Tuesday, November 2, 2010

Aye, There's the Rub: Korean Inflation Hits 20 Month High While the US, Europe, and Japan Fight Deflation

One week ago, Korea reported 3rd Quarter GDP which exhibited a slowdown on a quarter-over-quarter basis.  On that basis, the Bank of Korea has resisted calls and predictions of raising domestic interest rates.  The result has been a Korean Won which has been weaker than would have otherwise been expected.  The Lost Seoul has reported that the weak Korean Won, particularly when compared to the Japanese Yen, has greatly helped the performance of the largest Korean corporations.

As posted here, The Lost Seoul has suggested that while the KOSPI has risen to three-year highs, and unemployment is the lowest of all OECD nations, the average Korean isn't happy, largely because of rising inflation, particularly of food prices.  Weather has been particularly unkind to Korean farmers this year:  even cabbage which is used to make the most famous Korean food, kimchi, has been in short supply.  Today, that anecdotal evidence was confirmed:  Bloomberg reported that Korean inflation is the highest it has been in 20 months.  This makes the Bank of Korea's job more difficult.  As was posted previously, The Lost Seoul described how the "wealth" effect, was not being shared among average Koreans.  Inflation, in all forms, usually increases prices of all goods, relatively speaking.  That is not the case in Korea, however, and thus, the average Korean does not feel wealthier, which leads to less consumption.

First, wage inflation is kept low by the ongoing underemployment (described here), particularly among young people in their early 20s.  Second, the real estate market has remained subdued, at best.  Third, employee participation in Employee Stock Ownership Plans (ESOPs) is low.  Why does this matter?  It matters because the largest Korean companies are the largest, by far, employers.  As the KOSPI has risen to 3-year highs, the wealth effect due to increases in equity prices are not being shared by the employees.  As a result, the employees' purchasing power has risen to meet inflation.  Perhaps you could suggest that this is the case in the United States as well, except there exist far more developed pension plans, which are some of the most important equity owners of US equities.  As a result, employees at US corporations can actually see financial statements in which the value of their equity holdings will increase as the stock market rises.  The same cannot be said about Korea, so the "wealth" effect is small, and almost non-existent.

For the Bank of Korea, the spectre of stagflation has now appeared.  Stagnant economic growth coupled with inflation equals stagflation.  The global imbalances, if they persist, continue to make the outlook for the Korean economy shaky in the short-term, despite hard-fought gains made in quality and global competitiveness.  The Bank of Korea may have its most delicate balancing act in the months ahead.  No wonder it has not made violent moves in either direction, which would only increase the instability.  Small countries like Korea must wait and see what the effects of these global imbalances on Korean corporations, and as an extension, the Korean economy.

The Lost Seoul


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