[Viewpoint] Capital curbs are comingLast week was an interesting one to spend in South Korea - not because of North Korea’s war threats, or the triumphs and disappointments of South and North teams in the World Cup. It was interesting because of the unsexy topic of capital controls.
Seoul officials invited a tsunami of criticism by tightening rules on currency derivatives. They acted to reduce volatility caused by another surge - capital flows putting stress on Korea’s markets.
Let’s focus less on what Asian governments are doing and more on why they’re doing it. If you want to blame anyone, Ben Bernanke over at the Federal Reserve in Washington makes a good target, as do Masaaki Shirakawa in Tokyo and Jean-Claude Trichet in Frankfurt. The heads of the three biggest central banks are running the easiest money policies in history and, for better or worse, that liquidity is surging Asia’s way.
Korea’s efforts to tame the won are both a sign of things to come in Asia and a cautionary tale. Policy makers must tread very carefully on capital controls lest they unnerve investors and do more harm than good.
The trouble? Such actions are always a slippery slope. “These measures are not particularly worrisome, but introducing or discussing such measures at a time of great uncertainty and fear in global markets may end up being more destabilizing than stabilizing,” says Win Thin, a New York-based senior currency strategist at Brown Brothers.
Make no mistake about it - capital curbs are coming. Indonesia’s central bank set a one-month minimum holding period for investors in its bills last week, while India proposed a capital gains tax on stock trades. India’s move was similar to Pakistan’s on June 5.
We can respond with the usual free-markets-are-always-best tirade or look at the real problem. Central banks have entered into a new era of near-zero interest rates, limitless liquidity and no sign of exit strategies in sight. It’s requiring a huge adjustment in economic thinking.
Gone are the days when central banks were truly independent. Can you imagine if the Fed raised short rates this month? U.S. lawmakers would probably send a SWAT team to bring in Bernanke. Imagine if Trichet tightened policy at a time when Greece is being downgraded to junk and Spain is on the brink. The United Nations might have to get involved to save the euro zone from itself.
Nor does anyone expect the Bank of Japan to surprise markets. Central bankers are stuck near zero for some time.
That’s the problem with using all your ammunition. It’s hard to reload when credit markets are still malfunctioning and demand for credit is scarce.
The 34 percent rally in gold during the past year is one manifestation of how disoriented markets have become. Most are loading up on gold because they worry the financial world is coming to an end.
As investors sort out what they fear most, they’re eyeing the most attractive opportunities. And for many Asia bulls, that means economies like Korea. It’s growing 8 percent year-over-year, it’s well positioned to ride China’s rise and its stocks are arguably cheap.
Yet Korea faces too much of a good thing. As capital rushes its way, the risks of losing control and overheating increase - hence Korea’s move to join Taiwan, Brazil, Colombia and Russia in tightening rules on capital. Even China is shifting toward a stronger yuan amid inflation risks.
It’s volatility rather than mercantilism that’s at issue. This is about regaining some control over financial systems being swamped by too much liquidity chasing too few good investments.
Korea has its unique qualities. One is how the lessons of mid-2008 are still reverberating around Seoul. Executives can give you an earful about the events leading up to the collapse of Lehman Brothers Holdings Inc. Many small and medium-sized businesses entered into currency contracts with banks they couldn’t understand.
Many of the deals, known as knock-in, knock-out (KIKO) options, went sour as the won unexpectedly plummeted against the dollar in early 2008. U.S. investors were repatriating funds from overseas assets amid the credit crisis at home. It triggered a massive margin call many couldn’t meet. Lots of Koreans side with Warren Buffett’s characterization of derivatives as “weapons of mass destruction.”
Korea’s geopolitical status is also worth noting. Here, North Korea’s World Cup performance last week offered a useful metaphor. There was never any doubt Brazil would win, as it did 2-1. Yet it was just like North Korea to stick one in the back of your net along the way. It was not unlike the risks of pinning the North back militarily.
Korea’s challenges are coming to a head amid fast-increasing hot-money flows. Yes, governments should be careful not to overdo efforts to tame markets. It’s still important to recognize why policy makers see such steps as necessary in the first place.
The costs of ultra-low rates among Group of Seven economies are becoming all too clear. Monetary largess in Frankfurt, London, Tokyo and Washington is putting unprecedented pressure on open, less-developed economies like Korea. Think of them more as messengers of what’s wrong than as perpetrators.
*The writer is a Bloomberg News columnist.
By William Pesek