The plague of low interest

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The plague of low interest


By Kang Il-goo


Kim Kwang-ki

Interest rate levels these days are dismal for savers and a godsend for borrowers. Bank deposit rates have fallen below 2 percent. Those with good credit and collateral who are eligible to borrow at the most favorable rates have seen interest in the 3 percent range. Never have Koreans seen rates so low.

A deposit of 100 million won ($98,200) in a bank savings account at 2 percent per year will generate a yield of 1.7 percent after taxes. That’s just 140,000 won per month. To live off savings, a retiree would need more like 700 million won in the bank to generate an income of at least 1 million won a month. This formula equates to disaster for the retirement plans of many Koreans. If interest rates remain at such low levels, we could see a change in the wealth paradigm as sweeping as the land reform after the war and the Asian financial crisis in late 1990s.

So, what does this equation mean for the value of money? Has it devalued or appreciated? About a decade ago, 100 million won generated a relatively comfortable income of 1 million won a month. Now we need seven times more than that in savings for the same yield. But from the perspective of cash flow, the 100 million won 10 years ago might now be worth 700 million won.

The answer, therefore, can be both. This is meaningful.

It could be better understood if we compare cash flow to water. The difference is comparable to water in a well and water in a flowing stream. When kept in a well (bank), the money’s vanue is constricted. If it flows, by adding it to work revenue and investment, it becomes a much bigger pool. The wisdom of living with ultra-low interest rates might be found in this principle. Senior citizens should continue to create new cash flows for stable planning. Bank deposits no longer can be relied upon as the sole source of income. Putting money in the bank would be only marginally better than leaving it locked up in a safe.

Some people may still believe interest rates will head up again. The U.S. Federal Reserve has indicated it could start putting upward pressure on interest rates from next year. The Bank of Korea, too, would have little choice but to follow the direction of the world’s largest reserve lender and boost its policy rate. Market rates would then be normalized. But that’s naive thinking. We may have entered the age of ultra-low interest rates. Today’s rates are not at rock bottom simply because of the global financial crisis and the Bank of Korea’s feebleness. They are signs of lethargy from a structurally worn-out economy.

When money is likened to the blood of the economy, interest rates are the pressure. The 1 percent rate levels signify seriously low pressure. Low pressure can be more hazardous to economic health than high pressure. Most advanced economies in the United States and Europe suffer the same symptoms. Our yields are higher than those in America and the euro zone. But if Korea’s low pressure is not treated in a timely manner, the country could fall into a chronic deflationary lapse like Japan did over the past two decades. It may fall behind even when the global economy recovers.

The solution is already prescribed. The economy must change its diet and improve conditions to restore fundamental strength so that it becomes healthy enough to compete. In other words, it urgently needs structural reform. Most advanced markets are engrossed with such work. Korea must quickly remove all unnecessary red tape to bolster domestic demand and the service sector.

Entrepreneurship must be reinvigorated and more people encouraged to start and expand businesses. Interest rates would then move higher because of increased demand for liquidity. Despite the colossal and imperative task, progress remains slow. Politicians are too busy to take any time to review economy-related bills and various groups are protesting hard against any move that could adversely affect their vested interests. But let us not lose hope yet.

JoongAng Ilbo, Spet. 4, Page 28

* The author is the head of the Economist, a weekly business news magazine published by the JoongAng Ilbo, and the Korean edition of Forbes.

BY Kim Kwang-ki

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