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The Joy of Korean Bank Debt

Dear readers not already plugged into the planetary zeitgeist, prepare to be shocked: Korea is re-wiring the culture of the world.

Here’s why: K-Pop and Korean Soap Operas set the agenda. Seemingly innocuous, they are the most corrosive of all the alien influences attacking traditional, non-western culture. Love is and has always been understood everywhere. But South Korea, better than any western nation, commercialized the Western syrupy-sweet concoction called romantic love to good effect. Romance is an alien and very dangerous western concept that serves as a lethal viral agent to everyone from sheltered Sheikh’s daughters to Cambodian country girls to the most oppressed place in the world. Yes, even North Korea is falling under the spell of sensitive South Korean couples talking about sappy stuff and walking on endless beaches holding hands.

Korea is an outsized influencer, a rapier point, of the highly globalized planetary economy. It is the place to look for persistent and impactful trends. You can find South Korean consumer goods and entertainment to every point on the globe. South Korea feeds industrialized countries finished goods. It provides all this plus investment capital and to a limited degree technology transfer to China. South Korean financial assets underperform because they are so in synch with global economic growth. It is safe to judge a Chinese equity meltdown as only a nasty paper-cut brought on by speculative frenzy. Look to South Korea for confirmation that the slowdown in China is more broad-based, and global expansion is slowing to a crawl.

Simply put, look at the ripples in South Korean bond markets. The disturbances observed will spread elsewhere.

What I am seeing is a continuation of what I called “Japanification” in my book Tail Risk Killers (pretty close to out of print at this point). The basic gist of this phenomenon is that adverse demographic trends dampen economic growth. This makes the existing debt stack increasingly burdensome as liabilities remain constant as asset values collapse due to a decreasing expected value of future cash flows. To compensate, central banks make the cost of debt less costly by lowering short rates (funding costs) to near zero. There is only so far nominal interest rates can plunge, as there will come a point where yields will pay the funding cost of being short, creating an arbitrage. As Richard Koo has noted, under these conditions there is practically no interest rate that will induce greater leverage until balance sheets are restored. That said, provided that an economy has sufficient complexity to absorb it and a non-tradable sector to blunt the inflationary impact, the central bank can support asset markets and indirectly solvency of names by purchasing bonds and other assets.

Who benefits from Japanification? Everywhere it happens it is banks that benefit the most as they borrow from the central bank and charge a spread over their funding costs. Compare Korean financial bond yields to their Japanese counterparts. While there are differences in the particulars, the trend in both is spread compression. You receive more beta, a 150 spread over Japanese financial bonds, and plenty of room for BoK to ease yields down.

I’m not worried about Korean bank debt not proving to be money-good. Koreans are not afraid of leverage, but have shown they can tighten the belt when needed. Korean authorities have shown in the late 1990s that they prefer merging insolvent banks when the situation demands it, leaving equity taking the pain but leaving bond holders intact.

Koreans in opinion the most mentally tough people in the world. This is a natural consequence of being wedged for millennia between the two regional super-powers. That it is a tough, image-conscious society is indicated by it being the per capita plastic surgery capital of the world, the pressure to perform during exam-time, and that Korea is of all places in East Asia the most likely place to get punched in the mouth for being a rude and clueless jerk. Despite all their toughness, their banks are just part of a global trend falling into place.

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