The Investment Banks Turn on Korea

Even by the standards of foreign exchange currency speculators who call themselves investment bankers and asset managers, the collapse of the Korean won has been quite extraordinary.

The youthful gamblers (with other peoples’ money) from countries with crumbling banks, falling domestic demand, asset price collapses and current account deficits that amount to 5 percent of gross domestic product have decided that the world’s worst significant currency is in a country with relatively few of those problems: Korea. Korea has challenges but the lack of perspective shown by the flock of investment bank sheep and their tame economists is stunning.

The won is now at a near four-year low against even the dollar and has fallen almost 21 percent in the past year, and 11 percent in the past three months, including a 9 percent drop against an anemic yen. Those who forecast it would end 2008 below 900 to the dollar now talk about 1200. For sure, the US dollar has been experiencing a revival against most currencies (China’s excepted) but that does not explain why Korea’s has been so hard hit even compared with Asian ones with far worse political problems and no better economics.

Almost every statistic that comes out of Korea is now treated as a horror story by the analysts from houses with fine records of losing other people’s money while paying themselves huge amounts.

Thus Korea is now supposed to be on the brink of disaster because it had a trade deficit last month and its current account deficit for the whole year might at worst reach 2.5 percent of GDP – compared for example with the US and UK at 4-5 percent and even resources-endowed Australia at 4 percent. As for the euro area, Germany is propping up most of the rest.

The Korean economy is said to be in dire straits because its growth rate is falling and may be only 4.5 percent this year, compared with something closer to zero in most of Europe and the US. Even if it falls to half that level it still looks likely to outperform almost every developed country. Yet the won has fallen even faster than the pound sterling, which is facing what even the UK’s own Chancellor of the Exchequer (finance minister) describes as what could be the country’s worst economic situation in 60 years and has scant industry other than discredited financial services to fall back on.

Then there is the Korea inflation alarm. At 4.7 percent it is high by Korea’s recent standards but is roughly in line with the OECD average and would be lower than the US if Washington did not massage its numbers with ever-changing CPI weightings and dubious adjustments for technological advances in computers and the like.

The won should be weak, says the herd, because interest rates may have to go up to combat inflation, which would depress domestic demand. Yet Korea is one of the few countries in the world where interest rates – 5.7 percent – have remained positive, if only just. So the pundits are piling out of won into the US dollar and other currencies with massively negative real yields.

That is not surprising of course if they believe the reporter from the Times of London who told his readers that Korean foreign exchange reserves of US$247 billion were not enough. “The International Monetary Fund recommends that emerging market economies should hold nine months worth of import cover which would be about $320 billion”. This is of course complete nonsense. The guideline range is three months. Korea has most been criticized, like China and Japan, for having excessive reserves. It has a lot more than the UK.

For a UK paper to describe the Korean economy as “developing” would be hilarious if it didn’t define the level of ignorance of UK newspapers and London money market players. CLSA, sometimes a breath of independent thinking, joined the mob, with a “senior economist” opining that “once investors realize how tenuous Korea’s reserve position actually is they will start abandoning Korea in droves and send the currency tumbling.”

Not content with demeaning Korea’s reserves level, the scaremongers have been suggesting that a large part of the reserves might be at risk because of being invested in Fannie Mae and Freddie Mac debt. For sure, the shares in those companies may well be worthless, but if the debt is not to be honored by the US government, the whole global system will come crashing down and with it America’s role as a world power. Of course that’s always possible but the worst of all possible reason for selling the won to buy US dollars.

Economists are quoted saying the Fannie and Freddie bonds are illiquid. That’s sheer nonsense. They remain very liquid although the yield spread against treasuries has widened significantly. Only juvenile economists who love playing games with numbers but have no idea how the world really works could believe that the Fed will allow the quasi-government bond market to become illiquid.

Surely Korea has seen some capital outflow and could face more. But it could lose $100 billion of its reserves without worrying too much and still have more than enough to finance three months imports and carry a current account deficit of 2-3 percent of GDP for several years. The won collapse is all the more bizarre as it has coincided with the sharp fall in the very things that were supposed to make it vulnerable: commodity prices. And in case nobody noticed, the improvement in the US export balance is mainly due to falling commodity prices,not a surge in demand for US exports.

Of course there are plenty of things wrong with Korea. Household debt is too high, savings too low, and unless energy prices stay lower there is scant scope for consumer demand to grow much. Corporate profits too are under pressure and inventories are rising. Exporters will be helped by the won weakness against yen, euro and yuan as well as the dollar but times are tough in exporting everywhere except for China. Banks could face rising bad debts from both companies and households pinched by high leverage and interest rates. In a spasm of brainless pride, the Korean Development Bank may be dumb enough to buy the sickly US investment house, Lehmann Brothers. Politics has been unhelpful with the president facing opposition on many fronts and strikes have hit some industries. Yet such events are the norm in Korea.

Anyway the economic problems have to be placed in the context of situations elsewhere – be it the US, India, Spain, UK, Australia etc. It has not had a house price boom anywhere near the proportions of much of the US, UK and elsewhere. For a country wholly dependent on imports of energy and many other commodities, its external position has actually been better than could have been expected and government debt as a percentage of GDP gives some room for stimulus.

In short, the so-called Korean crisis may seem to some a construct of western institutions trying to distract attention from the financial disasters they have created at home and which continue to cause huge casualties among the ranks of the “experts” as the London employees of investment bank Dresdner Kleinwort (just taken over by Commerzbank) are about to find out.