Raphael Stevens

IN 1989, AT the peak of Japan’s economic and financial heyday, few dared suggest the country might one day be supplanted as the richest large nation in Asia. Per person, South Korea was not even half as affluent. But then mighty stock and land bubbles popped in Tokyo, kick-starting several “lost” decades for the Land of the Rising Sun. Meanwhile South Korea’s economy boomed. By 2018 its GDP per person, adjusted for purchasing power, topped Japan’s.Similarities between the two economies extend beyond converging income levels. Both built their wealth during periods of export-led growth. Now South Korea’s working-age population is shrinking, as Japan’s did after the mid-1990s. Most uncanny are echoes between the financial risks which emerged in Japan in the late 1980s and those mounting in South Korea today. They, too, could trap Asia’s mightiest tiger in the doldrums for decades.Super-expensive houses have become a major issue in South Korea’s tight presidential election, which takes place on March 9th. The two front-runners—Lee Jae-myung, of the ruling Minjoo Party, and Yoon Seok-youl, of the centre-right People Power Party—have clashed over housing policy throughout the campaign.The outgoing government’s repeated efforts to rein in the property market, through tighter loan-to-value restrictions on mortgage-lending and steeper taxes on owners of multiple homes, have had little effect. Low interest rates and an ageing population seeking rental income as it nears retirement have proved stronger forces. In the Seoul metropolitan area, home to around half of South Korea’s 52m people, property prices have almost doubled in the past ten years.There is no specific threshold beyond which the value of all land in a country, relative to the size of its economy, suggests asset prices are unsustainable. But the ratio for South Korea is both high by international standards and relative to the country’s recent history. It now runs at five times its GDP, up from around four times in 2013. At the peak of Japan’s folly, the value of all land rose to 5.4 times GDP, before collapsing through the 1990s.Pricking South Korea’s apparent bubble would be less dangerous had liabilities not risen in tandem with asset values. South Korean people and firms have been borrowing at a frantic pace. In September last year the country’s household debt stood at 107% of its GDP, compared with 58% in Germany and 79% in America. Non-financial corporate debt runs to 114%, above the average for advanced economies.This, too, recalls 1980s Japan—and not in a good way. Richard Koo of the Nomura Research Institute in Tokyo warns of a possible “balance-sheet recession”. During Japan’s boom years, asset values and liabilities surged together. When its land-and-stock bubble burst, asset values crumbled, but borrowers still had the same liabilities to repay. That left them in a state of negative equity. As firms and households all rushed to deleverage, the economy shrunk. “Individually they were doing the right thing. Collectively they were destroying the economy,” says Mr Koo.In 2020 the IMF flagged that South Korea was only one accident away from a damaging balance-sheet recession. Although lending to subprime borrowers was limited, it noted that about half of South Korea’s household credit was either linked to floating interest rates or required large lump-sum repayments, meaning it would need to be refinanced at potentially higher interest rates. It also noted that the country’s many small- and mid-sized firms, dependent on shorter-term bank loans backed by property collateral, looked exposed.Has the dreaded accident arrived? South Korea was one of the first major economies to raise interest rates during the pandemic, and has now done so three times. Most analysts expect the tightening to continue: the central bank has said it is concerned about both rising inflation and the financial-stability risk posed by soaring asset values. Yet again, that has an 1980s flavour: Japan’s troubles began when the central bank started raising rates rapidly to pop the country’s asset bubble.The Bank of Korea’s policy of “leaning against the wind”, as Jeong Woo Park of Nomura calls it, is having snowballing effects that may be hard to stop. As a result of stricter credit controls introduced to cool down property prices, mortgage interest rates are accelerating faster than benchmark ones. After surging through pre-pandemic levels, they flirted with decade-highs in January.The parallel has limits. Japan’s financial institutions were famously poorly regulated, leaving policymakers constantly surprised by the level of damage done to the financial system as crises popped up repeatedly through the 1990s. South Korea’s unusual Jeonse credit system, through which households borrow to fund lump-sum rental payments, makes it difficult to assess how risky household debt truly is.But the scary similarities will continue to grow as South Korean politicians, central bankers and regulators endeavour to engineer a smooth end to the explosion in asset prices. They have the Japanese experience to learn from. But understanding the worst-case scenario may prove easier than avoiding it. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter.This article appeared in the Finance & economics section of the print edition under the headline “Kindred Seoul” More

EVEN BEFORE Russia invaded Ukraine, emerging markets were braced for a testing year. The conflict threatens to lengthen a list of woes that already included inflation, slowing growth, public finances strained by rising interest rates and lingering disruptions from covid-19. In a worst-case scenario, the fallout may even top all these concerns.The main transmission channel is unlikely to be Russia itself, whose economy is falling apart in the face of sanctions. Comparable in size to Australia’s or Brazil’s, the world’s 11th-largest economy is mid-weight and only loosely integrated with global supply chains. It is not a major market for exports. Steps taken by Western banks to reduce their exposure to Russia following its seizure of Crimea in 2014 also limit the risk of direct financial contagion. Instead the fallout for the emerging world will come in three indirect ways.The first channel is that of global liquidity conditions, which are tightening. Though the war does not seem to pose a serious financial-stability threat at the moment, markets have grown nervier. If worry were to give way to panic, the rush to obtain dollars could cause liquidity to dry up and markets to malfunction—recalling the breakdowns seen in the early months of the pandemic. Then it took huge interventions by America’s Federal Reserve and other central banks to prevent a global financial shock. And even with that mighty support, most emerging economies faced a rapid and painful adjustment as their currencies tumbled. A few were pushed into default.For now such disasters seem a distant possibility. The invasion has nonetheless prompted investors to flock to assets they deem the least risky. Stockmarkets across the emerging world have slipped since mid-February. Over the week following the beginning of the war, yields on German bunds and American Treasuries, traditional safe havens, have been down by as much as 0.3 percentage points. Slowly but steadily, the dollar is climbing. Some indicators of market strain have begun to increase, too, though not yet into crisis territory. The spread between the rate that rich-world banks charge each other for short-term unsecured loans and the overnight risk-free rate has risen. But the uptick is dwarfed by the spike observed during the wild gyrations of early 2020, to say nothing of the market madness seen during the global financial crisis.A flight to safety could raise the cost of borrowing across emerging markets and increase the burden of debt. Prices for hard-currency bonds issued by governments and firms have fallen over the past week, while the spread between the yield on emerging-market corporate bonds and that on Treasury bonds has jumped by about half a percentage point. That, too, is a modest rise relative to what markets experienced in the spring of 2020, when the spread leapt by four percentage points in the space of a month. But higher borrowing costs for governments and firms are less easily managed after two years of rising indebtedness. And even in the absence of default, dearer credit stands to crimp private investment and further limit governments’ fiscal room for manoeuvre.Adverse moves on markets could exacerbate the challenges caused by new macroeconomic headwinds—the second channel of contagion. In peacetime both Russia and Ukraine are big exporters of commodities, including oil and gas, precious and industrial metals, and agricultural products. Since mid-February prices for many of these have jumped. Oil prices are up by more than 25% over the past fortnight. The price of wheat has soared by more than 30%. Some emerging-market exporters stand to benefit from rising proceeds. For Gulf economies the surge in crude prices is an unexpected windfall.Yet even the biggest commodity exporters are likely to face difficulties when food and energy costs rise above already high levels, squeezing household budgets and putting monetary policymakers in a bind. Before the war a year-long campaign by Brazil’s central bank to rein in high inflation—in which it raised its benchmark interest rate by nearly nine percentage points—seemed to be bearing fruit. Now food and energy price shocks it can do little about threaten to spoil its fragile achievement. Turkey, where year-on-year inflation surged to nearly 50% in January, is in an even stickier spot. On March 1st the Turkish defence minister urged Russia to accept an immediate ceasefire. Large importers of wheat and sunflower oil across north Africa and the Middle East, most notably Egypt, may see the price of staples rocket, fuelling popular discontent.As these developments unfold a third force will operate in the background. Russian aggression, and the West’s shock-and-awe financial and economic response, represent another jolt to a global economy which over the past half-decade has weathered trade wars, a pandemic, supply-chain disruptions and an increasingly unpredictable policy environment. As firms and investors watch the carnage in eastern Europe, they may reassess how to price geopolitical risk in foreign markets. That could inflate country-risk premiums applied to far-flung assets, increasing the cost of funding for emerging markets and reducing investment volumes.In difficult times, the saying goes, global investors worry less about the return on capital than the return of it. Should many of them decide to pack up and go home, the war’s collateral damage will include that suffered by the emerging economies they leave behind. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter.This article appeared in the Finance & economics section of the print edition under the headline “Shock, stocks and barrels” More

RUSSIA MAY have tried to build a “fortress economy”, but it is the West that currently looks financially impervious. Compared with the deep economic crisis brought about in the country by Western sanctions, the consequences for the rich world have been small. Though American stocks fell sharply when the war started on February 24th, on March 2nd they closed almost 4% higher than their level the night before the invasion. European stocks are about 4% down—a big hit, but nothing compared with the financial rout under way in Russia, where the currency has collapsed and stockmarket trading has been suspended for days.In part the muted reaction reflects Russia’s low weight in the global economy: about 2% in dollar terms. The country’s relative poverty and smaller population when compared with the rest of Europe mean that its exporters depend on European demand but not vice versa. Goldman Sachs, a bank, estimates that the loss of exports caused by a 10% fall in Russian spending would cost the euro zone only about 0.1% of its GDP, and Britain still less. Financial links are modest.Yet Russia’s economic importance vastly outweighs its GDP or financial clout owing to its energy exports. It produces nearly a fifth of the world’s natural gas, and more than a tenth of the world’s oil, the price of which drives much of the short-term variation in global inflation. Typically 30-40% of the EU’s gas supply comes from Russia (though this has fallen to about 20% in recent months as Europe has increased its imports of LNG from America). It does not just heat Europe’s homes but also powers much of its industrial production. Among big economies Italy and Germany are particularly exposed.Energy prices increased dramatically on March 1st and 2nd. European natural-gas spot prices are now more than double their level at the start of February. So are futures prices for delivery in December 2022, reflecting in part the cancellation of the Nord Stream 2 pipeline from Russia to Germany, which had been hoped to ease supply this year. The oil price is up over 25% to about $115 per barrel. The energy squeeze will worsen Europe’s inflation problem while also hitting its growth. JPMorgan Chase, a bank, has raised its forecast for euro-area inflation at the end of the year by 1.1 percentage points, to 3.6%, while cutting its growth forecast for 2022 by 0.6 percentage points, to 4.1%. As a producer of oil and gas America is mostly insulated from the drag on growth, but will feel the inflationary effects of pricier oil.Things could get much worse should sanctions expand in scope to cover ener gy purchases or if Russia retaliates against them by reducing its exports. JPMorgan Chase projects that a sustained shut-off of the Russian oil supply might cause prices to rise to $150 per barrel, a level sufficient to knock 1.6% off global GDP while raising consumer prices by another 2%. The stagflationary shock would carry echoes of the Yom Kippur war of 1973, which sparked the first of the two energy crises of that decade. It greatly worsened an existing inflation problem caused in part by the collapse earlier that year of the Bretton Woods system of fixed exchange rates. Today much pricier energy would be layered atop the inflation caused by the pandemic and the associated stimulus.If the oil and gas keep flowing, the existing increases in their respective prices will still make life uncomfortable for central banks, who were anyway raising or preparing to raise interest rates. They usually tolerate inflation caused by expensive energy. It tends to quickly dissipate, or even go into reverse. But recently they have worried that the persistence of high inflation since last summer might lead companies to think they should continue to increase prices at a rapid pace and workers to continue to ask for higher wages. Inflation, in other words, may have taken on a momentum of its own. Further increases in energy prices can only heighten that danger—while adding to the squeeze on growth that higher interest rates bring about.At present markets are priced for a fairly conventional policy response. Since February 1st investors’ inflation expectations, as revealed by the price of swaps, have risen sharply at a one-year horizon for Britain, America and the euro zone. Yet expectations for longer-term inflation, as measured by long-dated forward swaps, have not changed much (see chart). Projections of the ECB’s policy rate at the end of the year have barely changed. Investors have priced in another quarter-of-a-percentage-point rise in interest rates this year in both Britain and America. On March 2nd Jerome Powell, chairman of the Federal reserve, indicated that it would still raise rates.There have, however, been sharp movements in bond yields at longer horizons. In mid-February yields on five-year German government bonds had been in positive territory for the first time since 2018. They have since fallen to about -0.25%. On March 1st and 2nd the yield on an American ten-year Treasury bond fell from nearly 2% to 1.7%, a greater fall than in any two-day trading period since March 2020, before recovering slightly to 1.9% the next day.In other words, investors are betting that today’s inflation, even once exacerbated by the war in Ukraine, will be temporary—and that over the long term interest rates are likely to be a bit lower than on past projections. But that hardly means markets are sanguine. In recent years some scholars have argued that low long-term real interest rates reflect in part the impulse to hoard safe assets as tail risks—rare but highly costly events—grow more likely. After two years of a pandemic and with war raging in Europe, that thesis has never seemed so apposite. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter.This article appeared in the Finance & economics section of the print edition under the headline “The world economy at war” More

FOLLOWING RUSSIA’S invasion of Ukraine, an economic war has begun. The West has imposed unprecedented sanctions. Investors are dumping Russian assets as fast as they can. So far this year the rouble has lost one-third of its value. The government may soon default. Capital Economics, a consultancy, expects Russian inflation to hit 15% before long, with GDP falling by 5% this year.The ructions in Russia’s markets have taken many by surprise. For years President Vladimir Putin had, apparently successfully, built up Russia’s economic defences, such that it would easily be able to resist whatever Western governments threw at it—what Timothy Ash of BlueBay Asset Management dubbed the “Fortress Russia” strategy. It turns out that the strategy has been a failure. “From Fortress Russia to Rubble Russia in a week,” says Mr Ash.Fortress Russia was a product of Russia’s chaotic recent history. Following the dissolution of the Soviet Union in 1991 inflation exceeded 2,000%. In 1998 Russia defaulted, causing the value of the rouble to fall by more than two-thirds. Then in 2014 a collapse in oil prices, plus international sanctions over Russia’s actions in Crimea and the Donbas, sent the economy into a deep recession.As Fiona Hill and Clifford Gaddy show in “Mr Putin: Operative in the Kremlin”, a book published in 2015, the Russian president has long wished that his country could be self-reliant. Since 2014, however, that ideology has gone into overdrive, with Mr Putin desperate to ensure that the West could never again exert economic control over his country.The idea for Fortress Russia went something like this. On the economic front, Russia would diversify its economy away from oil and gas, two volatile commodities. It would lessen its dependence on Western technology and trade. On the financial front, it would reduce external debt. It would practise tight fiscal and monetary policy, allowing it to accumulate vast amounts of foreign exchange with which it would be able to defend the rouble, or that it would channel to favoured companies, at times of crisis.There have been some successes. Take the economy first. Russia is somewhat less dependent on hydrocarbons. In 2019 oil profits accounted for about 9% of GDP, down from around 15% when Mr Putin took office. Oligarchs remain exceptionally powerful, controlling a huge share of overall Russian wealth, but their influence appears to have stopped growing. Between 2000 and 2019 Russia’s services industry grew by seven percentage points of GDP, even if productivity growth in most sectors has been pitiful.In some areas Russia has developed technologies which operate independently of Western ones. Mir, a Russian payments system, accounted for a quarter of domestic card transactions in 2020, up from nothing five years ago. The share of Russian imports classed as “high-tech” seems to be falling fast, World Bank data suggest. In the past decade European exports of whizzy products to Russia have stagnated, while growing elsewhere.But the fortress walls have gaping holes. Russia remains enmeshed in the supply chain of Western ideas and technologies. According to our analysis of bilateral data on stocks of long-term investment (control of companies, say, or the construction of new factories), the Russian economy is somewhat more reliant on the West than it was a decade ago. About 30% of Russian imports come from G7 countries, hardly different from 2014. In some industries, such as chipmaking and computers, Russia remains wholly dependent on American parts. The cards of some Russian banks under sanction no longer work with Apple Pay or Google Pay, which on February 28th caused chaos on the Moscow metro as people could not get through the turnstiles.The chaos in Russia’s financial markets has been an even bigger surprise. After all, by 2022 Russia had $630bn-worth of international reserves (around 40% of GDP), the most ever, and had diversified away from American dollars. It had also greatly reduced its foreign-denominated debt owed to foreigners since 2014.But the country remains dependent on foreign investors. Their short-term asset holdings (including bank loans and stocks), relative to GDP, are about as high in Russia as they are in other emerging markets—and they have remained steady since 2014. Even without sanctions, Russian assets would be under huge pressure as investors run for the exits.And Russia always assumed that it would be able to access foreign exchange to defend the rouble. It is not completely cut off: Russia’s energy exports have largely escaped Western bans, so it still has some dollars flowing in. But, because of sanctions, 65% of Russia’s reserves may in effect be worth $0. The other 35%, held in gold and yuan, cannot be used to defend the currency in the dollar and euro markets.Russia’s difficulties will only compound over time. Being shut out of the SWIFT financial-transfer system will hurt trade; SPFS, a Russian-backed rival, remains far less popular. Russia still needs dollars to pay for a third of its imports, a problem when it has suddenly become harder to get hold of them. Even in its imports from China, where progress has been made on “de-dollarisation”, around 60% of transactions still take place using the greenback.A test from GodThe question is whether Mr Putin really cares about all this. He may not welcome the prospect of angry oligarchs, should some of them indeed dare to raise their voice. But, according to Ms Hill and Mr Gaddy’s book, a core tenet of Putinism is survivalism, where one sees economic warfare as a test of strength. The pain is the point. “In this narrative, Russia constantly battles for survival against a hostile outside world,” they say. “The one critical lesson from history is that Russia, the state, always survives in one form or another.” Russia faces a deep recession. But rather than relent, Mr Putin may double down on his attempts to cut Russia off from the outside world. ■Read more from Free Exchange, our column on economics:How to avoid a fatal backlash against globalisation (Feb 26th)A new history of sanctions has unsettling lessons for today (Feb 19th)The promise of former eastern-bloc economies is mostly unfulfilled (Feb 12th)For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter.This article appeared in the Finance & economics section of the print edition under the headline “From fortress to rubble” More

Billionaire investor Bill Gross listens during the Milken Institute Global Conference in Beverly Hills, California, U.S., May 3, 2017.
Lucy Nicholson | Reuters

Bill Gross, the one-time so-called bond king who co-founded fixed income giant Pimco, said he sees the possibility of stagflation in the economy and he wouldn’t buy stocks aggressively now.
The 77-year-old investor believes that although the Federal Reserve is aiming to combat surging inflationary pressures, it also fears that too many rate hikes could put too much downward pressure on asset prices, causing turmoil in financial markets.

“I think they’re sort of handcuffed in terms of what they can do, they went so low. And inflation now is so high on a historical basis that it’s going to be difficult raising interest rates too much,” Gross said Thursday on CNBC’s “Worldwide Exchange” in an interview with Brian Sullivan.
“And I say that simply from the standpoint of a realistic assumption that the stock market was driven, in part, perhaps 30% to 40%, by lower interest rates, and especially lower real interest rates. And to the extent that you now raise them even by 50, to 100 to 150 basis points … there’s a significant impact on financial assets, stocks especially, because the interest rate discount, the forward stream of earnings. So I think they have to be very careful,” he said.
If global central banks are stuck in a low interest rate world, that could result in persistent inflation combined with a global economic slowdown, an environment dubbed stagflation, Gross said.
“It perhaps means stagflation. And, you know, inflation above 3% to 4% for some time now,” he said.
Consumer prices increased 7.5% from a year ago in January, and the Fed’s preferred inflation gauge showed its biggest 12-month increase since 1983.

Fed Chairman Jerome Powell said Wednesday that he still sees a series of quarter-percentage point increases coming, but noted the Russia-Ukraine war has injected uncertainty into the outlook.
Markets have fully priced in a rate increase at the March 15-16 meeting but have decreased expectations for the rest of the year since the Ukraine conflict began, according to CME Group data.
Traders are now pricing in five quarter-percentage point increases that would take the benchmark federal funds rate from its current range of 0%-0.25% to 1.25%-1.5%.
Gross said he chooses to be a cautious stock picker, adding that he holds interests in oil pipelines, partnerships that are tax-free.
“I wouldn’t be a buyer of stocks here. I’d simply be a cautious investor,” Gross said. “There are ways around this in terms of earning a decent return without buying stocks and taking that outright risk, or selling bonds, which we found in the last few weeks involves significant risk as well.”
Gross on Thursday released his memoir “I’m Still Standing: Bond King Bill Gross and the PIMCO Express.” The investor managed Pimco’s Total Return Fund before leaving to join Janus Henderson in 2014.

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