What happens to inflation when a currency goes awry?


What happens to inflation when a currency goes awry?

Turkey was in the news a lot, along with Argentina as both economies experienced rapid currency depreciation.  In Turkey’s case, partly due to inflation, but primarily driven by diminished confidence in the government and a reluctance from the seemingly independent central bank to raise rates.  They finally did, but not before the currency fell -42% from a year earlier.  The central bank raised rates to 24% and since then the currency has stabilized.

In Argentina’s case, the central bank governor just resigned, and the economy is on yet another precipice.  The Argentinian Peso has fallen -60% in the year and now risks falling further.  The currency is approaching an all-time low.

The question we thought you would be interested in, is what happens when you live in Turkey, and suddenly everything costs more and your savings, if they were in TRY, are substantially lower.  In Turkey’s case, we look at prices for goods in September versus historical time periods to answer this question.

All of our work has been sourced using data available on Numbeo.  What is important to note about this analysis is all the factors at play when a currency crashes.  Specifically, the macroeconomic impacts of the substitution effect, the rise in rates and its impact on asset prices, rents, and what it does to profit margins for companies.

The top-line conclusion, in that the average Turk is going to be okay with no material impact to their lifestyle.  You can see the monthly income and assumed savings for the average Turk below[1].

This may seem surprising, but costs in Turkey have actually gone down, when you look at the average expenses of a Turkish household.  Specifically, the cost of renting is down -25% in Istanbul and the cost of purchasing is down -30%, while servicing costs for a typical 20-year mortgage has been constant over the past year.  What this indicates is that the property market is highly dependent on financing costs, people’s capacity for a monthly cost has not changed, and so the only thing that could change is price.  This indicates a very healthy free market, and despite material concerns with Turkey’s government and central bank, it is clear that the robust economy underpinning the country will be fine.  Monthly rental prices and monthly servicing costs for a typical home in Suburban Istanbul are shown below.

While rental prices have fallen, they still provide a 5% return.  However, this is materially less attractive, the more financing you have, given a 17% interest rate on 20-year mortgages.

This drop in housing costs more than offsets the 10% aggregate increase in the price of all other products.  Which is shown below on an aggregate weighted basis. The cost of produce has gone up the most, in particular the cost of potatoes, onions, and bananas.  Gasoline and other oil-dependent costs such as a bus pass have also gone up sharply since the end of 2017.

We hope this has been an interesting lens into what happens to average customer in period of rapid inflation.  If all costs went up 17% across the board then this would cripple most households globally.  What this also highlights is that official inflation measures around the world do not adequately represent the costs for a household.  These official measures are then used for guiding central bank policy.  Said another way, central banks are using poor inaccurate and often delayed measures as of optimizing the economy.  This should be concerning for all of us.

As always, any questions, please let us know.


[1] Costs are based on the following assumptions for purchases per month, per household: 5 inexpensive meals, 2 mid-range meals, 2 meals at McDonald’s (or equivalent), 10 cappuccinos per month, 10 coke servings, 20 water bottle servings, 4L of milk per month, 4 loaves of bread per month, 1 bag of rice, 4 dozen eggs, 2KG of cheese, 2KG of chicken, 2KG of beef, 1 KG of Apples, 2KG of bananas, 1KG of onions, 2KG of potatoes, 1KG of tomatoes, 2 heads of lettuce, 2 20-pack cigarette boxes, 1 transit monthly pass and 120L of gasoline, Utilities (electricity, water, heating/cooling, garbage), Internet, 4 movie tickets per month, 1 pair of jeans, and 1 summer dress.  All costs in TRY (Turkish Lira) using ~2,500 survey responses.  All data other than 2018 is based on year-end data.

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