1/10
I was wrong in the tweet below. Turkey's new deposit scheme is not like Mexico's 1994 Tesobonos, in which peso payments on onshore bonds were indexed to the US dollar, but with higher interest rates. This is much more dynamic and non-linear.
I was wrong in the tweet below. Turkey's new deposit scheme is not like Mexico's 1994 Tesobonos, in which peso payments on onshore bonds were indexed to the US dollar, but with higher interest rates. This is much more dynamic and non-linear.
https://twitter.com/michaelxpettis/status/1473547456583454722
2/10
In that sense it has more in common with the dual-currency bond issue that marked Mexico's return to the international capital markets (1998?) after the December 1994 crisis and the $50 billion rescue package organized by the Clinton administration in January 1995.
In that sense it has more in common with the dual-currency bond issue that marked Mexico's return to the international capital markets (1998?) after the December 1994 crisis and the $50 billion rescue package organized by the Clinton administration in January 1995.
3/10
As I understand it, with the new deposit scheme, investors are getting lira deposits at the normal interest rate plus (in effect) a free put option that allows them to sell their lira for a fixed amount of dollars at the current rate (i.e. at the money).
As I understand it, with the new deposit scheme, investors are getting lira deposits at the normal interest rate plus (in effect) a free put option that allows them to sell their lira for a fixed amount of dollars at the current rate (i.e. at the money).
4/10
Given the volatility in the currency, this option was always likely to be incredibly valuable, so it is not at all surprising that investors are piling in to take advantage. This should definitely give Ankara some breathing space.
Given the volatility in the currency, this option was always likely to be incredibly valuable, so it is not at all surprising that investors are piling in to take advantage. This should definitely give Ankara some breathing space.
5/10
The problem is that these kinds of financing are highly inverted. If things turn out well for Turkey, and the lira stabilizes, in retrospect the deposit scheme will have reduced financing costs, and the government will be widely praised for implementing such a clever plan.
The problem is that these kinds of financing are highly inverted. If things turn out well for Turkey, and the lira stabilizes, in retrospect the deposit scheme will have reduced financing costs, and the government will be widely praised for implementing such a clever plan.
6/10
If things turn out badly, however, and the lira depreciates, the deposits will effectively convert into Tesobonos – i.e dollar-indexed lira obligations – causing financing costs to soar and the government to be widely derided for doing something so risky.
If things turn out badly, however, and the lira depreciates, the deposits will effectively convert into Tesobonos – i.e dollar-indexed lira obligations – causing financing costs to soar and the government to be widely derided for doing something so risky.
7/10
This of course increases the volatility of outcomes for Turkey, and unfortunately this also means that the outcomes aren't symmetrical. While the upside is more or less linear, the downside can quickly become self-reinforcing by undermining credibility.
This of course increases the volatility of outcomes for Turkey, and unfortunately this also means that the outcomes aren't symmetrical. While the upside is more or less linear, the downside can quickly become self-reinforcing by undermining credibility.
8/10
That's because policies implemented to protect investors by effectively raising the cost of economic "misbehavior", like this deposit scheme, will increase credibility, but only up to a point, after which they begin to undermine credibility.
That's because policies implemented to protect investors by effectively raising the cost of economic "misbehavior", like this deposit scheme, will increase credibility, but only up to a point, after which they begin to undermine credibility.
9/10
I called this the "credibility Laffer curve" in my 2002 book, "The Volatility Machine" and explained how it works beginning on page 139 (which you can find through this link).
bailiping.github.io/assets/docs/Bo…
I called this the "credibility Laffer curve" in my 2002 book, "The Volatility Machine" and explained how it works beginning on page 139 (which you can find through this link).
bailiping.github.io/assets/docs/Bo…
10/10
The point is that with this new deposit scheme, Ankara gets some breathing space, and if they use it to implement workable reforms, this scheme will have been very helpful. But if they don't, it will only make things worse.
The point is that with this new deposit scheme, Ankara gets some breathing space, and if they use it to implement workable reforms, this scheme will have been very helpful. But if they don't, it will only make things worse.
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