South Korea could be excused for feeling a bit cocky these days. Its Covid-19 containment success is the toast of the developed world. And its economy, though hardly thriving, is among the least-worst anywhere.
Seoul’s shout out this week from the Organization for Economic Cooperation and Development is a case in point. After all, the 0.8% year-on-year contraction the OECD expects this year compares buoyantly with a US economy imploding at a 33% rate.
Just so long as these metrics don’t go to Lee Ju-yeol’s head over at Bank of Korea (BOK) headquarters.
Since March, Governor Lee and his team have been experimenting with a lower-grade version of the quantitative easing schemes taking place in most of the 10 biggest economies.
Or, as the Korean media calls it, “QE-light.”
Lee’s plan to begin purchasing unlimited amounts of government bonds has a three-pronged objective: to get more won into the financial system, calm money markets spooked by the coronavirus and buttress confidence that Asia’s fourth-biggest economy is not cascading toward Japan-like inflation.
Things seem to be working. Between the OECD nod and recent inflation data, the BOK may be tempted to throttle back, or at the very least, start planning an exit from extraordinary monetary measures.
Consumer prices accelerated to 0.3% in July from a year earlier, well above the flat reading in June. So-called “core” prices, which exclude agriculture and petroleum inputs, jumped 0.7%.
However, Seoul-based economists have raised a polite yellow card. Park Sang-hyun at HI Investment & Securities in Seoul, for example, flagged “some anxiety about the trend of inflation.”
This comes at a moment when gold prices are near US$2,000 per ounce and the United States is reporting its own upward inflation surprises. America’s consumer prices rose 0.6% in July, on-month.
Yet global economists are counseling sobriety. Like virtually all other major trading nations, the US faces a sizable output gap, elevated unemployment and shelter-in-place dynamics that are more conducive to falling prices.
The bottom line is, “the threat of prolonged higher inflation is limited,” says James Knightley, chief international economist at Dutch bank ING.
Such is the case in South Korea, too, broadly speaking. Granted, surging property prices are a complicating factor. In 2019, they rose to a level where values were 2.64 times the nation’s gross domestic product.
According to BOK data, the aggregate price of houses surged 7.4% last year to the equivalent of $4.7 trillion, nearly Japan’s annual GDP.
The boom clearly gave Lee’s policy board pause for thought. Faced with the opportunity to cut the seven-day repurchase rate in mid-July, the BOK stood pat. The central bank kept rates at a record low of 0.5%.
Even so, Lee made clear that the priority is supporting broader economic demand, not micromanaging real estate froth.
“We decided to hold the rate with the view that the current stance should be continued, considering the outlook, growth and inflation trends, rather than the situation in the housing market,” Lee said.
Government regulators are, of course, taking so-called “macroprudential” steps to tamp things down. They include marked increases in capital-gains taxes on home flipping and higher levies on corporate property.
The moves come amid a public backlash over multiple homeowners bidding up prices, some of them politicians. The anger is slamming President Moon Jae-in’s approval rating, which is now about 43.9%, according to pollster Realmeter.
While regulators address speculative excesses, Lee’s BOK needs to keep its eye on the broader economic climate – and confide in it. South Korea is still an export-driven economy.
And though bright spots abound – most notably, the solid chip earnings recorded by national flagship Samsung Electronics – the global scene is an increasingly grim one.
The US continues to stumble in this regard. Europe is seeing infection upswings in Germany, France and Spain and frantically throwing hundreds of billions of dollars at stagnant corporate and consumer sectors.
China may be stabilizing, but not to a point where South Korea, Japan, Singapore or Vietnam are commissioning fleets of tankers in the hopes Asia’s biggest economy is buying.
Japan’s biggest manufacturers were already the most pessimistic in 11 years before the nation displayed signs of a second Covid-19 wave.
Herein lies the problem that the BOK, and South Korea, face – a world without growth engines.
The OECD’s 0.8% contraction estimate for the country, remember, is still contingent upon 2020 not going further awry. A second global wave in the months ahead would have South Korean GDP shrinking by about 2% this year.
A devastating one, it follows, would upend the OECD’s current view that South Korea might rebound to the tune of 3.1% in 2021.
Lee’s team needs to focus somewhere in the middle. With US President Donald Trump flagging in the polls, the US president could announce a Trade War 2.0 at any moment. That could mean new tariffs on Chinese goods, autos, electronics and other sectors that upend Asian supply chains and, by extension, South Korean growth.
The BOK should be preparing. In April, Lee said the central bank might target yields, not unlike what the Bank of Japan has been doing since 2016. Since March, the BOK has been pledging to accept a wider range of collateral for liquidity.
That includes notes issued by state-run companies in repo auctions. That would channel more money into commercial banks and brokerages, which can use government debt as collateral.
The BOK gets a salute from a recent Bank for International Settlements report for having “introduced facilities to lend to financial institutions against corporate bond collateral.” Why not build up and expand the practice?
Lee’s team should go further. In conjunction with the parliament, the BOK could gain authority to load up on corporate debt. Even better – target those companies that are pledging to avoid mass layoffs or even to fatten paychecks a touch.
And the BOK could load up even further on local government debt from Seoul to Busan to Gwangju to create fiscal space to invest in job creation.
The BOK also could be liaising with lawmakers to prepare an emergency universal basic income scheme, even on a temporary basis, if a deep recession takes hold. The mistake the US made in 2008 and Japan is making right now is not getting cash into the hands of consumers.
Moon is trying his hand at just that with his $135 billion “New Deal.” As part of efforts to reshape the economy around technology including 5G, Moon hopes to create 1.9 million new jobs over the next five years.
Seoul has the fiscal space to ramp up spending. But greater coordination between Moon’s Ministry of Finance and the BOK would increase South Korea’s financial firepower.
Central banking is, in large part, a confidence game. As much as QE is about getting cash into the economy, it’s about signaling to businesspeople, investors and households that the BOK is leaving no financial stone unturned.
It would be a grave mistake for Lee’s team to turn away from the support the South Korean economy needs. Inflation remains far below the BOK’s 2% target. And Lee has repeatedly said monetary policy must remain appropriately accommodative until things recover.
All the good headlines emanating from South Korea these days don’t change the fact the global economy’s 2020 is darkening by the day. The BOK must act accordingly.