David DeRosa: Korean Woes Once Again a Problem for U.S. and Japan

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Just about everyone is at their wits' end over

Korea

. The reality is that regulators and investors are playing with bigger dice here than they had in

Indonesia

,

Malaysia

, the

Philippines

and

Thailand

.

The collapse of Korea is more bad news for a very troubled part of the world. Seoul goes broke and meanwhile Korea's half-sister nation to the north literally starves to death under the burden of the most psychotic of all of the communist regimes. I wonder what all this means for the upcoming Korean presidential election in December? The accidental timing of this crisis couldn't have been worse.

Korea's floundering offers another chapter in what are becoming heady times for the

IMF

. Just when it looked like the old dog had caught its last rabbit, along came all this Asian turmoil. Now the fund is looking less like a bureaucratic multinational governmental institution and more like

Red Adair

and his famed team of oil well firefighters (waiting by the telex machine for a cry for help, ready to go any time of the day or night). Advice for MBAs? Young man, you will miss the real action if you go to Wall Street -- get yourself to the IMF!

After last week's agreement in Manila -- no regional bailout funds outside the purview of the IMF -- the IMF now more than ever is on center stage. What happens in the next six months will set the paradigm for the fund's future. So far, it has ingested Mexico, Thailand and Indonesia without too much dyspepsia. But these were nice, "bite-sized" crises. Korea is a far bigger matter and a far bigger test.

With all this going on, one country after another knocking at its door, I have to wonder if the fund isn't getting a bit stretched. How deep is the IMF expert staff anyway? This week alone, working on short notice, it had to assemble yet another crack team of economists, accounting sleuths and finance specialists and send them halfway around the world. They have already begun the highly specialized work of untangling the complex web of conglomerates, financial institutions and government that constitutes the Korean economy. The fast fix is for them to find a way for Korea to meet its mountain of maturing short-term external debt without defaulting. The hard part is not raising the money. The IMF itself can draw down lines of credit. The difficulty will be in determining what it must demand of the Koreans in macroeconomic policy and reforms -- and then to get them to agree to the terms.

A long-term fix? It doesn't exist. There are no miracle drugs for what ails countries like the now-declawed tigers. The only remedy is the tincture of time with liberal application of the very Western notions of market transparency, capital market reforms and a healthy distance between government and markets. Cold comfort to Seoul, for sure.

The fact that the Koreans have asked for only $20 billion is a stark demonstration that analysis is no match for denial in Seoul. Realistic talk has the total package on the order of $75 billion. That much cannot come from the IMF. They will need some substantial money from the U.S. and Japan. America clearly has to do something about Korea.

Meanwhile,

Congress

has

Clinton

hamstrung. No fast track and no $3.5 billion of new money for the IMF. Except for the fact that he is in the White House, the Republican Congress has Clinton just where they want him. How can America say no to Korea? Think of the symbolism. We fought a war over Korea but now are not willing to lend them a dime? Anyway, there is too much at stake. Sober minds realize that we need a healthy Asia. Maybe this means another duty call for the famous Stabilization Fund that

Mr. Rubin

tapped for Mexico? One way or another, we will pay (or "lend" if you like that better).

Speaking of Mr. Rubin, I wonder if the secretary thinks it will be necessary to do something if dollar/yen hits 135? It's not at all out of the question if Japan is really in the pickle it seems to be in. On one hand, he is precluded from intervening in exchange rates by the rules that he himself set. In my opinion, Rubin's sparse and sometimes vague pronouncements on foreign exchange distill down to this one principle: America will intervene in currency markets only when it deems that exchange rates are dangerously out of line with fundamentals. Depending on how badly Japan is hurt by the problems of the countries in Asia, a good fundamental level of the dollar might be 135 to the yen.

Here is the dilemma. A good part of this crisis comes from the fact that the Asian nations stuffed themselves with dollar-denominated debt in 1993, 1994 and 1995, thinking that the dollar would fall forever. At the time that looked like a solid bet. But the buck did a big U-turn in mid-1995 and hasn't looked back since. Now the problem is that the higher the dollar goes, the bigger the Asian debt bomb gets, and hence the worse becomes the crisis. The devil is in the mechanism, not in the valuation.

Would this be sufficient reason for the U.S. to intervene in currency markets? I doubt it. I do not think that the Treasury wants to establish a policy that exchange rates can be used as a tool for dealing with international financial catastrophes.

Of all the countries, Japan is in the biggest jam over Korea. It is in a gigantic no-win situation. If it lends Seoul billions, the good people of Japan are going to scream bloody murder. Why? For all of this time since the Japanese recession started in 1990, the Japanese government has resisted using public money for bailouts. Conventional wisdom is that this would be political suicide. How could they now turn around and ship billions to the Koreans? Tell that to

Yamaichi

! The government lets the fourth-largest brokerage house go belly up and meanwhile

Hashimoto

is getting ready to send bailout money to Korea?

Suppose Japan does nothing? If Korea defaults on its loans, Japan will take a massive hit. According to Monday's

Wall Street Journal

, Korea in 1996 alone has borrowed $100 billion from overseas sources, $24 billion of that from Japan. Then there is the exchange rate problem. Further deterioration of the Korean situation means a lower value for the won. What about a level for dollar/won of 1200 or maybe even 1400? Remember who the Koreans are, what they make, and to whom they sell their goods. Korea is Japan's competition in the business of exporting finished, technologically sophisticated goods. If Japan was hoping that exporting would lead the way to recovery, dollar/won at 1200 would be a kick in the butt.

There are strategic risks here too. In the broadest sense, failure to straighten out Korea could destabilize the region. This might have been taken more seriously in the days when the old evil empire was around, but it is still worth considering. No one better explained this than

Richard Nixon

, who once described Korea as a "knife" that can cut at Japan. He was explaining why the communists wanted all of Korea so badly in the early 1950s. The Cold War is over, but the analogy still holds. Korea's downfall has left Japan vulnerable on many levels.

David DeRosa heads a trading research firm and is an adjunct professor at the Yale School of Management. His column on international finance and trading appears every Tuesday. He welcomes your feedback at

derosa@derosa-research.com.