Excess in global liquidity boosting stock prices
Bubble in global economy? As stock prices in major industrialized nations rise amid the excess in global liquidity, compelling arguments have emerged regarding the possibility that a global economic bubble has formed. Al-though the surging stock prices in the U.S. and Germany since 1995 are largely due to improvements in their real economies, excess liquidity has no doubt played an important role.
The liquidity trends in the U.S. and Europe show that Marshall K has been rising since 1995. Marshall K refers to the ratio between total liquidity (M3) and gross domestic product (GDP). An increase in this ratio means that liquidity is expanding more than the scale of the real economy. The excess global liquidity has resulted in the significant escalation of the value of assets, especially stocks, of major industrialized nations.
Unlike the continued swelling of stock prices in the U.S. and Europe, stock price fluctuations in nations plagued with foreign exchange crises can be explained by limiting the concept of global liquidity to trends in the U.S. dollar. Shifts in the global dollar supply translate into shifts in global liquidity. In this regard, events that occurred in September 1998 provoked a major turning point. During that period, the U.S. Federal Reserve Board (FRB) increased the dollar supply in order to counter the effects of economic crises in Russia and Latin America as well as the potential bankruptcy of long-term funds.
This raise in the global dollar supply, which ultimately linked stock movements throughout the world, has led some to argue that a worldwide bubble economy now exists and that once it bursts, a global depression will ensue. Others oppose the notion, saying that the increase in stock prices is the result of increased productivity. In either case, the FRB's action played a major role in modifying stock markets around the world.
Stock markets linked with dollar supply An interesting fact is that movements in the global dollar supply closely correlate with the movement of Korean stock prices. Moreover, stock prices in Asia and Latin America, which received economic bailout packages from the International Monetary Fund (IMF), along with those in the Middle East, Africa and Europe, have all moved in similar directions with changes in the global dollar supply. For instance, after reaching a low point in August 1998, global stock prices rose sharply, exhibiting a V shape configuration. Prior to August 1998, Korean stock prices had spiraled downward as the dollar supply plummeted from mid-1997, when the foreign exchange crisis was its worst. However, as the global dollar supply expanded, the Korea Composite Stock Price Index (KOSPI) recovered until July 1999, immediately before the Daewoo crisis. These occurrences reinforce the opinion that currently, global stock prices tend to move in tandem with the global monetary supply.
Dollar vs. yen A larger global dollar supply also affects the Japanese yen. That is, when the supply of dollars rises, its value becomes weaker. When the dollar supply surged during the periods of 1985-1986, 1990-1991 and 1998-1999, the yen was usually strong. Despite the yen's weakness this year compared to the 1985-1986 period, its strength is expected to reach a 13-year high. As the yen maintains its strength, international rates remain low due to low inflation.
Global capital flows Since the economic crises in Russia and Latin America began, capital in international financial markets has moved from the U.S. to Japan and then Europe. The U.S. invested a total of 3.7 trillion yen in the Japanese stock market from October 1998 to July 1999, a threefold increase from the annual average of 1.30 trillion yen invested since 1995, while Japan's investments in the European bond market increased two-fold from a yearly average of 3.79 trillion yen since 1995 to 7.75 trillion yen for the same period. However, Japan has retrieved 6.37 trillion yen worth of its bond investments in the U.S., while European nations have recovered $36.8 billion of their U.S. Treasury Bond investments. Capital inflow to Japan during this period was limited only to the stock market as Japan's real interest rate was at zero. Capital flowing into Europe was concentrated only on the bond markets. As greenbacks continue to flow into Japan and Europe, the dollar becomes weaker in these economies, causing a potential influx of hot money, which aims to make gains from foreign exchange rate fluctuations.
Capital flowing into Japan from the U.S. will likely have a significant impact on Asia, especially Korea. With the close link between the Japanese and Korean economies, capital inflows to Japan and the resulting strengthening of the yen are projected to have a positive effect on the Korean economy. As more capital enters Japan amid a stable yen, a portion of the capital is anticipated to enter Korea, enlarging the foreign presence in the local stock market. Moreover, given that the won/dollar rate is projected to drop to the 1,100-point level next year, the possibility of hot money entering Korea is great.
Korea's broadening reserve base Korea's money supply has broadened since last year in line with restructuring measures enforced in corporate and financial sectors. Officially, more than 51 trillion won in public funds has been injected into the economy, causing a significant rise in the reserve base. The reserve base further increased as Korea recorded gains of $24.3 billion, or 25 trillion won, by September in terms of its current account surplus, increased stock investments by foreigners and rising direct foreign investments.
A larger reserve base translates into a higher KOSPI, which ultimately leads to a more liquid market. Given that financial institutions will suffer 31 trillion won worth in losses under Daewoo's workout plans, an additional 20 trillion won in public funds is expected to be injected into these institutions. Also, public funds will be provided to the six life insurance companies exposed to Daewoo losses. Furthermore, in preparation for the massive redemption of Daewoo-exposed bonds owned by investment trust companies (ITCs), the government has decided to purchase an unlimited amount of bonds through the Bond Market Stabilization Fund, the Korea Asset Management Co. and the Bank of Korea. All of these measures will likely inflate liquidity exponentially since they all cause the reserve base to expand. Thus, efforts made to cover Daewoo's debt problems are projected to increase Korea's reserve base, which in turn will lead to a rise in liquidity.
Although the economy is recovering rapidly, Korea is still in the process of recovering from the IMF crisis. As the money supply currently outweighs the growth of the real economy, excess liquidity is anticipated. Consequently, the stock market is projected to mirror its performance during the late 1980s, when liquidity was at an all-time high. Though the economy has graduated from the initial recovery stage and is on the road to expansion, the most important factor of continued growth in the stock market will be excess liquidity, not the improved performance of corporations.
The writer is an economist at LG Investment & Securities. - Ed.
From Korean Newspaper
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