Things Fall Apart

February 13, 2022

It’s easy to be lulled into a sense that lessons once painfully learned, sometimes over hundreds of years—like the value of stable borders or rules limiting a leader’s power—are now accepted wisdom. I spent part of last week in Turkish-controlled Cyprus, a place that serves as a reminder of what happens when this wisdom is lost.

Cyprus, perched north of Egypt and west of Lebanon, is divided. It’s warm here now. Just past the UN monitored Green Line, I entered Turkish-controlled territory. The fields went from green to brown, the houses from painted to unpainted, the cats from silken to scrawny.  

“Cats aren’t dumb. It’s an island. They can choose where to live,” said my wife, once we were back in the south. “Here,” she said, referring to south Cyprus, “people lay out piles of nutritionally balanced cat food. Of course the cats look better.”

Dispute Resolution

At night, north Cyprus is dark and felt dangerous. Some places give off that vibe. Many buildings are empty. Initially, I wondered if I was imagining danger that wasn’t there. I later found out that as we finished dinner, a few towns over from us assassins emptied over 40 rounds into reputed drug lord Halil Falyali.

Violence is the same tool Turkey utilized to claim north Cyprus in 1974. Today Turkey is the one country that recognizes the “TRNC,” or the Turkish Republic of Northern Cyprus, which as a result is cut off from most investment. There is no Starbucks or Apple. Technically, north Cyprus is independent. Yet, the military, language and money are Turkish.

Erdogan, Turkey’s leader, is an opportunistic chameleon. He came to power in 2003. Early in his career, he supported long-standing EU efforts at reunification1; of late, the opposite.

Turkey was once held up as a post-9/11 example of a Muslim-majority democracy. Instead, Erdogan has systematically destroyed institutions cherished by Turkey’s urban, educated elite. Of all the disruptive things Erdogan has done—renditions abroad, bringing religion back into civic life, adjusting rules to prolong his reign—the one that has hurt ordinary Turks and north Cypriots the most is destroying the currency.

Inflation

“Good for you, but bad for me,” said a baker, as I bought a halloumi bun from him, referring to the exchange rate. He smelled of cigarettes. His eyes looked sad.

The cost of a fancy hotel room in Greek Cyprus is hundreds of dollars; in north Cyprus it was $57. Turkey’s inflation is about 50%. Erdogan believes printing more money (lowering interest rates) will reduce inflation, which is like using hydroxychloroquine against Covid. Among his edicts, he has fired central bank technocrats.

Like a virus, inflation touches everybody. The stores in north Cyprus had plenty of basic goods, but not many buyers, except for Greek Cypriots who cross the border to take advantage of the exchange rate. As the chart from Rose Technology shows, Turks who saved in lira have been wiped out.

Places like northern Cyprus are an argument for crypto. In a country with a relatively stable currency, like the dollar or euro or yuan, crypto’s main attraction seems to be doing illegal stuff, like computer hacking. Once a populist dictator willing to end central bank autonomy takes over, risks shift.

Rule of Law

At a restaurant edged out over crashing Mediterranean waves, air dried, eviscerated fish hung from the ceiling.

There was no Covid protocol. The waiter didn’t wear a mask. No one checked our vaccine status. Around us, young men in tight-fitting black jeans smoked. I opened a window and the waiter closed it. On the southern, Greek-majority side, Covid protocol was tighter than home in Connecticut. I needed to show I was vaccinated to get inside a grocery store.

The main industry in north Cyprus seems to be casinos and attracting price-sensitive tourists. I suspect the deed on many new projects is open to question. It is, however, an ideal location for money laundering, likely for people like Mr. Falyali.

Modern Turkey was founded on the notion that the path to wealth and stability was to wrest the country away from its parochial, religious dominated past and move to a more rules-based order. The venerated founder, Ataturk, was perhaps a bit like Russia’s Peter the Great, though I am no a Turkey specialist. But it seems rural tradition doesn’t easily yield to modernity.

A map of support for Erdogan, Putin or Trump looks similar. The countryside likes populists, city-folk don’t. Following a failed 2016 coup to topple Erdogan, the ensuing crackdown is undermining rule of law. Erdogan is supposed to step down in 2023. Modern Turkey was founded in 1923. Will the current form of government last even 100 years?

Negative Loop

That a place as dysfunctional as Turkey matters to Washington, Brussels and Moscow is a function of geography and religion. Turkey’s 80 million population straddles Asia and Europe and the straights of Bosporus. The country is a member of NATO but not the European Union, buys offensive weapons from the US, defensive weapons from Russia and sells drones to Ukraine.  During the Syrian War, Erdogan attacked Kurds, who are both US allies and don’t want to be part of either Syria or Turkey. Yet, US support continues.

Keeping a finger in north Cyprus gives Turkey a claim on possible natural gas deposits. Are there other motivations at work? A former Turkish mafia boss, Sedat Peker, moved to the Emirates and shares videos accusing Erdogan and his clique of widespread corruption, including Mr. Falyali.

Not surprisingly, those who can leave Turkey do, creating a brain drain.2 Inflows into Turkey are related to refugees fleeing places even worse.

Turkey may be strategically positioned, but it is economically and politically weak, another example of a bad emerging market investment. Given a global boom in energy, competitive manufacturing and tech, Turkey has little to offer but labor that, given the exchange rate, is quite cheap. Turkish-controlled Cyprus is an example of what life looks like when things fall apart. I always like seeing such places first hand and it is one of those regions where, upon leaving, I breathed a sigh of relief and, at that exact moment, felt a wave of sympathy for those who remain.

Market Update, Subscribers Only

US stocks have lost about 7% this year. Inflation is 7%. Money is disappearing fast, but this is not that surprising if you think about the mechanics of what is going on.

The high inflation will force the Fed (central bank) to raise rates a lot. At this point, their credibility is on the line. As interest rates go higher, stocks and other risky assets generally go lower. I don’t think the Fed will let up until the data shows inflation falling close to 2%. Given that a lot of the inflation is being caused by a supply chains mess that the Fed can’t control, they only thing they can do is crush US demand.

Then there is Russia risk. Russian and US assets began trading Friday afternoon as if an invasion was imminent. I repeat what I’ve said before: the only person who knows is Putin and he may not yet have decided. Subscribers have asked me to guess what happens next. Here is my guess: Putin will do something disruptive but short of all-out war. Stalin murdered millions; Putin uses targeted assassinations. Similar impact, fear, but lower costs. I imagine he will apply that template, somehow, to Ukraine.

What should a saver do?

As usual, this is said with the caveat that THIS IS NOT INVESTMENT ADVICE, I am telling you what I am doing for you to take or leave.

1.     My starting point is strategic asset allocation that is roughly 1/3 stocks, 1/3 bonds and 1/3 long inflation-hedging real estate like assets.

2.     I have made tactical shifts relative to this including:

a.     Reduced equities to roughly 25%, mostly achieved through owning individual stocks that benefit from a more inflationary environment, like banks and shipping stocks.

b.     4% short the S&P 500 outright.

c.     Roughly 60% short US bonds. I have moved my short from short-term bonds,(described in December) to the 10-year part of the curve.

d.     Overweight commodities and commodity producers.

3.     As of Friday’s close, my portfolio was up about about 0.70% this year (NOT AUDITED), so these hedges are helping but clearly they are not big enough…something I need to do better. Sometimes just staying flat is an accomplishment.

• Geopolitics