By Park Chong-hoon
The "Stockdale paradox" is about conflicting duality: accepting the brutal facts of reality but maintaining an unwavering faith in the endgame. Jim Stockdale, a high-ranking U.S. navy officer, survived an eight-year imprisonment in Hanoi during the Vietnam War without giving up hope of freedom while facing the brutal fact that he would not be returning home any time soon, and definitely not for Christmas that year.
We hear plenty of bad news about the economy these days. The KOSPI is down 21.40 percent, the Kosdaq has declined 25.82 percent and the Korean won has depreciated by 114.02 year to date. The benchmark interest rate has risen 75 basis points from the start of 2022 and is likely to increase to at least 1 percent by the end of the year.
Rising interest rates increase household debt payment burdens ― and especially the interest burden on young people who have bought homes. This raises concerns over a looming financial crisis caused by household debt. We probably have not seen the bottom of the downturn and the worst still lies ahead in the second half of the year.
When fears of such mounting uncertainties strike, we need to return to the lesson learnt from Jim Stockdale. We must try not to be too pessimistic and give up hope for the economy, but rather to make an honest assessment of the economic situation. We can relieve anxiety about the future if we anticipate the worst of the current crisis ― only then would we be able to grasp how and when things might change and improve. If we can gauge how long the bad news will persist, we may be less vulnerable to market uncertainties.
So, what are these brutal economic facts that we must face for the second half of 2022?
For one, high inflation is unlikely to ease in the near future in spite of rapid rate hikes. The central bank can control inflation through interest rate hikes if the reason is demand-pull, thus depressing consumption incentives with higher rates. On the other hand, the central bank would find cost-push inflation difficult to control.
On the other hand, excessively-rapid rate hikes could limit money supply, which reduces companies' investment and production incentive, which could increase inflationary pressure by lowering production and thus constricting supply. Given cost-push factors ― such as supply bottlenecks and rising commodity prices due to China's COVID lockdowns and the Ukraine invasion ― are at play in the current environment, we do not expect high inflation to be resolved in a short period.
June inflation was over 6 percent for the first time since 1998 and we expect it to stay above 5 percent until the third quarter. Because Korea imports commodities and agricultural products, it is likely to suffer more than other economies. Moreover, rising imports will probably weaken the won, thus driving inflation further higher.
Faced with high inflation, the central bank may be compelled to hike the base interest rate continuously. It will also need to control inflation expectations, as an increase in inflation expectations could make high inflation self-fulfilling. As most central banks appear to have misjudged the current inflationary environment as transient, they may need to hike rates until inflation is forced to a peak as soon as possible.
This reasoning may explain why some market participants expect the U.S. Fed to undertake a substantial rate hike of 75 basis points in July and the Bank of Korea by 50 basis points for the first time since it adopted the current inflation-targeting monetary policy.
The economy is likely to slow down in a steep rate-hiking cycle and will be unable to register continued growth. Rising interest rates hurt corporate profitability, reducing their investment incentive. Furthermore, they force wealthier households to save more and less wealthy households to spend less due to household debt interest payments.
This increases downward pressure on the economy as investment and consumption both shrink. Even though an accommodative monetary policy will be needed to turn the economy around, central banks will be unable to deploy this policy, as inflation remains high and rate-hiking cycles are well underway. Perhaps a much earlier start to a rate hike would have eased the path to taming inflation, but as it stands, we must now face the risk of a global economic slowdown.
Signs of a growth downturn are becoming clearer. Korean exports grew less than 4 percent year-on-year in June after enjoying double-digit growth in the past year. Some global economies look likely to experience a recession within a year and Korea will not be immune to the rising risk of a global slowdown.
Meanwhile, uncertainty and volatility in the financial markets can be expected to last longer. The KOSPI fell 41 percent during the global financial crisis in 2008. So far this year, the KOSPI has declined 30.2 percent from its most recent peak and could drop further depending on the stress scenario.
All that said, we may not need to be too pessimistic about all this bad news. Actually, it appears to us that the financial market has already priced in a very tough economic outlook. Barring some unexpected shocks and worse economic readings than are currently expected by markets, we do not expect the financial market to face a further substantial hit from here onwards.
The current economic environment and incoming economic data signal recessionary pressure within a year. We should therefore prepare for this eventuality, while also guarding against becoming too pessimistic, as excessive pessimism could create a self-fulfilling recession by depressing consumption and investment incentives too severely.
We need to ensure that cool heads prevail when judging the state of the economy and keep hope alive that a positive economic cycle will be around the corner when we reach the bottom of the current economic cycle.
Park Chong-hoon (ChongHoon.Park@sc.com) currently heads the Korea Research Team at Standard Chartered Korea. Before joining the bank, he worked as a senior research fellow and head of telecommunication policy at the Korea Information Society Development Institute (KISDI).
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We hear plenty of bad news about the economy these days. The KOSPI is down 21.40 percent, the Kosdaq has declined 25.82 percent and the Korean won has depreciated by 114.02 year to date. The benchmark interest rate has risen 75 basis points from the start of 2022 and is likely to increase to at least 1 percent by the end of the year.
Rising interest rates increase household debt payment burdens ― and especially the interest burden on young people who have bought homes. This raises concerns over a looming financial crisis caused by household debt. We probably have not seen the bottom of the downturn and the worst still lies ahead in the second half of the year.
When fears of such mounting uncertainties strike, we need to return to the lesson learnt from Jim Stockdale. We must try not to be too pessimistic and give up hope for the economy, but rather to make an honest assessment of the economic situation. We can relieve anxiety about the future if we anticipate the worst of the current crisis ― only then would we be able to grasp how and when things might change and improve. If we can gauge how long the bad news will persist, we may be less vulnerable to market uncertainties.
So, what are these brutal economic facts that we must face for the second half of 2022?
For one, high inflation is unlikely to ease in the near future in spite of rapid rate hikes. The central bank can control inflation through interest rate hikes if the reason is demand-pull, thus depressing consumption incentives with higher rates. On the other hand, the central bank would find cost-push inflation difficult to control.
On the other hand, excessively-rapid rate hikes could limit money supply, which reduces companies' investment and production incentive, which could increase inflationary pressure by lowering production and thus constricting supply. Given cost-push factors ― such as supply bottlenecks and rising commodity prices due to China's COVID lockdowns and the Ukraine invasion ― are at play in the current environment, we do not expect high inflation to be resolved in a short period.
June inflation was over 6 percent for the first time since 1998 and we expect it to stay above 5 percent until the third quarter. Because Korea imports commodities and agricultural products, it is likely to suffer more than other economies. Moreover, rising imports will probably weaken the won, thus driving inflation further higher.
Faced with high inflation, the central bank may be compelled to hike the base interest rate continuously. It will also need to control inflation expectations, as an increase in inflation expectations could make high inflation self-fulfilling. As most central banks appear to have misjudged the current inflationary environment as transient, they may need to hike rates until inflation is forced to a peak as soon as possible.
This reasoning may explain why some market participants expect the U.S. Fed to undertake a substantial rate hike of 75 basis points in July and the Bank of Korea by 50 basis points for the first time since it adopted the current inflation-targeting monetary policy.
The economy is likely to slow down in a steep rate-hiking cycle and will be unable to register continued growth. Rising interest rates hurt corporate profitability, reducing their investment incentive. Furthermore, they force wealthier households to save more and less wealthy households to spend less due to household debt interest payments.
This increases downward pressure on the economy as investment and consumption both shrink. Even though an accommodative monetary policy will be needed to turn the economy around, central banks will be unable to deploy this policy, as inflation remains high and rate-hiking cycles are well underway. Perhaps a much earlier start to a rate hike would have eased the path to taming inflation, but as it stands, we must now face the risk of a global economic slowdown.
Signs of a growth downturn are becoming clearer. Korean exports grew less than 4 percent year-on-year in June after enjoying double-digit growth in the past year. Some global economies look likely to experience a recession within a year and Korea will not be immune to the rising risk of a global slowdown.
Meanwhile, uncertainty and volatility in the financial markets can be expected to last longer. The KOSPI fell 41 percent during the global financial crisis in 2008. So far this year, the KOSPI has declined 30.2 percent from its most recent peak and could drop further depending on the stress scenario.
All that said, we may not need to be too pessimistic about all this bad news. Actually, it appears to us that the financial market has already priced in a very tough economic outlook. Barring some unexpected shocks and worse economic readings than are currently expected by markets, we do not expect the financial market to face a further substantial hit from here onwards.
The current economic environment and incoming economic data signal recessionary pressure within a year. We should therefore prepare for this eventuality, while also guarding against becoming too pessimistic, as excessive pessimism could create a self-fulfilling recession by depressing consumption and investment incentives too severely.
We need to ensure that cool heads prevail when judging the state of the economy and keep hope alive that a positive economic cycle will be around the corner when we reach the bottom of the current economic cycle.
Park Chong-hoon (ChongHoon.Park@sc.com) currently heads the Korea Research Team at Standard Chartered Korea. Before joining the bank, he worked as a senior research fellow and head of telecommunication policy at the Korea Information Society Development Institute (KISDI).
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