The Bank of Korea Has Taken Criticism for its Recent Decision
The other day, the Bank of Korea (BOK) kept its target interest rate stable, which differed from market expectations. Market participants widely believed that another rate increase would occur. In the Wall Street Journal’s Korea Blog, it was reported that the Bank of Korea has received a great deal of criticism about this most recent decision. The Seoul Gyopo Guide believes that over time, interest rates must increase in Korea. However, the criticism for the most recent, one-time decision, is unfounded because the situation is far more difficult than has been reported. The Seoul Gyopo Guide has described the Bank of Korea’s difficult position, three weeks ago. This difficult balancing act is one that the Bank of Korea will need to perform for the immediate future.
Demand Pull Inflation? Not So Fast.
Some economists would suggest that Korea has faced something called “demand-pull inflation,” which is that everyday Koreans are trying to buy more items, such as food, clothing, entertainment, and durable goods like appliances. Really? Anecdotal evidence doesn’t suggest that. While department store sales have increased, the fact is that there isn’t a shortage of items for sale in the stores. In fact, popular imported items have increased in price due to the relative weakness of the Korean Won compared to its counterparts, such as the Euro. That said, it is undoubtedly true that credit card companies have loosened their standards of lending considerably, which has added liquidity to the domestic Korean economy.
Much of the reason that everyday Koreans may be more confident is because they know that Korean companies are prospering in the international marketplace. It is the case that the weak Won relative to other currencies, especially the Japanese Yen, has contributed greatly to this. The Seoul Gyopo Guide has written about this a number of times. A reversal of this will make Korean products less competitive from a price perspective, which would, in turn, cause lower Korean corporate profits. Korean consumer confidence would fall, and the current optimism would fade. An sharply higher interest rate would make the Won rise.
The Real Estate Problem
The elephant in the room is the fact that the Korean real estate market is in trouble. In Gangnam, the district of Seoul of the most expensive apartments in Seoul, the price of only the most expensive apartments is stable. Apartments in the USD 1,000,000-3,000,000 range have dropped during the past two years. Lower real estate prices are especially damaging to Koreans, because Koreans have a larger percentage of their entire net worth invested in their homes. The number one factor in real estate prices? Interest rates. A rate increase by the BOK would only serve to worsen the situation. In the United States, the US Federal Reserve has fought very, very hard, to keep interest rates lower to slow the rate of price declines of real estate. It can be argued that this will not end well, but it shows just how important that the US Fed believes that the value of real estate is the US economy. In Korea, where the percentage of overall wealth spent on real estate ownership is higher than in the US, can the economic logic be much different? No.
The BOK Needs To Maintain Its Right to Be Unpredictable
If you knew for sure that the price (of anything) would be higher tomorrow, then the price would be higher today. You don’t need an economics degree in order to understand this. Interest rates can be defined as the price of money. So, if the Bank of Korea was entirely predictable in the direction and timing of its interest rate moves, than that, in itself, would be self-defeating. The BOK needs to have the element of surprise in its decisions. The reasons? First, it must maintain its ability to intentionally shock the markets. Gradual interest rate changes do not accomplish this. The reason for the need to shock the markets is that the BOK needs to be able to communicate to the domestic and international marketplace that there is an urgent need for interest rate changes. Second, the BOK needs to be able to move in large increments should conditions warrant. Why? The world remains unstable in the fallout of the financial crisis. The huge amount of governmental stimulus has created imbalances around the world. That has made different locations (Greece, Ireland, Middle East) subject to wild changes in fortune. Due its small size, small population, and very dense concentration in profits among a very few industries, the BOK must maintain all its options to the fullest extent possible. The element of surprise is one of those options.
One of the reasons for creating the Seoul Gyopo Guide was to educate those unfamiliar with the Korean economy about Korea. Along with that, native Koreans themselves must understand how Korea fits within the global market, where capital moves rapidly. In some ways, Korea is very prepared for that. Its end products are world-class in many industries. However, in other ways, Korea has not found the proper balance between openness to capital flows and its pursuit of economic independence. Complete economic independence is not possible unless Korea annexes larger, more heavily populated countries in a peaceful manner. In other words, it is virtually impossible. The Bank of Korea is reacting properly to this by maintaining its maximum flexibility. Criticisms of being a “tool of the administration” may be, in part, true. However, given Korea’s small size and inherent vulnerability, the BOK can accept that misguided criticism in favor of its pursuit of a combination of economic growth and price stability. Every decision that the Bank of Korea is, by its nature, controversial, and there will be Monday morning quarterbacks after each decision. Undoubtedly, the Bank of Korea is ready to accept that consequence.