[Viewpoint] The shadow of stagflation

The global financial market is wobbling due to the leading economies’ rising government debts and the current fragility of the euro zone. The financial turmoil does not seem as if it will settle down in the near future. There are many countries that have already fallen deep into the debt trap, and many others are on the brink of caving if one domino falls.

The problem is that they have no clear path to escape their financial burdens. Look at the United States, for instance. Ever since the Vietnam War, the United States has continuously accumulated both budget and trade deficits - a twin deficit, so to speak.

Recently, U.S. leaders agreed to raise the federal debt ceiling to avoid a global financial catastrophe. An instant antidote was injected for a temporary cure, but the fundamental cause still remains unresolved and global chaos could arise at any moment.

The solution for getting out of the current fiscal hole requires patience and pain. In order to reduce debt, there are no options other than raising taxes and cutting government spending.

Tax increases are not easy in today’s oversupplying economy. Note that China alone has enough capacity to supply twice the amount of goods to serve the whole world’s demand. This disturbs the cycle of manufacturing and consumption.

Moreover, consumer confidence has weakened in countries with crippling fiscal deficits, which in turn has damaged income distributions. With weak global demand, raising taxes could very well hinder an already slow economic recovery and minimize potential governmental revenues in the long run.

If tax hikes further stall business growth, the global economy could fall into a double-dip recession and leave governments with even fewer fiscal and monetary policy options to help weather the storm.

Now, let’s look at the effects of cutting government spending. In reality, this method will not solve the budgetary problems on its own, unless unprecedented circumstances called for some sort of debt moratorium.

You cannot expect politicians and bureaucrats in this world to shake off their inherent selfish instincts. Simply look at our government, which is generous enough to build palatial government buildings despite its debt.

There are two ways to get over a depression: fiscal stimulus and liquidity easing. With a heavy debt, the former policy is not feasible. This leaves us no choice but to take the latter - expanding liquidity.

Inflation depreciates currency value, and in turn the actual value of government debt becomes smaller. For instance, if inflation continues at a rate of 7 percent for 10 years, the present value of debt decreases by 35 percent.

Unfortunately, this policy would be effective only for countries like the United States and Japan that have debts in their own currency. Countries in southern Europe that have debts in a foreign currency are therefore in a dilemma. Japan is in a better situation, though, because its debt is being eased by the state’s citizens. This explains one of the reasons for the yen’s strength.

Struggling with heavy debts and stagnation, the world economy is in a fragile and dark state. Rising unemployment and inflation are inevitable, and the pain will be much greater for lower and middle classes.

History has taught us how to deal with economic downturns like this one. Citizens need to transform spending habits and adopt measures of austerity to end the current crisis.

And it may be time for the United States and Western European countries to pay for the welfare they have taken for granted over the past century. The world now has to suffer from the slowdown in spending by once lavish powers.

Economists say that Korea’s financial debt condition is considered stable. But looking at the rate of debt accumulation will not relieve our anxieties. It is concerning that the scale of household, corporate and public debt is not easily perceived by the public.

Transparency is urgently required to avoid unexpected damage when an economic crisis unfolds.

Korea - highly dependent on foreign trade - needs to prepare for the worldwide stagflation that is rapidly approaching.

*The writer is vice chairman of Baker Tilly Sungto LLC.

By Sihn Se-Cheol