EMRE DELİVELİ >Rashomon, the Eurozone crisis and Turkey

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AndrewLo, professor of finance at MIT, likened the different financial crisisnarratives to Akira Kurosawa’s Rashomon when he recently reviewed 21 booksabout the financial crisis. 

Inthe movie, a crime is recounted differently by each protagonist. Lo argued thatthere are “several mutually inconclusive narratives” of the 2008-2009 crisis. Similarly,there are two distinct tales of the Eurozone crisis.

Accordingto the German version of the story, fiscal profligacy is the culprit, andtherefore austerity the cure. Moreover, fiscal restraint will restore markets’confidence. Just look at how well Latvia and Ireland, two countries thatswallowed their painful pills, are doing!

Nobellaureate Paul Krugman, professor of economics at Princeton and columnist forthe New York Times, disputes this narrative. He first notes that Spain’sgovernment debt to GDP ratio was actually declining from 1999 until the crisis,whereas Germany’s was creeping up.

Asfor the two poster children, Ireland and Latvia’s GDPs are still significantlybelow pre-crisis levels. To add insult to injury, Ireland's
creditdefault swaps, which provide insurance against the country's not paying itsdebt, are more than twice Turkey’s and imply an annual probability of defaultof nearly 8 percent.

Thisnarrative is not without holes: Spain’s problem was not fiscal but private sectorprofligacy, led by housing. And the German argument holds much better forGreece. But Krugman is right that marketsare definitely not rewarding austerity. Besides, I have yet to meet thisfamous “confidence fairy”. 

Inany case, I would agree with Krugman that Europe’s main problem is balance ofpayments. Germany’s current account surpluses were matched by the deficits ofGreece, Italy, Portugal, Spain and Ireland, collectively known as the GIPSIs.

Concurrently,there were huge capital flows to the GIPSIs, which were the driving forcebehind the public or private spending binges. This was fine as long as themusic kept playing, but once it did stop, these countries could not use theexchange rate for adjustment and had to resort to internal devaluation, i.e. painfulwage cuts.

Howdoes Turkey fit in all this? For one thing, Turkish policymakers are firmly stickingwith the German narrative. For example, economy tsar Ali Babacan’s speech atthe IstanbulFinance Center conference last week could have easily come from DeutscheBundesbank President Jens Weidmann.

Butmaybe this adherence reflects realpolitik more than anything else. With a debtto GDP ratio of 40 percent at the end of 2011, Turkey looks like the realposter child for austerity, even though the IMF has recentlywarned that budget balances are not as strong as they look.

Moreimportantly, once you subscribe to the Krugman narrative, you may suddenlynotice that Turkey’s current account deficit of 10 percent of GDP is comparableto the GIPSIs’ levels before the crisis. Moreover, that deficit is stillfinanced by short-term capital flows, as Friday’s Marchfigures confirmed.

Unlikethe GIPSIs, Turkey can use the exchange rate and monetary policy as adjustmentmechanisms, but you just wouldn’t want to alarm markets.

Graphs 1, 2, 5 and 6 as well as the confidence fairy are from a presentation Paul Krugman gave in Brussels on Thursday. 


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