Korea’s Fight Against Record Oil Prices and Weak Dollar

By Chang Jae-chul

Economist at Samsung Economic Research Institute

The world has long enjoyed a Goldilocks economy ― an economy that is not so hot that it causes inflation, and not so cold that it causes a recession ― since 2003 before eventually hitting a snag in the second half of 2007, disturbed by oil price spikes and a meltdown in the global financial market. Departing from the golden days, many nations are now apparently heading toward a slowdown or even a recession in the face of greater inflation risks pressured by record oil prices and an unusual credit crunch in the global financial market.

Global Economy Going Downhill

International oil prices have surged more than 50 percent since the beginning of last year. The average monthly price of Dubai crude oil which accounted for 82 percent of Korea's oil imports surged to $77 in October from $52 in January. Oil prices continued the speedy run-up to break $100 per barrel earlier this year.

The latest breakdown of the global financial markets had been already predicted since 2006. There was a warning that a series of interest rate hikes would cause a slump in the U.S. housing market and the spiral growth in the subprime mortgage loans would lead to financial woes. Some even alerted the risky investment asset would trigger a credit crisis. In the end, the delinquency ratio of the subprime mortgage loans surged to 14 percent by December 2006. New Century Financial, the U.S.' second largest subprime lender, filed for bankruptcy in April, 2007. The tragedy then quickly sprawled into the well-established financial companies. Big names in the global financial markets, such as Bearsterns, BNP Paribas and Goldman Sachs, raised the specter of a credit crisis with actions to liquidate mortgage-backed funds or suspend redemptions. As a result, stock markets around the world have been on one of the most terrifying roller-coasters and the U.S., the epicenter of the subprime mortgage crisis, has seen the value of its currency plummeting.

The economic woes arising from a weak dollar and high oil prices are unlikely to end in the near future. The U.S. is facing a bleak economic outlook, with the financial markets reeling from a serious slump in the housing market and the fallout of the subprime mortgage loan crisis on the banking sector. The crisis forced the U.S. Federal Reserve to slash its benchmark interest rates by 50 basis points in September and by another 25 basis points in October. After the rate cuts, the dollar plunged against other major global currencies, with the euro hitting a record high of 1.47 per dollar on Nov. 9. Recently, Morgan Stanley, Citigroup and Bank of America announced billions of dollars in write-offs related to the subprime loan losses, highlighting the intensity of the credit market troubles. The U.S. central bank may have to undercut its interest rates at least two more times until the first half of next year in order to relieve the financial market's credit squeeze and avert a hard-landing of the world's largest economy. The additional rate reductions will then put more downward pressures on the US currency.

Oil prices seem to be gearing up for a peak of $100 per barrel. If the global economy starts to stagnate due to high oil prices and subprime mortgage loan crisis, then oil prices may turn lower. But unlike the first and second oil shocks in the 1970s and 1980s, oil prices spiked this time because demand grew faster than supply. Oil consumption surged on strong demand from the fast-growing economies including China and India while supply remained under control due to the limited capacity at oil producing facilities and refineries. Moreover a weak U.S. dollar sparked speculation-driven investment, with global hedge funds hoarding oil, grain and other raw materials. Given the tendency, international prices of major raw materials are expected to stay at the current high levels or even rise further. According to a study, the enormous speculative investment contributed the oil price hikes by about $20. If geopolitical risks in the Middle East or other oil producing countries emerge or escalate, then oil prices will continue to surpass the $100 mark.