South Korea’s uncomfortable place between US and China

South Korea has long known what it feels like to be “sandwiched.” This was how Samsung’s Lee Kun Hee in 2007 described the economy’s challenging place in between wealthy Japan and low-cost China.

These days, Korea’s sandwich problem is growing exponentially in scale as the ingredients get supersized. It now applies to the US and China, both of which are tightening economic policy in ways that imperil Korea’s outlook.

Lee debuted his metaphor at a much simpler time for Asia’s fourth-biggest economy. In the years since, Lee’s death put his son Lee Jae-yong atop Korea’s biggest conglomerate. Korea is also on its fifth president since then trying to get the special economic sauce right. 

That’s becoming harder and harder now that the two economic powers around which Korea has wrapped its future hit the brakes. 

To the West, the worst inflation in 40 years has US Federal Reserve Chairman Jerome Powell hiking interest rates with increasing urgency. As bond yields surge, American consumers and businesses may soon display less demand for Samsung’s gadgets, Hyundai’s cars or POSCO’s steel. 

The dollar’s rally, meantime, has capital racing into US assets at speeds reminiscent of the 1990s. Periods of extreme dollar strength don’t tend to end well for Asia. The 1994-1995 Fed tightening cycle helped precipitate the 1997 Asian crisis. As the dollar skyrocketed, currency pegs in Bangkok, Jakarta and Seoul became impossible to defend.

To be sure, Korea is a vastly stabler and more dynamic place 25 years on. Nor are the excesses of family-owned conglomerates, or chaebols, that Samsung exemplifies a grave danger to the economy. But as the US works on curbing overheating risks, it would be better if Korea’s other top customer wasn’t sabotaging its economy. 

In China’s case, the government’s “zero Covid” policies are stymying growth in Asia’s most important economic engine. Even though the People’s Bank of China is cutting borrowing costs, President Xi Jinping’s massive lockdowns are driving Chinese growth to 30-year lows. 

Forget 5.5% growth this year, as Xi’s team had targeted for 2022. China will be lucky to avoid a full-blown contraction. As amazing as it sounds, the 0.4% growth Chinese reported in the April-June period year-on-year may be as good as it gets for a while. The resulting supply-chain disruptions could further fan inflation risks from Seoul to Jakarta. 

Not that Japan is much help. The yen’s dramatic plunge to 24-year lows means even fewer Korean tanker ships heading Japan’s way. It also means officials in Seoul have some seriously big decisions to make with the yen down 24% this year and the Chinese yuan down 9.6%. 

Do the Ministry of Finance and Bank of Korea guide the won — already at 13-year lows — downward to support exports? Or should they go the other way amid rising global inflation and seek a stronger exchange rate? 

It’s not a straightforward decision as a uniquely uncertain 2023 approaches. In the years after 1997, a succession of Korean governments favored option No. 1 -- a weaker won. Today, though, there’s much chatter about a “reverse currency war.” The idea of boosting exchange rates to combat inflation and attract foreign capital has some merit. 

The biggest question is how President Yoon Suk-yeol decides to address Korea’s sandwich challenge with an eye toward the future. Unfortunately, Yoon's newish administration is already beset with a series of controversies that might weaken the appetite for economic retooling. 

With approval ratings already in the low 30s, Yoon may veer toward tried-and-true growth strategies — with exports at the very center — rather than bold reforms. One of Yoon’s early proposals to cut annual government spending for the first time in 13 years seems poorly timed as headwinds intensify from both the US and China. 

Nor does Yoon have a monetary yes-man at the BOK. In Tokyo, prime ministers are used to snapping their fingers and Bank of Japan governors dutifully slashing rates. In Seoul, newish Governor Rhee Chang-yong seems set on running a firmly independent operation. 

That will leave fiscal policy as the most likely lever of choice as Korea’s economic growth prospects darken. For now, the roughly 2.6% growth the BOK expects in 2022 sounds good. Until you consider the intensifying economic headwinds coming from all sides as 2023 approaches. 

Given inflation risks, it’s not reasonable to expect Rhee’s team to act like the BOJ and save the day. Odds are, Yoon’s 128-day-old administration will have to throttle back fiscal austerity plans. Odds are, too, that Yoon’s team will be looking to the chaebols for help in boosting gross domestic product, just like many of his predecessors. 

If Yoon thought the first four months of his tenure were tough, just wait until the next four as officials in Washington and Beijing squeeze Korea in ever-intensifying ways.

By William Pesek

William Pesek is an award-winning Tokyo-based journalist and author of Japanization: What the World Can Learn from Japan's Lost Decades. Previously, he was a columnist for Bloomberg and Barron’s.