Controversial as it might be in some economic circles, South Korea’s new central bank governor, Kim Choong Soo, sees nothing wrong with countries stockpiling high levels of foreign currency reserves. After all, a stash of reserves — along with accessing foreign currency liquidity through central bank swaps — certainly helped his country weather the recent economic downturn, he told an audience at Wharton’s recent Global Alumni Forum in Seoul. Kim now sees setting up a more formal “financial safety net” as a priority for the months ahead. “As the country now chairing the G20, advocating principles of liberalization and openness, Korea will do its utmost to ensure that discussions concerning the global financial safety net achieve specific and tangible outcomes,” he said.
Kim is no stranger to controversy. When the country’s president, Lee Myung Bak, appointed his former economic adviser to be head of the central bank for a four-year term starting in April, many of the government’s critics cried foul. Their concern: The appointment of such a close ally to Lee could compromise the independence of the central bank — a hot topic of broader concern among central bankers around the world, as U.S. Federal Reserve chairman Ben Bernanke recently observed in Tokyo.
In this interview with Knowledge at Wharton, Governor Kim discussed his views on central bankers’ independence as well as leadership strengths and weaknesses during the global financial turmoil and the hotly debated reforms he said the international foreign reserve system so sorely needs.
An edited transcript of the conversation appears below.
Knowledge at Wharton: There has been a lot of talk around the world about the independence of central banks and whether they can be free of political meddling. U.S. Federal Reserve chairman Ben Bernanke said at a recent conference in Tokyo that central bankers must be allowed to make policies “based on what is good for the economy in the longer run, independent of short-term political considerations…. Gains [from politically motivated decisions] may be popular at first, and thus helpful in an election campaign, but they are not sustainable and soon evaporate.” What are your views?
Kim Choong Soo: Regarding that issue, I’m in full agreement with what was said. Central banks’ decisions should be fully independent of political influences. There is no question about that.
Knowledge at Wharton: Over the past 18 months, what have South Korea’s policy makers and institutions done well in comparison to the Asian financial crisis in the late 1990s?
Kim: We did well because we experienced the financial crisis 13 years ago, which was a very harsh, severe crisis. Then, it was more of an Asian than a Korean crisis, but we were hit more than other countries. We overcame the crisis with the help of the [$57 billion] financial rescue package of the International Monetary Fund (IMF). Without it, we wouldn’t have been able to overcome the crisis because it helped us restore the confidence of the markets. But the key is that we — as in the Korean government and people — made an effort during the crisis to initiate our own reforms. That is the difference between Korea and other countries that experienced the crisis at the same time and other crises in emerging economies, such as Latin America.
Korea excelled in the late 1990s where others didn’t because we overcame the difficulties very fast and very soundly. How did we do it? The IMF proposed the program — we call it the conditionality reform program [which included, among other things, privatizations and the liberalization of foreign capital movement]. But with political leadership and the support of the people, we made it our own. I hesitate to refer to other countries specifically. But in the case of Korea, all economic agents — the government and the private sector — cooperated. So when the crisis hit, the public sector as well as the private sector cut wages and no one demonstrated against it. We all agreed.
The same was true in the current crisis after the collapse of Lehman Brothers. The first thing everybody did was cut wages. You didn’t see this happening in other countries… Korea was hit much harder than other countries — in the fourth quarter of 2008, the direct effect of Lehman on us was trivial, but our economic growth rate decreased by 16.8% on an annualized basis, which was a surprise to everyone. One of the reasons we were hit is that Korea’s capital market is very much open, much more than other emerging economies. There’s not as much regulation, and foreign capital can flow in and out, almost to the same degree as advanced economies. The market opening took place right after the Asian financial crisis.
As you may know, I served as the chief negotiator for Korea’s membership to the Organisation for Economic Co-operation and Development (OECD) in the mid-1990s. We had reservations about the capital movement. Korea and the OECD were not quite sure about the ability of Korea to cope with such rapid liberalization and market opening. But after 1997 and 1998, our government decided to liberalize further. We overcame the crisis in 1997 and today without introducing many protective measures. Usually, when a country is hit by a crisis, the first thing [its leaders] think of is introducing protective measures. You may wonder what those measures are, but if you look at the economy [in the U.S.], you know what I mean.
Knowledge at Wharton: During your speech at the Wharton forum, you mentioned that around $27 billion of liquidity was injected into Korea’s economy through its foreign-exchange reserves and the proceeds of currency swaps between October 2008 and February 2009. You also mentioned that Korea wants to put proposals for a “global financial safety net” on the agenda at the G20 meeting in Seoul later this year. Such measures, you have said, could reduce the need for countries to hold large amounts of foreign reserves. Could you explain more about that and what you want to achieve?
Kim: The background is quite simple. You and I can talk about the global current-account imbalances in the U.S. and China, and some emerging markets have reported surpluses. There are other countries that have accumulated foreign-exchange reserves, [so that] one party may start blaming the other [for using reserves as a form of currency manipulation, for example] and talk about the moral hazard [of keeping a stash of cash that a government uses as “free money” to finance projects promoting state interests].
But we need to understand why some countries, particularly emerging economies, have accumulated excessive levels of foreign reserves — “excessive” may be a matter of judgment, but anyway. Why? Because they want some form of insurance to protect their countries from a financial crisis. That is the safety net. There is a tradeoff between the moral hazard and a safety net.
We want a safety net as a sort of self-insurance. The insurance is an accumulation of foreign reserves. If you don’t have self-insurance, it is likely that the [current account] imbalance will be larger. [Some countries say there is already a safety net with] the IMF, which provides flexible credit lines. But emerging economies say, “No, that is not a true safety net.” Why? If you receive anything from the IMF, your [credit] ratings are likely to be lowered because it insinuates that your country is in a difficult situation. To avoid the stigma, we propose a sort of insurance system. There can be several different ways to do it.
Some countries are reluctant to join [the insurance safety net] because that means they will have to contribute [more than others] to the fund to get global stability in the financial market. But every country has a different probability of facing a crisis, just like an individual’s premium on insurance is different in different countries. This is a matter of negotiation, which we are now discussing.
There is a necessity to fine-tune how conflicts of interest are addressed between advanced and emerging market countries with respect to international capital movements. The specific proposals are eagerly awaited at the G20 summit in November.
Knowledge at Wharton: Are you expecting progress to be made this year?
Kim: That’s a good question. If there is a high probability of having a crisis, more countries are likely to agree to this. If the risk is lower, fewer countries will be [likely to agree]. It’s just a matter of paying the premium for the insurance. It’s all about risk — whether that’s objective risk or subjective risk.
Knowledge at Wharton: There are concerns throughout the global economy about the fallout from [the debt crisis in] Greece. Do you think its bailout measures were handled wisely?
Kim: I’m not in a position to assess whether decisions have been wise or not. But every country is fully aware of the importance of working with each other in resolving [Greece’s crisis]. Every country is facing a different political situation, and therefore, the decision [in Germany to support the European Union’s 110 billion euro rescue package] was not made as quickly as expected. But from now on, political leaders will understand the significance of the problem and strengthened political leadership among euro zone members is anticipated.
Knowledge at Wharton: Are we seeing strong leadership in the euro zone now?
Kim: I see strong leadership coming. Every country has a political event, like local elections, so some countries did not respond fast enough [to the euro zone’s weaknesses]. Now that the elections are over, they will search for a solution more actively. I’m sure they will come up with a reasonable solution. The euro zone was not established in a day. It was established over decades.
Knowledge at Wharton: Closer to home, the relationship between North and South Korea is at a new low point since the sinking of South Korea’s Cheonan naval ship in March. What’s your assessment of international support in helping to resolve the conflict?
Kim: Our political leadership is very strong, and there has never been a better relationship between South Korea and the United States. This relationship is really important. In the past, political leaders in Korea and the United States disagreed on some matters but now there’s a kind of perfect relationship — I can’t find any other words to express that. The two countries share the same understanding [of the situation], which is important because it shows the determination of the two countries in dealing with the problem. They are all united. [Hillary Clinton’s visit in May] helped stabilize the problem.
Knowledge at Wharton: What are the important aspects of leadership that you’ve learned as President Lee’s senior economic adviser and now as governor of the central bank?
Kim: I would like to make the Central Bank of Korea an institution that thinks and acts as a member of a global financial community. Every nation has its unique problems, but now we’re living in a globalized world so we cannot act alone. Furthermore, our markets are very much opened and the economy is liberalized. What that means is that whatever our policies might be, they might not have the effects that textbooks taught us in the past. Without cooperation among countries, the effects will not be as powerful as you might think. Because economies are open, countries have to act together. That is why political cooperation in overcoming the financial crisis in late 2008 was emphasized so much. So the U.S., Europeans and Asians took, more or less, the same steps. They were united. That was critical in overcoming this unprecedented crisis.
People thought the crisis was going to last several years, but it was over much more quickly. The reason was that political leaders were united. In the same token, the governors of central banks recognized the importance of policy cooperation among themselves. I’m not calling it policy coordination because every country has different issues. But they have to share information about their policies and economies so economic agents in the market are not surprised when a particular country carries out a policy. The importance of transparency is now much more recognized by economic agents. The key is information sharing.