The U.S. Federal Reserve, often called the "central bank of the world," is preparing for the inauguration of new Chair Kevin Warsh. Coupled with the inauguration last month of Bank of Korea Governor Hyun Song Shin, the near-simultaneous leadership change at the Korean and U.S. central banks marks a major inflection point for financial markets. Kim Jin-il, professor of economics at Korea University and a former Fed economist who was appointed a Monetary Policy Board member at the Bank of Korea on the 15th of this month, said in a recent interview with The Seoul Economic Daily that the arrival of Chair Warsh has placed the Fed at a "critical moment," and predicted that Warsh's monetary policy, which has signaled quantitative tightening, will have a significant impact on Korea. On the won internationalization that Governor Shin has stressed, Kim emphasized, "Even if it comes with some difficulty, it is right to push ahead," adding, "Now, when the dollar's standing is being shaken by the Iran war, is the opportunity to expand the won's territory." The interview was conducted at Korea University on April 28, before Kim was appointed to the Monetary Policy Board.
- The U.S. Fed is facing a leadership change. What do you expect from the Fed under nominee Warsh?
△ I think much was revealed at last month's Senate confirmation hearing. The Fed's independence was discussed extensively, but that is something that must be shown through direct action. He also signaled an intention to reduce the level of the Fed's external communication that has been active since Ben Bernanke's chairmanship. A change that could significantly affect Korea is the Fed absorbing the liquidity in the market and shrinking its balance sheet (quantitative tightening). The Fed's balance sheet has expanded sharply since COVID-19, and at the hearing, nominee Warsh emphasized gradual reduction.
- Is the Fed turning "hawkish"?
△ Warsh opposed the second round of quantitative easing (QE2) in 2010 just after the financial crisis, and he resigned from his Fed governor seat because of it. That is why he was known as a "hawk." There is still controversy today over the effects of quantitative easing after 2010. However, you cannot judge whether someone is a hawk or a dove based solely on remarks made during the financial crisis. We cannot know now what stance Warsh will take when the U.S. economy is caught in a dilemma between inflation and growth.
- Between Bernanke and Warsh at the time, who do you think was right?
△ We cannot know what would actually have happened in reality if QE2 had not been implemented. However, Warsh's argument deserves recognition in that it sounded an alarm against excessive quantitative easing.
- Recently, the possibility of the Fed cutting its benchmark interest rate has also been raised in the United States.
△ Even if not immediately, the Fed will not refrain from shrinking its balance sheet, and if that causes the economy to contract too much, it will likely try to lower rates rather than expand the balance sheet again. Of course, in that case, suspicions could arise regarding the Fed's independence. There is already a "conspiracy theory" that Warsh is trying to touch the balance sheet in order to lower rates as President Donald Trump demands.
- Is the U.S. economy at a level that can withstand quantitative tightening?
△ Warsh seems to think so. With the spread of artificial intelligence (AI) boosting productivity and the economy at a decent level, he seems to think now is the opportunity.
- President Trump will likely try to lower rates to lift the economy ahead of the November midterm elections.
△ If the Fed stimulates the economy, prices inevitably rise, which becomes a political burden. The current economic slowdown and inflation are due to a supply shock from war in the first place, so it is also difficult to respond efficiently from the demand side. In this situation, it is impossible to know what Trump will want or what choice Warsh will make. Ultimately, it is a process of finding what to do first. It is the same principle as in the game of Go, where the order of which move to play first matters.
- Internal opposition within the Fed to lowering the U.S. benchmark rate would seem to be considerable.
△ As Alan Greenspan did in the 1990s, nominee Warsh will have to persuade the 19 Fed members. It is not easy, but it can be done if backed by solid data on inflation and AI productivity. If it is the right choice, it will be fortunate for the U.S. economy, but it could also be unfortunate. In the 1970s, the Fed's wrong choice worsened inflation, and Paul Volcker eventually had to embark on extreme tightening. Thanks to that, prices were brought under control, but the economy was crushed. Timing matters. In that sense, this is a critical moment for the U.S. economy.
- Amid heightened global uncertainty, the BOK has also welcomed a new governor. What policy changes do you expect?
△ Responses to inflation or the economy can be carried out as usual. More importantly, the area where Governor Shin has a comparative advantage is finance, and the question is which of the various financial issues — the exchange rate, real estate, debt — he will weigh most. In that respect, it is notable that Governor Shin has emphasized the internationalization of the won. Governor Shin seems to believe that won internationalization is the path to truly making Korea strong. Of course, putting weight on won internationalization will push other matters down the priority list. Depending on what choices Governor Shin makes and pushes through, the merits and demerits of the Lee Jae-myung administration that chose him will be determined.
- What issue looks urgent now?
△ I think it is time to consider how to operate the jeonse system. In academia, opinions are divided between the view that the jeonse (a Korean lease system requiring a large lump-sum deposit instead of monthly rent) was a useful tool that helped overcome past financial backwardness and achieve economic growth, and opposing views. We need to pay attention to how to take the jeonse system forward in the medium and long term, and above all, what problems the jeonse system might cause as it becomes entangled with finance.
- What about won internationalization?
△ I also think it is right to push ahead with won internationalization, even if it comes with some difficulty. Now, when the global economy is being shaken by the Iran war, is precisely the opportunity to expand the won's influence even slightly. If the won can fill even a little of the space when the dollar's influence is reduced by 1%, it could lead to major change over the long term.
- The Iran war has heightened concerns about the collapse of dollar hegemony.
△ It is true that dollar hegemony has weakened compared to the past, but it is not to the extent that the dollar's international standing is shaking. Real weakening of dollar hegemony will come over the medium to long term when the United States fails to control inflation and fiscal deficits, the Fed loses its independence, and confidence in the dollar declines, but such a situation does not appear likely for the time being. There are also many forecasts that the "petro-yuan" will rise, but China will not fully expose its economy to internationalize the yuan. If China were to open its market now, it would risk following the path of Korea in 1996.
- The Korean economy, with its high dollar dependency, is particularly vulnerable to shocks originating in the United States.
△ There is a need to reduce dollar exposure. How to adjust the weighting is a matter of choice. Won internationalization can be an important choice, but if mishandled, you may have to bear the cost of the tail wagging the dog. There is no right answer. If there were, it would already have been put into action.
- With Governor Shin's inauguration, there are also many forecasts that the BOK will raise rates within the year.
△ Governor Shin appears to be relatively active in preemptive responses to prevent future inflation. In that sense, it is true that he has hawkish tendencies. However, I do not think the current price level is high enough to warrant raising rates. Rather, financial stability will be prioritized first. How that affects rate decisions will depend on the situation.
- With both the Korean and U.S. central banks welcoming new leaders, expectations have grown for a currency swap agreement between the two countries.
△ When the necessary situation arises, Governor Shin's global personal network will play a positive role. That means that if a real liquidity crisis hits, we may be able to communicate with the United States and conclude a currency swap even slightly faster than other countries. You cannot make something that is not needed and is not feasible happen. Korea is not in a liquidity crisis situation, is it? Politically, pushing too hard...
