Weathering a financial tsunami

While having lunch with 10 friends, I did an impromptu poll of them by handing out a questionnaire written on a napkin. What was the biggest problem facing the country? The popular answer wasn’t the controversial confirmation of prime ministerial nominee Lee Wan-koo or the record-low approval rating of President Park Geun-hye. It wasn’t economic inequality or taxes. Six out of the 10 cited snowballing household debt as the biggest danger and challenge to Korean society. They all shuddered at what they might face in 2017. It was all due to the reinforced might of the U.S. economy.

Household debt has reached 1,060 trillion won ($959.1 billion). Overdue interest rate on the debt is just 0.49 percent thanks to low interest rates, with the benchmark rate kept at 2 percent. The scene in the United States is the opposite. Unemployment is at an eight-year low of 5.6 percent, which means practically every working-age person has a job. The U.S. economy grew 2.4 percent last year thanks to eased liquidity backed by unconventional monetary easing, zero interest rates and the shale gas boom. The United States has not achieved its other goal for the three-phase quantitative easing plan of pushing up inflation, which still hovers below the target of 2 percent. But monetary authorities are less worried because they believe inflation has been subdued by other factors, like falling oil prices and the strong U.S. dollar.

What U.S. monetary authorities fear is a bust in assets that have been inflated by the 4 trillion dollars of new money pumped into the market. During 1994, 1999 and 2004 when the U.S. Federal Reserve raised interest rates in several bouts, the S&P500 index jumped 11 percent, 21 percent and 18 percent, respectively. In 2013, the S&P500 index jumped 30.5 percent and has risen 14.5 percent so far on average since the end of 2014. Last year, the Fed announced the era of quantitative easing was over and embarked on tapering its bond purchasing program. This year, it is poised to push up interest rates. The central bank is mulling dropping the word “patient” from its rate guidance. The market anticipates the Fed would move to raise rates as early as June or in September.

The question is how fast and by how much will the Fed raise its benchmark rates from the current 0 to 0.25 percent range? The minutes from a recent Federal Open Markets Committee meeting that included a survey on 15 of 17 members offered an ominous indication. They predicted the median interest rate would reach 1.125 percent by the end of this year, 2.5 percent in 2016 and 3.625 percent by the end of 2017. The projection for fed fund rates suggests the U.S. policy makers could raise the benchmark rate by 3.5 percentage points over the next two years. The Fed ratcheted up the key rate by 3 percentage points from 1994-1995 and 4 percentage points from 2004-2006. Coincidental ramifications included the 1997 Asian financial crisis and 2008 subprime mortgage meltdown.

Can the Korean economy weather another external financial tsunami? Currently, Korea has built a strong fortress with foreign exchange reserves of $362.2 billion and a current account surplus that reached $89.4 billion last year. But a U.S. rate hike will trigger domino actions from other central banks. The Bank of Korea may try to stay in sync and push up interest rates by 2 percentage points.

The government assures us the household debt front is safe. Mortgage regulations act as protection against bad household debt. It also points out that 65 percent of household debt is owed by middle-income families who can afford to pay it back. But a closer study shows there is a good reason to be worried; 1.37 million households have more debt than assets. Another 2.34 million are dangerously muddling along with principal payment on their debt exceeding 40 percent of their disposable assets. They are mostly low-income households and small business owners. Unlike salary workers who take out mortgages at a 3 percent rate from banks, these groups borrow from the non-banking sector at rates of over 5 percent.

The U.S. tightening will mostly hurt emerging markets. But Korea will also not be safe if the rates are higher. More than 7 million people could be screaming for help because they cannot pay their debt. Property, which accounts for 70 percent of Koreans’ assets, could be devastated. Political issues would hardly be on anyone’s mind then. Before ending the lunch, one of my companions who used to work in international banking observed that the biggest concern is that we cannot rely on financial and monetary authorities. He advised us to keep everything in disposable assets for emergencies with the hope that we will somehow make it through 2017.

JoongAng Ilbo, Feb. 17, Page 26

*The author is a senior editorial writer of the JoongAng Ilbo.

by Lee Chul-ho