[Outlook]Protect the economy nowFinancial markets are inundated with worry as Wall Street investment banking giants Lehman Brothers went bankrupt and Merrill Lynch was sold to the Bank of America.
What should be done? Should we patiently wait until the markets recover or should we take drastic measures now?
Let’s look at similar events in history.
When the New York market plummeted in 1929, not only the United States but also advanced countries in Europe were severely damaged. But new markets were hit even harder.
As money sources dried up, industrialized countries pulled their investments out of new markets. They did so based on the belief that when the global economy goes bad, the periphery sustains more damage than the center.
So who overcame the shock first?
The answer is Japan and Britain, according to Professor Charles P. Kindleberger, a renowned scholar of the Great Depression.
Japan prohibited exports of gold and abandoned the gold standard for currency.
It introduced the foreign exchange control act to protect its own currency. It restored deficit financing and increased public investment.
Its finance minister at the time, Korekiyo Takahashi, didn’t study Keynesian economics but he intuitively acknowledged that he must separate Japan’s economy from insecurity in the international financial market and increase total demand. That was where he put his efforts.
Britain also abandoned the gold standard and implemented an exchange equalization account to protect its exchange rate and financial market from hot money. It lowered interest rates to sustain the housing market.
At that time, the gold standard system was the cornerstone for free transfer of capital.
When investors took out their money, they were paid with gold. Interest rates had to be increased significantly to keep the value of the currency, which would hurt the economy even further.
Japan and Britain were the first countries to end this practice.
The current global economic situation doesn’t seem different from then. But now, the greenback plays the role that gold used to have.
When the subprime mortgage crisis began, the center of the economy sucked money from the periphery.
The money that foreign investors have pulled out of the Korean market over the past year exceeds 50 trillion won ($45 billion). People have been saying that Korea is an American ATM.
This week, it was American banks that went bankrupt or were sold, but Korea’s market plunged and the value of the won against the dollar nosedived.
But those who believe that things should be left to the market worry that if the government makes an unwise intervention, we will lose the trust of investors and the economy will worsen further.
Others positively believe that as advanced countries have accumulated skills and knowledge on how to manage a crisis, they can prevent the global economy from getting worse by providing liquidity or cutting interest rates cooperatively.
But the problem is that Korea can’t afford to cut interest rates.
The countries at the center of the economy can do so because they hold the key currencies. The European Central Bank and Britain have already cut interest rates and the United States is likely to do the same.
But Korea can’t because of worries about the exchange rate. Our nation is advised instead to raise interest rates to protect the exchange rate.
We are facing a dilemma because we have fully opened our capital market even though we are one of the countries on the periphery.
We will have a range of policy choices only if we abandon a blind belief in the liberalization of the capital market, just as Japan and Britain did in the 1930s.
China was recently able to lower interest rates because it controls its capital.
Before the economy worsens even more, we should take preventive measures.
We should make foreign investors wait longer to take their money out of the market, and when they do, we should allow them to take it out only a little at a time instead of all at once.
We should make foreign exchange speculation more difficult than it is now.
This doesn’t necessarily go against the interests of foreign investors.
When stock prices have fallen too much already, it is not good for them to hurriedly change their assets into dollars at bad exchange rates.
When there are shocks from outside, Korea’s economy amplifies and absorbs them.
If we wait until we have endured all these shocks to draw up measures to protect Korea, we will already have become ill.
*The writer is a professor of economics at the National University of Singapore. Translation by the JoongAng Daily staff.
by Shin Jang-sup