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[Viewpoint] Korea’s hot money dilemma

Published: 15 Oct. 2010, 21:25

I have never seen the stock market behave this way. The New York Stock Exchange is ecstatic over nothing but bad news.

Of course, sometimes it makes sense for negative news to excite Wall Street. As the unemployment rate in the United States rises, the Dow Jones industrial average jumps, and for a valid reason. The secret behind this seemingly contradictory trend is that traders anticipate quantitative easing.

As the impact of zero interest rates is running out, the government is ready to prescribe another camphor injection. In fact, the U.S. monetary authority is to release an additional $1 trillion. Treatment is inevitable to prevent the U.S. economy from turning into a vegetable. Japan and the European Union already implemented quantitative easing a long time ago. There is no better alternative if you want to prevent deflation. Liquidity has inundated financial markets around the world.

It looks like China is determined not to give up its controlled exchange rate. Premier Wen Jiabao has warned that revaluation of the Chinese yuan would be a disaster for the entire world. The battle of exchange rates between the United States and China has spilled over to other economies. The U.S. dollar is very weak, while the recent devaluation of the yuan was very limited, but other countries are suffering from the clash of two economic giants. Currencies of emerging economies are struggling with unusual strength. China and the United States have broken the rules of the game, but Korea is the one suffering the damage.

Seoul has long become a playground for hot money. The dollar carry trade, which is the practice of borrowing money in the United States at a low interest rate and making investments in Korea, is rampant in the Korean economy. The won had the largest margin of currency revaluation in Asia last month. The Kospi index is approaching 1,900 points and the bond rate is the lowest in history. The trend cannot be explained without understanding the influence of external liquidity. Hot money even has a political angle: investors are confident that as the chair of the G-20 Summit in November, Korean authorities won’t intervene at least until Nov. 11.

If developed economies are concerned about deflation, Korea has to worry about inflation. It is a normal reaction to raise interest rates if the consumer price rises by more than 3 percent. However, the Bank of Korea does not seem very eager to do so, because it is concerned that it will be criticized if an increase in interest rates leads to a rise in the strength of the won. The inflow of hot money is affecting interest rate policy as well.

Once Korea shakes off its duty as chair of the G-20, the government has a few tasks to undertake. Many emerging economies have already commenced emergency measures. Brazil and Thailand have begun to impose a tax on foreigners’ investment on bonds in order to inhibit speculative capital. Some countries are intervening in the foreign currency markets despite criticism for wasting cash. They came up with contingency rescue plans to prepare for a flood of liquidity from the developed world.

The U.S. is using the influence of the dollar as the dominant global reserve currency. As the euro and yen struggle, U.S. monetary authorities seem to have nothing to fear. If the U.S. does decide to embark on quantitative easing, a weakening dollar is unavoidable.

China deserves to don a satisfied smile as countries intervene in the currency markets one after another. Beijing’s calculation is to form a united front for “currency sovereignty” among other nations to dodge pressure from the U.S. and Europe to devalue the yuan. However, such a front is not easy to build or maintain. The confrontation between the developed economies focusing on quantitative easing and the emerging economies trying to block hot money is likely to continue for a while.

If trade protectionism during the Great Depression of the 1930s brought economic ruin for all, today’s challenge is the unsynchronized financial policies of developed and emerging economies.

Unless new rules of the game are prepared, international friction is not likely to be avoided. If exchange rates are to be determined by the market forces of supply and demand, excessive fluctuation of exchange rates and disorderly capital movements as a result of inflows of hot money should be controlled. Fortunately, there has been an international consensus for stricter control of hot money since the global financial crisis.

This is no time for Korea to think about dignity. A passive response of expanding our foreign currency reserves is not enough. We need to take a firm grip on the issue and respond intelligently to the movements of hot money. We no longer need to adhere to neoliberalism. It is about time we seriously consider imposing a Tobin tax on carry trade funds. When we have a solid external wall against hot money, the Bank of Korea will be able to set interest rates as they should.

Of course, the G-20 Summit meeting is a great international opportunity that deserves celebration and honor. However, there is no need to play a passive role about our economy in order to save face as the chair. After all, being the chair of the G-20 Summit does not bring bread to the table.

*Translation by the JoongAng Daily staff.
The writer is an editorial writer of the JoongAng Ilbo.

By Lee Chul-ho