Turkey is currently facing a new dilemma. The re-elected Erdogan government is struggling to decide whether it should increase the interest rate (which Erdogan once said is “evil") or let its ever-increasing inflation continue. The Turkish currency (known as the Lira) has lost almost 35% of its value against the US dollar since the start of this year due to US sanctions on the country's various export sectors. This devaluation is causing rapid price increases in the local market, especially on imported goods.
Turkey's growth rate (GDP):
Despite its struggling economy and devaluated currency, Turkey’s GDP was recorded at 7% in the year 2017. Since the start of this year, it has increased further to a record 7.4%. While these stats might look good, they can be another possible cause of Turkey's current crisis, because when the economy of a country starts growing at a fast pace, demand increases and outpaces the supply causing an imbalance. When the demand and supply theory is affected negatively, the inflation rate increases and the money you have today may become useless tomorrow.
How can this situation be managed? Well, any financial expert would advise increasing the interest rate immediately to decrease the money supply and removing money from the market to retain its value. But this is not the case here, because Erdogan and the central bank of Turkey do not like interest. This mindset resulted in an inflation rate increase to around 16% this year. Additionally, the country's market saw USD per TRY go from 4.60 to 4.75 in just minutes when Erdogan was sworn in.
The money problem in growing markets:
This problem is not only limited to Turkey. Other emerging markets including Iran and Argentina also face similar issues. Whenever the USD gains value against their currencies, their local economies suffer. This is due to uncertainty and weak policy-making in these countries. International sanctions can also play an important role in the devaluation of a local currency.
Turkey relies mainly on foreign investments made in its real estate and construction sector. It has developed a lenient monetary policy to keep the growth going. But any increase in the interest rate of USD can become a headache because of this loose policy. Huge external debts and low foreign reserves can also cause this inflation to surge.
The vital role of gold in this scenario:
Gold is well known for hedging against inflation. Many countries have tried and tested the durability of gold in intense economic environments, and it has yet to disappoint. When you have gold, even in the case of hyperinflation, gold’s price outpaces the inflation rate and helps to stabilize and heal the economy. That is why many countries start to accept gold as payment on their exports in tough situations to prevent further devaluation of their currency.
In hyperinflation, your savings in the form of local currency become useless because the interest rate is lower than the inflation rate, but for gold investors, their asset’s value increases faster than the inflation. This maintains the purchasing power of their money. A similar rule applies to the countries suffering from high inflation rates.
Countries like Turkey and Argentina have increased their gold purchases dramatically to prevent the economy from dying. The central bank of Turkey has almost doubled its gold holdings.
Good news for the gold market:
Although some countries are struggling with their economy and are trying to retain the value of their currency by rapidly buying gold as a balancing mechanism, this is a positive thing for the gold market. Because when countries buy gold, they buy it in huge amounts and the demand for more gold in the market suddenly increases. This causes an increase in the value and price of gold and thus the investors get a better return for their gold investments. What is trouble for one can be a good thing for the other, but that’s how the money works! Better policy-making and a suitable trade environment can help reduce inflation.