As the Turkish lira plunged further into the abyss and Turkey’s economy looked ready to implode, Turkish President Recep Tayyip Erdogan on August 10 did not speak of bringing in the IMF or introducing capital controls — instead he spoke of an “economic war” with the West and, the previous evening, addressing his supporters after arriving in his home town Rize by the Black Sea, he declared: "There are various campaigns being carried out. Don't heed them. Don't forget, if they have their dollars, we have our people, our God. We are working hard. Look at what we were 16 years ago and look at us now."

The market did not like what it was hearing and the Turkish lira (TRY) sank back under 6.0 to the dollar as Erdogan delivered further rhetoric in a speech to a crowd in Bayburt, south of Rize (where at 82% he got his highest share of the vote in the June elections) after regular Friday prayers at a mosque. During his address a new all-time low for the lira of 6.1480 versus the US dollar was recorded. The president said: “The ones who have dollars, euros, gold under their mattresses, shall exchange them. We will, Inshallah, respond with our local currency…The dollar cannot block our path… Our solidarity will be the best response to the West.”

Referring to Turkey as working on “alternatives” such as China, Russia, Iran and some European states, without specifying what he meant by that, Erdogan also stated: "We're going to continue to respond in kind to hands extended in friendship. Still, we have plans against all possibilities. I'm calling on interest rates lobbies: don't get high on your ambitions. You won't be able make money on the back of this nation. You won't be able to make this nation kneel."

Not long after Erdogan spoke, US President Donald Trump made matters very much worse for the lira by putting out a tweet reading: “I have just authorized a doubling of Tariffs on Steel and Aluminum with respect to Turkey as their currency, the Turkish Lira, slides rapidly downward against our very strong Dollar! Aluminum will now be 20% and Steel 50%. Our relations with Turkey are not good at this time!” That sent the TRY skidding to a fresh all-time low beyond an eye-popping 6.80, making it the world's worst performing currency of 2018, outdoing the Argentine peso. Following that spike, the TRY recovered some losses but by around 00:15 local time on August 11 it was still only at a far from reassuring 6.4291.

The Trump tweet came just as Finance Minister Berat Albayrak was unveiling a new economic plan to address Turkey’s economic woes.

His presentation did little to convince investors that Turkey has anything like a rational strategy to tackle economic imbalances that could push it into a full-blown currency-and-debt crisis.

The Turkish foreign ministry, meanwhile, addressing Trump's unhelpful intervention against a Nato ally earlier in the day, put out a statement reading: "The United States should know that the only result that such sanctions and pressure will bring... will be harming our relationship as allies."

Also of significance was a statement from Erdogan's office that came after Trump took to Twitter. It said that Erdogan and Russian President Vladimir Putin had shared a phone call in which they "expressed pleasure" that relations between Turkey and Russia were progressing "positively" amid joint defence and energy projects. The Kremlin said the two leaders had discussed economic and trade ties.

The statements will concern Western powers already nervous that Turkey has moved significantly closer to Russia geopolitically in the past two years. One of the unresolved rows with Washington is Turkey's refusal to cancel the planned acquisition of Russia's S-400 advanced missile defence system, which is not compatible with Nato military hardware. US senators have pushed to block the delivery of F-35 stealth fighter jets to Ankara unless it scraps the S-400 order.

Contagion

With Turkey’s crisis having become so severe, global markets were looking at what level of contagion might be expected to spread.

Exposure is "pretty international". "European, US, Japan, China, Middle East — everyone," Timothy Ash, senior emerging markets sovereign strategist at BlueBay Asset Management, told CNBC. However, Ash played down risks that Turkey could become a sovereign debt problem. "I don't see huge global contagion. Turkey is still a relatively small economy— [worth] $850bn, and [it is] unlikely this will be [a] sovereign debt event," he added.

The TRY has now lost more than a third of its value against the dollar since the start of the year, with markets aghast that the Turkish central bank appears to have lost its independence to a president with maverick economics. Turkey’s problems have mounted up relentlessly. The overheating economy is roiled by the never-ending descent of the lira, roaring double-digit inflation, a current account deficit that is one of the widest in the world and huge hard currency-denominated debts carried by corporates and banks that grow heavier the weaker the TRY becomes — yet Erdogan still does not support interest rate hikes for an economy he says still needs cheaper money for more growth.

Reports emerged on August 10 that officials at the European Central Bank (ECB) are concerned over southern European banks, which have lent significant amounts of money in Turkey. The implication is that investors holding equity in European banks could be at risk. The jitters had dragged the pan-European Euro Stoxx 600 index down 0.7% in early trading.

Bank for International Settlements (BIS) data showed Spanish banks were owed $83.3bn by Turkish borrowers; French lenders $38.4bn; and banks in Italy $17bn. Regulators will be anxious that the devastated TRY could spark defaults in foreign loans.

UniCredit, BNP Paribas and BBVA are being widely cited as the European banks with the highest exposure to Turkey. Carsten Hesse, a European economist at Berenberg, put out a research note saying that some eurozone banks were under pressure given "their direct equity exposure to Turkish banks or participation in syndicated loans — a loan offered by a group of lenders."

BIS figures also showed that Japanese banks are owed $14bn, UK lenders $19.2bn and US lenders about $18bn by Turkish borrowers.

ECB looking more closely

The Financial Times reported on August 10 that in line with the lira’s decline, the Single Supervisory Mechanism — the wing of the European Central Bank (ECB) set up to monitor the activity of the region’s biggest banks — has over the past couple of months begun to look more closely at European lenders’ links with Turkey.

It does not yet view the situation as critical, two people familiar with the matter were quoted as saying.

The ECB is reportedly concerned about the risk that Turkish borrowers might not be hedged against the lira’s weakness and begin to default on foreign currency loans, which make up about 40% of the Turkish banking sector’s assets.

Analysts at Goldman Sachs said earlier this week that a depreciation in the TRY to 7.1 against the dollar “could largely erode Turkish banks’ excess capital”. The analysts viewed Yapi Kredi as the weakest positioned of Turkey’s biggest banks in terms of capitalisation. UniCredit made a €2.5bn investment in taking a 40.9% holding in Yapi Kredi. The value of that stake has been more than halved.

Berat Albayrak, the recently appointed finance minister and Erdogan’s son-in-law, was unveiling Turkey’s “new economic model” on the afternoon of August 10, detailing moves to cut debt, the budget deficit and the large current account gap. The markets had been deeply underwhelmed by a preview the previous day.

Charles Robertson, chief economist for emerging markets-focused Renaissance Capital, said: “The markets have lost confidence in the triumvirate of President Erdogan, his son-in-law as finance minister and the [central bank’s] ability to act as it needs to.”