© YONHAP News

Triggered by the recent inversion of the U.S. yield curve, fears of a global recession are hanging heavily on the entire world and sounding alarms in financial markets around the globe, including Korea. Today, we’ll discuss the warning signs of a recession with Professor Gwak Roh-sung(곽노성) from the Department of International Trade at Dongguk University. 

Major economies including the U.S. have adopted the policy of quantitative easing and interest rate cuts since the 2008 global financial crisis. The policy proved to be effective with the global economic recovery in 2017 and 2018. 

However, in the ongoing U.S.-China trade dispute that started last year, the U.S. has imposed heavy tariffs on goods imported from China and put restrictions on China’s high-tech industry, making the Chinese economy tumble. The intensifying trade war between the world’s two largest economies has forced many other countries to reduce their exports. In the meantime, concerns over a no-deal Brexit have been looming in Europe. 

Against this backdrop, short-and long-term interest rates on U.S. government bonds have been inverted, stoking concerns over a contraction in future investment and a global recession. 

The yield on the benchmark ten year U.S. Treasury note was one-point-62 percent at one point in the trading session on August 14^th, breaking below the rate of the two year bond. It was the first time in 12 years that the long-term U.S. government bond yield fell below that of the short-term note. The unusual “yield curve inversion” in the U.S. bond market sent the financial market into a panic. That day, the Dow Jones Industrial Average sank over 3 percent, posting its biggest one day fall this year. 

Fears of a global recession are spreading to other major economies such as Germany and Japan, which are known for strong economic fundamentals. 

While the U.S. is enjoying an economic boom, Germany, Japan and the U.K. have seen their economies slow. Germany, in particular, recorded a negative growth in the second quarter. Concerns have been raised that the slump may continue during the third quarter and that the largest and strongest economy in Europe may be entering a recession. 

Germany saw a point-one percent drop in its GDP from April to June in the aftermath of the U.S.-China trade row. The world’s fourth largest economy is forecast to shrink again in the July to September period. 

Amid the growing possibility of a no-deal Brexit, in which the United Kingdom may leave the European Union without an agreement, the British economy also contracted by point-two percent in the second quarter from the previous quarter, marking its worst performance in six years.

Japan, the world’s third-largest economy, is also worried about a recession. Japan’s exports decreased one-point-six percent in July year-on-year, down for the eighth consecutive month. 

South Korea, in particular, is expected to be hit harder than any other country by a global recession. 

According to a report by the Swiss investment bank Credit Suisse, the five yield-curve inversions since 1978 have all led to recessions, while it took 22 months for a recession to follow such an inversion. 

The South Korean economy relies heavily on foreign trade. That means any setback in the external economic environment may take a toll on it, as evidenced in the Asian financial crisis in the late 1990s. Likewise, if the concerns about a global recession become a reality, the Korean economy is feared to suffer greatly. 

Typically, long-term bonds offer higher yields than short-term ones, reflecting the risk of tying up investors’ money for longer periods. When they flip, or invert, it is generally seen as a bad sign for the economy. The five such inversions in the last four decades were eventually followed by recessions. 

If the global economy really runs into a recession, the South Korean economy may deteriorate even faster than it is now. This is because it may be trapped in a vicious circle of falling asset values and prices leading to a contraction in finance.

With a possible recession looming, countries are preparing to stimulate their own economies. 

U.S. President Donald Trump and White House economic adviser Larry Kudlow have been confident about the local economy. But even the U.S. seems to be bracing for a recession and examining ways to boost domestic demand. 

Similarly, China is taking measures aimed at tackling a possible recession, such as massive tax reductions, large-scale investment in infrastructure and an overhaul of its lending rate system. 

The U.K. is also considering big tax cuts for economic stimulus ahead of a no-deal Brexit, while Europe’s industrial powerhouse Germany is likely to come up with a pump-priming policy and increase fiscal spending. 

Countries are examining economic stimulus measures such as interest rate cuts and fiscal input. President Trump said last week that he was considering payroll and capital gains tax cuts. He argued that the measures are not aimed at dismissing fears of a recession, which is emerging as the biggest stumbling block in his path to reelection in 2020. Still, if the tax reduction plan is executed, it would certainly help boost the domestic economy. 

Of course, the concerns of a recession may prove to be unnecessary. Some analysts say that it is hard to regard the inverted yield curve as the warning sign for a recession. Even so, Korea should brace itself for a worsening economic environment, due to alarming signs in various parts of the world.  

Former Federal Reserve Chair Janet Yellen has said that markets should not trust this yield curve inversion as a recession indicator. Excessive liquidity in the market is cited as a major reason for the latest inversion in the yields between two and ten year notes. In other words, ample liquidity funnels money into even longer-term bonds with higher investment risks. Strong demand for such bonds pushes up their prices and lowers their yields, as yields move in the opposite direction of bond prices. 

It remains to be seen whether this argument is right or wrong. 

In terms of the South Korean economy, it is quite vulnerable to the external business environment. A global recession will discourage large economies such as the U.S. and China from importing goods from overseas, and that will have a major impact on the export-driven Korean economy. For Korea, now is the time to boost domestic consumption, secure unrivaled technologies that cannot be replaced and diversify markets to reduce its economic dependence on the U.S. and China. 

Concerns over a recession could be another unfavorable factor that affects the Korean economy. If advanced economies increase liquidity through rate cuts, it will prompt Korea to lower its own interest rate and stimulate the economy in some way. But the country also has to deal with sluggish exports, investment and consumption as well. The government needs to prepare various policy measures and get ready to implement them swiftly when necessary.