Overcoming Myopia...

Picture from the Blog : http://teeth.com.pk/blog/2009/07/13/the-myth-of-independence-economic-imperialism    additional touch by Soojin Lee

Perhaps, by taking  political economy stands and pure macroeconomic views into consideration, we can think of a range of contributors to the instability of the Korean financial system and the root of these repeated financial crises. Among other things, I wanted to discussed the aftermaths of the Korean market liberalization brought by the IMF reform in 1998-2000, and  what the tides of foreign capital have done to the Korean financial system. As Lee and Crotty (2002) criticized, the hasty recovery right after the IMF regime was incomplete and short sighted. In fact, the failure of IMF-led neo-liberal restructuring by ignoring the coordination with the traditional fundamentals (Lee and Crotty, 2002) led to the growth of much more severe problems, which turned out to be true exactly a decade later. Chang (1998) also regarded the IMF bailout program as ill-managed financial liberalization and poor exchange rate management which all together deepened the crises. At the center of the causes, as both Chang (1998) and Lee and Crotty (2002) pointed out, there were oversights of increasing foreign borrowing and under-regulations for foreign capital and their opportunistic conducts.  

Looking back over the last ten years and realizing the detailed story behind the crises, many doubts remain. 

What could have the Korean economy done differently? 

What if the Korean economists had suggested mixed reform approach considering the Korean traditional economic model and slowed down the speed of restructuring? 

And, what if the Korean ministers and president had more political power when they negotiated with the IMF? 

Then, would the Korean economy have been better than now? 

Well.. no one can present absolute answers to that; however, it would be worthwhile to consider, especially, when there may be another yet potential financial swing waiting to conquer the Korean market and many other economies. 

With regard to such a broad topic of the Korean financial crises, I could have collected more balanced thoughts in this blog. Thus, I acknowledge that my view points may be viewed as presumptuous due to my  limited knowledge and understanding.  Having said that, I hope viewers of this blog will get the gist of my theme - not to show mere Anti-Anglo Americanism or to be against neo-liberalization, but to present different angles when implementing foreign institutional model instruments into the rough grounded domestic environment. 

Chang, H. (1998), 'Korea: The Misunderstood Crisis', World Development, 26 (8), pp. 1555 -1561.

Lee, K. and Crotty, J. (2002), 'A political-economic analysis of the failure of neo-liberal restructuring in post-crisis Korea,. Cambridge Journal of Economics, 26, pp. 667-678

Sweet Deathtrap - Currency Mismatch..

So, how exactly do 'Foreign Bankers' behave differently from domestic Korean banks? Why are their lending activities mainly short-term? Is it because they view the Korean market as unsafe and therefore do not commit in the long-term? Probably, as Cho and Kalinoswi (2010) commented, are they more likely to be risk adverse and biased regarding corporate lending? 

Such questions are extensively examined in the study conducted by Jeon et al. (2006). Considering the opposing view points with respect to the influence of foreign bank entry on developing financial markets, Jeon et al.(2010) analysed Korean banking sectors to find whether the degree of stability has been improved and the market volatility has been reduced by the induction of foreign banks. Their findings suggest that the lending practice by foreign banks tends to be more opportunistic; thus, follows portfolio theory. Such observations of foreign banks behaviours indicated plausible evidence that foreign banks poured massive foreign currency loans into the Korean market before the crisis (i.e. as long as the macro-economic conditions appear to be attractive for them); therefore, the rapid capital reversals at the on set of the global crises triggered mainly by those foreign banks (Jeon et al., 2010).  

Another overlooked danger in exposing domestic banking sector to foreign bankers would be the hidden trap of 'currency mismatch' which deepen the financial crises, especially when domestic banking systems were yet to be fully grown to protect itself from the sudden external shock.  

During the last Thursday lecture,  I briefly learned what is meant by 'currency mismatch' and its negative consequences in many Asian emerging markets, I researched this topic intensively.  After read through the report about the problems with currency mismatch written by Morris Goldstein and Philips Turner, in their book (to access click 'HERE'), I gained some background knowledge while analysing the graph below shown in the research by Yoon et al (2009).  

According to Yoon (2011) and Goldstein and Philips (2004), currency mismatch occurs mainly due to high volatility in foreign exchange markets and refers an increasing discrepancy in currency value between foreign assets and foreign liabilities, thus indicates the foreign liquidity trap. Especially, many emerging markets, where external debts are made mostly under the short-term base and denoted by foreign currency, are much more susceptible to abrupt movement of foreign capital and currency fluctuation as exemplified by the case of the Korea crises. 

In short, it seems that the more the domestic market is liberalized, the more unstable the financial market becomes. As long as a domestic economy is on its way to constructing solid market fundamentals with proper regulations before foreign investors coming to play, such expected externality from sudden liberalization forced by outsiders would be inevitable. 

Would it be fair to say that the culprit behind the short-term currency mismatch was the 'Banking Sector', and behind that banking sector, there were foreign branches of banks in Korea? I am inclined to say "Yes" to this question. 

Source: Yoon et al.(2009, pa 154) - graph above also presented in his article in 2011, page 118.

Data source: Bank of Korea http://ecos.bok.or.kr 

Cho, H., and Kalinowski, T. (2010), Bank Nationalization, Restructuring and Reprivatization: The Case of Korea since the Asian Financial Crisis, Korea Observer, 41(1), 1-30.

Goldstein, M. and Turner, P. (2004), Controlling Currency Mismatches in Emerging Markets, The Peterson Institute for International Economics, available at http://bookstore.piie.com/book-store/373.html, Accessed 23rd Feb. 2012. 

Jeon, Y., Miller, S. and Natke, P. (2006), 'Do Foreign Bank Operations Provides a Stabilizing influence in Korea?', The Quaterly Review of Economics and Finance, 46, 82-109.

Yoon, D.  (2011) 'The Korean Economic Adjustment to the World Financial Crisis', Asian Economic Papers, 10(1), pp. 106-126.

Short-term External Debts and Foreign Investment

Tobin (1998) argued that heavily borrowed short-term loans of banks and businesses were the biggest trap once the local currency became plummet, which resulted in the Asian financial crisis.
So, I extracted detailed data of the external debt component from the Bank of Korea database. Even though long-term debt is more than the short-term loan in terms of the value, the growth of short-term debt appears to fluctuate more than long-term debt.

Data Source: Bank of Korea  http://ecos.bok.or.kr


Since the banking sectors are the most severely crushed due to the crises, I wondered about their debt components. The data allows me to separate by the ownership of Bank, Domestic and Foreign Branch.

Data Source: Bank of Korea  http://ecos.bok.or.kr 


Interestingly, most of the external debts owned by domestic branches of foreign banks are "short-term' loans.
The data below supports the argument of Kang (2002) that the domestic branches of foreign banks were a major conduit of channeling unprecedented growth of short-term foreign borrowings while taking advantage of overly lax supervision for foreign banking operations in Korea. Kang (2002) pointed out that such conditions added financial vulnerability once foreign investor's deleveraging starts.


Cho and Kalinowski (2010) explained the IMF's persuasive reasons for its encouragement of foreign ownership of the banking system and branch operations. The IMF believed that inflow of foreign capital into  a stringent financial market would facilitate its recovery from the crises; therefore, financial market liberalization is the top-priority in the reform model (Cho and Kalinowski, 2010).

By transforming financial sectors regulations and the foreign exchange system to more foreign investor-friendly, in addition to the IMF's believed to be 'right' guide, Korean financial market became the free field for foreign investors.

(For more detailed historical information of how the Korean foreign exchange system has changed, please click Here.)

Cho, H., and Kalinowski, T. (2010), Bank Nationalization, Restructuring and Reprivatization: The Case of Korea since the Asian Financial Crisis, Korea Observer, 41(1), 1-30.

Kang, M.K (2009), 'Global Financial Crisis and Systemic Risks in the Korean Banking Sector', Korean Economic Institute Academic Paper Series, 4(5).

Tobin, J. (1998), 'Asian Financial Crisis', Japan and the World Economy, 10, 351-353.

Misprescribed Medicine

Let's review the Korean government homework list given by the IMF.
Lee, in his 2011 report, summarized the IMF reform agenda and framework as follows:

1) a tighter austerity economic policy
2) transforming the financial sector to be more transparent and market efficient
3) removing political influences on business decisions
4) stimulating "Free-Trade"
5) LIBERALIZATION OF CROSS-BORDER CAPITAL TRANSACTIONS 

Under the pressure of Globalization around the world in the 1990s, there must have been justifiable political and economic reasons for accelerating the reform. However, this agenda seemed to have been implemented with only short term goals in mind. Particularly, with respect to IMF-led neo-liberal structural reform (Crotty and Lee, 2002), there were widespread worried voices in the media and academia criticizing their approach as too radical and ill-advised. Probably, the new president, Kim Dae Jung, who was newly elected right after the crisis had overly ambitious targets in order to please the IMF. Chang (1998) condemned IMF policy in that the Anglo-American direction would not be effective for the Korean economy in the long run. the main problems surrounding this enthusiastic IMF approach would be the sequence and speed of implementing liberalization, not the extent of deregulation (Caprio et al., 2001). 

I reluctant to say that I am against globalization, yet I support the opinions of Crotty and Lee (2002) that the reform was like a 'Big-Bang' restructuring rather than gradual evolution. Even though open-market trends are an inevitable phenomenon, it doesn't necessarily apply to everywhere to the same degree. In my opinion, every economic traditional framework has its own way of healing its problems.
In fact, when we are looking back at the effect of neo-liberalism on many developed countries, including the U.S. itself, it seems not quite a foolproof plan, after all.

The graphs below show the increase in foreign direct investment in the Korean economy and the stock trading activity of foreign investors in the Korean stock market.
Well..Did the Korean economy welcome them too much...?

[FOREIGN DIRECT INVESTMENT IN KOREA]

[Value of Stock trading by foreign investor]

[Volume of Stock trading by foreign investor]

Data Source: Bank of Korea http://ecos.bok.or.kr 



Caprio, G., Honohan, P., Stiglitz, J.E.(2001)  Financial Liberalization: How Far, How Fast? New York: Cambridge University Press.

Crotty J. and Lee, K. (2002), 'A political-economic analysis of the failure of neo-liberal restructuring in post-crisis Korea', Cambridge Journal of Economics, 26, 667-678.

Lee, K.S. (2011), The Korean financial crisis of 1997 : onset, turnaround, and thereafter, The World Bank and the Korea Development Institute

Picture is from the Book cover, "Buy Korea" written by Korean novelist, Kim Jin Myung

Was the Homework Wrong? Or was the teacher not right?

We don't need to be economists to expect the obvious 'should-be' effects after the economic surgery by the IMF. Shouldn't the hard work have paid off?
As a naive Korean, I, like probably many other Koreans at that time, would have followed the simple logic below:

Korean economy bankrupt -> Couldn't meet the loan claims
-> Paid out through the IMF bail-out ->  Calmed down loan creditors
-> Even paid out all IMF rescue funds -> Free from the debt trap?

Well..It appears even worse! (The red line shows "Gross External Debt")

GROSS EXTERNAL DEBT - <Source from Bank of Korea : http://ecos.bok.or.kr >


Another logical progression would be...
Economic Chaos -> the value of Korean currency went to wild
-> Hard training from IMF -> Stabilising the Korean won exchange rate ?

When looking at the history of the foreign exchange rate of the Korean Won against the U.S. dollar, it seemed to cool-down after the 1997 roller coaster ride, at least before the 2008 crisis hit. However, the fluctuation of the worth of the Korean currency appears to have remained and kept accumulating the volatility in its foreign exchange market. The red-line indicate the actual value of the Korea currency to 1 USD and the blue line indicates the percent of change from the previous period.

EXCHANGE RATE AND % CHANGE <Source from Bank of Korea : http://ecos.bok.or.kr >

Of course, these two graph couldn't tell us the whole story of what happened. Moreover, it is quite presumptuous to draw a conclusion based on such a simple fact. Yet, I do believe that analyzing the components of the foreign debt and finding the cause of increasing sensitivity in the Korean currency would provide more focused insights into the root of the crises.

Too fast to Celebrate..?

On 23^rd August 2001, the bank of Korea announced to the public that the last portion of the debt from the IMF had been fully paid out and it was three years earlier than originally planned (The Korea times, 2001).  This historical day seemed to mean a lot to the Korean economy as it finally regained financial sovereignty. Even the IMF praised Korea’s economic achievement, due to the fact that Korea was the quickest country to recover among the others that received the IMF rescue fund. (IMF, 2001).

Yoon (2011) pointed out Korea's surprising economic turn-around during the crises. By comparing the results of the other countries, he illustrated the strong efforts in economic recovery of the Korean people themselves.

But what was the reality? During the difficult three year and eight month period, was the Korean economy really transformed? Or, was the Korean government too hurried to look good to the outside world? For the next blog posts, I will look more deeply at these questions by presenting various macro-economic indices to show the epicentre of the remaining problems that the IMF had not anticipated.

 

Pictures from Korean News paper Hankuk-ilbo http://weekly.hankooki.com    

IMF (2001) IMF Managing Director Congratulates Korea on Early Repayment of 1997 Stand-By Credit , Available at: http://www.imf.org/external/np/sec/nb/2001/nb0182.htm (Accessed: 12nd February 2012).

the Korea Times  ( 2001) IMF Graduation and the New Begin, Available at: http://www.koreatimes.com/article/50117 (Accessed: 12nd Feb. 2012).

Yoon, D.  (2011) 'The Korean Economic Adjustment to the World Financial Crisis', Asian Economic Papers, 10(1), pp. 106-126.

A decade later, the 2008 Crisis

Even though the Korean economy learned an expensive lesson from the experience of the 1997-1998 turmoil, it couldn't escape the 2008 financial crisis; yet the degree of effects and aftermaths of these two financial crises seemed somewhat different.

Ten years later, the Korea economy suffered, not as a result of their own market failure, but from the external market shock. Does it mean that the Korean economy could blame all the foreign capital and foreign investors?
Probably there were (or they still are now) entangling factors that keep putting it back into the danger zone.

This blog is about the Korean financial crises that occurred in 1997 and 2008. Throughout the series of posts, I will discuss the root of the problems that led to the tragic events and what such a disastrous period has brought into the Korean financial systems and banking sectors.
(Picture cited from http://www.futurekorea.org/docs/seminar/2.bmp)

No..it's not extreme patriotism..

Yes, some foreign reporters said it was a weird yet impressive phenomenon when they watched the Korean people's reaction to the IMF regime.
But, no..It was not an extreme patriotism.. It simply stemmed from the Korean's inherent belief in collectivism.
Just like Koreans tried to get out of debts while being colonised by Japan, they repeated the same public movement of collecting gold.

The ordinary citizen, perhaps having no idea about what IMF even meant to them, found all possibles ways to help the nation. After the Korean had heard the Bank of Korea didn't have enough U.S. Dollars or gold left to pay off the debt, the Koreans started collecting all their gold to donate to their government.  From the tiny wedding rings to bequests, literally anything made of gold, they wanted to give everything possible to the government in order to help get out of the economic blackhole.

   

Picture source from the Korean Newpaper, Chosun-ilbo (www.Chosun.co.kr)

Still Remember...The Dark Days of 1997

The Korean Government Declared the Moratorium on 3rd December, 1997.

On the same day, there were huge demonstrations against IMF surveillance in Seoul, but even protesters seemed to have no idea exactly whom we could blame for the disaster.

Image from Chosun-ilbo (Korean Newspaper) 

http://books.chosun.com/site/data/html_dir/2004/11/05/2004110555284.html