Currency crisis: Take 3

Over the span of merely three months, the won’s value against the dollar plummeted by 46 percent, from 1,006 won in July all the way down to 1,468 won. The exchange rate is wildly fluctuating by more than 100 won each day. One day it goes up by 90 won and the next it falls by 120 won. Over the month of October, the exchange rate fluctuated by a daily average of 3.19 percent. This can’t be seen as normal activity in the foreign exchange market. This is a distinctive symptom of a foreign exchange crisis.

In the turmoil occurring in our foreign exchange market, there are two key questions. The first is whether the private sector, including banks and companies, has the capacity to supply foreign currency. If not, the next question is whether the Bank of Korea’s foreign reserves are sufficient.

Regarding the first question, it seems the chances are slim that either Korean-based banks or foreign banks operating in Korea can borrow sufficient foreign currency needed, which amounts to tens of billions of dollars.

Credit risks in the international financial markets haven’t calmed at all. Financial institutions overseas want to apply terrible credit default swap rates on us, the same as those they would apply to very poor countries. This all adds up to an extremely difficult situation. Under these circumstances, it’s more difficult for companies to borrow money from abroad or to issue corporate bonds. It will also be very difficult to get foreign currency through exports, considering the economic slowdown in the United States and China.

Therefore, resolving the turmoil in the foreign exchange market depends on the second question - whether the central bank has sufficient foreign exchange reserves. The Korean government and the BOK have constantly emphasized that our reserve was worth $239.6 billion as of September 2008, making it the world’s sixth largest. But if the size of the foreign exchange reserve indicates the health of the country’s economy, can we say Russia or India, countries with much larger foreign exchange reserves, are safer than Korea? Or, on the flip side of the coin, are the United States, Canada, Germany and France, countries with much smaller foreign reserves, much more vulnerable to the foreign exchange crisis than us?

The size of Korea’s foreign exchange reserve or its rank in the world was not what most worried foreign exchange experts. As Korea has been mindlessly borrowing foreign currency and has become a debtor again in eight years, experts worried that Korea would probably not be able to make good on its short-term obligations to overseas institutions or to meet other demands for foreign currency.

There are two reasons why the foreign exchange markets were concerned about Korea’s capacity to pay back its debt from abroad. First, since the subprime mortgage crisis, the credit crunch in the international financial markets made it extremely difficult to borrow money.

Second, foreign investment in Korea - worth more than 150 trillion won ($115 billion), which is not counted as national debt - has been draining out of the country at the rate of hundreds of millions of dollars every day for months. And the decisive factor that worried the foreign exchange markets were the doubts about the health and security of the assets of the Bank of Korea’s foreign reserves.

No one knows what the BOK’s foreign assets are, and therefore no one can be sure that its foreign exchange reserve is healthy or secure. Fannie Mae and Freddie Mac were nationalized, the corporate bonds issued by those former mortgage giants are being traded at low prices and the prices of financial instruments of all kinds have fallen into a downward spiral. Thus, no one would believe that the value of the BOK’s assets remain the same as they are written in the books.

Besides, as the value of the euro has fallen by 14.8 percent this year, euro-denominated securities in the BOK’s foreign reserve must have lost significant value. If the worth of the central bank’s assets have fallen by 20 percent, its foreign reserves would be $190 billion, which is $50 billion shy of the amount the bank professed to have. If the value of the assets has plunged by 40 percent, the central bank’s foreign reserves would be merely $144 billion, $100 billion less than what it claimed to possess.

The foreign financial markets - foreign investment banks and institutional investors abroad in particular - probably have a more accurate estimation than we do on how much the BOK possesses and what its financial assets look like. Some of the foreign institutions may have statistics about the BOK’s assets. Some may have consulted with the BOK on its investments, or even been entrusted to mediate or manage those investments. This is why we listen more carefully to evaluations from the New York or London markets on Korea’s economy than to what is being said domestically.

Finally, Korea and the United States have signed a currency swap contract worth $30 billion. This is, in fact, a contract for short-term debt under which Korea will borrow up to $30 billion in three months. This proves that the BOK’s foreign reserves are insufficient. In the global financial turmoil, Korea is going through difficulties that neither China nor Malaysia nor India are experiencing.

We have experienced foreign exchange crises in 1985, 1997 and now in 2008. When will one happen next?

*The writer is a professor of economics at Sookmyung Women’s University. Translation by the JoongAng Daily staff.

by Shin Se-don