Never fall for the temptation of low interest rates

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Never fall for the temptation of low interest rates

Kim Dong-ho

The author is an editorial writer at the JoongAng Ilbo.

Leveraged investment was so heated in South Korea over the last three to four years that it produced new phrases like “soul-selling borrowing.” It underscores the recklessness from the cheap liquidity binge after the 2008 global financial crisis. Squeezing out one’s soul to borrow money to invest in assets is bound to end in disaster. The dizzy rate increases by U.S. Federal Reserve would be just the prelude to the grim and messy consequences from a debt party. The bubbles in assets from stocks to coins to real estate are fizzling out.

Bubbles build up from asset frenzy. When debt piles up, so do interest costs. When money is too loose, prices go up. But the world often neglects such common sense. Animal instincts often prevail over reason and rationality. Nobel Prize-winning economist Paul Krugman recently had to admit that he had been wrong about inflation, as he had brushed aside the concerns after the U.S. Congress approved $1.9 trillion stimulus package by the new Democratic president last year.

Economists are aware that they often make wrong projections about the economy. The estimate for the economic growth outlook at the beginning of the year rarely matches the year-end result. South Korea is no exception. Forecasts for stock movements are even more unreliable. When stock market crashes despite their rosy outlook just a day prior, analysts suddenly turn pessimistic and attribute all kinds of factors for a downside.

A new perspective is needed to explain the dynamics of economic development. Due to frequent unexplainable events since the late 20th century, mainstream economists have turned to psychology to understand unorthodox economic developments. Behavioral economics is one of the studies. The study of human behavior in the economic context has become a common winning theme for Nobel Prize in economic sciences. Psychologist Daniel Kahneman won a Nobel in 2002. His esearch discovered a loss aversion feature in human behavior — the idea that people are more averse to losses than they are eager to make gains. The commonsensical idea had been disregarded by economists until then.

Richard Thaler won the 2017 Nobel Prize in economic sciences for his behavioral study on so-called “nudge” that gently pushes people toward an option, or subtly manipulates human choices. There are handful of other concepts explained within behavioral economic context. Mainstream economics had been based on human rationality, whereas behavioral economics studies the psychology behind human choices and actions. Sensibility has become of greater importance, as knowing and responding to the feelings of others as well as oneself can become strength in today’s world.

Mistakes should not be repeated. As proven through behavioral economic theories, human behavior is often guided by senses and feelings rather than rationality and intuition. When borrowing beyond one’s means, one could be bombarded with interest costs. But blinded by greed and foolishness, many still take out loans beyond their ability. Excessive debt can always backlash. Real estate prices crash under soaring rates.
Bank of Korea Governor Rhee Chang-yong announces an increase of the base interest rate by 25 basis points to 2.5 percent from the current 2.25 percent during a press conference at the central bank in Seoul, Thursday. [JOINT PRESS CORPS] 

Uncertainties in the global economy these days as in the past crisis periods hasten the bursting in the bubbly economy. A rush to interest rate increases results from policy failures in the U.S. and other major economies — such as extended ultraloose fiscal and monetary policy. Since the outbreak of Covid-19 in March 2020, the U.S. government expanded fiscal spending in a colossal scale while the Fed kept benchmark rates at zero. South Korea also joined the trend. As lush liquidity fanned inflation, it sent central banks around the globe to hike their rates to fight inflation. As former U.S. Treasury Secretary Larry Summers has pointed out, authorities have missed timing for tightening.

Low interest rates heated the real estate market and fueled the pipe dream of making fast money through cryptocurrency. The bubbles are bursting as soon as rates are rising. Financing cost for mortgages are rapidly rising while the economy slows. Households must tighten their belts to pay for increased interest. Due to a terrible plunge in housing prices, long-tern lease prices are sometimes higher than the property prices.

We must remind ourselves never to fall for the temptation of low interest rates.
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