As of July 2015, South Korea’s central bank owned foreign exchange reserves worth over 370 billion US dollars — an astounding amount. This so-called “war chest” is a direct result of South Korea’s painful experience during the Asian Crisis in 1997-1998.
Confronted with massive capital flight as foreign investors demanded repayment for the loans they had granted Korean firms — which were mostly denominated in U.S. dollars — the Korean central bank quite literally ran out of foreign currency. In effect, the Korean private sector could not get hold of enough U.S. dollars and other major foreign currencies to pay back their cross-border debts. This situation led to a severe financial crisis, which left South Korea no choice but to petition the International Monetary Fund (IMF) for help.
The Asian Crisis took a severe toll on Korea: corporate bankruptcy rates skyrocketed and over two million people lost their jobs. To prevent future economic downturns from leading into another foreign exchange crisis, the Korean central bank has been building up massive foreign currency reserves ever since.
While this is arguably a rational policy, is it necessarily an optimal strategy in today’s world? Our guest for this episode, Youngwon Cho, argues that South Korea’s foreign exchange “hoarding” also implies significant opportunity costs and that a significant share of this “war chest” would be best allocated elsewhere. South Korea’s attempt to invest its massive reserves has yielded so far mixed results.
Youngwon Cho is Associate Professor at St. Francis Xavier University in Canada and Visiting Scholar at Korea University’s Asiatic Research Institute in Seoul. He is a specialist in financial globalization and emerging markets, as well as in the regional security complex in East Asia. Professor Cho has published in several academic journals, including the Journal of Contemporary Asia, Pacific Focus, and the Journal of East Asian Affairs. He was also a recipient of the SAGE Prize in International Scholarship for best article on international affairs for his paper entitled Method to the Madness of Chairman Kim: The Instrumental Reality of North Korea’s Pursuit of Nuclear Weapons, published in International Journal. Professor Cho received his B.A. (Hons) from Carleton University and earned his M.A. and PhD from Queen’s.
There is a tendency — and this is especially pronounced among Koreans — to see reserves as some sort of indicator of economic strength. If you turn to newspapers, there is almost a nationalistic expression, « Oh our reserves have broken the record again! », that sort of thing. But actually reserves are not cost-free. They are in fact very, very costly […] Think about stashing a big amount of cash under your mattress. You think at first that there is really no economic cost associated with it, because you think you are not really losing any money […] Next day it’s still there. But you have to think in terms of opportunity cost.
The interview was recorded on August 27th in Seoul.