All the reserves in the world will not suffice

Rulers have to live with their decisions. There is a point in Shakespeare’s famous play where Lady Macbeth is sleepwalking. She has recently plotted with her husband the murder of Duncan and Macduff’s family, and though this has given them power, she is now ridden with guilt, and maybe regret.

“There’s knocking at the gate. Give me your hand. What’s done cannot be undone. — To bed, to bed, to bed!” And then, looking at her hand, stained in imaginary blood: “All the perfumes of Arabia couldn’t make my little hand smell better.”

I first had that scene in my mind after I read that rather problematic Financial Times (FT) article about the inadequacy of the foreign exchange reserves of the Central Bank of Turkey (CBRT). It was the part about “all the perfumes of Arabia,” mind you, that first came to my mind.

I have three problems with the discussion on the CBRT’s reserve inadequacy.

Firstly, there is a slight assumption there that the CBRT has a stated FX rate to defend. This is simply not the case. The Turkish Lira is a free floating currency. It isn’t pegged to the dollar or any other foreign currency. It may adjust its value according to market conditions.

Secondly, it doesn’t really matter what kind of reserves you have if you don’t have a strong economic program. You could have access to all the reserves in the world, and the currency would still burn through it if there is no economic program that inspires confidence. Turkey does not have a strong program in place, hence the level of reserves is a secondary issue. It’s the wrong thing to focus on.

Remember the European Exchange Rate Mechanism (ERM), the system set up in 1979 to bring European currencies within the same range? Britain was in this system, but in 1992, the market lost confidence in its position and many began to speculate against the pound. On what became known as “Black Wednesday,” the Bank of England sold around $50 billion (around $90 billion in today’s values) and still fell out of the system, mind you.

Thirdly, CBRT is in a unique position among other central banks. As of early May, 53 percent of total bank deposits are retail FX deposits, which is an all-time high. High dollarization and FX loan restrictions imposed last year are forcing the CBRT to provide lira liquidity to the system through lira-dollar swaps. Extensive use of swaps understandably increases reserve volatility.

FX reserves would be nice to have, but it’s not what Turkey should be focusing on at the moment. It’s reforms the country needs, and not just in the economy. The drama unfolding over the mayoralty of Istanbul only highlights how badly we need judicial reform as well. Turkey needs a multi-faceted program that will put the country back on track. Until Ankara does this, no amount of reserves or elections will make things better.

Sometimes, guilt can be a good motivator. One imagines Turkey’s rulers, like Lady Macbeth, wandering the corridors of power at night, murmuring “what is done cannot be undone.”