[Lee Jong-woo's Economic Reading] Limits of Liquidity Supply from Han-eun... The Party Is Over

New Individual Stock Investments Total 21 Trillion Won Over 6 Months
Monthly Average 5.5 Trillion Won, Only 0.3% of Market Cap
Liquidity-Driven Market May Last Up to 2 Years
Without Sudden Factors Like Sharp Rises or Falls, May Only Limit Stock Price Declines

It has become difficult to discuss real estate and stocks without mentioning money. Despite the poor economy, asset prices have risen, making liquidity the inevitable cause of all phenomena. The experience over the past 11 years of lowering interest rates and injecting money leading to rising asset prices has also strengthened trust in money. People believe that money influenced the market in the past and will continue to do so in the future.

The increase in liquidity is due to central banks injecting large amounts of money. In June, the broad money supply (M2) increased by 9.9% compared to the same period last year, the highest figure since a 10.5% increase in October 2009. The growth rate, which was in the 6% range until mid-last year, rose to the 7% range earlier this year and exceeded 9% after the spread of the novel coronavirus disease (COVID-19).

Before the foreign exchange crisis, the financial market was fragile, so the Bank of Korea controlled the economy through money supply rather than using interest rates as a policy tool. In the 1990s, the target for money supply growth was 14%. Even when the growth rate fluctuated between 8-9%, the money supply growth rate was only about that much. Now that the economy has entered a mature stage, a money supply growth rate close to 10% shows how much money is circulating in the market.

As the money supply increased, idle funds in the market also grew. The market refers to cash currency, demand deposits, savings deposits with frequent withdrawals, money market funds (MMF), and comprehensive asset management accounts (CMA) collectively as idle funds. These products have the advantage of being easily liquidated without loss despite low interest rates, so the funds can move anytime toward higher returns. This money increased by 204 trillion won over the year, reaching 1,174 trillion won. The market believes that with such a large amount of money backing it, real estate and stock prices will not fall. Even if only 10% of idle funds move, it could buy 100,000 apartments worth 1 billion won each, so such confidence is understandable.

Regardless of the criteria applied, it is clear that an enormous scale of liquidity is present in the market, but there are points to consider.

First, the pattern of broad money supply growth differs from the past. Previously, even a small amount of money supplied by the Bank of Korea circulated multiple times within the economy, increasing in scale, but now the number of circulation cycles has halved while the amount supplied by the Bank of Korea has increased. This is a result of prolonged low growth and decreased economic vitality, and since the Bank of Korea cannot indefinitely increase money supply, liquidity supply is likely to face limits soon.

Idle funds in the market began to grow after interest rate cuts in March due to COVID-19, reaching a growth rate in the 20% range by June. Since 2000, there have been three similar situations. After the financial crisis in 2009 and in 2014 when the government encouraged borrowing to buy homes, idle funds played a role in raising stock and real estate prices, but in 1999, no change was created because asset prices, especially stock prices, were high. Whether idle funds can convert into investment funds depends on the size of the funds and asset prices. Currently, although idle funds are abundant, prices are also high, making capital inflow difficult.

What role has the increase in market liquidity played in the stock market?

It has played a significant role but not as absolute as the market suggests. Over the past six months, individual investors have net purchased stocks worth 41 trillion won in the combined KOSPI and KOSDAQ markets, but only 21 trillion won of this was newly introduced money. Of the 41 trillion won, 10 trillion won came from redemptions of equity funds used to directly buy stocks, and another 10 trillion won was from increased credit, so it is hard to consider this purely individual funds.

The situation with customer deposits is similar. Currently, customer deposits account for about 3% of market capitalization. Looking at the relationship between stock prices and customer deposits over the past 30 years, when stock prices fell, the proportion of customer deposits relative to market capitalization dropped to just over 1%, but when stock prices rose, it mostly increased to 3-4%. This time, customer deposits were 20 trillion won at the beginning of the year, about the mid-1% range of market capitalization, and rose to 3.2% as stock prices increased. Although customer deposits are large, this is not an impressive level compared to the past. The only difference is that in the past, individual investment funds entered the market alongside rising stock prices, whereas this time, funds entered in advance before the rise, playing a definite role in pushing up stock prices.

The largest inflow of individual funds into our market was right after the foreign exchange crisis. In 1999, when equity funds like 'Buy Korea' were popular, nearly 1 trillion won per day flowed into funds. At that time, market capitalization was about 150 trillion won, so the daily inflow was about 0.7% of market capitalization. The impact of this money on the stock market can be seen from the trading behavior of institutional investors at the time. Institutions started their day by buying major stocks like Samsung Electronics, POSCO, and Hyundai Motor at the upper price limit. Securing stocks regardless of price was the top priority. It is not like that now.

Future capital inflows are not expected to be large. After individual net purchases reached 11 trillion won in March, the monthly average purchase size has decreased to about 5.5 trillion won. It increased slightly in August to 7.76 trillion won, but considering the market size, a monthly net purchase increase of 2 trillion won is not a significant figure. The monthly net purchase of 5.5 trillion won is only 0.3% of market capitalization. This amount is less than the daily inflow into funds right after the foreign exchange crisis, making it doubtful what impact it can have.

For money to continue flowing into the market, stock prices cannot move slowly as they do now. Either stock prices must rise quickly enough to convince investors that they can surpass 3,000 and reach 3,500, or they must fall significantly below 2,000 as in March to firmly instill the perception that stocks are cheap. Neither scenario is likely now.

If stock prices rise slightly or move sideways, individual funds may flow out rather than in, as expected returns decline. In that case, the impact of liquidity on the stock market will change. In recent months, money actively pushed stock prices up, but that function will inevitably weaken. Instead, liquidity will play a more passive role in defending against price drops. This pattern is not new. After the U.S. financial crisis, low interest rates and money supply were maintained for over 10 years, but liquidity played a positive role in our market only for two years immediately after the crisis. Since then, liquidity has only kept the KOSPI from falling far below 2,000. Unless stock prices fluctuate sharply, liquidity’s role will inevitably revert to the past.

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