Turkey’s Predicament by Bill O’Grady of Confluence Investment Management

In 2013, we wrote a WGR that looked at Turkey’s likely rise to regional hegemon status.1 In that report, we made the case that Turkey was well positioned to return to its historic status as a dominant regional power. This remains our view over the next few decades. However, in the near term, the situation is much less clear.

Turkey has been trying to run a foreign policy of having “no problems” with its neighbors. This stance has become impossible to maintain. Unfortunately for its president, Recep Erdogan, Turkey is encircled by instability and is struggling to develop a response. In this report, we will examine Turkey’s geopolitical situation, the risks it faces as conditions deteriorate and how the Erdogan government has responded thus far. As always, we will conclude with market ramifications.

Turkey’s Situation

To some extent, Turkey is on the front lines of slow moving geopolitical “tectonic plates” that have been shifting since the end of the Cold War. The Cold War and the superpower duopoly created a whole set of “frozen conflicts.” Some were obvious, such as the walls that divided communist Europe from the free world Europe. In Asia, the U.S. demanded a pacifist constitution from Japan to prevent that nation from attacking the region again. However, what was generally unappreciated was the degree to which the Soviet Union was an empire. Numerous areas were capable of independent nationhood but were trapped inside the Soviet Union by Russia’s historic need to always expand its areas of control. Even the Middle East essentially divided along Cold War lines, with Iran, Saudi Arabia, the Gulf States, Israel and Pakistan siding with the free world and Iraq, Syria, Egypt and Yemen aligning with the communist bloc. There was some movement in the Middle East during the Cold War; Egypt and Yemen shifted their allegiances to the West, whereas Iran joined the non-aligned movement after the 1979 Revolution. Although the Mullahs’ economic stance was socialist, their aversion to godless communism put them in alignment with India and other non-aligned nations. In the end, the key geopolitical factor that dominated the Middle East was that the Cold War enforced the colonial borders drawn up by Sir Mark Sykes and François Georges-Picot.

Turkey, as it emerged from the collapse of the Ottoman Empire, existed in the borderlands of the Middle East, Europe and the Soviet Union. The U.S. quickly recognized its importance in the waning days of WWII. The Soviets were pressing for military bases in the Turkish Straits, and Greece was facing a communist rebellion. Aligning with Turkey would allow the U.S. to bottle up the Soviet navy in the Black Sea and act as a base of operations to quell the Greek communists. Turkey became a member of NATO and is generally part of both Europe and the Middle East.

The end of the Cold War tore all these relationships asunder. The Soviet Union fell apart with numerous new nations emerging from the old empire. The Baltic States along with Ukraine, Belarus and Moldova became part of Eastern Europe. The “stans” were established in Central Asia. Both ends of Eurasia blossomed economically. A united Germany emerged as an economic powerhouse and China became one of the most remarkable economic growth stories in history. However, Europe did face some issues. Yugoslavia devolved into several nations which led to a sectarian conflict that eventually required NATO involvement. Although the Middle East borders held together, Saddam Hussein made a bid to absorb Kuwait; this annexation was repelled by a large U.S. coalition.

During the 1990s, the U.S. held the dominant and undisputed position of global hegemon, a true unipolar superpower. The short war against Iraq in the early 1990s signaled to the rest of the world that the U.S. was unmatched in terms of conventional warfare. From the early 1990s until 9/11/2001, U.S. dominance was generally unquestioned.

The events of 9/11 showed that while the U.S. had unquestioned superiority in conventional warfare, it was vulnerable to unconventional attacks.2 The Iraq War and the subsequent quagmire that developed further undermined the perceptions of U.S. power. The Great Financial Crisis of 2008 added to evidence that the Washington consensus of democracy and capitalism as the only viable economic and political systems was flawed.

As perceptions of waning U.S. power have grown, fault lines have opened. Russia has begun to project power into its old area of control. The 2008 invasion of Georgia and last year’s incursion into the Crimea and eastern Ukraine are breakdowns of the post-Cold War order. Meanwhile, in the Middle East, the Arab Spring and the rise of IS have mostly obliterated the Sykes-Picot borders. The recent Iran nuclear deal is also likely to lead to a reduction of American influence in the region.

Turkey's Predicament

Turkey finds itself surrounded by turmoil. To Turkey’s north, the war in Ukraine sits across the Black Sea. The collapse of both Syria and Iraq and the rise of IS have led to turmoil on its southern border. To its east, although Georgia is currently quiet, the Russian incursion has not been resolved; its proxies still control Tbilisi’s rightful territory. In addition, Iran is in the midst of emerging from sanctions and looking to expand its influence. And to its west, Greece, its long-time enemy, is going through yet another financial crisis.

For the past several years, Turkey has tried to avoid involvement in the growing turmoil. However, as the old saying goes, “you may not be looking for trouble, but trouble is looking for you!” Turkey is facing internal dissention caused, in part, by the chaos in the region and the growing flows of refugees fleeing regional wars.

Turkey’s Risks

These are the primary risks we see Turkey facing.

The Breakdown of Sykes-Picot: The Ottoman Empire began in 1299 and ended in 1922. By the late 1600s, the empire was massive.

Turkey was a successful empire builder partly because it managed its territory with a relatively light touch. It tended to grant a high degree of local autonomy (at least for that time in human history) and showed a remarkable level of tolerance for different religions and ethnicity.

However, by the onset of WWI, its holdings had been reduced to Anatolia, the area east of the Bosporus, the Levant, the east coast of the Red Sea and the west coast of the Persian Gulf. After WWI, the rest of the empire was broken up by the allies; modern Turkey was created on the Anatolian peninsula by Ataturk.

The areas south of the Turkish republic were controlled by France or Britain, either as colonies or protectorates. Ataturk’s Turkey was mostly focused on Turks—it was a secular, ethnic state that tended to discourage other ethnic groups and frowned on public displays of religion. This was a major reversal from the policies of the Ottoman Empire. Running a successful empire requires a degree of tolerance; in running a smaller state, a government can be intolerant.

In Turkish history since 1922, the state has mostly maintained its secular nature even though many Turks are observant Sunni Muslims. Additionally, it has suppressed non-Turkish ethnic identity, especially against the Kurds. The nation-states established after Sykes-Picot in the Levant tended to

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