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.