Aug 2018


Aug 2018

Monetary crisis in emerging markets and the roles of gold

By StoneX Bullion

Turkey is currently facing a dilemma: bringing a new rise of interest rate which could inevitably dampen the economic growth or letting the hyperinflation goes. Turkish Lira has lost 35% value against US dollar till today since the start of this year, and its already high inflation and domestic consumer prices such as food and household equipment prices increase significantly in line with the devaluation. GDP growth in Turkey is robust, with 7% in 2017 and 7.4% in the first quarter of 2018. But a fast-growing economy tends to drive the prices high since the demand outweighs the supply, and high inflation can kill the economy because the currency today is becoming worthless tomorrow. An immediate way to increase and stabilize the value of the currency is to reduce the supply-by increasing the interest rate and taking the money from the market. However, Mr. Erdogan in Turkey and his central bank did the opposite and left the interest rate alone stating the interest rate as something evil. After Erdogan won in this summer, we didn’t see the interest rate and inflation decline as he vowed in the election, but higher inflation rate of around 16%, growing pressure for an increase of interest rate and accelerating devaluation of lira. When Erdogan sworn in as “president with enhanced powers”, the market responded with USD per TRY tumbling from 4.60 to 4.75 in the manner of minutes.Source: Zero Hedge, 2018 Source: Zero Hedge, 2018

Similar problems are faced by more emerging markets like Iran and Argentina as the US dollar appreciates, and the most frequent causes include inappropriate monetary policy, problematic economic mode, fiscal weakness and psychological factors, while it is too early to say certain systematic risks existing in emerging markets.

The economic growth of Turkey is mainly driven by investment in real estate and constructional projects. The easing monetary policy used to keep the economy growing. However, when there is a rise of interest rate in the US and strengthening of US dollar, losing control of inflation and currency depreciation can occur with the absence of a tightening monetary policy. In addition, the economy is at high risk of slowing down.

Lack of foreign reserves is one of the common reasons for the situation in Turkey and Argentina. They both have long-term trade deficit in the current accounts and high debts mostly denominated in US dollar, which weaken the local currency. In Argentina, for instance, the foreign reserve is only one quarter of its external debt, resulting in constant borrowing to serve debt. Once capital outflows occur in the market, people largely exchange local currencies for gold or hard currency along with the local currencies losing value. Furthermore, lacing confidence in the central banks can worsen the situation with larger scale of panic buying.

The gold reserve is often used for hedging against inflation, weak currencies and economic volatility as it’s seen as a durable storage of value. Facts and statistics show the rising desire of both public and central banks in investing in gold. Although weakening currencies have pushed local gold prices to a record high by 500% in Argentine Peso,230% Iranian Rial and 160% in Turkish Lira in the last 5 years. (Compared with the exchange rate with US dollar growth 426%, 40% and 200% respectively) Turkey’s demand for gold had surged by one third in the first quarter this year than that of 2017; at the same time, Turkey’s central bank has also been aggressively buying gold with its holding almost doubled, being the second largest net gold buyer among central banks; the consumption of gold in Iran has surged significantly since 2017, surpassing that of Saudi Arabia; similarly, Argentines are buying gold more than ever to protect their savings.


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