Turkey is suffering a full-blown currency crisis. That is how we could easily label the rapid depreciation of the Turkish lira by about 30 percent against the US dollar and the euro in just a few months’ time. The drop in the lira is increasingly leading to troubles in that country.
Many Turkish businesses, but also households and governments, have taken advantage for years of the extremely low interest rates in primarily the United States and accumulated large dollar-denominated debts. Manifold impressive apartment complexes, shopping malls, automobiles, homes and infrastructure-related projects have been built or bought with cheap dollar credit. According to some estimates, Turkey´s exposure to debt denominated in foreign currencies, principally the dollar, amounts to 70 percent of gross domestic product. Because more lira are needed to repay debt and pay interest, also in US dollars, some businesses and households have fallen into financial troubles. The early consequences are already visible on the financial markets in Turkey, where interest rates are quickly going through the roof and stock market prices have collapsed.
Over the past few weeks, the consequences on financial markets were not limited to Turkey. Last week, stock prices of most European banks were struggling as well. In the past years, several European banks have, in their search for yield, invested a tremendous amount of money in the Turkish economy. Repayments and interest on such loans and investments will become harder to collect. According to some sources, the European Central Bank (ECB) is becoming increasingly worried about the financial situation in Turkey. As a consequence, the euro fell in the past weeks against the US dollar.
It is rather remarkable that, as a result, gold prices have not only failed to rise, but even collapsed to their lowest levels in almost two years. Of course, a stronger dollar, all other things equal, translates into higher gold prices in terms of other currencies other than the dollar, which lowers the demand for gold. But in times of true panic among investors, this logic does not apply. When in 2010 the Greek crisis erupted, for instance, the EUR/USD dropped from about 1.50 to 1.20 in a question of months. Despite the enormous appreciation of the dollar, gold prices actually rose from approximately $1,050 to over $1,200 per troy ounce.
I view the fact that gold prices now have fallen significantly as a sign that the market is not worried that Turkey´s crisis forebodes a larger contagion crisis in emerging markets, which could easily turn into a global crisis. If investors would have worried about other emerging markets and both the European and American banks and economy, then gold prices would have risen sharply instead of having fallen. If we take that same reasoning and take it further, then I would not be surprised at all if gold prices remain under pressure. This because the odds are high that the dollar will appreciate further, for instance because of recent Fed policy. As we are nearing the end of the year, I expect that markets will begin to expect that the hawkish Fed is not so hawkish after all. And with the Senate elections in the United States in November, it could be easily the case that the political panorama is shifting in the US. One of the consequences could be a political deadlock.
Add to that the somewhat lower economic growth – it will turn out to be difficult to keep the economy growing at its current pace – and the Fed commenting between the lines during one of its press conferences that the pace of rate hikes will be dialed down in 2019 could very well be in the cards. If gold prices in the course of 2019 return to levels near $1,300 dollars per troy ounce, I would be far from surprised.