A Way for Turkey’s Erdogan to Have His Cake and Eat It Too

I t’s no secret that Recep Tayyip Erdogan aspires to become the sultan of Turkey. But there is one huge obstacle that might block Erdogan’s path: the Turkish lira. The lira is one of the world’s junk currencies. Indeed, with each passing day, the lira hits new lows against the U.S. dollar, and with that, inflation in Turkey soars. Today, I measured Turkey’s annual inflation rate at 82.9 percent per year. The lira hangs like the sword of Damocles over Erdogan.

For Erdogan, low interest rates are a fatal attraction. Just what is the source of this attraction? To answer that question, we must understand Islamic finance. It’s replete with theories about the evils of interest rates — theories embraced by Erdogan. Indeed, as he once clearly put it, interest rates are the “mother of all evil.” Yes, President Erdogan’s economic ideas are fundamentally rooted in charismatic, medieval texts that are far removed from the real world of today, or even yesterday. But as long as the lira is issued by a central bank with discretionary powers, “low” rates will result in a weak and vulnerable lira and relatively high and variable inflation rates.  In other words, as long as Turkey’s central bank possesses discretionary monetary powers, Erdogan faces a dilemma.

President Erdogan could easily remove that dilemma by turning Turkey’s central bank into a currency board. A currency board issues notes and coins convertible on demand into a foreign anchor currency at a fixed rate of exchange. It is required to hold anchor-currency reserves equal to 100 percent of its monetary liabilities, and it generates profits from the difference between the interest it earns on its reserve assets and the expense of maintaining its liabilities.

By design, a currency board has no discretionary monetary powers and cannot issue money on its own credit. It has an exchange-rate policy — the exchange rate is fixed — but no monetary policy. Its operations are passive and automatic. The sole function of a currency board is to exchange the domestic currency it issues for an anchor currency at a fixed rate. Consequently, the quantity of domestic currency in circulation is determined entirely by market forces, namely the demand for domestic currency. Since the domestic money is a clone of its anchor, a currency-board country is part of an anchor country’s unified currency area.

A currency board requires no preconditions and can be installed rapidly. Government finances, state-owned enterprises, and trade need not be reformed before a currency board can issue money.

Currency boards have existed in some 70 countries. The first was installed in the British Indian Ocean colony of Mauritius in 1849. No currency board has failed. This perfect record includes the National Emission Caisse, established in northern Russia in 1918 during Russia’s civil war. The Caisse issued “British ruble” notes, backed by sterling and convertible into pounds at a fixed rate. The father of the British ruble was none other than John Maynard Keynes, a British Treasury official at the time.

Despite the civil war, the British ruble never deviated from its fixed exchange rate with the pound. In contrast to other Russian rubles, the British ruble was a reliable store of value. Naturally, the British ruble drove other rubles out of circulation. Unfortunately, its life was brief: The National Emission Caisse ceased operation in 1920 after allied troops withdrew from Russia. That said, it redeemed all of the obligations presented to it before closing.

We don’t have to reach too far back in history for a currency-board success story that’s close to Turkey. Indeed, a relatively new currency board is located in Bulgaria, Turkey’s immediate neighbor. In 1997, Bulgaria was gripped by hyperinflation. Its domestic currency, the lev, had collapsed, and the monthly inflation rate had soared to 242 percent. As the president’s adviser, I designed a currency board that was installed on July 1. With that, the lev became a clone of the German mark, which, at the time, was the lev’s anchor currency. Inflation was crushed immediately. Lev interest rates plunged, with money-market interest rates reaching a stunningly low 2.43 percent by the end of 1998, only 18 months after the currency board was installed. Most importantly, a hard budget constraint was put on Bulgaria’s fiscal authorities, and the economy boomed. Since the installation of the currency board, fiscal deficits have been tightly controlled. Bulgaria’s fiscal discipline and debt reduction have made it a star performer in the European Union.

To save the Turkish lira and perhaps save his own skin, Erdogan should announce that Turkey will install a currency board. All Erdogan would have to do is follow the instructions that are contained in my book Gelişmekte Olan Ülkeler İçin Para Kurullari, which was published in Ankara in 2019. With a Turkish currency board, the lira would be tied to a stable anchor (the dollar, euro, or gold) at a fixed exchange rate. The lira would be fully backed by anchor currency reserves. With a currency board, the lira would become an international currency that holds its purchasing power over time.

If Erdogan wants to supplant Ataturk’s legacy and become sultan, there is only one solution – a currency board.