“IMF crises” 2.0

By Alex Gratzek

*Please note, in Korea it is referred to as the IMF Crises while in most of the rest of the world calls it the 1997 Asian Financial Crises.*

Twenty years ago, South Korea experienced the “IMF Crisis.” The contagion, spreading from Thailand, affected much of the rest of Southeast Asia and moved on to South Korea. The impact was brief but deep.

More recently, Korea was largely able to escape the worst of the 2007/2008 crisis. As a nation largely dependent upon trade, Korea needs to prepare for the next crisis.

In 1978, under the leadership of Deng Xiaoping, China embarked on a mission to grow its economy, allowing it to operate along increasingly capitalistic lines. However, it has never fully embraced capitalism and the state retains a large presence in the economic sector.

The decision to adopt “pseudo” capitalism has led to an unprecedented 40 years of uninterrupted economic growth, allowing China to become the second-largest economy in the world. Oftentimes, this growth rate has exceeded 10 percent while in recent years it had slowed to 6 percent.

This is a remarkable achievement but one that comes with costs that have yet to been paid. The Chinese government has come to stake its legitimacy on delivering economic growth. To this end, it has consistently intervened in its economy to ensure this. The time for a recession is long overdue. The longer one is artificially avoided through government machinations, the more drastic any eventual recession will be.

In recent years, the government has only been able to ensure economic growth by utilizing debt to promote it. This is becoming an increasingly expensive and perilous way of ensuring growth. The amount of debt that is needed to ensure growth is increasing in proportion, while the extra growth that is generated is shrinking. The input (debt) costs needed to create a fixed amount of growth (output) are increasing.

State companies have seen their debt load rising in recent times. With access to government officials, they have been consuming government loans in order to stay afloat, and have avoided laying off workers for the sake of stability. Their proximity to power means they can access loans and pay a lower interest rate than the market dictates. Increasingly, new loans are being used to pay off old loans while banks are reluctant to report loans as nonperforming. This is not a sustainable practice.

Another related issue of concern is the housing market which has been encouraged as a means of maintaining economic growth via construction. This market witnessed prices double between 2010 and 2017. Housing prices posted a double digit increase in 2016. Chinese capital controls prevent money from being invested abroad and many Chinese are weary of the domestic stock market. Money left in bank accounts receives a pittance of interest. Therefore, many Chinese with money to spare have parked their money into housing.

This accounts for the dramatic rise in the price of apartments, and many speculators and individuals own multiple units. Outside of major cities, there are so-called ghost cities in the interior ― fully constructed cities but with populations well below maximum capacity.

The one child policy and the cultural preference for males resulted in a skewed gender ratio in which males outnumber females. Bachelors know owning a house is a minimum requirement in order to be considered marriageable material to any potential partner.

Any resulting coupling will be two young adults with no children. Thanks to China’s former one child policy, which started to result in a shrinking population, married couples will stand to inherit two or more houses from their respective parents while already owning their own. This will ultimately crash the housing bubble if it hasn’t crashed before then. A couple owning three or more apartments will inevitably sell them; especially if a debated property tax is put into effect.

The Thai crises originated from the economy needing more and more money as asset bubbles grew within the country. Those who were able to acquire bank loans were those with access to the center of power. A key component of this bubble was real estate speculation. This is being mirrored in China at this time.

A key characteristic of capitalism is inevitable recessions. Forty years of uninterrupted economic growth is not a natural outgrowth of capitalism but a reflection of government intervention during bad times. Eventually, this will no longer succeed and Korea needs to be prepared for when it does.

The “IMF crisis” originated from a small economy in Southeast Asia before spreading throughout the region and to Korea. The 2007-08 crisis occurring across the Pacific, allowed Korea to escape the worst of the fallout. Korea was also spared because China, its largest trading partner, went ahead with government intervention to ensure economic growth.

It is not inevitable that China will suffer a recession. Its efforts at pursuing reforms to clean up its banking system along with an attempt to rein in the housing market could work. However, Korea needs to be prepared in case China fails in these endeavors or some other unforeseen event causes a recession.

China is the largest trading partner of South Korea, accounting for around 25 percent of South Korea’s exports and is the second-largest economy in the world. Any Chinese economic issue will dwarf the 1997-98 crisis in its impact, while South Korea will not be able to escape unscathed as it did in the 2007-2008 crisis. As the bible says, in times of plenty save for the bad times. I hope Korea has done so.