By Peter S. Kim
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Perception of deflation as a paramount issue caused governments to resort to ultra-easy monetary policies during the subprime crisis of 2009 and followed by equally aggressive stimulus in response to COVID-19. The ballooning of the central bank balance sheet and government debt without thought to its long-term consequences has empowered extreme theoretical frameworks like Modern Monetary Theory to make their way into the mainstream policy debate. U.S. Federal Reserve Chair Jerome Powell's "transitory inflation" is now one of the greatest understatements, given that the current inflation data is at its highest since the 1970s.
Each crisis or recession has been met with increasingly accommodative monetary policy for the past three decades, helping the economy take the least painful path to recovery. The subprime crisis of 2009 has taken the proven formula to the limit, with the U.S. central bank under pressure to avoid Japan's decades of stagnant growth.
At the time, then Fed Chairman Ben Bernanke implied that the mistakes made by the Bank of Japan heavily influenced his stimulus policies. Indeed, Bernanke concluded that any sign of disinflation required an aggressive and relentless response. The subsequent recovery has set the world in a permanent state of ultra-easy monetary policy.
The pandemic has taken all the shackles off debt discipline for all governments spending government money to ward off recession. Debt printing is one of the drivers of the inflation we are seeing today. The argument for dismissing the costs of debt-driven growth policies was the belief that we are in a Japan-like era of deflation and structurally low interest rates.
In other words, they believed that due to permanently lower interest rates, debt expansion would not be a detriment to the underlying economy. The major risk to this view is suddenly spiking interest rates sparked by unexpected inflation and a subsequent recession. This scenario is happening now.
The policymakers' reluctance to address inflation is understandable, as raising interest rates is never an easy choice, as no one wants to be blamed for sending an economy into recession. For decades, governments manipulated economic data to avoid the stigma of recession. The endless debate on the timing and length of "recession," as defined by two-quarters of negative growth, seems to be a matter of semantics rather than economic significance.
The post-COVID inflation is the kind most sensitive to politicians as it hits at the heart of working-class necessities of food and energy. For decades, rising prices in discretionary items like education, mobile phone charges and entertainment were considered a problem outside of mainstream consumers. However, the rising prices for food and other necessities have left policymakers with no choice but to tackle the inflation issue with firm aggression and commitment.
Unlimited debt printing can be only effective for major economies like the U.S., whose currency is the ultimate safe haven as a reserve currency. For structurally weaker economies, debt dependence poses structural risks leading to currency weakness. The recent currency volatility in many emerging economies is showing signs of distress.
Year to date, the Korean won has declined by almost 15 percent versus the U.S. dollar, alarming those earning income from South Korea. The decline comes from the recent trade deficit, in particular weak global demand for its key export product semiconductors.
As the global markets brace for the possibility of a global recession, export-led nations like South Korea are at the top of the risk class. This time South Korea's exporters' pain is acute due to its largest export destination, China, struggling with an unstable property market and continued clampdown on COVID.
There are also suggestions of a possible debt-related crisis from Korea, which is an overreaction, as the Japanese yen and British pound have declined by more this year. Typically, interest rate hikes from the U.S. hurt the emerging economies of Latin America and Southeast Asia. Due to high commodity prices, those countries are saved from currency drops. While Korea has relied on fiscal stimulus like other nations, its debt structure remains manageable.
The concerns of household debt are closely linked to the residential property market, which is cooling in accordance with rising interest rates. As the South Korean economy inches toward developed economy status, the current weakness in currency is not a reflection of Korea's structural weakness but a sign of transition from export dependence to a consumer-driven economy.
Peter S. Kim (peter.kim@kbfg.com) is a managing director at KB Financial Group.
