of the financing that caused the prosperity or that was the progenitor of the prosperity of Turkey, where people were talking about, oh look, Turkey is the model, developing nation, look at their economy and everything like that. A lot of that financing was around the 2008 timeframe. And when we're talking about long-term investing, the average time horizon for those type of debt instruments is usually 10 years. And when did the economy start going to shit in Turkey? Well, around 2018? And that's because what happens is when you have short-term financing... Again, it's not like classical theory where it's a static one and done deal. There's a constant flow of trade going on, which means there's constantly credit being extended and being extinguished as trade flows back and forth.

Henri (01:23:16):

And another thing about this interest rate is that these companies get financed on these bonds. With long-term bonds, obviously you have higher interest or rates. And the point is that, or the assumption is that these companies are going to use these long-term bonds to make big investments, big capital investments or whatever, to grow their business. This is obviously standards, nothing controversial about that. And after their business grows, obviously they make more profit more money and they can pay back the loans that were granted to them 10 years later.

Henri (01:23:48):

But the thing is, what happens if the economy is not healthy or if the loans were given in an unproductive manner? Then those profits are not being realized. And I'm not saying like this is some sort of a Ponzi scheme or something like that. A lot of times it just doesn't necessarily realize. You can be exuberant in the loans or the risk calculations weren't done properly. The company's still viable, but they don't have the cash to completely service their debt. So what happens is, well, banks are not cold hearted people, contrary to what a lot left-wing people would say. But they see this and say, okay, well the bones of your company are sound, we're looking at your Balance Sheets and your Income Statements, we see your financials are good. So what we're gonna do is we're gonna extend you more debt. So you basically take another loan out, which is used to pay off the original loan. And then now you have more credit, so you can go do more stuff and then you can expand your business. And this revolving line of credit, a lot of company, even in the United States and in Europe, this is just the standard thing. There's a revolving line of debt that you do. In fact, a lot of companies purposely take debt even when they don't need it. Google and Microsoft, you know, Amazon -- they're famous examples of this, because you get actually tax breaks from the interest payments from bank loans that you wouldn't get from just raising capital from your equity. So the extension of credit and the rolling of credit, it's a constant thing in the economy and raising interest rates means that 10 years ago, because of the economic prospect landscape was optimistic means the interest rates were lower. And if you're at this point where like, okay, your financials are good, but you don't have the free cash flow to service all your debt, getting a new loan -- that's now, all of a sudden, it has a higher interest rate, well now all of a sudden, yeah, your revolving line of credit -- now the cost of that has increased. Not because you're asking for more money, but because servicing that debt is now increased. So raising your interest rates, when your economy is based on a revolving line of credit is also damaging. And yes, again to the classical economists' credit, yes, you're going to absolutely slow down the economy, potentially slow down the, uh, inflation. But doing so in this particular case means the company goes under.

Henri (01:26:11):

This is exactly what happened with Lehman brothers back in 2008 or whatever it was. It wasn't that Lehman brothers was... I mean, sure they've done shady things, just like a lot of other banks, but that's besides the point. The point here is that the bones of their company were actually really sound. It's just that they had this liquidity squeeze. They didn't have the cash to be able to service whatever debts that they had. And they couldn't revolve the debt: banks wouldn't lend them new lines of credit to keep going, because they were over-leveraged on different things. And obviously there's tons of reports on this, but they famously went to the United States government to ask for a bailout, and George W. Bush said no. And of course they went under and they failed. But their assets didn't fail. And what happened was, like vultures to carrion, all the other big banks took all these amazing assets of Lehman Brothers and bought them pennies on the dollar and incorporated them, and improved their Balance Sheets. So it, it was good for them. It sucks for Lehman, but it was pretty good overall for the banking sector, because the underlying assets of Lehman Brothers were good. It's just, they were under liquidity squeeze.

Henri (01:27:25):

And that's kind of essentially what's happening in Turkey now. Well, not essentially, because there's other issues about the bones of the economy, not being good, which we'll get to, but when you have a liquidity squeeze, if you can't find debt, if you can't find people to lend you debt, then your company will go under.

Henri (01:27:42):

And in order to find debt, the riskier your company is the more interest you have to pay. And if the Central Bank increases the interest rate, well that means the floor, the starting position of that interest rate is going to go up, and is only going to further increase the interest load that you have to find to be able to service your debt. And of course, if it's too high, then you're gonna go under not because your company was bad, but it's just that you couldn't get money to pay for immediate needs.

Henri (01:28:13):

Again, in 2008, when a lot of these lines of credit were being extended, the Central Bank interest rate was below 20%. And normally like, who cares about what happened 10 years ago? Because most functioning, at least developed countries have a sound economy. So the prospects and health of the companies are going to expand and only get better. But if they don't, well, then what happened 10 years ago matters with these revolving line of credits. Because guess what happened in 2018? The central bank interest rate went above 20%. And that means the cost of revolving your debt, obviously it was higher. And if your company can't even service the principle or the original interest, a new loan, obviously being more, puts you under a greater financial burden.

Henri (01:28:58):

Now, another factor of this that we need to consider is that unlike countries like the United States, UK, Japan, where the credit that's being extended is in your home local currency to finance and facilitate the running of your ventures, the credit that was being extended to Turkish companies during this 2008 period of economic prosperity, that Erdogan on was ushering in, did not come from Turkey. It came from American and European lenders, which means that the debt that was being serviced was not a Turkish Lira, it was a foreign currency. Which exposes you to foreign currency risk. Because if you have a loan in lira and inflation happens, well, actually, hell that's freaking good. Because if the loan that you took out was for, let's say, a million liras, now a million liras today is now worth only, you know, a hundred thousand liras. Well, I'll make that deal every single day. Inflation. This is the whole point of the mortgages, right? Mortgages are an awesome thing, generally speaking, because, to take an example, when you take out a mortgage, you take a mortgage for the value of the house now, but you pay it off in 30 years. And the value of the mortgage, which is constant, 30 years from now is worth considerably less because of inflation. When you were paying, let's say a hundred thousand dollars in today's money, a hundred thousand dollars 30 years from now is not gonna be worth that much. So hell, you're actually making money. Add that on top of the fact that the value of the house presumably is going up. But you can see why housing is generally considered a good investment. But that only works because the value of the dollar has depreciated. You know, you have inflation and maybe healthy inflation, but inflation nonetheless, but the value of the dollar in the future is worth less than the value of the dollar today, and your loan being in dollars, that's what you pay, so you don't really care. It's, that's what it is.

Henri (01:31:06):

But when it's a foreign denominated debt, your inflation is actually a problem, because your loan, in case of Turkey, the loans that the Turkish companies took out were in dollars or euros. So, this is obviously wrong, but if the lira and the dollar is identical, and you take out a million dollar loan, okay, well, you've got to make sure you have a million lira and you can plan your financial forecast, that okay, 10 years from now, when I have to pay back this loan, I have to give these US debt collector a million dollars. So, okay, that's equivalent to a million lira, but I'm good. Just budget a million lira, because obviously I work in lira, right? So I'm good to go. But now with inflation, you still have to pay the million dollars, but now a million lira doesn't give you a million dollars. What you have now is you need 10 million lira to give you a million dollars, and you don't have that money because you didn't plan for that type of money. And what happens is, in the case of the Central Bank or in case of the central government of Turkey, their debt that they were being serviced on, which was in dollars and in euros, well they need to pay back these commitments, right? So the only way to do that was print more money, have more liras.

Henri (01:32:25):

And to an extreme case, this is what happened during the Weimar Republic in Germany is that all their debt that they had to pay to the Allied powers, especially France and Britain, were dominated in, in Franks and Sterling. The Germans had to pay this money to the French, reparations for World War I, but they weren't going to pay them in Deutsche Marks. They had to pay them in Franks. And at the same time, the French took control of the SAAR Land, which was the industrial Heartland of Germany, which means that Germany couldn't produce stuff, because the French controlled it. So they didn't have the means to produce stuff, to make their Deutsche Mark actually worth something. So the only way they could actually service the French Frank debt was to print more Deutsche Marks to keep up with inflation. But of course, when you print more Deutsche Marks, then the value of Deutsche Mark goes down, and then the case, like a never ending death spiral, you had hyperinflation. And that's all because they didn't have the productive capacity to finance the foreign denominated debt.

Henri (01:33:31):

And to a certain point, that's what you have in Turkey is that Turkey needs the service, the debts that are maturing, that they took back in 2008, 2010, 2012 timeframe that they just went on a debt binge, because everyone thought that Turkey was the darling developing nation. So foreign creditors were giving credit to Turkish companies and Turkish government left and right. Now the chickens have come home to roost and said, okay, well you need to pay back your debt. But because all that money wasn't put to good use, now you have inflation and they don't have the money to pay back. On the open market no one wants to buy the lira, because the Turkish economy is shit. So in order to get the dollars, they have to spend more liras obviously. And to do that from a foreign exchange standpoint, that's obviously inflation. And so what can the Central Bank do? Well now, if it takes 10 times more liras for a dollar, then you're going to print 10 times more lira to service those debts that you have to pay. And of course, by doing that, increasing the monetary supply, increasing the amount of liras. Classical theory, where in case of M equals P, well now more M means more P so the price of the dollar increases, which means you have to pay more. So we're starting to get to the point where the initial cases of a potential death spiral. You can clearly see this and that most of the debt debt that was being offered during this heyday of this Turkish Renaissance was almost to the day 10 years ago, which is considered the average lifetime of typical long-term debt structures.

Henri (01:35:14):

And this is not some sort of out of the blue thing that happened. The value of the lira, just from general inflation and just the general aspects of being a developing nation, there was inflation: lira was constantly losing value. It's just that it was considered acceptable and manageable. And assuming you have the bones of a healthy economy, well, the economic output that should produce should, in theory, counteract, and then some, the depreciation of your currency. But once the initial wave of these long-term debts began to mature in 2018, and you saw, yes, the lira was depreciating value, but it really skyrocketed around the 2018 timeframe. Which again, oh, coincidence or not, you can make that choice yourself, but that's when the first volume of these debt instruments came to mature.

Henri (01:36:10):

So how could have this been avoided? And that is, well, if you have foreign debt, presumably you're taking that debt to produce things that foreigners would want. So that if I'm a Turkish company and I'm taking a Euro debt, that's presumably to make an investment on something, to create something that I can sell back to the Europeans and they're gonna give me euros. And then with those euros, I don't have to worry about currency risk, and I can use those euros to pay back the debt that was granted to me.

Henri (01:36:41):

And this, again, this comes back to international trade. If you're gonna take foreign debt, you want to be able to make sure that you're exporting to that originating country or economic region in the case of the Euro, at least enough to service the debt of that currency denomination.

Henri (01:36:59):

So in the case of Turkey, you need to make sure that you're exporting enough stuff to United States and to Europe to acquire the US dollars and the euros to pay off US Dollar and Euro loans. But what do we know about Turkey with their trade? Well, they're not a net exporter. They're a net importer. So not only are they taking, not only is the Turkish government and Turkish companies taking foreign debt, but they're also trying to acquire foreign currency to buy the things in Europe and United States. It's not like they're building up a reserve or a reservoir of dollars and euros to pay back their loans. Any dollars in euros that they're picking up, they're immediately using to buy goods and services from the United States and Europe. And that's obviously not a good thing.

Henri (01:38:03):

And the reason why this has been such a poignant issue recently is that it's already bad enough that Turkey is a net importing nation, but you had this perfect storm of not only the maturation of these foreign denominate debts, but what happened in 2020? Well, the COVID pandemic hit, right? Well, there's a couple of things that happened. And specifically with Turkey, their biggest exports are heavy machinery, textile and tourism. Those are the big things. Now what has happened recently in the international scene? Well, you had the Trump's steel tariffs and what did that do? Well, that obviously put a downward pressure on Turkish imports of heavy machinery. Not only their steel products, but also just the general industrial machinery derived from those steel products. They were, aren't able to export those. It didn't just affect Turkey. A lot of the steel exports that Turkey does doesn't even go to United States. I think it's only like 5% or something, but those tariffs by the virtue of the United States economy, United States being the United States, it affected the global worldwide price of steel, which had cascading effects that ultimately reduced Turkish industrial exports based on steel.

Henri (01:39:23):

Then with textiles and tourism, obviously they dropped during the COVID pandemic. Well, obviously tourism went to a complete standstill. So you're not getting that. Now add to the fact just general economic growth. Usually if the sovereign country is financing its own debt with its own currency, it has reasonable power to keep the economic engine going. Say what you will... I mean, that's why, like the whole joke about Mussolini is like, well, at least they had trains running on time. Is that dictators may be bad from a political or a social standpoint, but there's nothing saying that dictators are bad for the economy. If anything, because they don't have to deal with internal politics, they theoretically could be very good for the economy.

Henri (01:40:15):

And Erdogan, yes was a strong man. It's not like foreign investors were stupid or naïve. They knew he was a strong man, but with the message that Erdogan was giving back during the early days of 2003 to 2008, timeframe was liberalization of the market and providing a lot of economic opportunity for foreign investors. And if you're an investor, would you rather get zero to 1% interest on your investment in the United States or would you rather get 20% in Turkey? Now, obviously there's a risk, because Turkey is, you know, riskier than the United States, but the risk premium that you're going to get, if it's large enough, you're like, yeah, why the hell not? And this was definitely the case last decade where economists all over the world were saying that Turkey is the darling developing nation and probably the safest developing nation to invest in. And so you're getting ridiculously high, in the perspective of a developed nation, you're getting ridiculously high returns from a practically un-risky country.

Henri (01:41:24):

Now, what did Turkey do with this? Did they actually take that foreign debt from those foreign investors and actually do something productive from it? You can argue yes or no, but most people would argue, no. All you have to look at is the GDP of Turkey over the past decade. But also notably during this decade, you had things like the Gezi Park protests, you had this supposed failed coup and a lot of other economic instability, him jailing his political rivals, which in Turkey's case, it's kind of like, Turkey's kinda like the opposite of Russia in that whereas Putin is in with the oligarchy. Well, yes, there's an oligarchy in Turkey, but they're against Erdogan. Or they were against Erdogan. So whereas Putin -- he works with is oligarchy to, if not improve the Russian people, at least improve the Russian Federation, Erdogan actually actively fought against the Turkish oligarchy and put a lot of them to prison and whatnot. And it was also if the oligarchy is in prison, well, there's not much... That's going to shake the confidence of foreign investors in the ability to extract financial returns from investments within Turkey.

Henri (01:42:34):

Again, you can have political instability in your country. Again, going back to that Mussolini joke or anecdote, as long as you're controlling the financial instruments of credit, because especially if you're the autocrat, you extend the credit based on your whim. But if other people, if a foreigners are doing it, if they perceive the investment to be too risky based on whatever, but in this case, because of political risk, well, that's a big problem. And if the whole basis of running your country is predicated on the perceived un-riskiness of the political climate of your country by foreign investors, well doing politically risky things like jailing opposition leaders and businessmen and having these coups and whatnot, doesn't exactly help invest their confidence. And there's nothing saying that they have to invest in Turkey. They'll take their money and their capital and invest in in another developing country. And of course, once they do that, we'll then not only do you have to increase your interest rates just from a general classical economics theory, but you'll also have to increase your interest rates to attract the foreign capital in, in the first place. And of course, increasing the interest rates to attract foreign capital that has gone to other countries that puts even a further burden on your society, on your citizens.

Henri (01:44:00):

And then of course on the other side of the coin is it's not just about the exports, but it's about the trade imbalance, if you will. Of the difference between exports and imports. And with Turkey, despite having economy, that's been mismanaged to the point of not producing real or stable or healthy growth, there has been a lot of economic activity, especially in agriculture and construction. But what do those agriculture instruction rely on? Well, that requires energy consumption. And if the price of energy is going up, not only with COVID, but just in general, Erdogan antagonizing of Russia. Well, Turkey is reliant on the Russian natural gas, not only from a general energy consumption standpoint, but most of the fertilizer that Turkey relies on for their agricultural sector comes from natural gas that Russia provides. So an increase in the prices of natural gas, or even a reduction of the flow of Russian natural gas, not only increases the cost of energy, but by the fact of reducing energy means that it reduces your economic output. Which means, again, another effect of not being able to service the debt that you have in foreign currencies, because you're not producing enough.

Henri (01:45:14):

But even from a more broader perspective, one of the reasons why Turkey, despite being a developing nation is almost paradoxically an importing one, a net importing nation is because traditionally Turkey has always had high inflation, which again, high inflation in itself is not necessarily bad if it's managed right. You just keep pumping in more money. And as long as people make more money than the inflation, it's good. It's not ideal, but it's manageable. It's okay. But the thing is what that causes from a psyche standpoint or zeitgeist, as Germans would say, is that the Turkish people as a whole, generally have low savings, because why would you save your money If inflation is persistently high? Whatever money you have now, you should immediately spend it. And this is the cultural thing. You go to Turkey. And then if you have a Turkish friend and you go to a restaurant, you know, one way to egg him on this is just that you you're gonna pay. And then of course like everyone on the table is like, no, I'll pay, no I'll pay, no, no I'll pay. It's a big, it's a big thing. And there's a big fight going on, who's going to pay. And then eventually someone does. But the point here is that in the culture of Turkey, is that wanting to pay for things or just not saving money, just the general part of tur or society.

Henri (01:46:35):

Conversely, for example, in Japan, it's the complete opposite, right? Japan has a chronic saving society. They constantly save money, which is one of the big factors in the deflationary troubles of Japan is that everyone is saving. So the economy is not moving along. You're getting all the deflation and, and with deflation, meaning the yen is constantly gaining value, which encourages the Japanese to save even more. And then you have a death spiral in Japan's case, but you have a spiral nevertheless in the opposite.

Henri (01:47:09):

So with low savings, if you have low savings, that means you have low investments, right? According to classical economic theory, which means that you're not increasing the productive capacity of your country. Well, if you're not improving the productive capacity of your country, but presumably living standards are increasing or your population is increasing, which in Turks definitely is the case. Big population boom. Turkey had a huge population boom in the past few decades, which means that Turkey needs more goods and services. But if there's no investments going on because of the lack of savings, then the only thing Turkey can do, or the Turkish people can do is increase their imports to gain those goods and services. So trade imbalance that you already have, that predisposes Turkey to importing.. Just the.. Because of the cultural or societal norms of not saving because of this ethereal spirit of inflation, it only exacerbates that trade imbalance, to make Turkey even more of a net importer. Which again, there's nothing wrong with that, provided that your economy can handle the importing. And in the case of foreign denominated debt, you can have enough exports to counteract that drain of currency.

Henri (01:48:28):

So yes, Erdogan is an autocrat, but he was also a populist. That's how he got into office in the first place. One of the things that he said was that the current political climate, or back then the current political climate was... It's essentially the same thing here in the West. It's essentially it's the right wing politics, but you know, whatever. That's not good or bad necessarily. To basically saying, in some cases rightfully so, or in a lot of cases rightfully so, the Turkish political elite were only servicing elite and the common man was being left on the wayside. So in this populous wave of support that Erdogan got, one of the things that he wanted to do was to improve the lifestyle of the average Turk citizen. So he need to make a lot of investments. And with all the economic liberalization policies that Erdogan introduced during his first couple of years back then as a prime minister, he attracted a lot of foreign investment. And of course, if you're trying to rapidly grow your foreign investment, you'll gladly take it. But of course, foreign investment does have a specific risk if it's not serviced properly. And with the perception of foreign investors, that Turkey was not only a safe country, but a model developing nation, well, of course it's going to be flooded with financial investments. And the more financial investments are being flooded, obviously the interest rates of those investments are going to be low. So essentially even though the risk premium of a supposed developing nation should be at a specific high level, the amount of foreign investment that was flooding the Turkey meant that it was actually cheaper than the quote market rates of a developing country. So why wouldn't you take it?

Henri (01:50:16):

Okay. Well, we just explained why classical theory doesn't apply here based on the, the Curtis LeMay effect. So you're probably thinking, okay, well, you know, let's close up the shop: we got it, Erdogan clearly is right, and he should lower interest rates. I mean, we just spent, I don't know how long, but we talked about all the underlying conditions, why he should be lowering the interest rate. It makes more sense... Well, actually, despite everything I just said, I agree with the classical economist. He should be raising the interest rates..

Henri (01:50:49):

And I'll tell you why in Part II. So stay tuned for the thrilling conclusion of this episode!

Henri (01:51:08):

If you would like to comment on this podcast or on the topics covered within it, or you'd like us to raise a new topic in our next episode, please feel free to leave us a message or a voicemail on That's Charlie, Oscar, Delta, Bravo, Sierra, Mike, dot com. Thank you for listening and see you at the party, Richter!