Falling back on a standard excuse of besieged strongmen, President Recep Tayyip Erdogan of Turkey is blaming traitors and outside powers for his nation’s financial crisis, and describing the strong United States dollar as among “the bullets, cannonballs and missiles” foreigners are using to wage “economic war” on his country.
Many emerging markets make themselves vulnerable to financial crisis by spending more than they can afford, and relying on foreign lenders to fund these profligate habits, but Turkey was an extreme case even before Mr. Erdogan took power in 2002. Of late, his reckless economic policies — including setting interest rates at artificially low levels, and driving up debts, deficits and inflation — have only made matters worse. Many wealthy Turks saw another crisis coming and were fleeing the country well before foreigners joined the recent rush, accelerating the fall of the Turkish lira over the past few days.
Turkey’s troubles are homegrown, and the economic war against it is a figment of Mr. Erdogan’s conspiratorial imagination. But he does have a point about the impact of a surging dollar, which has a long history of inflicting damage on developing nations.
Like many emerging world currency crises before it, this one comes at a time when the U.S. Federal Reserve is raising interest rates, pushing up the value of the dollar. As the dollar strengthens, developing countries like Turkey have a harder time paying back their dollar debts, and eventually investors start to flee.
Now the question is whether Turkey is poised to trigger a wider global crisis, the way the fall of the Thai baht did in 1997. The answer is not clear. The fall of the Turkish lira has had a negative effect on other emerging market currencies, but few of those countries share Turkey’s dual problem of having large foreign debt and government policies that fuel inflation.
But there is an even bigger question looming: The strong dollar that is weakening Turkey’s economy may also be undermining the world’s second-largest economy, China.
China is vulnerable to the strong dollar for different reasons. At one level, China is far less dependent on imports than Turkey, which has to buy virtually all its raw materials, including oil from abroad. Unlike Turkey, China does not run a chronic trade deficit and does not have to borrow heavily in dollars to finance its purchases abroad.
In the wake of the global financial crisis of 2008, however, Beijing tried to keep its economy humming by ordering state banks to pump out new loans. More than half the increase in global debt over the past decade was issued as domestic loans inside China. There is now much more money circulating in China than in the United States, much of it in the hands of Chinese who are constantly on the watch for higher returns.
So China also faces a serious risk of capital flight. The last bout began in 2015, amid early indications that the Federal Reserve was going to start raising interest rates. China stopped that exodus by tightening its currency controls, but controls rarely work for long. Savvy locals find creative ways to get their money out.
This year, the Fed’s tightening has further strengthened the dollar, while Beijing’s easy money policies have further weakened the renminbi — increasing the incentive for Chinese investors to dump China’s currency for dollars. Right now Chinese can earn the same interest rates in the United States for a lot less risk, so the motivation to flee is high, and will grow more intense as the Fed raises rates further.
Beijing could also diminish the allure of the strong dollar by trying to raise the value of its own currency. But that would mean tightening the supply of renminbi, which is likely to derail the economy at a time when growth in China is already slowing under the burden of too much debt.
China has also tried to challenge the hegemony of the dollar by making the renminbi more widely popular, but that is a long-term project, so far unsuccessful. Though the United States share of the global economy is down to 23 percent from a high of 32 percent in 2001, the dollar is still by far the world’s favorite currency for everything from lending to paying for exports and imports.
More than 60 percent of the foreign currency held in reserve by central banks around the world is in dollars, and China’s ambition to make the renminbi a reserve currency has attracted hardly any takers. Global central banks and investors are still wary of holding a currency that Communist authorities may slap controls on at any time — as they did in 2016.
As this crisis unfolds, attention is likely to shift from the relatively small global threat posed by Turkey to the much larger one posed by China — and from President Trump’s tariff wars to currency wars. Though the Trump administration has accused China of weakening its currency to make its exports more competitive, over the past few days China has shifted to trying to prevent the renminbi — already down 7 percent against the dollar over the past two months — from weakening further. The last thing Beijing wants is a sudden crisis in confidence.
So China is in a tough spot. The strengthening dollar threatens to provoke more capital flight out of China, but any effort to shore up the renminbi in response could further slow the Chinese economy. For years Beijing has responded to signs of weakness in the economy by printing more renminbi, which worked fine when the United States was also running a very loose monetary policy. Now that the United States is raising interest rates, lowering rates in China will only give Chinese investors more reason to leave the country.
The fate of the world economy depends on how China negotiates this dilemma. Its $14 trillion economy is more than 15 times larger than Turkey’s, representing about 16 percent of the global economy. It is pivotal. For the rest of the world, the collapse of the lira may prove to be a passing event, and China is likely to decide which way this crisis goes.
Ruchir Sharma, a contributing opinion writer, is the head of emerging markets and chief global strategist at Morgan Stanley Investment Management.