(Bloomberg) – It took weeks of frenzied gold trading in Istanbul’s historic commercial center to prompt one of the largest gaps between the cost of physical dollar bills and the official exchange rate in 18 years.
Home to dozens of foreign-exchange kiosks that also broker precious metals, the Grand Bazaar is often considered the country’s benchmark. Traders there also mostly use cash to settle gold trades – and dollars are in short supply.
As a result, the premium of U.S. currency over the official exchange rate in this market over the past month has hit its biggest record since at least 2002, according to calculations by local data provider Matriks Bilgi Dagitim Hizmetleri and Bloomberg. The difference has narrowed to near zero this week.
As the price of gold bullion soared above a record $2,000 an ounce in August while the lira plunged to an all-time low, traders in the world’s oldest covered market began bidding up the price of physical dollars to meet surging customer demand for gold, a popular form of household savings.
“There has been a cash crunch in the Grand Bazaar,” said Cumhur Tasdelen, a board member of Istanbul-based Troy Precious Metals.” This has caused a cash crunch due to a surge in demand for hard currency and gold, which has expanded the profitability of the kiosks.”
Over the past 30 days, dollar bills have become, on average, 0.83 per cent more expensive than the exchange rate offered by the global wholesale money market.
With gold prices now showing signs of easing and Turkish authorities beginning to tighten policy to stabilize the currency, the chaos appears to be receding. The precious metal suffered its biggest three-day drop since March this week, helping the spread between the two U.S. dollar exchange rates narrow to just 0.3 percent.
However, the last time there was such a broad outpouring of public opinion was during a political impasse in 2002, when the then coalition government was forced to hold early elections. The vote proved to be a seismic event that wiped out Turkey’s ruling class and ushered in President Recep Tayyip Erdogan’s AK Party, which has been in power ever since.
This time, however, it’s not so much politics as the pressure on the economy from the coronavirus pandemic and outflows of foreign capital that have helped distort the exchange rate.
As the lira depreciated, local households and businesses began hoarding dollars to hedge against bouts of inflation and currency devaluation that had eroded their savings for decades.In July, Turkish households and businesses bought $11.7 billion in foreign currency, pushing their dollar and euro deposits to a record $213 billion, equivalent to more than a quarter of Turkey’s economy.
Hedges for savers
Others prefer to hold U.S. dollar bills at home. That’s because they can avoid the government’s 1 percent tax on foreign currency purchases executed through banks.
The levy was implemented in May 2019 as part of a series of measures aimed at slowing the currency’s devaluation.
A currency trader in Istanbul’s Atasehir district, who wished to remain anonymous because of the sensitivity of the topic, noted that low yields on dollar accounts further reduced the attractiveness of storing foreign currency in banks.
A steep monetary easing cycle and a government-backed credit push have also played a role, exacerbating Turkish mistrust of its currency.
According to central bank data dating back to late 2006, money supply growth, as measured by money in circulation and bank deposits, reached a record annual rate of nearly 70 percent, after adjusting for foreign exchange movements.
At the same time, holding lira guarantees consume real savings, as the average annual return on a one-month deposit account in the local currency is 6.87%, compared to an overall inflation rate of just under 12%.
Faced with pressure to depreciate the currency, but reluctant to raise interest rates, the authorities have instead begun to curb the supply of credit. On Thursday, the central bank announced its latest measures, which will effectively raise the cost of capital.
The question now is whether the shift in monetary policy will be enough to convince Turks to get out of gold and the dollar and regain ownership of their local currency.
“In the past few days, we have seen a correction – we have to watch how long this will last,” said Tasdelen of Troy Precious Metals in Istanbul, referring to the pullback in gold prices.” But some investors see this as a buying opportunity.”
©2020 Bloomberg L.P.