More elephant fightingIt is naive to believe foreign exchange rates are determined by the market. There is a term called collaborative intervention. In 1985, representatives of France, Germany, Japan, the United States and Britain signed an accord at the Plaza Hotel in New York City to jointly depreciate the dollar against the Japanese yen and German deutsche mark. The agreement bound the governments to devalue the dollar and help the economy fight inflation and recession. Through a United States-led attack, the dollar plummeted to 120 yen by 1988 from 240 yen. Currency policy was one of the strongest economic weapons available to global economic powers.
Last week, I met Kim Seok-dong, former chairman of the Financial Services Commission. Kim, who is well versed in international finance, was wearing a serious face. He believed the United States was targeting China by endorsing Japan’s so-called Abenomics, which included unprecedented quantitative easing and intervention to devalue the yen to rein in China’s rise. The Chinese economy is slowing at a faster than expected pace and its stock market is crashing. China’s troubles could deepen if the United States moves to increase interest rates. The two countries are engaged in a war of nerves over foreign exchange policy, he observed.
The world is being shaken by the so-called September Curse. A very large shock could come from Washington where the Federal Open Market Committee (FOMC), the monetary policy-making board of the Federal Reserve, meets next week to deliberate on raising short-term interest rates for the first time in nearly a decade. It may decide to hike the federal fund rates in September rather than putting it off to December. Some members of the FOMC want to delay the move as inflation has not reached a 2 percent target and because global markets are too fragile, having already been rattled by the Chinese stock crash. But there are also calls for “normalization” of monetary policy. The U.S. economy is doing better than expected, growing by a solid 3.7 percent on an annualized rate in the second quarter. Its unemployment rate fell to 5.1 percent in August, which is tantamount to full employment. America Inc. is back in full force with IT giants Apple, Google and Facebook ruling the global technology domain. The United States has turned into an energy exporter thanks to the shale gas boom. Moreover, the excessive money supply unleashed through an unconventional policy mix of massive purchases of financial assets and interest rates kept close to zero since the Lehman Brothers collapse in 2008 are posing dangerous risks to the financial sector and the overall economy.
Even when the United States raises interest rates, the European Union and Japan will remain protected by their own versions of quantitative easing and near-zero interest rates. But China is different. Its asset bubble is declining and economic activity as a whole is slowing at an undetermined rate. Beijing has tried one remedy after another, including successive lowering of interest rates and reserve requirements and tightening of regulations on the stock and currency markets to prevent an exodus of capital. But as the saying goes, when elephants fight, it’s the grass that suffers. The spike in the dollar and plunge in international raw material prices have badly affected energy exporters like Russia, Brazil and the Middle East. Southeast Asian markets like Indonesia, Thailand and Malaysia will likely be the next victims.
Federal Reserve Vice Chairman Stanley Fischer recently indicated there were more reasons to raise the Fed rate in September than not. “In making our monetary policy decisions, we are interested more in where the U.S. economy is heading than knowing whence it came,” he said. He was suggesting that economic factors in the United States would influence the rate decision more than overseas ones. The International Monetary Fund has advised the U.S. Fed to put off tightening until the global economy is healthier, but it is unlikely that the Fed would pay attention. When it moves, the Fed tends to be decisive. It hiked the benchmark rate by three percentage points between 1994 and 1995 and four percentage points between 2004 and 2006. It continued increases until the market obliged. Investment banks in Wall Street are pitching for a rate hike because there is bigger money in greater volatility.
The Korean economy is in a parlous state. The central bank won’t be able to mimic the U.S. rate hike with household debt at 1,100 trillion won ($917 billion). If borrowing costs for households go up two percentage points, about 1.37 million households with liabilities exceeding assets could go bust. Then again it cannot risk an exodus of foreign capital if interest rates are kept too low. There is the currency intervention option, but it could stoke criticism of favoritism for exporters. Moreover, Washington may not allow a devaluation of the won as long as we are raking in current account surpluses.
There have been three occasions in the past 50 years when the dollar was overly strong against a weak yen. The consequences were harsh. Korea’s boom was cut short in 1989 and we were hit by the financial crisis in 1997. In 2006, we managed to get along thanks to strong demand from China. We are now at a fourth challenge. How we can weather the turbulence with such weak monetary and fiscal policy options is questionable. We have too often been victimized by the power game among economic powers. Let’s hope our markets stand tough this time.
JoongAng Ilbo, Sept. 8, Page 34
*The author is a senior editorial writer of the JoongAng Ilbo.
by Lee Chul-ho