(EDITORIAL from the Korea Herald on Dec. 22)

Worse than inflation

The government and the Bank of Korea are saying they are willing to use all means
possible to ease the credit crunch and put the distressed economy back on track.
Should the economic crisis get out of control despite all their efforts, they
would certainly print money - a possibility to which neither the central bank nor
the government has referred in explicit terms yet.
The actions that have been taken since the collapse of Lehman Brothers on Sept.
12 are truly mind-boggling. The central bank has slashed its benchmark rate by
225 basis points to a historical low of 3 percent. It has also supplied 11.2
trillion won in funds to financial institutions by buying treasuries and other
securities from them.
Ensuring an easier access to loans in foreign currencies is another mission for
the government and the central bank. As such, they have injected, or have
committed themselves to injecting, a total of $55 billion into the foreign
exchange market. In addition, the Korean government has concluded currency swap
deals with the United States, Japan and China, each amounting to $30 billion,
which will serve as backup facilities.
If these measures prove to be insufficient, domestic banks will have to turn to
the government for debt guarantees. To help them borrow money from abroad, the
Korean government has committed itself to $100 billion in debt guarantees.
In addition to all these monetary policy measures, the government is set to incur
a sizable budgetary deficit, increase spending on public works projects and
encourage corporate investment by cutting corporate taxes.
The government and the central bank are taking these extraordinary actions in the
belief that inflation is no longer a concern. They also believe it would not be
as risky to allow deflation to run its course unchecked as it would face the
threat of post-crisis inflation.
Few dare to voice a contrary opinion. That is understandable, given that some
economic think tanks project the domestic economy to contract in 2009. The
economic crisis is deepening despite the huge amount of liquidity provided by the
government and the central bank.
Commercial banks are hoarding cash, instead of making loans, at a time when the
government and the central bank are pumping liquidity into the financial markets.
Blame cannot be leveled against them - they claim that they have no other choice
as victims of debt deflation.
A substantial portion of their loans is turning into bad debts. An increase in
nonperforming assets is undermining their soundness, as measured by the Bank for
International Settlements' capital adequacy ratios. No wonder they are holding
cash, the safest asset in times of trouble.
Against this backdrop, the government is planning to establish a $20 trillion won
fund in January with investments from the central bank and institutional
investors. The fund will be used to buy stocks and bonds from the banks.
If the plan to provide the banks with a cushion against losses and writedowns
works as well as the government intends, the average capital adequacy ratio of
the banks is projected to rise by 2.6 percentage points from 10.86 percent at the
end of September. As the banks regain health, they will be pressured to help
speed up the economic recovery by making loans to corporations and consumers.
At this juncture, the government may regard worries about post-crisis inflation
as a mere luxury. But a more responsible government would commission its economic
think tanks to work on how to mop up excess liquidity when the economic recovery
has gained momentum. Inflation needs to be tamed before it gets out of control
and becomes hyperinflation, which is no less damaging than deflation.
(END)