[Outlook]Stay out of the whirlpool

They said that a new era had arrived. They said the soaring housing prices in the United States were not a bubble. They said the revolution in information technology permanently increased the economic growth rate and cutting-edge financial techniques made it easier to raise capital. As a result, it became possible to have both high economic growth and low interest rates, they believed.

This illusion was shattered last summer. But still, the optimism about the global economy didn’t dissipate. They said the losses financial institutions experienced when housing prices fell were limited and therefore as long as there was sufficient liquidity in the market, the U.S. economy would be restored in the near future. They also maintained that the decoupling era was coming, meaning that rising industrial countries no longer heavily depend on the United States and therefore the global economy would continue to grow despite the U.S. slowdown.

A rumor swirled, however, that a financial crisis would break out in Korea in September of this year. As it turned out, the crisis erupted in the United States. The U.S. government took over institutions that accounted for half of the supply of the housing market and nationalized the world’s biggest insurance company, AIG. A giant investment bank was shut down and the others were either sold to commercial banks whose savings are protected by the government, or transformed into holding companies in an attempt to get under government protection. The U.S. government announced a plan to spend a huge bundle of public funds almost equal to Korea’s entire gross domestic product, and is waiting for congressional approval.

Just as Koreans made up for our banks’ losses with taxpayer money, Americans will probably have to make up for losses the rich have accumulated by gambling with taxpayer money. It is shocking to see that Wall Street, once a symbol of the spirit of the times, overnight became a laboratory for experiments with socialist financial policy. Intellectuals will hastily push their pens. Even culture critics who have no idea what financial derivatives are will join the choir singing a sloppy funeral march for neoliberalism.

However, we don’t have the luxury of simply watching the misfortune in the United States as if it doesn’t concern us at all. We should remain alert to make sure that we are not dragged into the whirlpool. The bigger the vortex becomes, the more alert we should become.

The expectation that $700 billion in public funds will end the financial crisis in the United States may also turn out to be unreasonably optimistic. That amount of money is not enough to maintain all the assets and swollen debt of financial institutions. There has to be a massive depreciation of assets and debt and this will turn many financial institutions’ bonds and stocks into trash.

Additional reduction in housing prices will worsen the situation. Investors expect that housing prices in the United States will further decrease by 16 percent. If so, the housing prices in the United States will be 40 percent less than what they used to be at their peak. If assets equivalent to the gross domestic product disappear, all types of funds will likely become insolvent as well.

It is time to forget about decoupling, too. The housing and financial markets in Europe are sending warning signals and the economies of new industrial countries are shaking. Our economy will worsen further if the international financial markets freeze, making it more difficult to borrow foreign currency. The exports that have sustained our economy will decrease at the same time.

Fortunately, conglomerates and large-scale financial institutions remain healthy, so a crisis like the one we experienced in the past is unlikely to happen again. However, there is still a possibility that stocks could plummet, foreign exchange rates could surge or the financial market could tighten. Credit spreads on Korea’s bonds are not good compared with those in developing countries and Korea’s foreign debt is not small enough to be comfortable about when comparing it with exports.

There is no magic way of resolving these problems. The only possible method is to increase interest rates and control the transfer of capital if an emergency breaks out.

We must not cut interest rates significantly in an attempt to boost the economy and sell out massive foreign reserves to try and stop the foreign exchange rate from surging. Under the current circumstances, this will only invite a crisis. If the interest rates are to be reduced it should be done carefully, keeping pace with other countries. Also, projects that are not critical or not urgent must not be pushed ahead. That will only cause political insecurity, as did the push for lifting the ban on American beef imports.

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

by Song Eui-young