[Outlook]Subprime aftermath

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[Outlook]Subprime aftermath

Some predict that the subprime mortgage crisis could be over because the U.S. Federal Reserve has drastically cut the interest rates. This cut has boosted financial companies that had been struggling. However, even though Korea’s stock markets are also responding positively, it is too early to say that the crisis is over.
Financial companies haven’t solved their problems yet and the real economy in the United States, which the credit crunch has severely damaged, will negatively impact the world economy.
The subprime mortgage crisis exists because of risky investments on derivatives. Problems in derivatives are revealed gradually, which is why it has taken a long time for financial companies to solve their problems.
Woori Bank wrote off subprime mortgage-related bonds late last year, but that didn’t end problems. Volatility in the financial market caused by the subprime mortgage crisis will likely continue until the end of the year.
What’s more serious than the weakness of the financial companies is a slowdown in the real economy. In most cases, a financial crisis leads to a slowdown in the real economy and the impact gets more serious when the crisis hits the real economy.
The fall in housing prices and the credit crunch in the United States has reduced U.S. consumption significantly. And consumption accounts for a large part of the U.S. economy.
That is why many predict that the slowdown of the U.S. economy will get worse. Moreover, a slowdown in the U.S. economy is likely to spread around the globe, and the subprime mortgage crisis is likely to continue for a considerable period.
As if confirming this worry, the International Monetary Fund recently lowered this year’s global economic growth forecast from 4.1 percent to 3.7 percent.
A U.S. slowdown, the aftermath of the subprime mortgage crisis, has a seriously negative effect on Korea’s economy.
It reduces Korea’s export volume, which will worsen Korea’s current account deficit. In turn, this deficit will slow down Korea’s economy as well.
If our current account deficit grows, our economy might face another financial crisis. For the last two months, our current account deficit has been above $5 billion.
If we have to continue to pay high prices for imports because of high oil prices, our current account deficit will likely surpass $7 billion, which was the Korean government’s earlier estimate.
A balanced current account indicates a healthy economy. Thus, if our current account deficit increases significantly, we will have difficulty borrowing foreign currency, which might cause another financial crisis.
In 1997, we had a foreign exchange crisis, as the current account deficit grew steeply. Therefore, even though the insecurity in the financial markets caused by the subprime mortgage crisis has calmed down to some extent, the Korean government must prepare measures to respond to a slowdown in the real economy.
First, exports must be increased in order to prevent the current account deficit from growing further.
The problem is that the exchange rate must be improved in order to increase exports, but it isn’t easy to do so because this move might raise the price of commodities, which have gone up already due to the increase in oil prices.
However, when the current account deficit soars, we need to lower the value of the won to export more. This can help prevent our economy from entering a crisis.
The Bank of Korea must examine its current high interest rate policy. Korea’s short-term key interest rate is 5 percent, much higher than 2.25 percent in the United States and 0.5 percent in Japan.
When there is a difference between our interest rate and those of other countries, there will be an influx of foreign currency into our market, lowering the exchange rate and increasing liquidity.
The unfavorable exchange rate and increased prices of commodities will make it even more difficult to export our products.
If the United States cuts the interest rates further, more foreign capital will come into Korea’s market. Thus, Korea’s central bank must think seriously about cutting its key interest rate to narrow the gap with other countries’ interest rates.
Now is the time for the authorities to make the right decision in preparation for the aftermath of the subprime mortgage crisis.

*The writer is a professor of economics at Yonsei University. Translation by the JoongAng Daily staff.

by Kim Jung-sik
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