In Kim's words:
I want to thank the Bank of Korea and the Governor Kim for inviting me to this conference. It is a distinct honor to participate in and learn from a very timely and important discussion on the topic of Central Bank’s roles in the credit market. As a regulatory agent in a non-reserve currency country, this topic is important to me and the Korean economy. I hope the presentations and discussions here will bring some direction, opportunities and risk-assessment for the expanding role of central banks from around the world.
One of my favorite TV shows when I was studying in the States was Star Trek. I am probably carbon dating myself by admitting this fact. But I do recall enjoying the “cutting-edge” si-fi at that time. At the intro of each episode, Captain Kirk starts the show by saying “to boldly go where no man has gone before”. In some ways, I feel like this comment fittingly describes current state of global economy and markets. Over the past 10 years, governments and central banks around the world have engaged in very “unorthodox” policies to “save” the global economy and markets. From my vantage point, the jury is still out on how all these complex alphabet soup of emergency policies (TARP, QE1,2,3, LTRO etc) will work themselves out and how it will shape the economic and financial markets for the generations to come. The uncertainty and questions come from the fact that the global policy makers have not done what we are doing now, certainly not at this scale. It looks like the global economy is headed where it has not gone before. This is the challenge we face today.
In a way, I see many countries around the world exhausting both fiscal and monetary tools to “fix” their economy. One casual observation is that many are treating the current set of problems as a classic supply-demand imbalance driven growth-deficiency cycle. In other words, the remedies adopted by both fiscal and monetary policies are suited for an “income statement” cycle. What I do sense from my perspective is that the current global cycle is not an “income statement” cycle. It is a classic “balance sheet cycle”. The only difference is that it is BIG and it links either directly or indirectly, all corners of the global economy and markets. We can try to discuss and identify “how did we get here?” I am afraid this is probably a topic for another conference… However, the reason why I am trying to make a distinction between and an income statement or a balance sheet cycle is that the policy remedies and the effectiveness of them will be different depending on which “cycle” we are experiencing.
Korea too had a major cycle not too long ago. In 1997, Korea faced a major financial crisis. We identified early that it is a balance sheet cycle and adopted policy remedy accordingly. We cleaned up bad assets, recapitalized the banking system, and adopted new sets of policies to prevent repeat of such situations. Korea was fortunate enough to recover from the financial crisis faster and in my humble opinion is now stronger. In looking back, what if we did not do this but just have the Bank of Korea lower interest rate to zero. Meaning, how would Korea’s recovery looked if we treated it as a classic income statement recession. Would zero interest rate have fixed the problem? That probably made it easier for some to recover but it would not have fix the primary structural problem—inability for the banking system to lend as long as it is fighting a NPL cycle, no matter how low the interest rates get. Some call this a liquidity trap. Many OECD countries are reporting record low post WWII money velocity figures. This diminishing marginal effectiveness of incremental additional liquidity should be an early warning sign that 5-years after the major market cycle, we are still fighting a balance sheet crisis. This should be an important recognition as we discuss merits of additional and new measures.
As I mentioned earlier, we are now becoming experts on unorthodox monetary policies around the world. In general, at the global central bank meetings, I hope we do not start something like 300% Club. Meaning there is an exclusive club whose membership invitation only goes out to the central bank whose balance sheet increased by 300% over the past few years. Or a $5 trillion club… Sorry this is my poor attempt at humor. In all seriousness, the pace of central banks’ balance sheet expansion has been fast and furious. I think we should pause and think about what this accomplished.
One benefit of being a regulator is that I can say things without writing an extensive research paper. So here is my two cents worth on what the unorthodox monetary policies around the world accomplished over the past few years. First, for the reserve currency countries, it bought time. What the Fed did not do earlier this month says that the economy is still fragile and not being able to digest the impact of an exit. What if this “zero” interest rate policy becomes a permanent feature for the reserve currencies? It may continue to buy time and prevent its economy from slowing but collateral damage for the financial market bubble and economic bubble for the non-reserve currency countries will be quiet damaging. What we have not done is to discuss the true costs of such unorthodox monetary policy measures. This “avoid pain at all cost” logic can cause some collateral damage—in some cases, I can see moral hazard and market imbalance as some side-effects of such aggressive central bank actions.
Also, what I have seen lately is central banks getting more directly involved with credit formation. Over the past few years, central banks have been setting cost of credit artificially as a temporary stop-gap measure. As what started as a short-term measure becomes permanent feature, I see central banks expanding its role and getting directly involved in credit creation. In many cases, I see this development when the fiscal policy gets maxed out. It looks as though, we now have central banks expanding its role as an extension of a fiscal policy.
I personally do not have problems for the central bank’s involvement in credit formation, especially if the government’s balance sheet is sound and has room to expand. Whatever is the setup, I believe that the central bank initiated credit formation should not be done independently. Since, it will impact the overall economy and markets. As such, this type of activity should be treated like a credit or resource allocation. It should be conducted in discussion as a part of economy wide credit and resource allocation.
In the current challenging environment, we are faced with challenges that we have not experienced. As the global community navigates this turbulent water, what I hope for is for each country to think about the implications of their actions to others around the world. In some ways, countries like Korea, medium-sized non reserve currency country, challenges are immense. We can only play defense but playing defense only is not a popular strategy at home.
I hope that there could be more of these types of open discussions and sharing of what we are thinking and doing. At the end of the day, we are now all in this turbulent water together. We need to share and figure the solution out together.
It was my general comment on the issue so far. And if you need more detailed information, please refer to the additional technical note separately prepared in the back of the room.
Once again, thank you for this opportunity to share my views and thoughts.
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