[Viewpoint] Soothing words won’t end crisis

The tsunami of European debt is crashing down on the South Korean economy. Stock prices and the won value are in free fall. Media and investors are gripped with panic at ominous happenings similar to the 2008 implosion of Lehman Brothers, which froze credit markets and sent the global economy into recession.

The plunges in the benchmark stock price index and currency value are happening faster than in 2008. The cost of protection against default risks on Korean sovereign debt are shooting up. The spread in the Korean credit default swap was 202 basis points on Friday, more than the 197 basis point spread on French debt, despite France’s direct exposure to euro woes.

From the CDS premium data alone, investors appear to be more worried about the South Korean financial market than France’s, despite the latter’s position as a major lender to Greece, which is teetering on the brink of bankruptcy. In 2008, the Korean market took a heavy beating even though local lenders had no exposure to U.S. subprime mortgage loans. Individual investors on Monday joined the foreign-led selling spree in fear of a replay of the 2008 wipeout. But their sell-off was a poor investment move because the leading index rebounded the following day.

The European credit debacle is not as sudden as the Wall Street-sparked financial crisis in 2008. It is prolonged because European leaders have failed to come up with a good solution.

Economists are divided and unsure about the Greek debacle. Some suggest Greece should be left to go insolvent and ousted from the euro zone. Others propose more a aggressive rescue package financed by euro bonds. Leaders are tilted toward the idea of allowing a Greek “controlled default” on its debt obligations without taking away its EU membership.

But this idea cannot easily generate a consensus, as it means hefty losses for banks and taxpayers. What is certain is that the dark clouds over Europe will not clear away any time soon and are likely to spread.

The question is how wide and how far the spillover will be. If the EU leadership fails to contain the Greek credit crisis, they will have to swallow the losses, and the international credit market might freeze. As in the case of Lehman Brothers, the shockwave would be a global crisis. European banks, incapable of raising new loans, are cashing in their holdings in bonds and stocks at home and abroad, causing a crash in stock and currency markets here.

But few anticipate a mass capital exit. Korea probably will not face a major liquidity crunch with foreign exchange reserves of over $300 billion and a relatively small share of short-term external debt. What remains a risk is a speculative and panicky selloff by local investors.

The bigger danger is beyond the European debt problems. Even if it somehow patches up the immediate crisis, the European economy under fiscal austerity and tightening will not pick up for a long while. The United States is also staring at the danger of a double-dip recession. Japan is still struggling under the cost of reconstruction after the major earthquake and tsunami. The export powerhouse China will likely lose steam due to poor external market conditions. The global economy as a whole will have to brace for a slowdown.

Despite such a backdrop, Minister of Strategy and Finance Bahk Jae-wan recently expressed confidence in the local economy while in Washington, citing rating agencies’ positive views on Korean fundamentals. But just because the country can weather a liquidity crisis, its fundamentals - backed by growth and industrial activity - remain vulnerable because they are mostly powered by external trade. Moreover, the incumbent and future administrations are poised to appropriate extravagant sums to welfare benefits because of the momentum of the general and presidential elections next year.

Private think tanks forecast next year’s economic growth at well below 4 percent. Some foreign banks estimate it at less than 3 percent. The fundamentals, about which the government is so confident, are shaky. Instead of boasting about how strong the fundamentals are now, the authorities should concentrate on how to keep them healthy in the face of challenges. We must seek ways to drive the economy when the primary engine - exports - loses steam. We can truly convey confidence in the fundamentals once the economy successfully weathers the new challenges.

*The writer is an editorial writer of the JoongAng Ilbo.

By Kim Jong-soo