[Viewpoint]Manage the boomThe stock markets in almost all countries are now in the mist of a major boom, breaking records in both trading volume and share prices. This global bull market owes a lot to improvements in business profitability and brighter overall economic prospects.
However, it is abundant international liquidity that is contributing the most to the global trend of rising stock prices. The bull market has increased asset prices not only in advanced countries, but also in relatively volatile emerging markets.
Fortunately, as the world economy maintains a reasonable degree of stability both in terms of the real economy and financial variables, the overall perils of steep investment risk are being reduced to a considerable degree.
In this period, the world is enjoying brisk business growth, with the skilled workforce increasing tremendously as China and Eastern European countries become major factors in the world economy. Low interest rates also help to drive the stock market increases. This in turn creates a positive cycle of improved business profitability and rising stock prices.
The global economy has already entered the long tunnel of finance capitalism. As the volume of financial activity grows, the process of turning the global economy into one controlled by finance is rapidly gathering speed.
The sheer amount of financial assets, such as securities, is part of the transformation. The scale of financial assets compared to worldwide gross domestic product has increased from 1.1 times in 1980 to 3.3 times in 2005. The number of corporate mergers and acquisitions is also increasing very fast.
In the meantime, the financial industry has achieved brilliant growth. The three major business lines of the financial industry ― banks, investment banks and insurance companies ― have all expanded to join the list of the top five largest industries out of 18 major industrial fields. Ten years ago, only banks were included in the top five.
It is highly likely that the brisk business in the stock market at present and the trend of putting the economy under the control of the financial industry will continue in the future. It is because factors within globalization ― abundant international liquidity, low prices and the expansion of the U.S. current account deficit ― have formed a long-term trend rather than a temporary aberration.
Domestically, the flow of funds from real estate to the stock market and the explosive growth of the national pension fund seem to be two of the pillars supporting the current Korean stock market.
However, sometimes too much can be worse than not enough.
With the unbalanced expansion of the financial sector, the chances are growing higher that capital will become concentrated in the money game instead of in productive investment.
It can be said that the appropriate earning rate can be determined by adding a risk premium on top of the earning rate of a government bond, which is essentially a risk free asset. Now, however, as the expectation of stock price increases fuels more expectations of increases, it could be that the stock prices are rising excessively high.
In the business sector, speculative entrepreneurs, such as hedge fund companies that have no experience in business management, can also damage the independence of sound businesses, creating instability once an industrial firm comes under their control.
Substantial increases in household debt are also a problem. Because such increases are not necessarily accompanied by an increase in household assets, a mismatch can occur between the need to settle debt in a fixed manner and the resulting rise ― or loss ― in asset value. If the debt is not paid on time and the assets do not produce sufficient income to meet the obligations, shortfalls can occur.
From a short-term perspective, the most worrisome possibility is “liquidity shock,” which could be caused by a sudden contraction of money supply in the market.
The worries have become reality in some way because of hedge funds that are facing a crisis as a result of the subprime mortgage crisis in the United States. It is also troubling that new financial products offered by some investment banks are so complicated that it is very difficult to calculate the risks involved.
Past financial crises often share the common feature that asset prices plummet as a result of tightened liquidity.
The shocks expand as the correlation between different classes of assets increase. When the crisis reaches a serious stage, the real economy can contract.
In the longterm, the bullish stock market will stabilize as liquidity is controlled. With increases in wage levels and commodity prices, deflationary pressures from China will weaken and it is highly likely that interest rates will be raised as a result of the weakening U.S. dollar internationally.
However, we cannot just wait with folded arms believing that the market will take care of itself eventually. First of all, we need to maintain liquidity at an appropriate level so it does not hurt the economic recovery.
Although the internationalization of finance is an ongoing process, the supervision of financial companies must be implemented on a governmental level. It is urgent, therefore, to establish a network of international cooperation for the stabilization of the financial sector.
*The writer is a research fellow at the LG Economic Research Institute. Translation by the JoongAng Daily staff.
by Shin Min-young