China Money

The U.S. Federal Reserve Board from June 2004 to March 2006 raised its benchmark interest rate from 1 percent to 4.75 percent when the global economy enjoyed a boom. The U.S. government bond yield slightly rose from an annual rate of 4.62 percent to 4.85 percent over the same period, however. At the time, Fed Chairman Alan Greenspan called the phenomenon an "incomprehensible matter," spawning the term, "Greenspan`s riddle." The primary cause for the gap in the policy and market rates was massive purchasing of U.S. government bonds by certain countries.

The Korean bond market is facing a similar situation. The Monetary Policy Committee of the Bank of Korea hiked the benchmark rate last month and has hinted at another raise by year’s end. The yield on a five-year Korean treasury bond, however, plunged for three consecutive days through Friday to an annual rate of 4.13 percent, the lowest level in 16 months. China has shifted its attention and investment from U.S. government bonds to those of Korean and Japanese since the onset of the global financial crisis in 2008. China`s move has spurred other foreign investors to purchase Korean bonds en masse, pulling down the Korean market interest rate.

As of late June, China possessed 2.45 trillion U.S. dollars in foreign currency reserves, a level unrivaled in the world. The figure is more than twice that of second-place Japan with 1.05 trillion dollars and nearly nine times that of Korea, which ranked sixth in the world with 274.2 billion dollars. China, which is seeing its economic status escalate, wants to develop natural resources in many parts of the world. It also seeks to increase real estate purchases by banking on its ample capital while expanding its influence in the global financial market. China since August last year has purchased Korean government bonds worth more than 4 trillion won (3.3 billion dollars). Nevertheless, this amount accounts for less than 0.2 percent of China`s foreign currency reserves.

As “China money" enjoys growing influence, Korean financial authorities feel increasingly uneasy. The Bank of Korea`s rate hikes will have a limited effect if Chinese investors continue to buy Korean bonds. The Korean financial market is also more vulnerable to Chinese policy than before. Seoul should also prepare for the shock caused by Chinese investors selling Korean bonds and stocks en masse to pull out their money. Lying behind the advance of China money into Korea could be Beijing`s plan to increase its influence in consideration of variables in international politics surrounding the Korean Peninsula, as well as for economic reasons. Korea, a small open market economy easily swayed by external factors, needs to arm itself with a safety net, including the acquisition of ample foreign reserves, to prepare for a worst-case scenario.

Editorial Writer Kwon Sun-hwal (shkwon@donga.com)