[Desk Column] Interest Rate Hike, the Attack of the Gray Rhinoceros

The United States is set to begin raising interest rates in earnest starting in March. Of course, this was an expected step. Federal Reserve (Fed) Chair Jerome Powell has been consistently signaling interest rate hikes to the market since the end of last year. The Bank of Korea’s preemptive base rate increase last month was also a measure to respond to this anticipated move. The government’s forecast during the macroeconomic and financial meeting held immediately after the Federal Open Market Committee (FOMC) regular meeting?that "the impact on the domestic financial market will not be significant"?was likely based on the same reasoning.

However, the domestic financial market tells a completely different story. The KOSPI has plummeted more than 10% since the beginning of the year, and the KOSDAQ has fallen by 15%. In particular, on the day of the macroeconomic and financial meeting (January 27), the KOSPI index dropped by as much as 3.5%. The won-dollar exchange rate also fluctuated wildly, surpassing 1,200 won. This is a case of being caught off guard by the U.S. interest rate hike risk?a risk that has been repeatedly pointed out as a threat to our economy and one we are very familiar with.

As a result, some voices have raised concerns that a different gray rhinoceros might be emerging, unlike the 2008 global financial crisis. The term "gray rhinoceros" was first introduced by Michelle Boucher, head of the Global Policy Institute, at the 2013 Davos Forum. It refers to a situation where a known risk is recognized by everyone but still causes harm. If the 2008 global financial crisis was an unforeseen event, the current financial market is in a state of chaos, helplessly suffering from a predicted risk. This is not the only threat we face. Even if we set aside the now constant COVID-19 crisis, there is an abundance of highly volatile inflammable materials such as high inflation, global supply chain issues, China’s economic slowdown, and escalating tensions in Ukraine.

Nevertheless, the government’s judgment that the impact on the financial market will not be significant because our economy’s fundamentals remain solid is overly complacent. Of course, given the sound basic conditions of our economy, it is likely that the government made this statement to prevent excessive anxiety. However, if, while trying to quell fears about interest rate hikes by sending weak signals, various risks accumulate and suddenly explode, the terrifying gray rhinoceros that can no longer be controlled will become a reality.

Last month, the Davos Forum identified "debt crisis" and "asset bubble collapse" as the greatest threats to the global economy over the next two years in its Global Risks Report. These risks were nurtured by the competitive quantitative easing monetary policies implemented worldwide after the COVID-19 crisis. Central banks around the world, which have been competitively injecting money, are now determined to resolve these risks. The problem is that during this process, debt and asset bubbles could act as triggers for an economic crisis. Emi Nakamura, a UC Berkeley professor and recipient of the John Bates Clark Medal?considered a gateway to the Nobel Prize in Economics?warned that "the volatility caused by interest rate hikes could exceed the levels of volatility experienced during the COVID-19 crisis."

South Korea’s household debt has surpassed a serious level of 1,800 trillion won. Housing prices, which seemed to have no ceiling, have also started to decline. This means it is not the time to feel reassured just because the Korean economy grew by 4% last year. Already, the trade balance recorded a deficit of $4.89 billion in the first month of the new year. At this rate, we could fall victim to a gray rhinoceros attack. It is time to heed the warning that we must prepare for volatility different from the COVID-19 crisis.

Lee Eun-jung, Economic Editor