[보도] Korea’s Fight Against Record Oil Prices and Weak Dollar

The world has long enjoyed a Goldilocks economy ― an economy that is not so hot that it causes inflation, and not so cold that it causes a recession ― since 2003 before eventually hitting a snag in the second half of 2007, disturbed by oil price spikes and a meltdown in the global financial market. Departing from the golden days, many nations are now apparently heading toward a slowdown or even a recession in the face of greater inflation risks pressured by record oil prices and an unusual credit crunch in the global financial market.

Global Economy Going Downhill

International oil prices have surged more than 50 percent since the beginning of last year. The average monthly price of Dubai crude oil which accounted for 82 percent of Korea's oil imports surged to $77 in October from $52 in January. Oil prices continued the speedy run-up to break $100 per barrel earlier this year.

The latest breakdown of the global financial markets had been already predicted since 2006. There was a warning that a series of interest rate hikes would cause a slump in the U.S. housing market and the spiral growth in the subprime mortgage loans would lead to financial woes. Some even alerted the risky investment asset would trigger a credit crisis. In the end, the delinquency ratio of the subprime mortgage loans surged to 14 percent by December 2006. New Century Financial, the U.S.' second largest subprime lender, filed for bankruptcy in April, 2007. The tragedy then quickly sprawled into the well-established financial companies. Big names in the global financial markets, such as Bearsterns, BNP Paribas and Goldman Sachs, raised the specter of a credit crisis with actions to liquidate mortgage-backed funds or suspend redemptions. As a result, stock markets around the world have been on one of the most terrifying roller-coasters and the U.S., the epicenter of the subprime mortgage crisis, has seen the value of its currency plummeting.

The economic woes arising from a weak dollar and high oil prices are unlikely to end in the near future. The U.S. is facing a bleak economic outlook, with the financial markets reeling from a serious slump in the housing market and the fallout of the subprime mortgage loan crisis on the banking sector. The crisis forced the U.S. Federal Reserve to slash its benchmark interest rates by 50 basis points in September and by another 25 basis points in October. After the rate cuts, the dollar plunged against other major global currencies, with the euro hitting a record high of 1.47 per dollar on Nov. 9. Recently, Morgan Stanley, Citigroup and Bank of America announced billions of dollars in write-offs related to the subprime loan losses, highlighting the intensity of the credit market troubles. The U.S. central bank may have to undercut its interest rates at least two more times until the first half of next year in order to relieve the financial market's credit squeeze and avert a hard-landing of the world's largest economy. The additional rate reductions will then put more downward pressures on the US currency.

Oil prices seem to be gearing up for a peak of $100 per barrel. If the global economy starts to stagnate due to high oil prices and subprime mortgage loan crisis, then oil prices may turn lower. But unlike the first and second oil shocks in the 1970s and 1980s, oil prices spiked this time because demand grew faster than supply. Oil consumption surged on strong demand from the fast-growing economies including China and India while supply remained under control due to the limited capacity at oil producing facilities and refineries. Moreover a weak U.S. dollar sparked speculation-driven investment, with global hedge funds hoarding oil, grain and other raw materials. Given the tendency, international prices of major raw materials are expected to stay at the current high levels or even rise further. According to a study, the enormous speculative investment contributed the oil price hikes by about $20. If geopolitical risks in the Middle East or other oil producing countries emerge or escalate, then oil prices will continue to surpass the $100 mark.

Gas stations engage in fierce competition to attract motorists amid soaring oil prices. The photo shows gas stations along the Freedom Road leading up to Ilsan, Gyeonggi Province, putting up billboards advertising cheap prices. / Yonhap

Impact of High Oil Prices

Korea has sustained a solid economic growth through 2007 even in the face of high oil prices and the dollar's setback against the Korean won. The GDP growth rate hit a bottom of 4 percent in the first quarter and then accelerated to 5.2 percent in the third quarter, a pace faster than the nation's growth potential, backed by a revival in consumption and investment and robust export performance. Consumer prices rose by a well-tamed level of 2.3 percent during 1st and 3rd quarters compared to the same periods of last year. According to an official data by the National Statistical Office, consumers' view on the current economic conditions and their outlook on the economy for the six months ahead improved in October from a month ago, although oil prices hit a fresh record almost everyday and global financial markets spiraled out of control due to the uncertainty over when the credit crisis would come to an end. Then can we say the Korean economy is safe from high oil prices and a weak dollar?

Unfortunately, the latest economic indicators began to reflect the fallout from the high oil prices and a weak dollar. Consumer price index for October jumped 3 percent from a year earlier. The CPI is expected to accelerate beyond 3 percent in the fourth quarter and well into the first half of next year. Exports showed a steady growth but lost much steam by slowing down to 9.6 percent in the third quarter from the first half's average of 14.4 percent, with the won surging against the greenback to sap local exporters' price competitiveness in the global market.

Exports, a long-time major growth engine, will likely decelerate as much as to undercut the economy's growth potential since the dollar is expected to stay weak and the global economy will run into recession. The recent collapse of the Korean shares sparked by a turbulent global financial market will likely dampen the domestic demand, especially private consumption in the near future. The private consumption enjoyed a rapid recovery since the first quarter, partly driven by the stock market's rally.

A Path Through Crisis

If no one can stop the oil prices' rally and the dollar's slide, it is well expected that the Korean economy will undergo unusually high inflationary pressures, a bearish stock market, a sluggish domestic consumption, a slowdown in exports, and an economic recession. In order to overcome this crisis and avert a depression, a series of short- and long-term countermeasures must be devised. As a short-term measure, the government should take an action to facilitate the efficient use of energy, restrict the demand for oil, and minimize the pressure of the cost push inflation arising from oil price hikes by keeping public fares under tight control. At the corporate side, exporters need to upgrade the quality of their products and technology edge by heavily investing in research and development activities and secure a more stable profit base by hedging against foreign exchange risks in order to compensate for the profitability squeeze due to the won's appreciation.

The U.S. dollar is expected to stay under heavy downhill pressure for a while as the world's largest economy already tattered by chronic problems of the twin deficits is now facing a threat of rising delinquency by household borrowers and a financial market meltdown in the wake of widespread fallout of the subprime loan crisis. Furthermore, a number of governments around the world have moved to adjust the portfolio of their foreign exchange reserves and reduce their dollar-denominated assets while oil producing countries, including Iran, have attempted to allow non-U.S. currencies for the settlement of oil transaction. The world economy may be entering into an era of inflation as prices of raw materials including oil and grains are expected to stay at the current record levels or even rising further, given the strong speculative demand to capitalize on a weak dollar and the steady demand from the emerging markets, including India and China, which will likely sustain a fast growth in the years ahead. Therefore, the long-term counteractions for Korea against the adverse global economic conditions are to minimize the inflationary pressures by boosting the economy's supply capacity through a steady economic growth.

In order to beef up the economy's supply capacity, Korea needs to develop a number of new growth engines, which should include new energy regeneration business. The new industry is critical not only for the expansion of the growth potential but also for the reduction of the economy's susceptibility to the fluctuations in global energy prices due to the heavy reliance on overseas suppliers. An increase in bio-energy agricultural products and price hikes in international grains resulting from higher oil prices will likely contribute to streamlining Korea's agriculture industry and improving the standards of living for the poor farmers. A further developed agriculture will mitigate the political and economic backlashes caused by the market opening in the wake of the free trade pacts with the U.S. and other major trading partners.

The financial industry needs a strategy to expand the size of the local capital market. The government also needs to reinforce the financial supervisory functions to minimize the possible fallout of global financial shock on the local financial and other sectors. Another urgent task is to encourage more aggressive entry by local financial institutions into overseas markets. Further instability in the global financial market could mean more attractive opportunities for local financial companies to purchase foreign rivals and increase their global presence.

This article was carried on the Web site of the Center for Free Enterprise based in Seoul.