Time to Get Back to Basics of Real Economy

By James Rooney
Market Force Company CEO

Suddenly the world around us has fallen apart. Twelve months ago, oil prices were rising to record levels, and the prices of minerals and numerous foodstuffs were going through the roof, reflecting strong demand outpacing supply. Today demand for goods and services seems to have almost dried up and the word you can hear most often is ``depression.''

James Rooney

Yes, it is depressing. We are facing a depressing reality. But the depressing reality that we are facing is not caused by simple economic factors, and it is not of our own making. It has been caused by complex financial matters that have exploded in our midst like a neutron bomb ― everything seems to be still standing as it was, but the economic life is being destroyed. And it gets worse every day.

For most of us, we do not need to be affected by stock markets collapsing or hedge funds having problems. But we are affected by our banks refusing to lend and our companies being unable to sell their goods and services. Because when that happens, we cannot buy things even if we want to, and we cannot keep our jobs even if our companies did nothing wrong. And it is the traditional banks that are at the heart of this problem.

Particularly in some countries like the U.S. and the UK, traditional banks lost sight of their proper role as deposit-takers and lenders, and allowed their balance sheets to become corrupted with all sorts of dangerous instruments and activities. Today they are being bailed out by their governments to protect their depositors, and they are trying to shrink their lending because they have destroyed the capital that should protect their depositors from risk.

The consequence is a huge shrinkage of the money available to consumers and companies. This shrinkage then leads to less buying and selling of goods, reducing imports, exports, and leading to a collapse of normal business activity levels. Then companies have to lay off their workers, either to survive the downturn or because they already have been forced into bankruptcy. Ask the automakers how many cars they can sell today, and then think how many jobs are supported by making all those cars that used to get sold.

As this shrinkage intensifies, whole sectors of the economy can go into a ``Death Spiral'' syndrome. And the collapse of the financial system triggers a collapse of the broader economic system ― the real economy starts to die. The real economy is where you and I live, spending money on our housing, our food, our children's education; and we start to be profoundly affected by somebody else's problem.

So what should be done about all this? Well, making the correct diagnosis has been difficult enough, but writing the correct prescription is much harder. Many wise men have failed to see the problem clearly, and most actions to date have not provided a solution to the problem. Part of the reason is because most solutions have focused on saving the financial institutions, and have not focused on directly helping the Real Economy participants ― you, and your neighbours, and the companies that you work for.

The banker's view is that there must be a shrinkage of credit and the associated pain will make us healthier in the longer term. Well, there may need to be a shrinkage of traditional banking to purge them of their past excesses, but it is difficult to see what we will achieve by destroying good companies through a massive contraction in economic activity. Instead, it seems that we may need to have an alternative to the current traditional banking system to see us safely through their correction. Perhaps one day banks will become healthy enough to support the economy again, but in the meantime the patient needs to receive infusions of fresh blood to replace those being sucked out by the financial sector's difficulties.

This suggests that there is an urgent need for the real economy to have access to emergency liquidity support, just like the banking sector has been able to receive. And to the extent that the banking sector is still able to function, they need to become more proactive in reducing the liquidity risks that the Real Economy is facing.

For example, in Korea we still have ``Time Bomb'' mortgages and ``Silver Bullet'' credit cards. Time Bomb mortgages mature after a dangerously short period of five years, and are not structured to pay down gradually over 20 or 30 years as in other countries. Silver Bullet credit cards have to be paid off in full at the end of each month, which creates huge risk for the user and for the credit card companies; they are not really crediit cards at all. It would be much safer for everybody if the minimum payment was only 5 percent of the outstanding balance each month, and the credit card company could earn steady interest on the unpaid balance. This is normal in other countries.

We have similar problems with corporate lending ― one-year loans and three-year corporate bonds; unless you have extremely high inflation rates, it must take longer than that to pay off an investment in new equipment. So this borrowing becomes a huge and necessary gamble at the roulette table ― the assumption is that the loan or bond can be rolled over into a new debt when it matures, but that can be a very foolish assumption, especially in tough times like these. Why create such a risk in the first place? It would be far better to make the loan for a longer period and pay it down gradually over time.

And finally, if big companies are not going to pay their suppliers promptly and in cash, then let there be a clearing house for their commercial paper and notes, so that their suppliers and smaller companies can always convert those notes to cash right away without having to take the risk of bad credit from their customer.

This is not the crisis of 1998. It is a fundamentally different and more dangerous crisis. The way out of this crisis is going to come from getting back to the basics of the real economy, not from some magic bullet of financial sector rescue and restructuring. And the longer we take to get around to rescuing the Real Economy and restoring consumption and the market for demand of goods and services, the more collateral damage will be done on the way. It is time to listen closely to the Real Economy, to hear its heartbeat through the chaos . We can fix the banks later, but if we do not save the consumers and the companies now, there will be nothing left to rescue.

Who Is James Rooney?
Born in Scotland, Rooney is president and CEO of Market Force Company. Concurrently, he serves as vice chairman of Seoul Financial Forum, co-chairman of AmCham Capital Markets Committee and director of Macquarie Korea Opportunities Fund. Rooney, who has based in Seoul since 1996, is a well-known and respected investor, advisor, analyst, consultant and commentator on Korea's economy and financial sector. He is the author of One Million Jobs Report in 1998 focusing on critical policy measures for Korea's economic recovery.

Prior to the establishment of Market Force Company, Rooney served as governor of AmCham (1999-2005), CEO of Templeton ITMC in Korea from 1996 to 2000. He received his BSc in Civil Engineering, Imperial College of Science & Technology, 1975, London, England; and an MBA in business administration, Harvard Business School, 1983, Boston, Massachusetts