By Frederic Neumann
Chief Korea Economist at HSBC
The last ten years or so were a bit of a roller coaster ride for the Korean economy as one financial bubble succeeded another with almost predictable frequency. First, in the run-up to the Asian crisis in 1997, the country’s conglomerates splurged on foreign debt, leading swiftly to a collapse of the exchange rate as capital fled the country.
Then, after two short years, technology stocks became the next big hit, with the Kosdaq scaling unheard of _ and since unseen _ heights: remember the good old days when the index was trading at over 2,600?
Even as tech stocks were losing their appeal, another bubble began to emerge. When Koreans discovered the joys of credit cards, spending soared along with household debt.
This bubble only popped in 2003 when the authorities put their foot down, in the process cooling consumption growth for years to come.
Yet, the bulls were not easily cowed. After a couple years of rest, they moved on to real estate. Especially in 2006, property became red hot, seemingly defying gravity in some of Korea’s posher neighborhoods. As apartment prices are now easing in response to policy measures, one might reasonably ask, where the stampede is headed next.
Clearly, predicting the next bubble is an almost impossible task. Even if there are signs that savers are increasingly parking their cash in foreign equity funds, for example, it is too early to tell whether this trend will persist, let alone approach bubble dimensions.
Korean stocks have also done well in recent months, and there is always the chance that property speculation might re-ignite. Recent history, in any case, suggests that the next bubble is still some time away, given that these events seem to reoccur with an uncanny regularity every three years.
Apart from spotting the next big thing, one interesting question is why such bubbles have developed repeatedly over the last few years. Here, the views differ substantially, with some observers blaming excessively loose monetary policy while others suspect a cultural penchant for punting.
But, there is no single reason that might explain the regularity of Korea’s bubbles. Rather, a combination of factors provides an environment where such events can occur, not all of them being specific to Korea.
First, it is important to recognize that Koreans were not the only ones experiencing financial bubbles in recent years. The boom in technology, for example, and the recent surge of real estate investment occurred on an almost global scale.
Observers often point to the physical integration of international capital markets, which can raise the correlation among asset prices all over the world, as the reason for the synchronization of financial cycles.
However, a much more intangible factor may also be at work: Koreans, as much as anyone else, may be vulnerable to psychological spillovers as investment fads spread across the globe.
Second, loose monetary conditions indeed helped to drive up asset prices. Certainly, the Bank of Korea kept interest rates relatively low to help the economy come to terms with the consequences of one bubble, thereby inadvertently fueling the next.
But, to lay blame purely at the door of the central bank would be misguided. Monetary conditions internationally have been rather loose over the last several years.
There are many reasons for this, including Japan’s desperate attempt to re-inflate its economy and the purchase of US treasury bonds by Asian central banks.
The Bank of Korea, therefore, had little scope for tightening the screws single-handedly: higher interest rates would only have served to attract capital, rendering the country’s currency itself a speculative asset.
Third, Korea’s financial markets remain relatively underdeveloped. As the country’s households rapidly built up their wealth especially over the past twenty years, the financial industry, for various reasons, did not keep pace.
The relative lack of financial products to recycle these massive funds, therefore, led to the periodic boom in certain financial assets, or to the excessive use of alternative forms of borrowing such as credit cards and foreign bank loans.
In this sense, Korea’s bubbles are less a product of an alleged cultural trait of financial frivolity but a by-product of the ongoing development of the country’s financial markets.
Will a new bubble emerge in Korea at some stage? Recent history certainly suggests that it might, although its exact form is hard to predict.
There are, therefore, two fundamental questions facing policy-makers.
First, should they care that asset prices periodically come under speculative pressure or that borrowers might occasionally splurge on new-found sources of cash? And, second, what can officials do to prevent financial bubbles from developing in the first place?
The first question is harder to answer than the second. Even if the bursting of bubbles can have severe macroeconomic consequences, this is not necessarily a justification for regulators to always step into the fray.
Apart from the technical difficulty of telling a speculative bubble apart from a sustainable rise in asset prices or the opening of new channels of finance, markets should generally be left to operate relatively unencumbered as the natural rise and fall of prices provides valuable signals to economic agents.
Of course, excesses can be harmful, but this does not always imply that government action is necessary. The return to earth of the Kosdaq index in 2001, for instance, left the wider economy relatively unscathed.
The second question is in many ways more relevant for Korea today, as the property frenzy has already been brought under control and the next big financial bubble has not yet formed.
The various factors contributing to the periodic occurrence of bubbles in Korea listed above suggest that the ability of Korean policy-makers to prevent another one from emerging is relatively limited.
Loose monetary conditions internationally are beyond their control, and aggressive tightening domestically is inadvisable in a world of great capital mobility. Also, the authorities appear ill-prepared to counter the spillovers of global investment fads.
But, this does not mean that Korean officials are entirely powerless. What does matter is a smoothly operating financial system to prevent some of the excesses forming in the first place.
By offering a wider range of investment and financing alternatives a mature financial system becomes relatively more immune to the possibility of bubbles and more stable should financial excesses threaten to unwind.
In this regard, plans by the government to push through the Capital Markets Integration Act are a step in the right direction. But, it may take some time before the financial system in Korea can adequately serve the needs of its citizens and corporations.
Luckily, the authorities have about three years ahead of them to implement reforms before the next bubble strikes
from -http://www.koreatimes.co.kr/www/news/biz/2008/04/128_4703.html
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