The weakening of US leadership and the global spread of yen carry funds, accelerated US bond sales, and increased market volatility are expected. The era of tight money is coming to an end as the US lowers its interest rates next week after the Chuseok holiday, marking the end of the ‘global tightening era’ that has been ongoing since March 2022. Already, money is flowing freely in the US, with the total money supply (M2) turning positive from April 2024 after being negative from 2023 to March 2024. Lowering interest rates in September will result in a greater amount of money being released. Other countries, including South Korea, are likely to follow the US lead. As the era of money shortage gives way to a surplus, concerns outweigh expectations.
The US interest rate cut is due to two reasons. One is to prevent future economic downturns, and the other is due to the ongoing current downturn. The state of the US economy is uncertain, but the signs are not positive. Employment is the most important indicator for the US to assess the economy, looking especially at the monthly increase in non-farm payrolls. In July, this figure dropped to 89,000, then rebounded to 142,000 in August, falling short of market expectations. Considering that around 100,000 monthly job additions are a key indicator of a downturn, the situation is precarious.
The US interest rate cut signifies the decline in global economic leadership. When the US raises interest rates, the world looks to the US. When interest rates rise, the value of the dollar goes up, causing funds to flow out of other countries, resulting in significant economic damage. However, when the US lowers interest rates, the situation is less intimidating. The dollar weakens, and money flows from the US to other countries, leading to rate cuts in countries like Canada, the UK, Switzerland, as well as Brazil, Mexico, and Chile. This signals that there is no longer a need to be wary of the US, and each country’s independent currency policy further increases market uncertainty.
The void left by the US is being filled by Japan and China. Japan has had zero interest rates for over 30 years, allowing easy borrowing without interest whenever needed. The so-called ‘Mrs. Watanabe’ yen carry trade funds, mostly in dollars but held in yen, are difficult to predict in terms of their whereabouts and amounts. Unlike the US, Japan is poised to raise interest rates, which could lead to a rise in the value of the yen and a return of yen carry funds to Japan. The movement of yen disguised as dollars could cause fluctuations in financial markets worldwide.
Amidst the economic challenges and the ‘economic war’ with the US, China is selling off its substantial holdings of US Treasury bonds. China’s holdings of US Treasury bonds decreased by over $320 billion in the three years between February 2021 and June 2024, dropping from $1.1042 trillion to $780.2 billion. While China used to buy US Treasuries with the dollars earned from selling goods to the US, the relationship has deteriorated since 2021. As US-China relations cool down, a US interest rate cut could create a favorable environment for China to sell bonds, further adding to global financial market uncertainty.
The US interest rate cut is likely to expose existing problems rather than solve them, as seen in the Dotcom bubble crisis, the global financial crisis, and the economic crisis caused by COVID-19, all of which occurred when the US lowered interest rates. From the perspective of South Korea, a small open economy highly vulnerable to foreign influences, this is a time to be even more vigilant.
[No Young-woo, International Economics Reporter]