By John Richardson
ACCUMULATING yet more debt was the very last thing that South Korea needed and here is why:
- South Koreans had average debts 1.6 times their disposable incomes before July of this year.
- This compared with 1.4 times disposable incomes in the US in 2007, before the sub-prime housing bubble went pop.
And yet in July, finance minister Choi Kyung-hwan announced a supplementary budget of $39.8 billion to be spent over two years.
This has led to a surge in bank lending in August-September, with most of the extra credit flowing into the real estate sector.
The stimulus programme, dubbed “Choinomics”, also involves tax incentives aimed at encouraging companies to invest in new capacity.
Choi launched his programme just as the global economy began to turn for the worst. But long before July, it was clear the Fed’s stimulus policies had failed, as had China’s attempt to use a big surge in lending as a means of achieving sustainable growth.
And yet the thinking of politicians and central bankers the world over is still that all you have to do is print enough money and eventually the opposite of deflation – healthy levels of inflation – will happen. For example, Mario Draghi, chairman of the European Central Bank, is pushing for an increase in Eurozone monetary stimulus.
This thinking is still in place despite all the evidence that the world is slipping into a prolonged period of deflation.
When deflation happens, it is best to minimise rather than add to individual and corporate debt.
Here is why:
- In a deflationary world, there is the constant temptation to put off purchases in the knowledge that if you wait, what you want to buy will be cheaper tomorrow.
- And if you are loaded up with debt, your priority in a deflationary world is to pay down that debt rather than spend or invest. The reason is that as deflation occurs the real value of your lending, based on yesterday’s value of money, keeps on going up.
But, as we can see in South Korea and the world over, central bankers are printing money in an effort to make people take on even more debt. Crazy, surely?
Printing money is a lot easier, however, than structural reforms, as Japan’s prime minister, Shinzo Abe, has discovered.
Like Japan, South Korea desperately needs structural reforms because of its rapidly ageing population. Sadly, you cannot print babies.
Here is some alarming data:
- According to Statistics Korea, the current population of 50 million will start to decline at some point between 2020 and 2030; by 2060, it will have plummeted to somewhere between 34 million and 44 million.
- By then, South Korea will be a country full of old people. Half of the population will be over 60, while only a fifth will be under 30. There will be few workers available to pay taxes to support health care for the elderly, or to buy the cars and houses and other goods that drive an economy.
- Most developed countries have birth rates below the 2.1 babies-per-mother needed to sustain the population. But South Korea’s is among the very lowest, at 1.2. Partly, that’s because most parents pay for private education for their children, which strips the typical South Korean family of virtually all disposable income.
And in the West, demographics are causing a fall in total demand for everything made from chemicals and polymers. As populations age, due to the retirement of the Babyboomers, major changes in spending patterns are happening. Most people have started buying only what they need to get by – e.g. they will only replace their car when it is absolutely essential, and, when they do replace their car, they will want value for money.
There is also China – South Korea’s near neighbour and its most important trading partner. The legacy of the one-child policy is one of the reasons why China has to move up the manufacturing value chain. It if it doesn’t it will not repeat South Korea’s success of escaping the “middle income trap”.
The evidence of huge state backing in China for innovation, essential for escaping the middle income trap, is already plain to see. Samsung’s third-quarter net profit fell by almost 50% year-on-year, largely because China’s smartphone manufacturers have gained more market share.
And here is something even more worrying for South Korea: Within five years, Chinese manufacturers will likely catch up with or surpass their South Korean rivals, according to a new report from the Korea Institute for Industrial Economics and Trade.
South Korea will lose out to China in smartphones, of course, as we have already pointed – and also in petrochemicals, display screens, shipbuilding, steel and textiles, said the report from the institute.
Demographics obviously, therefore, drive demand globally. Wake up central bankers and politicians.
There is a further problem in all of this. As China aggressively exports its manufacturing surpluses in basic low end products, as well as increasingly high-end goods, it will of course add to global deflation. It has no choice. It must do whatever it takes to gain more share of export markets.
And more and more consumers in the West, because they are retired and so have lower incomes, will be delighted to buy lots of cheap Chinese goods – and will be constantly demanding even cheaper products. This is assuming that the world doesn’t retreat behind trade barriers.
What does South Korea need to do to avoid an economic decline?
The thing is, as I said, to not add any more debt. It would be fantastic if Choi relooked at his stimulus programme.
Tomorrow I will look make some suggestions, based on discussions I’ve had with senior South Korean civil servants, about what the country needs to do in the long term.