Jan. 24, 2022

E6: Bombing the Turkish Economy - Part 2

This is Part 2 of a 2-part episode on the Turkish economy and its ongoing currency/debt crisis. In this part, we will  look into some prescriptive options for Turkey and the lessons that the US and the rest of the Western world can draw from the Turkish experience. 

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Henri (00:00:00):

Welcome back to Part II of our look into Turkish economics. In Part I, to set the stage, we talked about the differences between theory and practice of interest rates and inflation. So if you haven't listened to that or you need a refresher, I recommend you revisit that episode. Here in part two, we'll discuss the prescriptive options for Turkey and how those prescriptions apply to Western developed nations. To kick things off, here's final thoughts from Part I. Let's have a listen.

Henri (00:00:32):

Okay. Well, we just explained why classical theory doesn't apply here, based on the "Curtis LeMay effect". So you're probably thinking, okay, well, let's close up 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 rates, it makes more sense. Well, actually, despite everything I just said, I agree with the classical economists, he should be raising the interest rates.

Intro (00:01:11):

Come on. Don't me.

Henri (00:01:25):

He always said: the scariest words in the English language they hear is "I am from the government, and I'm here to help."

Intro (00:01:38):

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

Henri (00:01:51):

Well, first off let's, address the elephant in the room: as of the recording of this podcast Erdogan announced that he's going to guarantee the bank account of the Turkish Lira to Turkish citizens. It's basically the Turkish equivalent of a FDIC. And on this news, the value of the Lira shut up. Now whether this is gonna hold or not, I don't know, I doubt it will, my personal opinion. But what matters is the reality.

Henri (00:02:19):

But the funny thing about this though, is that again, we already, I established that Erdogan hates interest rates. And interest rates, it's not like the bank is like, you know, "Nomine patris et filii et spiritus sancti", and then the interest rates go up, right? Or I guess in Erdogan's case, it would be "Bismillah hirrahman nirrahim", and then the interest rates go up, right? Before the interest rates to go up, what happens is... It's different in the United States nowadays after quantitative easing, but generally speaking, for Central Banks and in this case for Turkey, what would happen is, to raise interest rates the Central Bank has to sell bonds, right? So what happens is, the primary dealers, or the main banks at the Central Bank, who have accounts at the Central Bank, give money to the Central Bank. So that money's removed from the economy. And in exchange, they get bonds, that give an interest payment. And those bonds, by virtue being bonds, are also not in the economy. It's like a savings accounts, right? And because there's less money in the economy, then presumably inflation will drop, right? That's what in the classical economics theory is taught.

Henri (00:03:39):

See, but that actually is not the case, because it's not like the bonds are being issued by the Central Bank. It's issued by the Treasury department of the country in question. So those bonds are already out there, they're already issued. So it's a question of are the interest payments going to be paid to the Central Bank, right? To the Fed. Which, because by virtue of that the Central Bank is effectively outside of the economy, those interest payments don't do anything. Or those interest payments are gonna go to the banks themselves, which actually are in the economy.

Henri (00:04:14):

And the best way I can explain this.. I don't know why I keep going back to food or Italy, or Italian food, but anyway, you know about the espresso machines? So, let me give you a story about espresso machines.

Henri (00:04:27):

When I was stationed in Italy, we had a lot of downtime. And you know, that's not a knock against Italy saying, Oh, Italians don't work, so you got a lot of downtime. No, it just, as there is an expression war is, it's sudden bursts of chaos with long periods of boredom. So during those long periods of boredom, for some reason, I decided to read macroeconomics textbooks to try to understand the economy. But the way I kind of visualized the economics was staring at my surroundings. And for my surroundings, which was in the break room at the Command Center or the Ops Center, as we call it in the Air Force, was a barista. And he would fill out the entire Base's orders. Because basically everyone would come over to the break room and he would fill out all the orders of all the coffees. And me, being an American, not really being exposed to the Italian coffee culture, it was my first time seeing a proper, real espresso machine. I didn't really even know what an espresso was, 'cause I was that culturally inept, but <laugh> I would see, it's almost like an art form with the grinding of the beans and putting in the machine, and getting it with the pressing of the grounds and then the extraction of the coffee. And it was really mesmerizing. It was kinda like watching a classical music orchestra: it's simultaneously boring, but mesmerizing.

Henri (00:05:52):

So the way I was able to imprint the economy into my brain was basically that the entire espresso machine is the economy and the top of the machine, or where the coffee beans are whatnot, -- that's the government. And the amount of beans you put in -- that's what's going to go ultimately and turn into coffee. It's essentially what the Treasury department spends, right? The government, your government is going to spend, based on either, if it's a autocracy, that's dictated, or if your democracy, that's some sort of parliament or congressional laws passed, and that's how the payments happen. And this is kind of like what we were talking about with the government printing the bonds. Bonds, as we said, could either end up with the Fed or in the general economy.

Henri (00:06:43):

And in espresso machine, you have the multiple spouts. So generally you have two spouts, and with the two spouts you can either put two espresso cups and then fill two orders at one time, or you put one giant cup in there and then get both of the streams in that one cup, and then you can make doppio, as they say in Italy. So this is kind of like how, the way the bonds and the interest payments work, right? Because the bonds are being issued by the Central Government and not the Central Bank, right? There's a distinction between government and bank.

Henri (00:07:15):

So the central government is going to issue the bonds, based on whatever laws are passed. And the Central Bank is kind of like the barista in charge of putting the cups underneath the spouts. And by lowering the interest rate, what you do is, you're essentially putting two cups in there, where some of the money is going into the economy, like in one cup; and the other is, because of by virtue of the fact that you have low interest rates.. And again, like we said, low interest rates means the Fed or the Central Bank in broader terms has bought a lot of those bonds, means, those interest payments are going into the Central Bank. And of course, then it gets recycled back to Central Government and essentially it is washed out, it's outside of the economy, right? Whereas when you raise the interest rates, those bonds are now, rather than being locked up in the Central Bank, are now back in economy. So in this case, it's kinda like with the espresso machine analogy, rather than having two cups for the two spouts, you're putting one giant cup underneath the machine, and both spouts are going to that one cup.

Henri (00:08:19):

The government payments of interest, payments are gonna happen regardless. Regardless of what happens with the Central Bank, because that's determined by law or in authoritarian regimes by a decree. And the only thing that Central Bank can do is divert those payments either into or out of the economy.

Henri (00:08:38):

And that's key point here is that interest rates are not raised by decree. Raising interest rates is done through the buying or the selling of bonds by the Central Bank. And all that does is divert already existing central government coupon payments, right? 'Cause the bonds are already issued. The coffee is already ground. It's gonna come out of the spout regardless. It's either gonna go into a separate cup or into the drip tray, right? Or it's gonna go into the actual espresso cup, that's being served. Or in an economic sense, if the Central Bank raises the interest rates, that means all those bonds that were locked away from the economy are now actually in the economy and the constant interest payments that are being paid, regardless of it's in the Central Bank or in the commercial banks, the Treasury department of the central government is paying the money on the interest of these bonds. And now, because they're not locked away in the Central Bank, but actually all that money is being issued to the commercial banks, well, that's more money that's actually going to the economy and more money just increases the price level, so it increases inflation. So a higher interest rate actually, contrary to what classical economic states, increases inflation.

Henri (00:10:02):

And again, like I said before, this is perfectly evidenced by both Argentina and Japan as classic examples here of this. Argentina, they've raised interest rates, thinking classically that it's going to reduce inflation, but inflation has been going up. And Japan, again, the opposite, is that they've lowered their interest rate and the interest rates have been, uh, have been lower. Plus all the other things that we've been talking about with the price level increasing, because of the time lag of trade financing.

Henri (00:10:33):

So this is the thing that Erdogan is against, right? What he is saying is, he's against interest rates. And again, whether it's because of Islamic theory or not, that's immaterial, the point is, he is against interest rates. Which functionally means, he is against the Central Bank giving bonds to the economy. And when the Central Bank gives bonds to the economy, what does that mean? That means the Central Government, the Treasury department, rather than giving these coupons to the Central Bank, which is immaterial to the economy, that interest payments on those bonds is being given to the commercial economy. So by him saying "I am against raising interest rates", he is functionally saying, "I am against injecting money into the economy".

Henri (00:11:26):

But what is this buyback or what is this Central Government guarantee that he just announced yesterday, functionally doing? Well, he is saying that if the price of the Lira falls, well, I'm gonna give you more Lira to guarantee the conversion to the foreign currency. Well, functionally, that's exactly the same thing as interest rates. So this whole thing about him saying, oh, I'm against interest rates, well, he's actually doing the very thing that he's saying that he's not going to do. Which from a classical theory standpoint, the classical economists recognize, saying, yeah, okay, whatever, Erdogan, you can say, whatever the hell you want, but you just said, you're going to increase interest rates, so for us that's good news. And that's why the lira shot up. So he's actually doing the things that the foreign investors want to do.

Henri (00:12:15):

Now, all that aside, again, 'cause this is just a funny little anecdote, but more broadly, again, like I said, despite the fact that classical economics is not applicable to the Turkish environment and raising interest rates will just raise inflation, is think raising interest rates is the right thing to do. Because like I said earlier, controlling inflation is not the end all be all of governing an economy, or managing an economy. It's about facilitating the goods and services and providing for the citizens. And right now with Turkish people, struggling so much with the shambles of an economy, they need capital flow. And again, the capital flow is not coming, because the foreign investors are not coming. Because again, because of the risky business and all the things that we've been discussing for this entire episode.

Henri (00:13:10):

So the only way to get the funding to facilitate the flow of the Turkish economy is to attract foreign investment. And right now, unfortunately, or fortunately, depending on your perspective, what that means is the Central Bank has to raise interest rates. Not because it's going to help with inflation, but because it's going to help attract foreign investment. Because right now what Turkey needs is foreign investment. Because the Turkish Lira is an ineffective medium for facilitating trade within the country. You need the foreign investment, unfortunately.

Henri (00:13:47):

And the only way to attract that foreign investment is to raise the interest rate, to match the perceived risk premium that is in investing in Turkey.

Henri (00:13:56):

We also could say politically, things that Erdogan can do, is become more liberal, less autocratic. But obviously you can see, that's a Total Order, and that's not really gonna happen. We will see that happening, when pigs fly.

Henri (00:14:09):

Now, all that being said, there are some other reasons, a lot of people write off, what Erdogan is proposing. As in, oh he's either being senile, he doesn't understand economic theory. Or because he's Muslim and he's just trying to create a Sharia theocracy and dismantle thee secular institution of the Republic of Turkey. And that's fine, we can get into conspiracy theories and all that. But there're a lot of economic reasons for why he is proposing these things, that we need to consider. Which may not necessarily help the Turkish situation, but will definitely help understand why he is espousing the situations that he's in.

Henri (00:14:53):

Well, one thing is that, like we just said that he needs to attract foreign investment. And in order to attract foreign investment, one way to do that, again, is to raise the interest rates to match the perceived risk premium. The other way to attract foreign investment is through currency swaps. And Turkey has been doing a lot of this with China. This is a part of China's One Belt One Road initiative. They are trying to increase their economic and political influence throughout the world. Good on them, every country has the right to do that. But the way these currency swap deals work is that Turkey and China are swapping their currency. And not only they're swapping their currency, but they're also swapping their interest rates.

Henri (00:15:42):

And we've got to look at this from the perspective of Erdogan. He has an election coming up in 2023, and he's a populist autocrat, so he relies on populism to get him forward. And with the economy the way it is, he either needs to improve the economy or find someone to blame. And also the 2023 election is actually very important to him, because again, as this moderate Islamist, or whatever you want to call him, but this "theocratic light" person that Erdogan is, it is no big secret, he detests Ataturk, the founder of the Turkish Republic, and more specifically, the secular institution that he built within the Turkish Republic. And 2023 will be the hundredth year anniversary of the founding of the Turkish Republic. So him being at the at the helm, being able to say at the Centennial anniversary of the Turkish Republic, you know, "I have restored the Islamic glory of Turkey", is something that's very much on his mind. So that's also, that's well, one of the reasons why from a rhetoric standpoint, he's really leaning into this whole interest is a bad thing, interest is haram, it is, not condoned in the Quran. So there's that.

Henri (00:17:05):

But from a functional standpoint, the economy as bad as it is right now because of the current Turkish Lira depreciation, it can actually be a lot worse. Because one of the things that Erdogan is doing is that whatever reserves -- Dollar, Euro reserves -- that Turkish government has, they are selling that to prop up the Turkish Lira. Obviously they are not doing good job, because the Turkish Lira is skyrocketing, but the point is that they're actually trying to prop up the Turk Lira by selling these foreign reserves, by selling US dollars to at least not make it as bad as it really could be. And right now a lot of economists are saying that, oh, well, Turkish reserves are diminishing, it's pretty low. But what they're referring to is the gross foreign reserves, the gross amount of US dollars.

Henri (00:18:01):

But if you take away the currency swap deals that Turkey has made over the couple years, they actually have a net negative balance. So while the gross reserve balance is positive, their net balance is negative. And that means removing the currency swap deals that they are having. So basically with the currency swap deals, that Turkey has made with China. For example, this summer they made a $6 billion, it was worth 6 billion dollars of a currency swap, where basically the Turkish government gave $6 billion worth of Turkish lira and the correspondent Turkish interest to China; and then the Chinese government would give $6 billion worth of Chinese Yuan, plus the Chinese interest rate to, Turkish government. And of course, how this works is that you have that foreign currency of your partner, which means now it makes it easier for you to facilitate trade.

Henri (00:19:01):

Of course, this is good in the sense that from both standpoints, 'cause China is a net exporter, so they want people to use the Yuan so that they will buy Chinese products, and Turkey by, as we just discussed, necessarily being a net importer, they need to buy stuff. And if they have Chinese Yuan, they are locked in with that currency, so they can easily facilitate the importing of Chinese goods. But another part of this, again, it's not just the principle that's being swapped, but the interest rates. And if Erdogan... And again, the economy is already bad as it is, and people are suffering, losing jobs, they are already angry, right? But it could be a lot worse when Turkey does not have the foreign reserves to sell to prop up the Turkish Lira.

Henri (00:19:48):

So essentially, because he is refusing to raise the interest rates, the only way he can get foreign reserves, particularly because of Turkey being a net importing nation, is through these currency swap deals. And China, obviously, with the desperation of Turkey is in, China is in a pretty good situation where for the swap, they don't want a high interest rate. They're gonna obviously go with Erdogan and say, No, keep the interest rate low, because if we're gonna do these swaps, if you want our Yuan, if you want our foreign reserves, you need to keep the interest rate low, because we want to pay you a low rate during the swap deal.

Henri (00:20:27):

So that's another issue it's kind of overlooked right now is that, as bad as the Turkish Lira is, it could be a whole lot worse without the infusion of foreign capital through these currency deals. And the only way these currency deals, these other countries are going to give that to them is if they keep the interest low, because it's in their interest to have a low interest.

Henri (00:20:52):

So Turkey is in a really messed up position right now. Erdogan is stuck between a rock and a hard place, because he really should be raising interest rates to attract the foreign capital needed to kickstart the economy back up, but he can't because he is being held hostage by these currency swap deals, where the rates have to be low so that he can get the foreign reserves needed to prop up the Lira. Because if he doesn't prop up the Lira, the situation's gonna go from bad to worse.

Henri (00:21:36):

And then from the domestic standpoint, Erdogan also has considerations, where he's replaced the old oligarchy with a new oligarchy. And that new oligarchy is in construction business. Part of his removing of the old guard, if you will, was giving his cronies cheap investments in construction. And this is one of the things that even classic economists would say, is that lowering interest rates means you are obviously not getting as much of return as you would normally want from those bonds. So what does that do, that's a capital flight to other assets. And one of the primary assets that people give flight to is construction to real estate.

Henri (00:22:21):

And with his cronies, the oligarchy that he's created revolves around construction, so for the past decade or so, there's been constant construction projects going around all over Turkey and Istanbul right now. There's so many, I don't know how true this is, but people are saying that there's more skyscrapers in Istanbul, than in any country or any city in Europe or America, which is freaking insane.

Henri (00:22:47):

And most of these construction projects, they are empty. Now, this is another situation that we're seeing in the middle east and China as well, is that a lot of these wealthy investors that wanted to park their wealth, parked it in dubious real estate investments. And a lot of skyscrapers or what have you, are half constructed, because they just take the money and run. And that situation is no different in Turkey. And specifically in Istanbul, they had tons of construction projects, and with the fact that a low interest rate boosts the value of that real estate. Because again, there's a capital flight from, from fixed assets, from bonds, to real estate. And if Erdogan is going to stay in power, he obviously needs to satisfy his cronies, his oligarchy. And with that oligarchy being centered around construction, well, not only do they rely on the low interest rates from a speculative standpoint, because people are more likely to invest in their construction projects, but also again, going back to that revolving debt nature is that they're constantly relying on new debt on new domestic debt in this case, because these are just domestic construction projects. And because they're not actually collecting any returns from these dubious construction projects, because they're just sitting there empty, they need to finance their wealth with revolving credit. And increasing the interest rates is only going to increase the cost of that revolving credit to fuel their own wealth. So that's another aspect of why from a more real politics standpoint of why Erdogan is refusing to increase the interest rates.

Henri (00:24:32):

And the other issue, again going back to the populous nature of his political campaign, is that in appealing to populism in Turkey, what Erdogan has done over the past decade or two is... He was the former mayor of Istanbul, and it has always been a thorn on his eye that his own city wouldn't support him. So what he wanted to do was flood Istanbul with people from the countryside -- supposedly the poor people, the more religious types, the more pious of Turks -- to win, to basically control the seat of local Istanbul politics. Because essentially, it's kind of like a "Dune" situation: whoever controls the spice controls the empire. Well, same thing is in Istanbul: if you control Istanbul, politically it's much easier to control the whole country, right? Because it is the economic powerhouse of the country. So he needed his own local people in the government there to facilitate all the things that he was doing.

Henri (00:25:35):

And by doing that, well, two things happened. One is that he encouraged the mass migration of countryside of rural Turks into Istanbul where Istanbul immediately ballooned in population. I think it doubled in population within a couple years. And Istanbul does not have the physical infrastructure to handle this.

Henri (00:25:59):

So there's the political standpoint of him trying to flood the pious into Istanbul so that he could win those local elections. But also there's no other aspect of it, is getting all these people to move to Istanbul, would finance... They would presumably move into these buildings, these new buildings there, that his cronies are constructing, and that would fuel the growth of their own personal wealth. But because obviously the real estate in Istanbul is already high, because it's a desirable city, and giving sweetheart land contracts to your cronies and then them building apartments and skyscrapers and having rural Turks, presumably move into them -- it's a good operation here that you can cook up. Of course, that didn't really happen. And a lot of these rural Turks became homeless. There's this phenomenon called "gecekondu", which means, it's buildings or like basically shacks or shanty towns, that were put up in the middle of the night where rural Turks were living. So you have like when you go down the highway in Istanbul, you'll see all these random shacks of just people living there. And these just popped over in the middle of the night. And that's what "gecekondu" means literally in Turkish is like "put up in the middle of the night".

Henri (00:27:16):

So that obviously wrecked Istanbul as the economic engine of the country, because just from a personal or from an individual person standpoint, the fact that the infrastructure of Istanbul couldn't handle this doubling size of the population. You look at the average Istanbul person. Usually it's kind of like in New York city, where most people in New York live in the outer boroughs, you know, they live in like Bronx or Brooklyn and then you commute to Manhattan to work, right? You take the Bridge or tunnels and go to work, and then you take the Bridge or tunnels to go back. It's kind of similar in Istanbul, where usually people lived on the Asian side of Istanbul and then would take the bridge to go over to the European side and work, and then come back. And it was bad enough that the population back in the nineties for Istanbul was around 8 million, which is the population of New York city. Not the metropolitan area, because metropolitan area is larger, but New York city proper is also an 8 million. And New York city has how many bridges and tunnels? At least a dozen. But in Turkey they only had two. Right? And then all of a sudden now the population of Istanbul is 15 million. And just recently they finally built a third bridge, but still it's, it's pretty bad.

Henri (00:28:35):

But not just from the bridge standpoint, but just normal. It's not like, you know, United States where these are brand new cities. Istanbul, Constantinople, Byzantium -- is an old cit. It's one of the oldest cities in the world. So it's not like you have large boulevards where you can park cars. There was actually a Turkish article, were they were saying that if you lined all the cars of Istanbul in the streets, it would exceed by three times the amount of street available in Istanbul. So lengthwise, there's three times more cars than there's actual streets in Istanbul. Which means there's physically no room to park cars in Istanbul.

Henri (00:29:15):

And not only that. The traffic is horrible, and there are people where normally the commute back in the nineties, it would take you 20 minutes - half hour to go to work, now people literally are stuck up in traffic for two-three hours. So if your economic engine, the economic engine of the Turkey is Istanbul, but the people physically can't get to work or get back from work, because they're stuck in traffic literally a quarter of the day, well the productive capacity of your supposed economic engine is severely diminished.

Henri (00:29:45):

Plus that doesn't even consider the fact... Okay, forget about Istanbul for a second. All these rural people... Again, Turkey is not like some super industrialized or service economy-based country, like Europe or Western Europe, or United States. It's very much an agrarian society. The economy, I should say, is very agrarian. But what Erdogan did is, by moving all these rural Turks to Istanbul and Ankara -- the capital -- was that they removed the farmers that were actually producing the agricultural base for the Turkish population. And again, the Turkish population... Turkey is one of the only European countries, whose population has ballooned. And so obviously it needs more food, but now you have less farmers, less agricultural workers that actually provide you the food. And of course you need food. It's not like you cannot have food, like we've already discussed.

Henri (00:30:40):

So what does Turkey do? They have to import their food. So just from a base standpoint, even though, and normally like it's, it's fine, because a lot of European countries import food too, right? But those European countries are developed nations, whose economy is not agrarian based economy, right? The are service or industrial based economy. But Turkey very much being an agricultural-based economy... Well, if you're an agricultural-based economy and you can't and produce your own agriculture, obviously that's a big red flag. And foreign investors, obviously, can see that too. Which provides further political and economic, or societal instability within the country. Which further increases the perceived risk premium from foreign investors and further exacerbates, the current issues in Turkey.

Henri (00:31:28):

And this is where classical economists will come and say: well yeah, no, duh, that's the whole point of comparative advantage. You know, you just go get your import, all your agriculture or all the food that you need from Europe or whatever. Okay. Well that's good. But like I said earlier, there's a time delay with trade. And that time delay translates into a real cost in your imports in the form of short-term interest rates. So raising the interest rates is going to make it more expensive for your imports. So the comparative advantage, while again, this is a classic problem of classical economics, is that it all sounds good in theory, just like with Norden bomb site and the bomb testing in the American ranges, but as soon as you take your bombers over to Germany or Japan or whatever, then you see that your theory doesn't quite work. And here it is again with Turkey, is that, okay, yes, comparative economics theoretically exists, but because of the time delay nature of trade finance and the cost of importing, those goods are going to be affected by the interest rates that you're going to have to pay.

Henri (00:32:46):

So is there a way out of this? Honestly, I don't know because Turkey's stuck between a rock and a hard place. Either they keep the interest rates low to keep propping up unprofitable Turkish Lira, or they actually bite the bullet and raise the interest rates, which again, doesn't really help from an inflationary standpoint, but at least it brings foreign investment and, which hopefully they could use to turn the country around. Either way things are going to get a lot worse before they get better. If they ever get better. And Turkey hasn't really in its modern history shown any strong track record of providing evidence to the global economy, that it can lay the groundwork for solid fundamentals of a sustained growth in this economy. But you know, hopefully I'm wrong and they can actually, whatever investment they ultimately get, they can actually do that.

Henri (00:33:35):

But at least it acts as a warning sign for us in other countries.

Henri (00:33:40):

The main lesson that we can take from Turkey is that the immediate impacts of monetary policy, whether it's raising interest rates or reducing interest rates, can provide certain effects. What those effects are, can always be up to debate, because frankly, there's too many variables for it to be accurately deduced. Monetary policy has always been an equivalent of trying to push a piece of string. Monetary policy will never be as effective as the sound fundamentals of fiscal policy. Fiscal policy, being the spending and taxation of the Central Government as opposed to the Central Bank. And if in the developed world, we've become developed by virtue of the fact of the proper and the good management of, despite our political differences an political turmoils within our respective countries, the fundamentals of the economic growth have always been there, which allowed us to be developed nations.

Henri (00:34:39):

Now you can argue about, well, yeah, that was done on the backs of exploiting the Third World and indigenous people. And that's a social issue that we can address. But the lesson we can learn here is not where Turkey is now, but how Turkey got there. And the common theme throughout this entire episode has been to complete absolute mismanagement of Turkey's finances and the structuring of the Turkish economy. Specifically the extreme politicization or using the economy as a hostage to ensure political hegemony. And that happened because economic decisions were made not for the facilitation of economic growth, but for the consolidation of political power. And unfortunately this is what I'm seeing happening in the US. And also what we're seeing, definitely in Eastern Europe, but lately it started to happen in Western Europe too.

Henri (00:35:41):

And now there's all this talk about raising interest rates in the US, well in EU too, but anyways. 'Cuz they're saying, oh, the economy's overheating, the inflation is rising. The same shit that's going on in Turkey, they are saying is happening in the US and the rest of the first world. So they're saying, oh, we've gotta raise interest rates. And hopefully this episode has been kind of a warning sign to at least pause and consider: Hey, should we really be raising interest rates? Because if we reference back to the Curtis LeMay effect, it's not just about what the theory says. It's about what the conditions on the ground are.

Henri (00:36:20):

And we went back and forth about Turkey said, okay, the theory says we should raise interest rates, but actually theory is wrong, because for various different reasons, mostly the time delay in financial transactions, and in reality we should actually be lowering interest. And when you look at this broadly, I shouldn't say conventionally, but you know, broadly speaking, raising interest rates actually raises inflation and lowering interest rates lowers inflation. Going back to that espresso analogy.

Henri (00:36:52):

But then again with Turkey, that's not really the issue. The issue is they need to get their investments in order. They need to get some injection of capital. They basically need an emergency shock. And right now presumably the easiest way to get that emergency shock or fusion of currency, of money, money flow, cash flow into their economy is through foreign investment. It's kind of like what they say, like dieticians would always tell you, oh, you know, sugar is bad, sugar is bad. Well, sugar is only bad, if you're in a First World sedentary diet. If you are starving for resources or, you know, if you're feeling a little woozy, sugar is actually the best thing for you, because it's the best way to get immediate energy. Now, of course, if you just rely on sugar, then obviously of course that's bad, because all that immediate energy is going to turn into fat, and you are going to have all these other problems and whatnot. But for initial shock of energy, sugar is obviously the best thing, which is why they say for the elderly, they always recommend that you carry like little tin can of hard candies, so that if whenever they get lightheaded or woozy, you just pop in one of those hard candies and then you're good to go. And I remember like my grandmother would have a tin can of these little sour candies. And then she would pop it anytime, if she felt a little woozy, when she needed a little bit of energy.

Henri (00:38:10):

So with Turkey, yes, I did say Turkey should raise interest rates, but not to combat inflation. It is to encourage the foreign investments, so they can actually get some cash flow. And hopefully Erdogan, I mean even though he won't, but you know, that's neither here nor there, but hopefully he would take this foreign investment to actually do something sound for the Turkish economy so that they would have the solid fundamentals as a base to exercise the economic policies that he espouses. Which is lowering of the interest rates to keep inflation low and increase economic prosperity, and I guess in his terms, you know, bring a rebirth of the Ottoman Empire, which he seems to be obsessed about.

Henri (00:38:53):

But so the methodology may be the same, but the desired effects are different. So I still stand by that: the theory is wrong. It's just that this time the blind squirrel has found it's nut <laugh>.

Henri (00:39:10):

And we, again, we have to remember that the end goal here is not to combat inflation. I mean, obviously you want to combat inflation, but again, that's not the end goal. The end goal is to do what is best for your citizens. And just like with LeMay, the end goal is not to prove whether the Brits were wrong and that high altitude or low altitude bombing is the best way to go about. The point is to rain destructive firepower on a country's... on your enemies' manufacturing capacity, and ultimately to win the war. That's the end goal. And that's what we should be focusing on.

Henri (00:39:46):

So when it comes to United States, or I guess the first world in general, we gotta look at what are the economic realities on the ground are. All these things that the conservative economists are saying, it's like, oh yeah, we have to raise interest rates to slow down the economy, because the inflation is going high up. Well. Yeah. Okay. Broadly speaking inflation is increasing. Yes, that is absolutely true. But inflation is not just some, one off measure and inflation is about too much money chasing too few goods. So you just can't focus on the "too much money" part. You have to also focus on the "too few goods".

Henri (00:40:24):

You know, it's kind of like with the Marvel Cinematic Universe where Thanos has got the Infinity Gauntlet and his whole deal was that the Universe is overpopulated, it's overcrowded. So there's a lot of starvation and suffering, because there's not enough resources in Universe. So what's his solution? He's going to kill half the people in the Universe. And I, I feel like that's a very classical economics way to think about things, because yeah, sure, you can definitely solve the starvation and suffering problem, but of course what you're doing is, you kill half the people.

Thanos, Marvel Cinematic Universe (00:40:59):

Little one, it's a simple calculus. This universe is finite, its resources finite. If life is left unchecked, life will cease to exist. It needs correction.

"The Little One", Marvel Cinematic Universe (00:41:11):

You don't know that!

Thanos, Marvel Cinematic Universe (00:41:14):

I'm the only one who knows that. At least I'm the only one with the will to act on it.

Henri (00:41:21):

There is another way to do it. If you have the power to kill half the people, Hey, Thanos, why don't you consider the doubling of the resources of the Universe? Or for the pedants out there, doubling the productive capacity of the Universe, and accomplish the same exact thing: end suffering, but without actually, you know, waxing half of the population.

Henri (00:41:42):

So you could either be like Thanos and attack the "too much money" part of the inflation equation, or you could be a little bit more benevolent and attack the "too few goods" part. And what's been going on for the past two years or so? The COVID pandemic, right? And we have supply chain disruptions everywhere. And we can get into arguments and debates on what are the causes of that. But that's immaterial at this point. What matters is that we have a lot of supply chain shortages and that's what's causing the inflation -- it's the "too few goods" part.

Henri (00:42:14):

And of course other people will bring out some metric that they pulled out from some random statistic from the Fed and say, well, no, that's actually not true, because of this or that. Look, we can debate all the different statistics that you want, but it's kind of like voodoo fortune telling by throwing the chicken bones on a trash lid, trying to tell the future. Because the statistics that matter, are the statistics that are relevant to your citizens.

Henri (00:42:40):

And you could look at household debt, for example. And that has actually been pretty flat. Despite this high rate of inflation, household debt has been relatively flat. And even, we heard about this during the stimulus checks is that, there were reports about how the stimulus checks that came, most American households were using that to just to pay down the already pre-accumulated debt.

Henri (00:43:06):

So if debt is not increasing... You know, this was the thing back during the Clinton years, was that household or private, whatever you want to call, it was increasing, it was going through the roof. And therefore they had to raise the interest rates to cool down. And sure, you might remember, during those years, the Clinton years, much to the chagrin of a lot of GOP, they hate to admit this, is that, you know, we had a field day in the economy: everything was going amazing and great. During those years, people were living on their credit card. The bond traders on Wall Street... 'Cause my mom was working in Wall Street, so she would have all these stories about how they'd be like comparing dick sizes, they'd be comparing their credit cards, and be like, oh look, I got the Amex black card! Or it's like, oh no, I got the visa! Well, I mean, it doesn't matter: if you got the Amex black card, nothing beats that, but you know, everyone would say, oh, oh, let me get the bill! Right? Everyone was trying to one up each other. So when the restaurant bill would come, they'd be like, oh no, I got it, I got it. And they would like drop down their credit cards, like flopping their dicks on the table. It's like, oh, look at mine! I got visa platinum! Like, oh yeah, well check this out, Bam! I got my Amex black card! Because that was the whole cultural environment back then. Private debt, real household debt, whatever you wanna call it, was going through the roof. So of course, back then it made sense: you wanted to raise interest rates to cool down the economy, because people were spending like crazy.

Henri (00:44:33):

But again, you look at statistics now: household debt has, in some sense in some metrics has been decreasing from, again, the story about the stimulus checks going towards paying down debt, but just broadly speaking, definitely in the us and more broadly in first world is that household debt has been relatively flat. I mean, I say "relatively", because obviously it increase, but it's the first world, of course it's gonna increase. We don't need to be little pedantic about it there.

Henri (00:45:00):

And of course, more importantly, business borrowing... Because that's the other side of this, right? Is you have the private individuals with their own private consumption, but then you also have the economic powerhouse of a country, which is its businesses. And business borrowing in recent history has been the slowest it's ever been. So you can see here that not only from the private side, but even from the business side, the economic growth has been slow.

Henri (00:45:28):

And this is even despite all those, you know, they made a whole big fan fair, the Democrats, about, oh look, we passed this huge COVID relief bill, and this is all great, it's going to help businesses out and everything like that. No, it didn't do shit, because, I mean, you can just look at the numbers yourself. It's that even without offering of all these cheap loans for the pandemic business, borrowing is still at a, I shouldn't say all time low, but as far as recent history is concerned, like last decade, business borrowing is, we'll just call it, anemic at best. So raising the interest rates on a already flat private and business debt metric is going to do little to no good. And again, when you talk about how the fact that businesses rely on low interest rates to finance their operations, that's only going to hurt the first world.

Henri (00:46:16):

So again, the problem is not easy credit, because we already have easy credit. Both households and businesses have it. So we do have this cheap and easy money, which presumably means that we have plenty of money available in the economy. But if we have all this available money for us and the economy is still slow, well then the only other option that we have to consider is the supply side. Which of course makes sense, given the pandemic. And everyone knows it, anyone trying to buy a car or GPU, or PS5 can readily attest to the fact that the supply chain is in shambles right now.

Henri (00:46:53):

And of course we can also go into the fact about labor force participation rates and unemployment. Or more importantly, underemployment. Because this is another way that classical economists will try to get you: they'll point directly at the unemployment rates and completely ignore the underemployment rates, right? Because the people, especially in the United States, how a lot of your benefits are tied to being employed, people are in such a bad position right now, they'll just take any job they can get their hands on, just so they can get insurance or some sort of other type of federal or local benefit. And that doesn't mean that they're gainfully employed. It just means that they are in such bad conditions, that they're essentially reduced to what I would consider, you know, one level above slavery or an indentured servitude. So you should always be careful when the economists say, oh, look at the employment rate! Because unemployment rate is a bullshit statistics, and you have to look at the overall labor market participation rates. We can go into a separate long-winded conversation on difference between U3 versus U6 unemployment, but that's a story for another time.

Henri (00:48:01):

So, the labor force participation rate is down. And then even in business circles we like to talk about capacity. There's this obscure statistic called capacity utilization rate. And that's been down by over 3%. Capacity utilization rate is just a fancy term, broadly speaking, for your industrial sector. And with that down, when we're talking about supply chains, because obviously those two are inexplicably linked together, and that industry is very reliant on supply chains, and so when you have supply chain reductions or disruptions that affects your industrial capacity, and also from the financial aspect of it, again, one of the biggest sectors that are heavily reliant on short-term financial instruments, you know, short term loans and what have you facilitating trade finance is the industrial sector. So the industrial sector being down by 3% or so, which doesn't sound like much, but in economics terms, it's a big fucking deal, as Joe Biden would say. It matters.

Henri (00:49:04):

And we can't just blindly or arbitrarily say, oh yeah, let's just raise the interest rates, because inflation is high. There's a lot more that goes into that number. And it's not just about inflation, because inflation inherently means two different things: too much money chasing too few goods. All these metrics that I just spent all this time ad nauseam talking about, is pointing to the fact that, Hey, we do have enough money in the economy. It's just that we have too few goods. We need to increase the productive capacity. We need to increase the goods.

Henri (00:49:35):

Anecdotally, Ronald Reagan would famously say, oh, are you better now than you were four years ago? Just go around asking people, how is their disposable income? Most people would say that yeah, their disposable income is shit.

Henri (00:49:48):

But can I really blame... In some sense, you can't really blame the Fed for saying these things, because they are mandated to stabilize the economy. They have the dual mandate of maintaining a low unemployment rate and stable prices or as most people would say, low inflation. So, not to sound cliché, but the old adage goes, if have a hammer, then everything starts looking like a nail. And the fed, they only have one way, one effective way to regulate the economy, and that's the raising or lowering of interest rates. Well, if the interest rates are already at zero, there's only one thing left to do and that's to raise it. So from their mind, obviously the only thing they can really do is raise the interest rates. And when you have theories saying, oh well raising interest rates will lower inflation, well, it's an easy choice for them. Because when everyone around you is saying, oh yeah, high altitude precision bombing works, well then yeah, you're going to follow. It's easy to go on and follow on and say, oh yeah, we should totally do high altitude precision bombing. It takes a big man to step forward and challenge the prevailing wisdom to do what's right.

Henri (00:50:56):

With the Fed's dual mandate their job is to control and affect monetary supply. So the only thing the fed can do is affect monetary policy. Which when we're talking about inflation being too much money chasing too few goods, well obviously they have no bearing or no effect on the "too few goods" part, because they are a Central Bank. The only thing they can do is address "too much money" part. So if you have inflation... And in their mind again with the hammer and the nail analogy, well the only thing that they can see is, oh, there's too much money in the economy, we need to constrict it. Or in other terms, too much money chasing too few goods. Well, too much money is the demands part. And too few goods is the supply part. So the only thing that the fed can do is affect demand.

Henri (00:51:44):

And that's why classical economists always say, oh, you've got to reduce demand to reduce inflation. But the Fed, all they can do is affect the demand side, vis-à-vis, monetary policy. The supply side, which is the "too few goods" part, can only be affected by the actual government in question, the Central Government question.

Henri (00:52:05):

And this is one of my main problems with classical economists or specifically... I shouldn't shit on all classical economists, but a major subset of them is supply side economics. But supply side economics makes no sense, because... It's pretty much popularized by Ronald Reagan, he was really big into supply side economics. But he also famously would say that the problem with the government is the government. He said said that the scariest words in the English language to hear is "I am from the government and I'm here to help." Well, you can't say that stupid quip and then also be a supply side economist, because as I just established here, the only entity that can affect the supply side is the government. So you're either gonna have to be a supply side economist and pro big government, or say I'm against big governments and I'm going for the demand side.

Henri (00:52:57):

Obviously it's a marriage of both, because it's a balance between "too much money" and "too few goods". It's a balance between the demand and the supply. But the Fed can only do the demand side, where it's up to the government to address the supply. And if the government doesn't address the supply, well, the Fed ends up taking control of the economy and the only thing that they can do... Again, I don't want to blame the Fed, the Fed is just doing what it's trying to do. I mean, I actually, I can blame the Fed. They could just not do anything and say, and actually educate people, just educate the public and say, look, this is not a demand issue. This is supply issue, but that's, you know, regardless, that's besides the point.

Henri (00:53:38):

The point here is that if the government abdicates its responsibility in addressing its own economy, well then the only thing left to do is to rely on a Central Bank, right? And if you only look at the money supply part and ignore the productive capacity side, well, you end up just like Turkey, where we just spent this entire episode, talking about the gross mismanagement of the Turkish economy by Erdogan, by the Turkish president. And in this case, especially in America, I wouldn't say well, I mean, I would say, the United States government has grossly mismanaged the United States economy. But in this case, it's not in a malicious sense as it is with Erdogan, but it's just an abdication of responsibility.

Henri (00:54:25):

Ever since George W. Bush left office, we've had over a decade of political gridlock, leading to the abdication of the government's management of its own economy. Which has led to such a fragile state of affairs for our productive capacity and supply chain, that all it took was some guy in China eating a bad bowl of soup to send, the world's greatest economy into a complete and utter disarray.

Henri (00:55:00):

But we can't just get on Twitter and start shouting at each other, because a that's not going to help with changing the discourse. But more importantly, the point here being that lately the West is starting to use, or the Western politicians are starting to use the economy as a political weapon. Just like Erdogan has been doing so in Turkey. I mean, again, this is the whole point. The reason why we've had, we've enshrined that Central Bank should be independent, because the management of the economy should be relatively independent from political squabbling. Well, here, now we have it not necessarily on the monetary side, but definitely on the fiscal side, we've lost that independence. Or at least, I should say, the bipartisanship or coalitionship, if you are European. I don't even know if that's a real word <laugh>. But this is a dangerous path to be on, as Turkey has readily demonstrated, but we just can't shout on social media to affect this change.

Henri (00:55:59):

So the thing about Curtis LeMay is that, okay right now, ex post facto from a historical perspective, we're looking and talking about Curtis LeMay and his career and the fact that he had during World War II and saying, oh my God, look at him, he's such a genius. And all the things that he did, he's such a great man, yadi yadi yada. But you have to remember that at the time that this was all going on, he was going against the grain. He was going against the conventional theory. And as far as the economists are concerned, he was in the heterodoxy, as opposed to the orthodoxy. And ultimately economics, as well as military theory as well, it's a social science and it implies convincing or affecting change with people. And during the time of Curtis LeMay's career, he didn't make too many friends. As a matter of fact, he made a lot of enemies. And in retrospect, he was proven, right, but of course, people that were interacting with him at the time, obviously didn't know that. And people did not like him. And he made a lot of enemies. And despite raising up to the level of Chief of Staff at the Air Force, which is the highest position that an officer in the Air Force can achieve, he was not taken seriously by the civilian leadership by the president.

Henri (00:57:17):

And this was readily evident during the Vietnam wa,r where during the commencements of the Vietnam war, after the Gulf of Tonkin incident, basically, it authorized LBJ, president Johnson, to essentially carry out the Vietnam war. Curtis LeMay was a big advocate of, okay, well, we basically got to bomb them into the stone age. There's a misattributed quote about him, saying that we can, we're gonna bomb the North Vietnamese back to the stone age. Of course, LeMay later on in certain interviews said, "No, I never actually said that. I just said, we have the capacity to bomb them back to the stone age", but you know, whatever, that's neither here nor there.

Henri (00:57:58):

But because he was so against the grain, he didn't follow conventional theory, others in the military leadership convinced president Johnson, convinced LBJ, to go with what we call a tactical bombing or bombing with fighter aircraft. And obviously Curtis LeMay, he was completely against this. He would say, flying fighters is fun, but flying bombers is important. And nowadays military historians would look at this and say, yeah, it was pretty stupid to go with fighters, because the whole point of fighters is their aerial maneuverability and loading a bunch of bombs on them weighs them down and slows them down, which negates the whole aerial prowess of these platforms. And of course, we know all through history of countless POWs during the Vietnam war of how many fighters got shot down by anti-aircraft and anti-air artillery fire by the North Vietnamese. And despite his powerful position, and despite all his success that he's had in his career, the United States essentially ignored the sound advice. I wouldn't call it advice with LeMay it was more like an over demand. But either way, the United States ignored the advice of its highest ranking Air Force general.

Henri (00:59:21):

And it wasn't until he retired and about eight years and a president later with Richard Nixon in 1972, when finally Nixon said, you know what, this whole piecemeal bombing that we've been doing in the Vietnam war is stupid with fighters. Let's just bring in our bombers. And this is a famous operation Linebacker, more specifically operation Linebacker II, which is a seminal moment in modern Air Power history, because it showed in a lot of sense that the United States could have won the war if the Air Power was managed properly.

Henri (00:59:57):

So with operation Linebacker II we finally did strategic bombing, which is what LeMay wanted eight years ago. And only then did the North Vietnamese capitulate, or I'm using quote, "capitulate", and actually come to the peace table and sign a treaty, which is what we wanted at that point, which is what we wanted to do to end the war and get out. And even though LeMay was right, because of his blow hard nature, people didn't listen to him.

Henri (01:00:28):

The point here is, that being right doesn't mean you're going to be heard. Being right and having the track record the past performance, showing that you're right, doesn't mean you're gonna be heard either. You know, as they say in Wall Street, you don't get what you deserve, you get what you negotiate? So who knows what would've happened. This is a good historical "What if" scenario to kind of think about. You know, as Einstein would say, do the "gedanken experiment", what would have happened in the Vietnam war, had LBJ listened to Curtis LeMay and actually started with strategic bombing from the get go. Maybe United States would've actually won the Vietnam war.

Henri (01:01:11):

And this is the parallel that I want to bring back to the current situation with the economy is that we don't want the Fed to raise interest rates with the assumption in that raising the interest rates is going to combat inflation. Because as we just explained, what in reality it's going to do, is destroy the already fragile recovery from this COVID pandemic recession. And what we don't want to be is just like with Curtis LeMay, is eight years from now say "I told you so".

Henri (01:01:40):

So the challenge is being like Curtis LeMay and taking the theory and seeing how it applies to the real conditions on the ground. But simultaneously, the challenge is not to be like him and actually be heard, so that we can avoid another eight years of needless suffering.

Henri (01:02:05):

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 voicemail on www.codbsm.com. That's Charlie Oscar Delta Bravo, Sierra, Mike, dot com. Thank you for listening and see you at the party, Richter!