Good as gold: Turkey uses bullion to stabilise its economy

Turkey’s economy has been in a tailspin with an inflationary currency, but the country is using something rare to help stabilise itself: gold.

In late 2011, Turkey started to allow commercial banks to use gold instead of the Turkish lira for their required deposits at the central bank. These deposits are known as reserve requirements and help ensure that the banks are capitalised.

Over the past six-or-so years, Turkey’s central bank has accumulated an additional 400 metric tonnes of gold. That’s a lot of yellow bricks – more than what Britain has - and the sizeable stash has the possibility to take the edge off the crisis.

To put the Turkish gold haul in perspective, there are 10 million ounces of gold – roughly 311 tonnes - at the Bank of England, according to the New York-based financial consulting firm CPM Group.

The burgeoning balance of bullion comes as the result of a change in banking rules made earlier this decade.

I thought the Turkish thing was pure genius

- Jeff Christian, CPM Group

“I thought the Turkish thing was pure genius,” says Jeff Christian, founder of CPM Group. “It was using gold in the way that you should use it.”

In the simplest terms, the tweak to the rules allows gold to be used as a financial asset by the banks. In addition, the new regulation helped flush out a lot of gold that was previously held privately.

“This change allowed the government to get hold of the under-the-mattress gold to help stabilise the banks and the underlying economy,” says Ivo Pezzuto, professor of global economics, entrepreneurship, and disruptive innovation at the International School of Management, Paris, France.

The result of the policy change has been that Turkey’s central bank has seen a huge jump in its apparent gold holdings.

There are now more than 18 million troy ounces of bullion deposited at Turkey’s central bank, up from less than four million before the rule change was introduced in 2011, according to the latest data from CPM Group. There are 32,150.7 troy ounces in a metric tonne.

Private gold deposits into Turkey's central bank

Almost all of the increase came from commercial bank deposits of the metal at the central bank, rather than government purchases to bolster national reserves. 

The Turkish gold, which previously would have languished under the proverbial mattresses, or in private safety deposit boxes, now serves a more useful economic purpose in allowing the banks to make more lira-based loans.

It also helps the banks during times of high inflation.

With inflation running at a 40 percent annualised rate, the value of the gold grows as well when measured in terms of lira. In short, the commercial banks' deposits of gold become worth more and more in terms of the local currency as inflation rages onward and upwards.

Although the purchasing power of the local currency dwindles with each passing day of double-digit inflation, the gold’s value does not. For instance, while one dollar fetched 4.10 lira a month ago, it will now buy 4.53 lira, meaning the lira has fallen in value. Whereas, gold prices in dollars have remained roughly static versus the beginning of the same period.

So what does this all mean? It means that managers at commercial banks don’t have to worry as much about continually sending more deposits to the central bank to maintain the required reserves.

The value of the gold naturally adjusts upwards, meaning if the bank is growing its loan book, it doesn't need to worry as much about stashing more cash with the central bank. Put another way, it automatically can help stabilise the banks' finances - at least in theory.

However, it is also worth remembering that the government does not own these additional gold reserves. They are the assets of the commercial banks and/or those of the investors who deposited their bullion with the financial institution.

That in turn means that private investors have the choice to get their gold returned to them. It’s basically the same as someone taking cash out of a deposit account. It is also true that everyone taking their cash out would likely cripple a bank.

Similarly, although not identical, it is true with the gold that the investors deposited. If everyone took out their gold then the banks would need to immediately send a slew of Turkish lira to the central bank, which is theoretically possible.

Turkey's economic problems

However, Turkey’s implementation of gold deposits may not offset its economic problems in the long run.

Turkey has a credit problem, which Middle East Eye reported last September. The economy grew too rapidly and sparked high inflation.

Ballooning inflation has led to the dwindling value of the lira. One dollar would fetch 4.48 Turkish lira recently versus 3.52 lira on 1 June 2017, according to data from Bloomberg.

While the official rate of inflation was an annualised 10.85 percent in April, which seems relatively measured for the economy, it may not reflect reality.

A more realistic rate is likely 40 percent, according to estimates from Steve Hanke, professor of applied economics at Johns Hopkins University, and also an expert on inflation. He uses a technique known by economists as purchasing-power-parity, which looks at the actual cost of goods and services inside Turkey.

The plunging currency has come hand-in-glove with a scramble for the exits by investors who wish to save their capital from the wealth-withering surge in the cost of living. In other words, they have sold their lira-denominated investments in favour of US dollars and other major currencies that aren’t suffering from high inflation.

“Basically the problem is that inflation is very high and they don’t want to slow the economy in order to crush the inflation,” Pezzuto says.

Those two policies tend not to go hand in hand, so observers are anticipating more inflation for the time being.