Turkish crisis: It's the Fed and trade, Turkey was only the weakest link and more may come

The match that sparked the Turkish crisis was the US sanctions on Turkish ministers, an outcome of the spat around the imprisoned American Pastor. The explosion came with the concern expressed by the European Central Bank about three euro-zone banks.

This was only the spark and the keg is composed by the rising credit issues and inflation issues of Turkey and its refusal to stop the drop in the Turkish Lira by raising interest rates. This underlying problem has been going on for months.

The Turkish crisis may find a short-terms solution, but the problems are far from over. The result of Turkey's problems is Turkey's policy, but Turkey's policy was exposed due to changing global conditions.

The Fed and trade

The Fed began raising interest rates in December 2015 and has accelerated its pace of late. The current composition of the Fed is more hawkish and the US economy is growing at a faster rate. A higher interest rate in the US exposes Turkey that lent money in US Dollars and now has a harder time paying debts. It's not only the government but also Turkish companies.

The problem of a stronger US Dollar has been exacerbated by Trump's tariffs. The mere talk of duties pushes the dollar higher. In addition, the uncertainty caused by the sometimes erratic policy of US President Donald Trump does not help.

Uncertainty already caused delays in investment decisions in emerging markets and elsewhere. A tariff on China has an adverse impact on a Chinese company but also on a supplier that the Chinese company works with. So, also countries that are not affected directly by the tariffs suffer. 

Strong dollar, weaker world

A strong greenback has an additional impact on countries that do not use the dollar. The goods and services involved are still denominated in US Dollars. A higher exchange rate makes trade more complicated. 

All in all, the US government's policy and the policy of the Federal Reserve impacts the whole world. A gradual change in interest rates is enough to push more fragile economies with defiant leaders out of balance. That would be Turkey.

But as we have already seen, the currencies of India, Indonesia, South Africa, Brazil, Mexico, Argentina, and many other countries have seen some contagion. Each country has a different economy, a different policy, and will react in a different way. But no economy is fully immune to the seismic movements of the Fed.

Who will be the next to fall? It is hard to tell. It may be the largest emerging economy, China. It may be another weak one such as Argentina that recently asked for help from the IMF. It may a country not on the radar at the moment. 

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Developed economies

Developed economies are far from immune as the experience from recent days has shown. Three European banks are exposed to Turkey. If the crisis continues, we may discover other vulnerabilities related to the nation. And it is not alone. 

Trade wars with China hurt the US consumer. Britain, which is hardly exposed to Turkey, may have other exposures, such as to mining in African countries. Japan has investments in emerging Asian economies. 

The higher the dollar rises, the worse for everybody. The worse trade wars become, the worse for everybody. A significant test will come on Setember 6th, when the US plans to impose tariffs on no less than $200 billion of Chiense goods, a significant escalation in the trade wars.

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