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Wednesday, May 27, 2009


the korean example

while i was recently out, john hempton posted a couple of really insightful looks at long-wave systemic crises in japan and korea, highlighting the defining difference between the ossifications of the japanese zaibatsu and the korean chaebol as the nature of domestic savings.

Korean banks – unlike their Japanese counterparts – were short funds. Endless funding at zero interest rates was simply not possible. Given that the banks eventually collapsed – with many becoming government property and with the government winding up as the largest shareholder in almost all banks. This was a spectacular crash – as opposed to a slow-burn malaise. Chaebol failed. In some instances their founders were imprisoned. The strongest Chaebol is the one most associated with new industries (Samsung). It survived and prospered – but others did not.

Korea had a much worse recession than Japan. Vastly worse. Japan was just low growth for a very long time. By contrast the Korean economy crashed and burned. But it also recovered very fast and at one point (1999-2000) the Korean Stock market was 1932 Great Depression cheap. It bounced.

It is my contention that the main difference between the Korean and Japanese crashes (and Korea’s case recoveries) was the funding of the banks. In this view Korea’s was so sharp because the banks simply ran out of money – and that caused massive liquidations across the economy – systemic failures.

one might recognize immediately the pertinence of the contrasting examples with reference to an earlier discussion with hempton which drew my focus to the reliance of the united states -- much like the pre-1998 heyday of the korean chaebol -- on wholesale funding drawn from international depositors above and beyond the deposit base to fund the boomtime activities of the private sector.

as such, the united states cannot now quite follow in japanese footsteps. where japan was flooded with deposit funding thanks to a very high savings rate exceeding the funding needs of its private sector as manifested by its national current account surplus, the united states is faced with "running out of money" -- that is, the inability to import sufficient capital from overseas to fund balance sheets -- and forced liquidations as foreign funding dries up and our current account deficit narrows sharply. where japan's banks turned to lend to the government when faced with collapsed private sector loan demand, american banks are faced with having to end their dependency on wholesale funding either by selling lots of assets or gaining lots of deposits. even as government stepped into the breach last september as the wholesale-funded shadow banking system collapsed into a liquidation which is still ongoing, banks are now delevering from those government liquidity provisions to bring their assets into line with their deposit base.

hempton analyzes the situation positively, noting that the sudden stop and capital flight witnessed in korea suffocated not only zombie legacy industries and weak players but even some share of the innovative and healthy, leaving ample room in the aftermath of the banks delevering into a position where deposits exceeded assets for a strong rebound in activity. and he doesn't see the need for that kind of scorched earth:

... [T]he problem with Korea was that the banks became totally illiquid and hence were unable to lend at all. This mattered because not only inefficient Chaebol died – but plenty of good stuff suffered the same fate. A banking system that cannot lend is indiscriminate about who it kills. It will result in the death of dodgy businesses – but will also kill perfectly fine businesses that need cash for short term requirements.

If you want to avoid the really deep malaise that was Korea then keep the banks liquid. Then at least they will lend to the more worthy borrowers – and whilst industry will die banks can be selective about who they kill.

but hempton does seem to shoot a hole in the idea that the united states can suffer as little economic volatility as japan did in its long malaise of corporate delevering from 1990 to 2005. america has in the initial stage of the depression addressed the attack on its massive wholesale funding/current account deficit complex for a mixture of forced shadow bank systemic delevering and substitution of explicit treasury financing by foreign savings where agency or private-label financing once stood, all augmented by government backstops to prevent destabilizing runs. this has already rendered a deeper recession than any japan then experienced as the current account gap has closed. but a look at the balance of current account indicates that this trend probably could have quite a lot further to run -- and potentially, should treasuries lose the confidence of heretofore mercantilist financiers of the united states, even a sudden-stop capital flight is not out of the question.

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Welcome back!

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Welcome back too, gm. This seems to bring us back again to what we previously discussed -- the currency crisis issue that Koo did not rule out or the "inflation deanchoring" versus "output gap" scenario that Simon Johnson outlined.

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BTW, those were interesting comments in Hempton's post. The Korean scenario described by Apolitico@10:40 PM highlights the need for fiscal spending to not exceed available deposits. But how do you know what is the right amount? It seems to be equivalent to the question of how to engineer a physical system that is critically damped, with just the right amount of spending. Hmm...methinks I should find ways to hedge my bets.

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