A matter of interest

The relationship between an economy’s fundamentals and asset prices can be compared to a dog that goes out for a walk with its owner. Once the dog becomes familiar with the outside environment, it can run ahead for a while and then come back to his owner. It can lag behind when lost in contemplation of a smell, a person or another dog and then hurry back to its owner’s side. It can also get lost and look frantically for its owner. The owner will scold the dog for wandering off and a happy ending ensures when they return home together.

This reminds me of the global stock markets these days. There are no particular shocks happening. A U.S. interest rate hike and a slowdown in the Chinese economy have been adequately forewarned. But the markets didn’t pay attention. Investors recklessly went on with their buying binge, inflating some shares 50 to 60 times above their price-to-earnings ratios. When the party was over, they blamed the blood on the floor on the U.S. Fed and the economic technocrats of China. They whined and panicked as if they would die if nothing was done to help them. It’s as if the dog naively looks the other way waiting for its owner to clean up its stinky mess.

The owner needs to discipline its pet from time to time. Chinese authorities trotted out stabilization measures to prop up their stock markets. The U.S. Federal Reserve is in a dilemma. There was no question that the Federal Open Market Committee would move to raise short term interest rates for the first time in nearly a decade during a meeting on Sept. 17. But then came the panic. Now expectations are mixed. Normalization of interest rates above zero percent is the biggest financial news since the United States embarked on radical monetary easing to recover from the 2008 global financial meltdown. Frankly, there’s no reason it must raise interest rates now in view of its monetary goals of inflation, employment and stable financial market.

The U.S. Fed insists it will be “normalizing,” not just raising rates. It has to “normalize” what had been unnatural: keeping interest rates at nearly zero percent and purchasing massive amounts of financial assets under the so-called quantitative easing program. If interest rates are left at near zero percent, the United States would be admitting that its economy is mired in deflation like Japan. The Japanese economy was in a comatose state for 15 years under zero interest rates. For the United States, how much interest rates are raised is not the issue. It needs to attest to the world that its economy is not like Japan and is in recovery. Only then can economic players stop relying on ultra-loose rates and manage on its own feet. U.S. pride was damaged with the dollar - the world’s key currency - generating no returns. The U.S. economy has become confident and strong enough to become used to higher rates. Its unemployment rate is near 5.1 percent and companies are turning in record performances.

There is no doubt that a rate hike will come this year, whether it is in September or December. The scope of tightening won’t be big. Most expect short term interest rates will reach close to 2 percent by the end of next year since inflation won’t likely hit the target 2 percent next year as well. Even with improved employment, wages won’t likely rise and prices of raw materials will remain soft due to sluggish demand. The U.S. benchmark rate will likely stay at 2 percent to 3 percent for some time after 2017. In short, low interest rates are the new normal.

Considering these prospects, it could be better that the first hike comes in September rather than December. At least all the uncertainties and anxieties will be lifted. Only then can the market move on. If the rate hike is deferred to December, the market could be briefly relieved. But the agonizing period of dread would be prolonged. Once the United States moves to tightening, the direction in global capital will inevitably change. Capital is bound to shift to safer markets. The Korean market must assure investors that it is strong and worthy of accepting their money. Reforms must proceed to strengthen long-term fundamentals and inter-Korean economic cooperation must be expanded to increase investment potential and opportunities.

JoongAng Ilbo, Sept. 10, Page 32

*The author is the head of the JoongAng Ilbo Sisa Media.

by Kim Kwang-ki