The Incredible Shrinking Won…

It’s no secret that the won’s value is falling like it’s going out of style. It seemed as if the bottom fell out last Thursday, where during the trading day the won dipped as low as 1,484.90 per dollar, the lowest level since the Asian financial crisis of 1998, before finally rebounding to close at 1,383.30. The one month tally? A drop of over 25% from 1,101.3 to 1,385.0

So what the hell is going on? Well, for starters, there are a number of internal structural problems that are coming home to roost that have combined with more international financial “shocks.” Well the simplest answer for the most recent fall has been the weakening international economy creating increased uncertainty that is causing investors to flock to currencies deemed more stable (i.e. the dollar and the yen) and leaving currencies deemed more “risky” or from “emerging” markets. Yes, despite what the FTSE says, Korea is still seen as more of an “emerging” economy by many investors.

Believe it or not, even if the U.S. appears to be the nexus of the financial crisis, paradoxically, the dollar goes up in value. Like I said, the U.S. economy is like the skinny hot chick who can eat whatever she wants and not gain weight. So, the dollar goes up, the yen goes up (also seen as a safe currency), the Euro stays respectable but most other currencies (including the won) fall relative to the dollar, yen and Euro.

So that explains why the won may have gone from 1,200 or so to 1,400, but what explains the drop from 1,000 to 1,200? The simple fact of the matter is that Koreans are too fond of exchanging their won for other currencies (as evidenced by the current account deficit). Clearly, foreigners won’t sell you shit unless you convert your currency to their currency. But if you do this too much, you are essentially flooding the global market with won. The more won outside of Korea, the less demand there is for it and it’s only natural that the value of the won declines. Won for overseas capital products, won for overseas raw materials and won for overseas subcomponents, travel, etc. Korea’s inordinate appetite for overseas items means that they must flood the international currency exchange markets with won, making it overly plentiful. This naturally makes the won decline in value.

The decline from 900 to 1,000 is likely the responsibility of the BOK itself. 900 won to a dollar is a little on the high side for a nation that depends on exporting a lot of product. About 1,000 won to a dollar is more comfortable. However, the BOK never foresaw, in early 2008, that there would be a looming financial crisis, a strengthening dollar and a chronic current account deficit all at the same time. They thought they could control the decline in the won. Boy were they wrong!

So, where does this all leave us? Not in good shape I’m afraid. The greatest cause of economic crisis in Korea in 1998 was short term debts, which are notes that need to be paid (or at least refinanced) within a year and can sometimes be called by banks immediately. Back in 1998, as the won fell like a meteor, foreign banks called in their short term debts. With no money to pay the banks back, Korea had to take a painful loan from the IMF to avoid total economic collapse. Well sadly, today Korea finds itself in a somewhat similar position.

Korea has huge amounts of short term debt. It was fine at the end of 2007, at around $160 billion. Korea had $260 billion of foreign currency reserves. It could pay all its short term debts and still have $100 billion left over. Today? It has $242 billion of foreign currency reserves but its short term debt has ballooned to $260 billion. This means that Korea doesn’t have enough money to cover the spread of all the foreign banks called in their loans. In most situations, banks won’t call in their loans all at once, but having enough cash on hand helps foreign banks feel more comfortable regarding your ability to make good on your obligations.  Short-term debts got this out of control because Korean companies, through banks, were using them to buy futures to hedge against the rise in oil and other commodity prices.

Yes, many of you people with relatives outside the states find the shrinking won really annoying. But the declining won has greater consequences than that. It’s essentially putting Korea in a potential liquidity crisis. A crisis as bad as 1998? Well no. The main thing that’s missing today is contagion, or the wildfire-like spreading of bad economic events making nations fall like dominoes. Yes, there is stress in the system, but there is no collapse. As long as the world’s economies can avoid a financial melt down, a pure economic crisis in Korea will likely be avoided. However, if things do get bad, Korea may need to swallow its pride in order to save its economy from falling apart.

As it is, the Korean economy can’t handle much more decline in the value of its currency. What’s the tipping point? How far will it go? That’s hard to say. A lot depends on how the international economy does. If the worldwide economy faces a slow decline, lending is freed-up and there is no significant crashes (i.e. Iceland doesn’t count) the won can be 1,500 and Korea will be o.k. Some experts think that 1,400 is about as low as it will go.  If there is a worldwide melt down, the won better be 1,000 to 1,050 otherwise it will be déjà vu all over again 1998 style.