Korea's Tenuous FX/Interest Rate/Inflation Situation (Update 1)

Korea Declares A "War" on Inflation:  Too Late, It's Here
This past week, President Lee Myung-bak declared a "war on inflation."  Official statistics reflect what every day Koreans have already know:  inflation is a problem at home.  The Seoul Gyopo Guide has pointed out here, months ago, that the KOR-US Free Trade Agreement needed passing immediately in order to reduce the cost of any imports that come from any country.  Later this year, a Korea-EU Free Trade Agreement should also be in place.  These agreements are important, but they are not the dominant factors affecting everyday Korean life. This post describes some of the issues that face the Korean economy, and potential effects on the Korean population.

Korean Inflation Has Been Rising and Looks Like It Will Continue
After the fact, it has been reported that Korea's inflation rate has risen to 2 1/2-year highs.  To working-class Koreans, this is not news.  As a country that is highly dependent upon foreign sources of energy, the rise in the price of oil to nearly USD 90/barrel is an unwelcome development.  In addition, the price of commodities such as metals and food have also risen dramatically.  Given that Korea is a net importer of each of these, inflationary pressure is set to rise for the foreseeable future, as companies will attempt to increase prices of final goods.

Korean Interest Rates Are Going Up
This past week, the Bank of Korea increased interest rates, to the surprise of many.  The reason that interest rates are used to curb inflation is because higher interest rates will create additional demand for the Korean Won relative to other currencies.  In addition, people may choose to save instead of spend which will gradually reduce demand.

Rises in Interest Rates Could Hurt Korean Competitiveness
The other side of this balance is that stronger demand for the Korean Won relative to other currencies will make Korean-made exports less profitable for Korean corporations, or reduce demand for Korean-made products.  Since the beginning of the financial crisis beginning in 2007, Korea has benefited a great deal from the relative cheapness of the Korean Won.  This point has been made by the Seoul Gyopo Guide a number of times.  In fact, one reason that Japan's economy continues to lag is because competitive Korean-made products are cheaper than their Japanese competitors' products.   Conversely, if the Korean Won strengthens compared to other foreign currencies, particularly versus the USD, EUR and JPY, Korean products may suffer on the international marketplace.  This would be a major source of concern for all Koreans.
(Update 1)In the English version of Dong-A Ilbo, this article was written to reflect the same opinions already posted here on the Seoul Gyopo Guide.  The downgrade of Japan's debt rating by Moody's may have contributed to a slight depreciation in the Japanese Yen against the U.S. dollar last week.  Whether or not this is coupled with Korean Won strength or weakness is yet to be seen.

Rises in Interest Rates Will Hurt Domestic Real Estate
In addition to the challenge that a rising Korean Won would create on the international marketplace, the domestic Korean real estate market will continue to struggle.  The single biggest factor in the value of real estate is the level of interest rates.  Higher interest rates make it more expensive to borrow to buy an apartment, even in Gangnam-gu.  If the Bank of Korea continues to raise interest rates, then the value of domestic real estate cannot rise dramatically.  There are other factors influencing the price of Korean real estate.  For example, the aging population will reduce demand, over time, for apartments in the busiest parts of Seoul.  That will translate to lower prices over time.
In addition, greater transparency and greater belief in the laws governing Korean corporations will reduce the percentage of household wealth used for real estate.  Why is that?  It is because there are other assets, such as stocks and bonds, which may be more promising.  Those investments have been hampered by the fact that Koreans themselves are very wary of the largest chaebol, the government, and the legal structure that keeps corporate misuse of funds in check.  As the Korean economy and regulations mature, native Koreans may re-allocate their wealth from real estate to other areas.
The problem with lower real estate prices is that people will feel less secure, and may be unwilling to spend.  This has happened in the United States, where the plunge in real estate prices has depressed consumer spending.  It is not a heroic prediction to suggest that if Korean real estate prices decline, then Koreans that own their apartments are going to spend less money for food, movies, entertainment, and mobile phones.  (Well, maybe not for mobile phones, but you get the idea.)
The other problem with lower real estate prices is that there are lower amounts of real estate taxes that will be collected by the government.  Why is this bad?  It is bad because then the government would have less money to spend, if further economic stimulus is needed.  Korea has spent a great deal of money during the financial crisis by bringing forward infrastructure projects, as well as compensating construction companies who built large apartment complexes outside of central Seoul, and that remain unoccupied, even today.

A Few Potential Solutions
The Seoul Gyopo Guide has pointed out that the government and companies and society face difficult choices.  That is what is called a conundrum.   There are no easy solutions.  However, here are a few, some of which have been proposed in earlier posts.   
First, Korean companies need to hedge their exposure to the possible appreciation of the Korean Won.  This point has been made by the Seoul Gyopo Guide months ago.  If the Korean Won rises, and Korean products are less competitive, then the only way that Korean companies' profitability will be sustained is if there are measures to counteract a stronger Korean Won.  That is fundamentally different from recommending that Korean corporations should speculate on the KRW/JPY rate.  If there is a decline in global demand, or an appreciation of the KRW relative to other currencies, then Korean corporate performance will suffer, almost regardless of the quality of Korean-made products.  In short, the relative strength of the KRW is to Korean corporations can be compared to jet fuel prices to airlines.  The best-run airlines partially hedge their exposure, and so should Korean corporations.  Korean corporations need to do this without taking excessive risks; the knock-in, knock-out (KIKO) options debacle was a situation where Korean corporations misused derivatives (with the help of securities dealers) can be avoided by using simpler, more straight-forward strategies.
Second, Korean companies' investments in technology to create the most sophisticated, leading-edge products must be accelerated.  Korean companies have made huge market gains, even since the beginning of the financial crisis.  The hard-won profits and market share must be deployed to make sure that Korean-made products are the best from both a quality and features standpoint.  The Seoul Gyopo Guide has pointed out that China has overtaken Korea in shipbuilding during 2010.  Korea must reclaim its lead by offering superior products, and Hyundai Heavy, Samsung Heavy, et al seem to have responded. Samsung Electronics, Hyundai-Kia Motors, and other leaders must do the same.   
Third, the Korean economy must support small and medium-sized enterprises.  There needs to be a better way for the highly-educated Korean population to create wealth other than via speculation or working for a large chaebol.  This includes, but is not limited to, tax incentives for new businesses.  Small businesses employ the largest number of Americans, and while that is an unrealistic goal for Korea, there is little doubt about the fact that Korea has a well-educated, creative population which can create new ideas/products, and thus, companies. 
Admittedly, this is only a partial list of suggestions.  There will need to be changes in every aspect of Korean life, and perhaps even the way of thinking, in order for these suggestions to be taken seriously.  However, the benefit would be that Korea would become more independent in determining its own economic course.  That has limits, certainly, because of Korea's lack of natural resources, small population, and small geographic size.  Nevertheless, moving forward in this way will reduce the burden on the government which has to tread carefully.  Currently, if there were policy errors of any sort, then the consequences would be devastating.  The time to address these issues is now, while Korea's economy is in relatively good shape compared to its global counterparts, not when there is an emergency situation.

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Amazing! Logic Reigns, The S. Korea - US (KORUS) FTA Finally Resolved

Korea-US Free Trade Agreement, At Last
A few hours after the Seoul Gyopo Guide's third post regarding the necessity of the S. Korea - US (KORUS) Free Trade Agreement, an agreement was reached, as the impasse regarding auto tariffs was resolved.  The Seoul Gyopo Guide has argued, on multiple occasions, that the FTA would benefit Korean citizens who are suffering due to inflationary pressures in Korea.  Any extra measure to reduce this pressure would be welcome.

Korean Government Acted Wisely by Conceding Insignificant Points
Korea's concessions were proper in the larger context, given that the country is suffering from a higher cost of living than is necessary, due to tariffs on all types of imports.  In addition, it was refreshing that Korea's delegation properly pointed out that there are many levels and stages of international cooperation.  Korea rightly gave concessions in on the very smallest points in the interest of its people as a whole.  If you want to iterate with cooperation, then give-and-take is necessary.  

Time to Remove the Fakers
Now, it is time for the politicians in Korea and the U.S. to pass the FTA in their respective legislatures.  The Seoul Gyopo Guide will identify all those in either country who oppose the passing of the KORUS FTA.  It is quite simple, really.  For those that oppose, the citizens can return that legislator to the private sector.  In other words, both Americans and Koreans can, and should, vote any legislator that opposes the KORUS FTA out of office.  The voting records of legislators in both countries are a matter of public record.  Citizens of both countries should make it very clear to those legislators that their futures in public office depend on their vote of the KORUS FTA.  You will be able to find those that cater to special interests instead of the well-being of their constituents as a whole.  This is especially true for Korean legislators: members of the General Assembly should vote unanimously.  Korean citizens should watch the General Assembly carefully.  Protesters and activists who suggest that the KORUS FTA should not be ratified will be revealing themselves as narrow-minded parties that are looking for publicity only, and not to serve the Korean citizens.

Ignore the Korean Press Coverage Regarding Protests
In the coming months, there will be the inevitable protests, and potentially, there will be news on the internet reporting that Korea (or Koreans) do not approve of the KORUS FTA.  That is fiction created by those who want greater viewership or sponsorship.  Everyday Koreans understand that they will want to purchase American-made products as soon as they are available in Korea.  Many, many of the American brand names that are popular in Korea will be affordable to everyday Koreans, as opposed to only the privileged. In the coming days, the Seoul Gyopo Guide will explain that there will be some resistance for the KORUS FTA, but that will be from the largest deluxe department stores, like Shinsaegae and Hyundai Department Store, because the "designer" boutiques of American brands will be revealed to be massively over-priced. The pictures and footage of Korean protesters is entertaining, maybe, but will not reflect the sentiment of the Korean population. Do not be led to believe otherwise.

The Sooner, The Better
For the suffering Americans in the midst of an anemic economic recovery, and to everyday Koreans where inflation is high (and rising rapidly in many areas), the KORUS FTA cannot be passed soon enough.  The Lost Seoul hopes that both sides can proceed quickly and finally ratify the agreement.  Delays are unwarranted and those causing delays should be punished by voters at their next possible opportunity (i.e. election).

Korea is Right on the FTA Impasse, But the Bigger Picture is More Important

The Seoul Gyopo Guide has pointed out the importance of the Korea-U.S. Free Trade Agreement (KORUS) to the Korean population here, and pointed out that the lack of a ratified agreement victimizes the Korean people.  The KORUS FTA  was an agreement reached many years ago, and there was anticipation that Presidents Obama and Lee would have used the G20 Seoul Summit in order to be a place where they would announce a final agreement which could be ratified by both legislatures.  Wrong.  No final agreement has yet been reached.

In today's Wall Street Journal, it is reported that tariffs on the auto industry is the only remaining sticking point.  Korea objects to the phasing out of the existing tariffs over a five-year period.  Instead, Korea wants to have the tariff removed immediately.  It is perfectly reasonable that Korea would attempt to get this concession from the U.S., given that the other matters have been resolved, and that Korean auto manufacturers have invested heavily in the U.S. and employ a large number of Americans.  Hyundai Motors, in particular, is well-known to have manufacturing plants in Alabama and Georgia.

Even though it will hurt Hyundai Motors and Kia Motors on the margin, the fact is that the overall agreement will help the Korean population.  Given that inflation is the most difficult domestic economic challenge faced by everyday Koreans, the Korean government must consider this first, and do everything that it can in order to lessen the burden of the increased cost of living in Korea.  It should ratify the KORUS FTA as soon as possible.  Korea should not attempt hold up the agreement on this minor point, so that the general Korean population can benefit immediately.  Korea is the U.S. 7th largest trade partner, and there will be additional negotiations in the future.  The notion of not setting a negative precedent must be weighed against the notion of reasonableness and cooperation.  Since those two basically cancel each other out, the benefits to the Korean people should be the deciding factor.  Hopefully, the Korean government fully understands this.

The Real Victims of KORUS FTA Failure? Korean Citizens

The G20 Seoul Summit Was Anti-Climatic in Many Ways....

Before the G20 Seoul Summit, there was great preparation, great anxiety, and not-so-great anticipation of a final agreement to ratify the KORUS (Korea-U.S.) Free Trade Agreement.  At best, the G20 delivered on one out of the three.  Perhaps the only certain outcome?  Continuing inflation in South Korea to the detriment of Korean citizens.

War of Words Among the Largest
In a strange twist, Ben Bernanke was the target of most of the verbal attacks by foreign leaders around the world.  As a result of QE2 (Quantitative Easing 2), which is a program where the US Federal Reserve Bank will purchase between USD $500-750 Billion in U.S. government bonds, foreign central bankers roundly criticized "Helicopter Ben."  Of course, this is somewhat ironic, given that governments around the world have also propped up their domestic economies in various ways.  The EU, Japan, China, and yes, South Korea have embarked on massive government spending programs in order to prevent deflation and the resulting loss of consumer confidence.  That, in turn, would start a spiral in which consumers don't spend, which creates another round of economic duress.  In South Korea, the Bak administration has spent a great amount of money in buying vacant apartments outside of Seoul (신도시) to avoid further losses by Korean construction companies.  In Europe, the ECB has purchased government bonds of Greece and now, Ireland is next in line to received direct financial aid.  Countries are trying to preserve their domestic economies but the result is artificial currency depreciation.  For global leaders to point at Helicopter Ben is irony at its height.

No KORUS FTA = Increasing Inflation for Koreans
The bottom line is that both the U.S. and Korean governments are being foolish by not reaching final agreement on the Korea-U.S. (KORUS) Free Trade Agreement.  Beef and autos continue to the main points of contention.  However, the fact that many other common goods would be imported into Korea at much lower prices would have created downward pressure on inflation.  That is very important to the average working Korean, where food inflation is rampant to the point where even cabbage used in making kimchi has become unaffordable to many.  Now, The Lost Seoul isn't stating that final ratification of the KORUS FTA would result in instaneous downward pressure on all prices, but the fact is that greater competition due to lower tariffs on many goods can do nothing other than help mitigate the increasing pressure on the cost of living in Korea.  So while special interest groups are delaying ratification of the KORUS FTA, the victims are Korean citizens who are struggling to make ends meet.  The Bak administration would do well to attempt to break the impasse, or pressure will increase on the Bank of Korea to increase interest rates to strengthen the Won.  Doing so would jeopardize the competitiveness of Korean products on the international marketplace.  That is a vicious cycle that may be difficult to stop, at precisely the wrong time if the global economic recovvery continues to be painfully slow.  Korea has difficult choices in its immediate future:  pressing the U.S. to finally ratify the KORUS FTA should be a top priority.

Korea-US FTA: Why Hasn't This Passed Yet? Both Sides Are Being Equally Ridiculous

The leaders of the largest 20 economies in the world are going to gather in Seoul this week.  Presidents Lee (South Korea) and Obama (United States) have been trying, at various speeds over the past 3 years, to ratify the the Korea-U.S. (KORUS) Free Trade Agreement.  Apparently, according to Reuters, there are two areas where disagreements still exist: autos and beef. 

It's hard to decide whether South Korea or the U.S. is being more ridiculous in this 3-year delay:  let's just call it a draw.

Autos
Ford took out a full page advertisement against the KORUS FTA late last week, with claims that Korean manufacturers would be allowed to ship 52 cars to Korea for every American manufacturer.  This advertisement has received a fair amount of publicity in the United States' press, including from think tanks, and via newspaper coverage.
Most people in the United States are well-aware of Ford Motor Company's dramatic strides.  It declined government aid during the financial crisis and bankrupcies of both General Motors and Chysler; now Ford is generally-considered to be the best managed U.S. auto manufacturer.  Equity investors have been handsomely rewarded as well:  Ford stock has risen by 62.1% in the past 52 weeks alone.  Senator Carl Levin, Michigan Senator, has also voiced concerns to support his contituency.  American complaints against the  KORUS FTA concern tariffs, and adherence to emissions standards.  Not only are both areas without merit, but neither addresses the fundamental problem:  Korean consumers won't buy a Ford passenger car in large numbers anytime soon.

This is a quote from the Reuters' article,

"Levin and others had advocated the United States phase out the 2.5 percent U.S. auto tariff over at least 15 years, but allow for a quicker elimination if sales of American cars to South Korea hit certain levels." 

Linking the elimination of U.S. tariffs to the level of American car sales to Korean consumers?  Let's be frank and honest here:  the U.S. auto manufacturers are worried about the increasing market share of Hyundai and Kia in the U.S.  That's it.  GM is silent, which is being interpreted as neutral.  Do you know why?  In Korea, GM owns Daewoo Motor, which failed as a result of the Daewoo Group's enormous debt, coupled with the Asian currency crisis.  So GM, if it complained a la Ford, GM would be criticizing itself. 

For its part, Korea should also drop any price barriers, and let Korean consumers decide.  Ford would have a long, long way to go:  it has no dealer network, no maintenance facilities, and most importantly:  what Koreans would buy a Ford Focus instead of Hyundai Elantra for essentially the same price?  There will be some, of course, that want to buy as a result of being different.  That would be the extent of it. Until a foreign-made product is unquestionably superior, everyday Koreans won't buy it.  One day, take a Korean Air flight from Seoul to the U.S.  Do you see all the Koreans onboard?  They pay, easily 10% higher prices for a ticket on Korean Air than on United Airlines or Delta Airlines.  Nevertheless, those seats do not go unfilled.  Long gone are the days when Korean-made products are objectively inferior to American counterparts.  When you add this simple fact to everyday Koreans' affinity for domestically-made products, Ford has a long uphill battle.  It knows this and that is why it wants to tie the phasing out of the 2.5% U.S. auto tariff to the level of American car sales. 

On emissions standards, the complaints of American manufacturers are easily answered by one simple statement.  Lexus, Honda, BMW, Audi, and Mercedes-Benz all comply with Korean emissions standards.  We can have all sorts of other discussions about the inequity of Korean emissions standards, etc.  None of them matter in the least.  Other, foreign-based automanufacturers know the laws, and comply. 

In short, the U.S. objections do not make a lot of sense.  They reveal two worries: the loss of domestic market share, and the inevitable failure to gain a foothold in Korea.

Beef

Koreans love the idea of conspiracy, and do not quite understand the power of the fear of litigation.   There is good reason for this.  The large conglomerates (chaebol) have dominated almst every facet of Korean life for as long as anyone can remember.  When there is a production problem in some area which causes illness, there is little recourse for a consumer to complain, or sue.  A couple of years ago, it was found that some lunches prepared for schools was defective.  There was little press coverage, and no report of compensation to the students. 

The nature of the complaints against U.S. beef, in The Lost Seoul's view, are tied to this lack of belief in consumers' rights.  There would not nearly be the "fear" of BSE (mad cow disease) if Korean citizens fundamentally believed in the concept of consumers' rights.   Think about U.S. corporations' actions.  If you think about the recent over-the-counter drug epidsode, the manufacturers pull everything off their shelves immediately.  Why?  The public good?  Yes, you can make that claim, and the companies certainly state that.  However, it is a fact that there are HUGE legal liabilities that need to be avoided.  To everyday Koreans, this is not a part of the psyche. 

The fact is that Americans eat beef of all ages, without knowing the age, and without asking any questions.  If there was a problem that was known by the company responsible, the legal consequences would be severe to the point of potential extinction of the company. Have any Americans asked at a restaurant, "How old is the beef that is being served in this dish?"  Nope. 

There is the issue of wagyu, which is similar to Japanese kobe beef.  It is indeed tender, and expensive (although not as pricey as kobe).  Korean objections to American imports as a result of potential are also pointless:  the number of Koreans that insist on buying, or choosing restaurants because wagyu is being served are relatively few, and they won't change their consumption of wagyu because of the fact that there is filet mignon available. The downside of the tariffs on U.S. beef?  Inflation on existing products.  Food inflation is a major problem in Korea.  Any Korean complaints against the import of U.S. beef are outweighed easily by the benefits that everyday Koreans will enjoy due to greater supply, and lower price inflation.  Even if this benefit were small, the average Korean household would benefit. 

Not suprisingly, special interest groups are blocking the passage of the KORUS FTA.  They do so without merit, and at the cost to both American and Korean consumers.