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By Kim Tae-gyu decrease
Staff Reporter
Falling asset prices bring fresh woes into the already-struggling economy, forcing people to cut back on spending amid the increasing debt burden on their balance sheets.
Economists are concerned that the snowballing debt burden may freeze the market, since people care only about paying off debt, choking consumption and investment sentiment. This causes another round of asset deflation and an eventual severe economic slump. The vicious cycle is dubbed ``balance sheet recession.''
``Balance sheet recession is underway in such developed nations as the United States, where home prices started sinking as early as 2006,'' said Song Tae-jung, a researcher at LG Economic Research Institute.
``Should the local economy follow the footsteps of the U.S., which is highly likely, then the country will have to worry about balance sheet recession in the not-so-distant future,'' Song said. Domestic house prices remained strong by 2007 but began dropping this year.
A balance sheet is composed of three major categories ― assets on the left-hand side and debts and capital (exactly owner's equity such as cash or real estates) on the right-hand side.
The sums of both sides should be equivalent by definition. Hence, if asset prices go down, capital also decreases because the amount of debt has nothing to do with asset prices. As a result, the proportion of debt expands.
``When asset prices are declining, people are usually cutting back spending, scared by the possibility that they would default on debts because of the shrinking capital. Things are similar for companies,'' Song said.
``If this is the case, people or firms do not spend money even if the central bank pours liquidity into the market. They just try to shore up their balance sheets by trimming debt,'' he said.
Fiscal Policy
Indeed, Korea Inc. is highly indebted. For instance, overall household debt amounted to 660 trillion won in June, the most recent data available, according to the Bank of Korea.
This translates into approximately 40 million won per household, which has doubled in seven years from 20 million won at the end of July 2001.
But the ability to redeem debt is on the decrease as each household incurs debt 1.48 times larger than annual income, the norm at the end of last year.
The figure was 1.27 in 2004 but increased to 1.35 in 2005 and 1.43 in 2006.
``When home prices move upward, household debts rarely cause anxiety. But if they start to dwindle, things are different,'' said Song Min-kyu, an economist at the Korea Development Institute.
``I don't think house prices plummeted enough to spark pressures of balance sheet recession here. But if they dip, say, 20 percent, we will be in trouble,'' he said.
In addition to preventing asset deflation, Goodmorning Shinhan Securities analyst Lee Sun-yup recommended a fiscal policy, rather than a monetary approach, as ammunition to hunt down balance sheet recession.
``When balance sheet recession is about to set in, monetary policy rarely works because people or companies use up new liquidity to reimburse their debts,'' Lee said.
``Instead, fiscal policy, including stimulus packages, works. Hence, the government is required to come up with various ways to pump the economy through fiscal spending,'' he said.
voc200@koreatimes.co.kr
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