Turkey will almost certainly be the largest EM default of all time, should it resort to capital controls as your analyst expects, but it could also be the largest bankruptcy of all time given the difficulty of its creditors in recovering any assets. …
The loss of hundreds of billions of assets recently considered liquid by global financial institutions, through the de facto debt moratorium of capital controls, will be a huge shock to the global financial system. This is a different type of default and its nature, as well as its magnitude, will blindside financial institutions. …
Be in no doubt that President Erdogan has more than something of the Chavez about him. Surely we have learned, through bitter experience, that relying on discounted cash flow calculations in Excel spreadsheets is a meaningless form of analysis when a Chavez stalks the land. … History is full of those whose ability to pay is well measured, even to more than one decimal place, but who chose not to repay their obligations. To steal once again from Hamlet, ‘one may smile, and smile, and be a villain’, and you can’t capture that in a spreadsheet. … History is littered with numerous examples of those who could pay but have chosen not to pay, and a historian who points out these facts commits apostasy in the eyes of the keepers of the spreadsheets.
One wonders why investors expect President Erdogan, a man who has referred to them as like the loan sharks who enslaved the Ottoman Empire, to choose to repay the foreigner and accept the crushing socio-political cost on the local population of doing so?
Even if Turkish institutions have the ability to pay, something your analyst has long doubted, the President will forbid them from doing so. This is a large default and it will prove to be almost a total default.
It matters and, of course, it may be politically expedient for others to follow the advice of Paul Krugman and the IMF and choose not to repay their debt obligations to foreigners. This is the new normal. In a world where ten years of extreme monetary policy has failed to inflate away debts, it will become increasingly common to repudiate those debts. Those under the most pressure will be those with the highest levels of foreign currency debt where inflation can play no role in reducing increasingly crushing debt burdens – almost exclusively emerging markets.
What we are seeing at the moment is a rising US dollar as countries and investors scramble for US dollars to pay interest and pay back loans, or a flight to safety out of emerging markets. When and if the defaults hit, they might be of sufficient magnitude to threaten the financial viability of the web of Western banks.
The bigger picture emerging:
For the past few years professional investors have fretted about the implications of something widely referred to as ‘populism’. This, it seems, is a developed world phenomenon. While others see populism, all your analyst sees are sovereign peoples trying to bring power back to their elected representatives. This is a movement to strip power from multi-national organisations (the EU, WTO), multi-national corporations, independent central banks and any other body that has stripped sovereignty from elected representatives over the past three decades. That is an exercise in democracy that may well be bad for returns on, and of, capital but it is a constitutional swing within the rule of law.
Investors, focused as they are on the sanctity of the spreadsheet, often forget that the sacred numbers have no meaning if there is a breakdown in the rule of law and thus your right to collect your coupons, dividends and ultimately your principal. So while the fretting about so-called ‘ populism’ in the developed world continues, investors choose to ignore the retreat of the rule of law and the rise of the rule of man across the emerging markets – Turkey, Romania, Hungary, Poland, China, the Philippines, Mexico – to name just a few of the countries where the laws that protect the cash flows in those spreadsheets are likely waning as rule by man waxes.
The move by Turkey to repudiate de facto its debt obligations will reveal the truth about populism: it is red in tooth and claw in emerging markets because it is there that title to assets and their cash flows have limited constitutional protection.