So something that has been bugging me for a couple days now regarding South Korea is their foreign debt obligations.
Yesterday I mentioned that it seemed as if they were in the green, with $240 billion in the foreign reserve piggy bank, with only $180 billion in debt.
Well it turns out that the information in the Washington Post was not quite right (which is where I grabbed the info from). They were quoting the finance minister, who apparently forgot to carry over $80 billion in liabilities.
Based on an updated news blurb from Forbes, South Korea actually owes $260 billion.
Ouch. No wonder the administration is having a headache figuring out where to interfere!
You see, during his election campaign last year, Lee pledged to push economic growth by 7% per annum. Ignoring the flawed methodology underlying GDP, assuming that the current GDP numbers are accurate, Korea will apparently hit around 4% this year.
So, as I mentioned before, in an effort to stimulate the economy, Korea cut rates yesterday. But as the Forbes piece notes, this will hurt the currency, the Won. In order to keep the Won from falling, the government intervened by selling dollars (from its piggy bank) and buying Won on the open market.
The problem now is impossible for South Korea. On the one hand the political establishment wants to stimulate the economy, but in doing so it will kill their currency.
And it has zero ammo to actually defend the Won with. In fact, it owes money, so they really are trying to play a game of chicken and hope to bluff out an oversized Mack truck on a narrow bridge.
And it gets even more absurd.
I mentioned how Lee has started demonizing anyone buying dollars and selling Won. Apparently the finance minister spent the last few days trying to convince exporters to sell their dollars in a vain psychological effort to boost the won.
The continued capital flight from Korea also makes sense now that the underlying banking problems have been highlighted with their inability to turn over debt through bond sales. Last month the government shelved a $1 billion bond sale because of increased rates. Those rates have only increased.
It’s no wonder that the administration has been appealing to both China and Japan for financial assistance. If neither one of these entities can prop up either the Won or the failing banks, then the event my coworkers have been despondently murmuring about could very well take place: another bailout from the IMF.
I should note that I do not want this to happen as the Korean people have been great to me and have endured more than their share of crap over the past century. However, this is exactly the endgame that fractional-reserve, fiat banking systems will ultimately cause.
With any luck, in 3-5 years Korea will come out on top swinging — without a central bank.
See also: South Korean banks are vulnerable, analysts say
Seoul faces growth and currency tests
Will this be as low as it goes?
How low will it go?
Asian Tiger or Asian Kitten?
“Economic Crisis and Chaebol Reform in Korea” (pdf) by Phil-Sang Lee
It has only been a few days since I last discussed it, but things keep going south for South Korea. Yesterday the currency plummeted to a 10 year low. Today it hit a 10 1/2 year low (1485) before the government used its foreign reserves to prop up the Won, bumping it back up to a mere 10 year low (1383).
So what is next?
One good piece of news is that the government itself is solvent in terms of paying for outstanding debt, which it couldn’t 10 years ago. It has $240 billion in foreign reserve to cover its short-term debts of about $180 billion.
But that’s pretty much where the good news ends.
Because capital flight increases, because foreign investors are looking for security over return-on-investment, everyone is gobbling up dollars and selling the won.
And unfortunately, the sometimes hands-off president is now blaming dollar “hoarders” and won “exploiters” for the current situation. But there are several reason why foreign investors continue to leave the peninsula and why the dollar is a temporary safe-haven.
As I mentioned a few days ago, over the past four years foreign direct investment (FDI) has declined precipitously (from $9.2 billion in 2004, to $2.6 billion in 2007).
One of these reasons is many industries still have relatively high barriers to entry which are still in the stages of being liberalized, as well as militant unions which put the UAW to shame.
On the domestic side, while Chinese and Japanese residents are notorious for being frugal savers, South Koreans have dug themselves into a huge hole. And while GDP is not really an accurate measurement of real net worth, household debt is at 180% of Korea’s GDP. Yes, that is right — it is actually higher than household debt in the US.
WTF, right?
As the saying goes, one step forward — two steps backward. So what more could go wrong?
Another not so bueno intervention took place today when the central bank lowered the interest rate. While this boosted the stock market results for a day, the long-term consequences of it will be negative — because one day they will have to raise rates and ultimately face financial purging.
This rate cut also undermines the strength of the Won and serves to debase it in the long-run. Ouch.
Are interest rates important?
As mentioned above, due in part to artificially lower interest rates, no one has the incentive to save (i.e., if you’re ROI from savings is less than the rate of inflation, you lose money). This lack of savings has started to hit commercial banks which are over-levered like their Western counterparts.
And while I’d like to discuss rates for credit-default swaps (CDS), the market is going nuts everywhere right now and it’s hard to get a firm long-term trend; other than the obvious ‘up’. In general, CDS rates for commercial banks in Korea continue to rise. Yesterday CDS rates for Kookmin Bank (KB), the largest lender in the Korea jumped 150 bps to 600.
That is twice the CDS rate for the non-AAA sovereign debt of Korea. CDS contracts for Korea’s sovereign debt was at 310 today.
Will they default? I doubt the Korean government will, but based upon the high risk signals from the CDS, the commercial banks may. And no malice intended, but the insolvent commercial banks should go bankrupt instead of being bailed out.
What does this all mean?
As I mentioned a couple days ago, while it is likely that South Korea will undergo a protracted recession like it did in late ’90s, it could ultimately miss the worst downturns from Western welfare states.
I’m bullish on this one point for the simple fact that the Korea is trying to privatize state entities while the US, the UK, Germany and many others are not only propping up dead banks, but actually taking full-ownership of them. As a consequence Korea could be more nimble by the middle of next decade. At least if they do not try to bail out every bank and financial service.
How can Korea solve their currency problem?
As an expat I am paid in Korean Won. And I planned on moving to another Asian country in a couple of weeks. As a consequence I would love it if the government used its huge foreign reserve purse to temporarily boost the exchange rate. But that would not only be unfair, but really irresponsible.
Even if trade barriers remain high and labor unions can legally dictate terms, the way the Lee administration can increase the value of the currency is one, temporary simple action: increase the interest rate. Yes, even ignoring the bullet points from a couple days ago, higher interest rates would help immensely.
In order to take out loans or use credit cards, higher rates will force consumers to save more. This would also allow banks to offer higher interest rates on savings accounts, money market funds, CDs and a slew of other saving vehicles. And since economic growth is ultimately funded by savings, not spending, because banks would have more assets they could offer more loans to entrepreneurs who in turn can create wealth. Rinse, wash, repeat.
A higher interest rate would also purge the economy of deadweight firms whom survive at the expense of the taxpayer and Won-holder.
Will they do this?
As much as I enjoy the country, the people, the food and the culture, I have my doubts that the political establishment will allow the necessary economic purges to take place.
I personally think the Lee administration will probably be able to get a number of the state firms privatized before he loses office to a New Deal-socialist type (like the two who preceded him). I doubt that the bittersweet KORUS FTA will be ratified by both the Korean legislation and US legislation. In addition, based upon recent press releases the administration will try to bailout ailing firms. This is not too surprising given the historical collusion and perpetual pardoning between big business chaebols and the political class.
And I don’t have some kind of ancient Korean saying to quote regarding this situation. Rather, I think the faux cover for The Economist sums up the current situation and then some.
See also: Asian Tiger or Asian Kitten?
How low will it go?
Seoul faces growth and currency tests
“Bailout Mania” an oldie but goodie by Jeff Herbner
“Economic Crisis and Chaebol Reform in Korea” (pdf) by Phil-Sang Lee
