'The Great Decoupling' But... Why Money Must Keep Flowing

Stock Market and Real Economy Move Completely Differently
Currently Difficult to Judge 'Appropriate Liquidity' Level
Liquidity Supply Must Be Maintained Until Real Economy Recovers

[Asia Economy Reporter Kim Eunbyeol] Recently, a phenomenon called the 'Great Decoupling,' where the real economy and stock prices move in completely different directions, has emerged. However, the massive liquidity injected into the market is expected to be maintained for the time being. This is because the economic damage caused by the novel coronavirus disease (COVID-19) has not yet recovered, and uncertainties remain high. Central banks worldwide, including the United States, have established the principle of 'not withdrawing liquidity until the economy recovers.' The problem is that no one knows exactly how much liquidity is appropriate or whether the bubble caused by the rapid rise in asset prices is at a dangerous level.

◆Rapid Recovery of the Stock Market... Based on Massive Liquidity= On the 11th, the KOSPI index started trading at 2,184.36, down 11.33 points (0.52%) from the previous trading day, and as of 9:57 a.m., it was trading at 2,190.77. Although it is showing a downward trend today, the KOSPI index has been recovering recently and is heading toward the yearly high of 2,267.25 recorded on January 22. The KOSDAQ index was up 5.61 points (0.74%) at the same time. The situation is similar in the U.S. New York stock market. On the 10th (local time), the Nasdaq index, which is technology stock-centered, closed at 10,020.35, up 66.59 points (0.67%). It set a new all-time high for the third consecutive day. It is the first time the Nasdaq has settled above the 10,000 mark at closing, marking 49 years since its inception in 1971.

The rapid rise in the stock market can be attributed to the liquidity injected into the market. Central banks around the world, including the U.S. Federal Reserve (Fed), lowered benchmark interest rates to near zero and began large-scale purchases of assets such as government and corporate bonds.

The Bank of Korea (BOK) is also keeping pace with global central banks. After the COVID-19 outbreak, the BOK lowered the benchmark interest rate twice over about three months, from 1.25% per annum to 0.5%. It announced that it would supply virtually unlimited funds if financial institutions faced shortages and implemented measures to stabilize the bond market. As a result, the amount of money circulating in the market increased to an unprecedented scale. According to the BOK, as of the end of April, the money supply (M2) was 3,015.8163 trillion KRW (won series, average balance), an increase of 9.1% compared to a year earlier. This is the highest growth rate since September 2015 (9.4%). M2 is a monetary indicator that includes cash, demand deposits, savings deposits with frequent withdrawals, and money market funds (MMFs), representing funds that can be converted into cash at any time. Until January this year, M2 recorded a growth rate in the 7% range, then rose to the 8% range in February and March, and jumped to 9% in April.

In absolute terms, it is true that there is a lot of liquidity in the market. Korea's M2-to-GDP ratio stands at around 157-158%, a sharp increase from 151.5% in 2018. However, this level of liquidity cannot be said to be excessive unconditionally. Under normal circumstances, a high amount of money relative to GDP would raise concerns about inflation and asset price surges, but the current economic situation has deteriorated to an unprecedented level, making concerns about liquidity premature.

[Image source=AP Yonhap News]

◆Fed Chair Powell: "Some Do Not Agree That High Asset Prices Delay Economic Recovery"= This perspective is also reflected in the Federal Open Market Committee (FOMC) press conference of the U.S. Fed. At the meeting on the 10th (local time), the FOMC decided to maintain zero interest rates for the time being and indicated that there would be no rate hikes until the end of 2022.

Fed Chair Jerome Powell, in response to a question about whether a bubble burst could negatively affect economic recovery, said, "The Fed's policy is aimed at restoring market functioning and is not targeting asset prices," adding, "There are people who do not agree with the idea that high asset prices will delay economic recovery." He also pointed out that adjusting monetary policy to fit the market could be problematic.

Regarding concerns about the recent stock market situation, he responded, "The current economic situation is very different from the Great Depression in the 1930s. We had experienced 128 months of economic expansion until recently, and the financial system is in a much better position with sufficient capital." The Wall Street Journal (WSJ) evaluated that Chair Powell does not appear to be greatly concerned about the rapid rise in the stock market.

In summary, it can be interpreted that asset price surges arising during the recovery of the real economy must be tolerated to some extent for the time being. There is also an argument that it is not always appropriate to perceive and worry about 'asset price surges = bubbles.' The stock market serves as a leading economic indicator, and when stock prices rise, it becomes easier for companies to raise funds, which can eventually lead to increased employment and real economic recovery. The fact that the companies whose stock prices are rising recently are mainly post-COVID-related and 'Untact' (contactless) companies also suggests that the surge cannot be viewed solely as an excessive asset bubble.

However, if COVID-19 prolongs and money continues to be injected into the market without the real economy recovering, policy considerations will be necessary. A Bank of Korea Economic Research Institute official said, "In the past, monetary policy was thought not to have a significant impact on wealth distribution, but now, with very low interest rates and ongoing quantitative easing such as government bond purchases, those holding government bonds, including financial institutions and the government, will benefit. This aspect needs to be considered."

This content was produced with the assistance of AI translation services.