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How to avert a crisis

May 18,2018
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Choi Jong-ku, chairman of the Financial Services Commission, explains the government’s plan to rein in household debt, which now accounts for nearly 95 percent of Korea’s gross domestic product. [YONHAP]
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Yi Jung-jae
*The author is a columnist at the JoongAng Ilbo.

I am cautious to discuss economic crisis theory in an election season. It is hard to get credit for it, especially when the biggest opposition party attacks the government and ruling party for their economic policies. Nevertheless, I need to talk about crisis theory. It is like a routine check-up that gives you signs of your health. When you ignore the signs and let an illness develop, you might not be able to treat it. Crisis theory could prevent a crisis.

Household debt is a good example. A crisis theory on household debt first appeared in 2002. Lee Keun-yeong, then the governor of the Financial Supervisory Service, said in private that household debt could be the next detonator of the Korean economy and bring a greater shock than the 1997-98 financial crisis. The household debt had just surpassed 400 trillion won ($370 billion) at the time. Since then, reining in household debt has become the primary task for heads of the Financial Supervisory Service.

Fifteen years have passed, and household debt now exceeds 1.5 quadrillion won, almost 95 percent of Korea’s gross domestic product. It’s higher than the 75 percent that the World Economic Forum warns is the tipping point and the OECD average of 76 percent.

The quality of the debt has also worsened. Not only do more people owe multiple lenders, but borrowing outside of banks has also grown. Despite all the warning signs, a financial crisis ignited by household debt has yet to come. Financial authorities and the Bank of Korea say everything is under control.

How is this possible? A theory of crisis served as a stepping stone for structural reform and overhaul. Financial authorities have been controlling the debt by extending loan regulations and writing off debt. Banks have been put under intensive stress tests. The work is not satisfactory, but it has prevented a major crisis from happening. The Korea Institute of Finance projects that household debt will not turn into a risk for the financial system unless real estate prices drop by 30 percent in the short term.

A theory of crisis usually ends up being just that because economic entities make preparations. Problems arise when preparations are not made. I don’t even have to ask about the result. My memory is vivid. At the time of the Asian financial crisis 20 years ago, the Kim Young-sam administration brought disaster to itself by denying talk of crisis and claiming that fundamentals were solid.

And what about the Moon Jae-in administration? The Blue House is concentrating on controlling the North Korean nuclear threat. I do not know who is commanding the economic ministries, but they are bent on praising the establishment of a fair economy and income-led growth without presenting the results in numbers. It is the first time since the 1997 crisis that employment has only increased by a mere 100,000 for three consecutive months, but the Blue House considers the employment shock as “just a phase.”

Major indicators show clear warning signs. Exports are shaky, production is decreasing and companies’ market predictions are worsening. But the Ministry of Strategy and Finance claims the economy continues to recover. Kim Kwang-doo, vice chairman of the National Economic Advisory Council, raised a question about the ministry’s judgment and claimed that the economy entered the beginning of stagnation.

Politicians are going further. A veteran lawmaker in the ruling party said the country never actually went broke despite all the theories of crisis. The opposition party is using crisis theory as a way to attack the government and ruling party. Last week, Argentina practically declared state bankruptcy, and the crisis spread to Turkey. Talk of crisis in emerging economies is growing, but no one is paying attention.

A real crisis comes when you ignore the theory. You cannot reject it. A crisis theory is destined for a small open economy like Korea’s. Whenever big economies like the United States go through a turning point, small economies get major shocks. Only when the economic muscles are built up by using crisis theories as signals can the shocks be minimized at the time of a real crisis. Now is the time for a prescription of structural reform, overhauling and tightening the money supply.

JoongAng Ilbo, May 17, Page 30