Eco­nomics of a Re­ces­sion in the Mak­ing

Dünya Executive - - ANALYSIS - Gunduz FINDIKCIOG­LU Chief Econ­o­mist

Glob­ally or lo­cally, or both? Let’s see why sea­soned an­a­lysts have greeted the new pro­gram with al­lu­sions to Lego-nomics, Alice in Won­der­land, patent un­re­al­ism, ob­vi­ous in­con­sis­tency and such­like. Sim­i­lar words were used in the eco­nomic press to de­scribe the new pro­gram, which ap­par­ently no­body took se­ri­ously. Why is that so? In other words, why come up with an un­re­al­is­tic and in­con­sis­tent set of pre­dic­tions? The only take from this is the fol­low­ing: Ex­change rate sta­bil­ity de­pends on Fed poli­cies, the global re­ces­sion out­look, sheer luck, and what not. In the end, it hangs in a bal­ance. Peo­ple don’t seem to have un­der­stood what hap­pened last year. The mes­sage is clear: The eco­nomic vi­sion is noth­ing more than the time-hon­ored, old school re­liance on con­struc­tion and au­to­mo­tive, sec­tors that re­quire cheap credit, sec­tors that can be in­cen­tivized in the old vein, sec­tors that don’t cre­ate catch-up growth, in­crease to­tal fac­tor pro­duc­tiv­ity and so on. Po­lit­i­cally speak­ing, the only take I gather from all this is that the sword of Damo­cles, i.e. early elec­tions, will hang over Turk­ish polity. Oddly enough, Trump is also in peril. He can’t be eas­ily im­peached but who knows what the im­pact of the re­newed im­peach­ment ini­tia­tive will be on the elec­torate next year?

Early elec­tions

Pos­si­ble, but is it prob­a­ble? Well, it may turn out to be very prob­a­ble if the in­cum­bent party loses a lot of po­lit­i­cal-eco­nomic ter­rain to newly-formed par­ties, es­pe­cially Mr. Baba­can. If this hap­pens, the thresh­old barely main­tained via the al­liance with MHP can no longer be passed, and even to­gether the rul­ing par­ties would lose the next elec­tions. Ob­vi­ously, no in­cum­bent would choose to go to early elec­tions at a mo­ment when opin­ion polls sug­gest such an out­come, but if there is a po­lit­i­cal-eco­nomic earth­quake-like event, another ma­jor cur­rency shock or a large tail risk in­curred in Syria, then early elec­tions may be­come a dis­tinct pos­si­bil­ity. Clearly, the main tenets of the Turk­ish po­lit­i­cal land­scape re­main in­tact: party sol­i­dar­ity is lower than ide­o­log­i­cal se­quen­tial fi­delity, eco­nomic vot­ing ap­plies via a con­vo­luted cul­tural and ide­o­log­i­cal de­tour – but it ap­plies none­the­less, etc. A shift not only at the mar­gin of ‘swing vot­ers’ but at­tain­ing larger por­tions of AKP vot­ers can then be pos­si­ble. CHP won’t ben­e­fit, but all other rightwing par­ties can. Iron­i­cally, the one true mea­sure that would main­tain the sta­tus quo lies in fi­nan­cial prow­ess, not in toy­ing with ad hoc in­cen­tives or print­ing money or more pub­lic spend­ing and what not.

That the Turk­ish fi­nan­cial sys­tem is bank-cen­tered can be a bless­ing also. Mainly, toxic as­sets that have to be wiped out lie in bank bal­ance sheets. By the same to­ken, in­sol­vent busi­nesses would or could be elim­i­nated; healthy en­ter­prises can be fi­nan­cially as­sisted, pos­si­bly after take-overs oc­cur. Shift­ing grounds and re­sort­ing to FX-de­nom­i­nated over­seas fund­ing quite heav­ily in or­der to close the sav­ings gap rather than ex­u­ber­ant pub­lic spend­ing led to a prob­a­bil­ity limit in about 15 years. True, the net pub­lic debt fell, but it was re­placed by the ris­ing cur­rent ac­count deficit. True, the pub­lic sav­ings went up, es­pe­cially in the early 2000s, but the pri­vate sec­tor bor­rowed in­stead. Trad­ing one gap with another is no panacea for the set of struc­tural prob­lems the Turk­ish econ­omy faces, how­ever. Now it is the pri­vate sec­tor that is the lo­cus of not only a marked slow­down – stag­na­tion per­haps or even worse - be­cause the FX-de­nom­i­nated debt stock it has piled up over the last 1215 years is large and its open po­si­tion is sig­nif­i­cant. Should we bail out at least some of the pri­vate en­ter­prises? Should we let them go bank­rupt, hop­ing that on the ba­sis of cheap­ness they will be bought by (for­eign) cap­i­tal and ex­pect that the new own­ers will act more ra­tio­nally? Should we de­sign a scheme whereby banks par­tic­i­pate in their eq­ui­ties? Al­though the real es­tate and con­struc­tion and en­ergy sec­tors come to the fore­front, the im­pact of a fast de­pre­ci­at­ing cur­rency wasn’t or isn’t con­fined to them. The im­pact is wide­spread across sec­tors.

Ad hoc mea­sures won’t de­liver –and they are costly

So, would the govern­ment opt for a rad­i­cal so­lu­tion? By rad­i­cal, I don’t mean any­thing un­known thus far. Be it la­belled TARP-like or not isn’t the real is­sue here. Last year, one could eas­ily come up with some­thing like a new “Ankara ap­proach”, but this wouldn’t be good eti­quette now. Is­su­ing bonds can pro­vide us with a start­ing point. It may be a work­able idea. Two rounds of su­per­bonds, 6 months each, could trans­late the lo­cus from liq­uid­ity to the P&L. When? Ex­actly in Oc­to­ber last year. Now that there is a de­lay, the SPV would is­sue bonds for longer ma­tu­ri­ties, and dis­solve it­self in at least a few years –like a pri­vate eq­uity. In case some firms pass on to banks as col­lat­eral be­cause they couldn’t pay their debt at all, it could be bet­ter to lock them in an SPV – pos­si­bly run by the TMSF (SDIF – Sav­ings De­posit In­sur­ance Fund of Turkey) - and let them be taken over by a team of real

sec­tor ex­perts. As such, the cap­i­tal ad­e­quacy of banks can be shored up against the in­com­ing storm – if there is one of course, but this is likely. Gen­uine NPLs could be trans­ferred to the P&L in­stead of be­ing re­tained in the bal­ance sheet, with a hair­cut of course. Or else they can be off­set against SDIF pre­mia. A fur­ther real econ­omy ben­e­fit would show it­self in un­em­ploy­ment fig­ures be­cause ex­perts would de­cide to what ex­tent lay-offs are re­quired be­cause such de­ci­sions are bet­ter made not by the cur­rent own­ers. FX debt should be con­sol­i­dated un­der one cen­ter thereof. If ev­ery­thing goes well, own­ers can al­ways re­claim their firms after they are cleaned and ev­ery­thing is net­ted off. In or­der to do all of these, govern­ment guar­an­tees and a cash in­jec­tion would be re­quired in the very be­gin­ning. The Turkey Wealth Fund can deal with this; so, it can ac­tu­ally is­sue se­cu­ri­ties and par­tic­i­pate to eq­ui­ties.

Another ap­proach could be the es­tab­lish­ment of a ‘bad bank’ and/or a REIT. Bank­rupt firms’ credit col­lat­er­als would be trans­ferred to the ‘bad bank’, other banks would ac­cept a hair­cut, and the rest of the shares could be re-is­sued to the pub­lic. Banks need be fi­nanced via long-term bonds un­til the IPO or SPO is com­pleted. Banks could also be al­lowed to par­tic­i­pate di­rectly to eq­uity through debt-eq­uity swaps. If they so choose, banks will have to in­ject cap­i­tal be­fore the swap. The ex­tent of the hair­cut can be ren­dered de­pen­dent on the amount of cap­i­tal in­jec­tion; the more re­cap­i­tal­ized a bank is the lower is the hair­cut. Hence, with a tri­par­tite scheme, risk can be re­dis­tributed and the ma­tu­rity can be re-ex­tended. Of course, to be able to do any of this, a ma­jor macro pro­gram has to be de­signed and mar­kets, both do­mes­tic and over­seas, should ac­cept it. That would or should bring in a large chunk of front-loaded FX loans. When the prob­lem is a gar­den-va­ri­ety bal­ance of pay­ments cri­sis or a stan­dard fis­cal deficit is­sue, what is to be done is al­most clear. When the lo­cus of the prob­lem is the pri­vate sec­tor it­self, how­ever, one needs a lit­tle bit more fi­nan­cial prow­ess. Can it be done? Yes, I be­lieve. Will it be done? Prob­a­bly not in the very short-run. Nev­er­the­less, this is the only route via which (a) the govern­ment can win again; (b) the credit im­pulse can be re­stored at full speed.

Did sim­i­lar mea­sures truly help after 2008?

Yes, de­spite many a caveat, they did. They will help a lot here also. I start with a tes­ti­mony of no lesser mor­tal than John Tay­lor tes­ti­fy­ing be­fore the U.S. Se­nate (John B. Tay­lor, “As­sess­ing the Fed­eral Pol­icy Re­sponse to the Eco­nomic Cri­sis”, Tes­ti­mony be­fore the Com­mit­tee on the Bud­get, U.S. Se­nate, Septem­ber 22, 2010). John Tay­lor had pre­vi­ously pro­vided ev­i­dence on the fact that the Fed’s pol­icy rate was kept too low for too long a pe­riod prior to the cri­sis com­pared to what the Tay­lor Rule had im­plied, and that as an in­di­ca­tor of cheap and am­ple USD liq­uid­ity pro­vi­sion this was one of the causes of the cri­sis. He picks up from there and claims the fis­cal stim­u­lus was too dis­cre­tionary, spo­radic and short-lived dur­ing the first phase. Tay­lor claims that, per­haps in a wa­tered down ‘New Key­ne­sian’ fash­ion, fis­cal stim­u­lus in­tend­ing to jump-start per­sonal con­sump­tion –checks sent to house­holds and tax re­bates - did not achieve that goal. Rather, dis­pos­able in­come rose, but did not spread to per­sonal con­sump­tion ef­fec­tively, vin­di­cat­ing thus life-cy­cle per­ma­nent in­come con­sump­tion mod­els rem­i­nis­cent of Robert Hall, 1978. What­ever re­cov­ery there was came from in­vest­ments – in­clud­ing in­ven­tory changes - in­stead. Tay­lor clearly states, re­turn­ing back to the early 2009 de­bates with Christina Romer and Jared Bern­stein, that the im­pact of the fis­cal pack­age was rather lim­ited, to a large ex­tent be­cause it was not pub­lic spend­ing di­rectly or through lo­cal gov­ern­ments, but con­sisted rather of a house­hold spend­ing jump-start stim­u­lus that failed.

Tay­lor does not agree that mon­e­tary mea­sures were that help­ful at the time they were in­tro­duced ei­ther.The Fed’s early open­ing up of its bal­ance sheet be­fore Lehman – Bear Stearns is a case in point - and the TAF (Term Auc­tion Fa­cil­ity) were rather harmful, but TARP and AMLF (As­set Backed Com­mer­cial Pa­per Money Mar­ket Mu­tual Fund Liq­uid­ity Fa­cil­ity) were timely moves. The Fed’s mort­gage backed se­cu­ri­ties pur­chase pro­gram (MBS) was also not that ef­fec­tive ex­cept its early an­nounce­ment ef­fect. Tay­lor does also re­veal that such large bal­ance sheet-driven moves shadow the in­de­pen­dence of the Fed, an im­por­tant po­lit­i­cal point that will be raised re­peat­edly in the fu­ture in my opin­ion. Tay­lor con­jec­tures in the In­ter­na­tional Jour­nal of Cen­tral Bank­ing Con­fer­ence hosted by BoJ on Septem­ber 16-17, 2010 that, based on his own joint re­search with Jo­hannes Stroebel (Stroebel, Jo­hannes C. and John B. Tay­lor, 2009, “Es­ti­mated Im­pact of the Fed’s Mort­gage-Backed Se­cu­ri­ties Pur­chase Pro­gram,” NBER Work­ing Pa­per 15626, De­cem­ber 2009), the im­pact of the MBS pro­gram on mort­gage rates was rather lim­ited once con­trolled for pre­pay­ment and de­fault risks. If we take this view as true, that is un­ortho­dox mon­e­tary poli­cies do not work, then we should come up with a po­lit­i­cally in­clined ex­pla­na­tion of QE2. The 2007-2009 cri­sis has been dif­fer­ent from the 1929 cri­sis in terms of its po­lit­i­cal im­pli­ca­tions be­cause Democrats had largely en­hanced their hold on both houses in the 1930s, but the Tea Party and all that sug­gest that this time it is the rise of the Repub­li­cans in more than ever a con­ser­va­tive mold that the world now wit­nesses. Same po­lit­i­cal con­clu­sion ap­plies. Should there be a po­lit­i­cal change it won’t be in the di­rec­tion of CHP – cen­ter-left - but a few right or cen­ter­right par­ties – MHP, IYIP; Baba­can’s new party if it ef­fec­tively runs - in fact would ben­e­fit in­stead.

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