The psychology of Turkish investors

people always think that things are SOME worsening. According to them, “time is off the hinges” (Shakespeare); advice is ‘out of joint’ with financial realities, banks won’t be able to lend because there is a funding cost increase of gigantesque proportion awaiting EMs and Turkey, that there will inevitably be a credit crunch. The economy is dislodged; demand will surely collapse, reserves are being depleted, the fiscal deficit will soar. Who knows what other calamities wait for us around the corner?

A RECIPE FOR LOSS BUT THERE IS MORE THAN A GRAIN OF TRUTH IN IT

For finance people, this mood is a recipe for a loss, and in general, if you cry wolf too often people will stop believing you. While causes for concerns are genuine enough to pursue them from time to time, there is nothing that gloomy about the general EM environment - not yet. However, Turkey seems to be an exception. I am not a doomsayer but the political and economic problems this country faces are formidable. More importantly, they pertain not only to policy issues or to technical problems that can be remedied but to deeper quandaries that lay in the domain of political and economic psychology. In the end, it all depends on what you want to build and how you want to build it. Is the goal achieving prosperity for the majority? Is it a distributional goal? Is there a long-term growth strategy?

FINANCIAL DECISIONS AND ECONOMIC PSYCHOLOGY

Consider an SME boss or the boss of a large conglomerate. The logic doesn’t isn’t too different. If the currency goes up by 50% in a week and drops back and goes up again, and if this tail risk is believed to be entrenched into the economic landscape, what would you do? Is investing in physical depreciable capital an option in such a volatile environment? You couldn’t even calculate your cost of production a couple of months into the future and you wouldn’t be able to price the final output correctly.

You could lose billions of Liras in a few days – or exactly the opposite could happen. Is your operational profit truly that important when your monetary loss or gain is uncertain? Is your foreign exchange position all that matters? What kind of an entrepreneur you would turn into if the market becomes a kind of casino capitalism? We may need behavioral economics and experimental economics to assess what would happen to the decision-making process of a previously fully rational individual? If there is a heterodox economics approach that is warranted here, it must be a psychology-driven approach. Moreover, even the average wage-earner has been making the same calculations over the past months. This is why almost everybody has become an ‘expert’ on gold prices, crypto currency, aluminum futures, etc. The Lira depreciates so fast and inflation is so high that it doesn’t make sense to keep your TL-denominated wage in your pocket. The mindset of the representative consumer has been changing. People keep ‘betting’ on some asset type in the very short-term, and we all gamble every day, in a sense.

BETWEEN THE HAMMER AND THE ANVIL

According to the economic administration, there is a trade-off between lower interest rates (growth) and inflation (Lira depreciation). If one opts for growth one has to cut rates to the extent one can. With the resulting Lira depreciation and inflation, well, one can always sell reserves and intervene in the FX market. But this isn’t even an impasse because there is no trade-off between inflation and growth and employment. Cutting the policy rate has already resulted in both a massive Lira depreciation and higher inflation and led to an environment where all other interest rates increase. People have a hard time understanding the logic behind the current policy mix. E.g. if the funding rate for banks is set at 14%, and if the same banks can instantaneously place the funds they borrow at 14% from the Central Bank in Treasury bills that yield 25%, is there an economic logic behind that mechanism? It is simply a transfer from the public accounts to the private sector banks.

If the policy rate is hiked, as it should normally be, the Lira could stabilize for some time, and inflation might begin to fall. Then growth will slow down some people can claim success. However, it is set to slow down anyway for the psychological economic reasons I have referred to. If the current policy mix is maintained going forward, the remaining gross reserves will be lost. Please note that the foreign currency sales that have occurred in roundabout ways aren’t sales from net reserves. Net reserves are about minus USD 56 billion

(negative net reserves). Whatever is or can be sold comes from an effectively non-existing source; swaps or required reserves, which are debt. The current policy mix is unsustainable unless households change their outlook and see a bright future for TL assets, and switch to TL. This isn’t happening. Selling all gross reserves and raising the policy rate after all of the reserves are gone would be the hammer. The anvil would be a quick U-turn before reserves erode further.

TIME OUT OF JOINT

Communism didn’t work. Did liberalism work? Well, at least it fared better. As Deirdre McCloskey wrote recently, the idea that commoners could be capable of technological innovation, economic advances, and “trade-tested betterment” was an aberration back in the 16th, 17th, and even 18th centuries. The claim that the bourgeoisie could become the politically ruling and/or hegemonic class anytime soon was even less convincing back then.

Yet it happened more or less, at least in the Dutch Republic of the 17th Century and in England after that, and in its off-springs further down the road. It didn’t happen in what Karl August Wittfogel named oriental despotisms or neo-patrimonial regimes of the late 20th and early 21st Centuries. It began somehow in China after 1978 and in somewhat less clear terms in India after 1990, in the same countries Marx had classified – rightly or wrongly – as totally Asiatic. Tsarist Russia was semi-Asiatic according to him.

A CULTURAL BOURGEOISIE

Deirdre McCloskey wrote a lot on the attributes, mostly negative, to the word “bourgeois” although most of us are bourgeois. She also acutely observed that ‘Marx himself does not in Das Kapital or many other places use the word Kapitalismus’. He freely uses Kapital, Kapitalist, kapitalistisch. From there we can jump to a relatively new term, cultural bourgeoisie, a term that the sociologist Michael Burawoy coined two decades ago. This is what is meant by bourgeois virtues; dignity, liberty, equality, and down to prudence, temperance, courage, and justice. If the entrepreneurial classes of Anatolia are to put on a successful economic show, they would need as essential ingredients religious freedoms –not merely tolerance, but also ideas, books, research, and independent thinking habits. They shouldn’t be all alike even in their daily practices and their social norms, and they would need new political ideas.

ECONOMIC PSYCHOLOGY AND THE CULTURAL TISSUE

Where does Turkey fall by this metric? Well, there are many energetic entrepreneurs in Turkey, and they face more or less competitive markets. Most of them are small and medium-sized, but there are also relatively high-tech investors. Capital, that is equity, is rather scarce but not for all of them. Capital markets are shallow. Capital can’t be easily raised, and as we face a trend-wise 35-55% ‘official’ inflation going forward, raising capital may not be rational. Banks dominate, and public banks that act out of political motives mostly lead the way in credit generation. Both households and firms are heavily indebted. Many firms have incurred a rising FX-denominated debt also. Yet they grow, export, and struggle to firmly entrench themselves in the market, and if this proves hard, at least for economic survival. Good.

ECONOMIC RENTS… WHO NEEDS THEM?

Nevertheless, there is also a huge rent-seeking sector that blurs the picture. Political survival is at least as important as economic survival, and the two have been intertwined over time as the good, sound, hard-working types struggle through various hardships. For one, input costs, electricity, and all related production costs rise all too often. If entrepreneurs are FX-indebted, they often face a rising exchange rate and book in FX losses.

They also have to pay high TL interest rates, which even if they were low, would add up to a heavy burden. Generating EBITDA isn’t the end of the story. From EBITDA to bottom lines, much is lost along the way. The only segment of the cost of production that can be saved on is, therefore, labor costs, and immigrants help lower the wage curve so to speak. This is where we stand today. There is neither appetite nor incentive nor the means to invest to shift the technological frontier, at least for most of the SMEs. They can only compete on prices, especially if they export.