Monday, 12 March 2012

Monetary policy case study: South Korea vs Japan

The picture may be four years old, but it does a great job of showing the South-Korean eagerness to take Japan`s place as high-end apparel exporter. While most of the eyes focus on the miraculous growth story of China, the economic power of South Korean business conglomerates (formally called chaebols) is ever-increasing at the expense of their Japanese counterparts (named keiretsu). This is because South Korean companies have a fortunate advantage in the relative weakness of their national currency.

Race to the bottom ?

Asian countries have been artificially "helping out" their balance trade by weakening the national money for some decades now. What is different today, is that most of the civilised world, and subsequently, their national governments are in a full-fledged race to the bottom of who can get the weakest currency. Long gone are the days when the strong dollars, D-marks and pounds were tilting the balance of trade in favour to the Asian exporters. The Chinese model of cheap labour and low-end exports and the Japanese one of focusing on quality products at reasonable prices were well based on the level of the yuan and the yen compared to the importing countries` currencies. 

A weakening yen would mean that exporters would get more money for their dollar, pound or euro denominated inflows. A strengthening Japanese currency goes in the opposite direction: it entails lower revenues if the company exchanges the foreign currency back into yen. This basically shows that the export driven model of economic growth is ultimately dependent on the relative weakness of their money. Until the 2008 economic crisis, high export Asian countries could safely rely on the central banks to flood markets with liquidity at the slightest sign of strengthening.

But all this has changed, as the United States and the European Union have joined the race to the bottom, not because they are particularly interested in reversing the trade balance and become net exports, but rather because the amount of credit they acquired during all these years of credit consumption has to be de-leveraged in some way: default, inflation or currency devaluation. It seems that the natural choice was a combination of option two and option three. This has acerbated the economic rivalry between the two Asian tigers because they were forced to cannibalize each others demand.

Weak won, good won

In the aftermath of the 2007 financial crisis, the cross rate between the Korean won and the Japanese yen tanked from the peak of 0.13, to the lowest recorded value of 0.06 and is not trading in the 0.07 area, a more than 50% drop in the space of four years. This development was obviously a boon for South-Korean chaebols like Samsung Group, LG group, Hyundai Kia Automotive group and SK group, seemingly at the expense of their Japanese peers: Mitsubishi, Mitsui (part of which is the fallen angel company Sony), and Toyota group (Tokai).

From Yahoo Finance

It looks now as if it is forming a massive double bottom and heading towards the secular support-turned-into-resistance level of 0.09, but a financial shock like the 2007 one could bring the KRW/JPY to even lower levels. The likes of Elpida, a Japanese maker of, among other things, DRAMs, which claimed court protection from its creditors on the 27th of February could testify in favour of a massive round of quantitative easing from the Bank of Japan. Indeed, the central bank took action and it expressed its commitment to purchase government bonds until they reach the 1% inflation target, but all this liquidity could end-up back at BoJ as excess reserves. 

Foreign investors are getting more and more reluctant to use the JPY carry trade as there are now more and more perils lurking in the massive volatility and domestic savers and funds are sticking to the negative yielding money market funds, a situation which Keynes would describe as a liquidity trap. It comes into effect when easing policies fail to generate any effects on the interest rates because investors become less concerned of the return on their capital, and more of the return of their capital. They prefer hoarding cash or near-cash assets instead of purchasing governmental "so-called risk-free securities". And it is official, isn`t it: Greece showed us how risk-free are treasuries.

It seems as Japan is indeed the victim of its own economic success and is now squeezed out of the market by the next on the list: South Korea. How long will it be until South Korea experiences the same economic malaise ?


  1. I like reading your posts and I find many useful information but I have no idea what you call a "Japanese economic success" when the country has 1 quadrillion yen debt with 43 trillion yen in annual revenues and debt/GDP 220%+. Japan is the next on the list of sovereign debt crisis ... Yes give me 1 quadrillion yen and I will also show you some economic success. Trust me, the victim here is not Japan but their citizents who have no idea that their money are put in JGBs that either will lose value or their value in foreign currencies will soon dramatically go down. If you are interested, you can read my analysis about the Japanese debt crisis that I do expect to hit the newspapers very soon:

    1. You are right sir, I should at least have used the past tence: "Japan was the victim of its own economic succes". By that, I am referring to the period 1960 to roughly 1980, when many were talking and suggesting that Japan`s GDP would at one point become higher than the one of USA.

      I am suggesting that the pattern of high growth based on exports has to reach a plateau at some point, beyond which monetary stimmulus becomes a requirement and monetary stimmulus always leads to business cycle booms and busts.

      Yes, you are right, it is fair to say that savers and taxpayers are the ones who lose most in a negative real interest rate environment. Your article on the Japanese debt crisis is indeed a good read.

  2. I got it now :) Your articles are really interesting and I appreciate what you have to say. I just wanted to point out about your comment on success because I disagree with most of the banks and analysts about how strong and good the Japanese economy is. I believe that a debt crisis will hit their economy soon and that will have devastating effect on the world economy growth as well as the wealth and prosperity of their nation.