Weathering the fallout from a global meltdown
The financial crisis, which began unfolding in earnest in August 2007, has been deepening in 2008. The current financial volatility has intensified and is lasting longer than previous market turmoil. Stock markets have plummeted around the world and the dollar’s depreciation has accelerated. Investors have become more risk averse as shown in a new record hit by the Emerging Market Bond Index Plus.This is because subprime mortgage woes have begun to rapidly affect not only subprime mortgage products but also mortgage-related derivatives and bond insurers that guarantee those derivatives. Thus, subprime-related losses are increasing, with the present estimate up to $600 billion.
It will take at least one to two years for the world’s economy to escape from the subprime mortgage crisis. The most important factor in resolving the crisis is the recovery of the U.S. housing market, but the housing construction market is expected to remain weak throughout 2008.
In particular, although the world’s financial institutions have responded intelligently by writing down $180 billion over the short term, the subprime mortgage debacle is deepening and causing huge losses. The good news is that financial institutions have large amounts of cash holdings that were accumulated during the previous boom period and sovereign wealth funds from Asia and the Middle East are going to supply additional capital, which will lead to gradual resolution of the subprime mortgage problems.
As the ripple effect of the subprime mortgage debacle kicks in, the U.S. economy has been seemingly driven into a serious slowdown. To make things worse, it is not likely to rebound to a potential growth rate of 2.5 to 3 percent by 2009. The global economy is also anticipated to enter a correction stage soon, ending a period of high growth.
Global inflation, which has eased since the 1990s, is also expected to stay put for a while as international raw material prices soar owing to a weakening dollar and a global excess of liquidity.
Unlike in the 1970s, though, if the global economy slows down, inflation will be contained because international raw material prices will fall progressively. Why? The recent hikes in international raw material prices have been mainly caused by high demand, rather than short supply, that resulted from high growth in big emerging economies such as China and India.
There are some other positive effects. The U.S. economic downturn and the dollar’s descent will likely narrow its current account deficit, thereby redressing the global imbalance, which has expanded significantly. Meanwhile, when financial volatility ends, central banks across the world are going to toughen previously too loose monetary policy and start reducing excessive liquidity.
Amid the worse-than-expected external conditions including the prolonged subprime mortgage woes, Korea needs to make complete preparations so that the current financial volatility will not affect it.
First, the government had better be armed with more flexible fiscal and monetary policies, considering that the economy is losing its growth momentum and showing signs of a decline. Second, it ought to address price instability by further lowering quota tariffs on international raw materials or grant them tax exemptions. Third, it has to strive hard to stimulate domestic demand by lowering the corporate tax, lifting regulations and stabilizing labor relations because a slowing global economy will inevitably hold back domestic exports.
The writer is a research fellow at the Macroeconomic Research Department, Samsung Economic Research Institute. Inquiries on this article should be addressed to SERIKSW@ seri.org.
By Kwon Soon-woo
with the Korea JoongAng Daily
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