Is Korea's excess liquidity main culprit behind weakening won?

A screen at Hana Bank’s headquarters in Seoul shows the won–dollar exchange rate and the benchmark KOSPI closing at 1,468.4 and 3,994.93, respectively, Tuesday. Yonhap

Korea's money supply is expanding at its fastest pace in years, intensifying a debate over whether excess liquidity is the real culprit behind the won's prolonged weakness, industry officials said Tuesday.

According to data from the Bank of Korea (BOK), M2 — a broad gauge of funds circulating in the economy — rose 8.5 percent in September from a year earlier, pushing the total to a record 4,430 trillion won ($3.02 trillion). The gain, sustained for six straight months, is nearly double the U.S. rate of 4.5 percent.

While the government has attributed the won's slide partly to a spike in overseas investments by individuals, critics argue that expansionary fiscal policy and abundant liquidity are the primary drivers.

"The exchange rate is where it is because Korea expanded M2 far too aggressively, because the economy isn't growing, and because dollars are being reinvested in the U.S. instead of in Korea," wrote a finance content creator on Threads, gaining traction among younger investors. "Gov. Rhee's latest remarks are truly shocking."

The post cited BOK Gov. Rhee Chang-yong's Nov. 27 remark expressing concern that investing in foreign stocks was becoming a trend among youth trying to appear "cool," triggering a backlash from retail investors and government critics.

"The government flooded the economy with consumption coupons, weakening the won," said Rep. Jang Dong-hyeok, leader of the People Power Party. "Now it's trying to solve the problem by squeezing retail investors."

In theory, a rapid increase in money supply can fuel inflation and weaken the currency. The BOK, however, pushed back on the idea that fresh stimulus is to blame.

"It is true that liquidity remains abundant," Rhee said. "But the amount of newly injected liquidity isn't large. Much of the recent growth stems from a reallocation of previously accumulated liquidity."

Korea defines M2 more broadly, including ETFs and mutual funds — instruments excluded in the U.S., Europe and Japan due to their price volatility. The International Monetary Fund has for years urged Korea to revise its methodology.

Excluding these instruments, M2 growth falls to about 5.5 percent, according to the BOK — still elevated, but more in line with global peers.

Economists say rapid liquidity growth warrants caution, but doesn't fully explain the won's slide.

"Domestic liquidity conditions have eased, but Korea’s liquidity relative to the U.S. hasn’t deviated significantly from historical averages," said Wee Jae-hyun, an economist at NH Futures. "We don't see liquidity as the main factor driving the won’s depreciation."

Other variables include a wide Korea-U.S. interest rate gap, a weak yen and a growing reluctance among exporters to convert dollar earnings into won due to expectations of further depreciation. It's also true that Korea is seeing a sharp rise in outbound investment — a shift experts view as structurally significant.

In response, the government is coordinating with major institutions, including talks to extend a swap deal with the National Pension Service and incentives for exporters to sell dollars. Financial regulators have also launched inspections of securities firms to rein in risky overseas investments.

Yet, experts agree that any lasting solution to the currency's weakness must come from the real economy.

"Concentration remains high in the industrial sector, and consumers have limited spending capacity, which means real economic recovery will be slow," said Shin Yoon-jung, an economist at SK Securities. "The won lacks strong intrinsic momentum and that will continue to weigh on the currency."

The won closed at 1,468.4 per dollar on Tuesday, down 1.5 won from the previous session. After sliding to 1,477 per dollar on Nov. 24 — its weakest level since April — the currency has been fluctuating between 1,460 and 1,470.