In 2006, seven years before he became Bank of Japan governor, a testy Haruhiko Kuroda told me he thought China was raising its own living standards at the expense of its Asian neighbors. "The relationship between exchange rates and poverty reduction is not so direct, but a more flexible Chinese exchange rate would benefit Asia," Kuroda, who at the time was head of the Asian Development Bank, told me in his office overlooking the Manila skyline. "It would make a difference."
Today, those remarks demand to be read with a sense of irony. As Japan's leading central banker for the past two years, Kuroda has relentlessly weakened the yen, which means he is now responsible for precisely the same regional dynamic he once lamented.
None of this is to suggest Kuroda is up to anything sinister. His mandate, after all, is to produce 2 percent inflation for Japan, and thus pull its $4.9 trillion economy out of a two-decade deflationary spiral. But it's impossible to deny that the yen's weak exchange rate is indirectly exporting deflation to the region. Taiwan's export-dependent economy is feeling the strain, and Singapore might be next.
But South Korea has been hit particularly hard. The country's 4.7 percent plunge in industrial output in February is the latest sign that deflation is on its doorstep. The country's consumer prices also rose by only 0.5 percent last month (the slowest pace since 1999), and its exports were down 3.4 percent.
Korean manufacturers have responded to the yen's 20 percent drop in value by trying to keep the prices of their own products down. In practice, that's meant executives with excess cash on their balance sheets have avoided making investments or giving workers a raise. The resulting wage suppression, however, is having negative consequences of its own, by hampering domestic consumption. (It doesn't help that Korean households are sitting on record debt, equivalent to about 70 percent of gross domestic product.)
Take Samsung Electronics, Korea's biggest and most important family-owned conglomerate, or chaebol. Last month, it decided to freeze the salaries of all workers in Korea for the first time in six years amid weak sales and plunging earnings.
The company didn't tie the move to the yen. But for economists like Ronald Man of HSBC in Hong Kong, it's pretty clear what's going wrong in corporate Korea at the moment. "Monetary easing in Japan may not push its neighbors into outright deflation just yet, but deflationary pressures are certainly rising," Man explains. He added that "a number of companies, including the chaebol, have decided to freeze wages entirely. The key implication is that even if inflation remains at a multi-year low, real wages will still contract. This hurts private consumption."
The last thing Korea should do is read too much into its recent announcement of a healthy 2.7 percent growth rate. As long as the two biggest economies in the region -- China (which is struggling to meet its 7 percent growth target) and Japan (which saw a 3.4 percent drop in industrial production in February) -- are in a malaise, the region's economic situation will be fragile. It may only be a matter of time until Kuroda drops the yen's exchange rate even farther.
Containing the fallout will require a united front in Seoul. The first step would be for the Bank of Korea to push for lower short-term interest rates, something it had been reluctant to do. On March 12, central bank Governor Lee Ju Yeol finally faced reality and cut the benchmark interest rate to 1.75 percent. But the bond market suggests Korea should drop its rate by another 25 to 50 basis points. Lee should get over his fears of high household debt and commit to monetary stimulus.
President Park Geun Hye should also quickly craft a supplementary budget to boost demand, while also accelerating her efforts to build a more "creative economy" -- a startup boom would lift the country's productivity and its wages. She should also implement her plan to tax excessive cash hoards that companies like Samsung could use to fatten paychecks.
If Kuroda's experience can teach Korea anything it's that deflation is the most stubborn of all policy challenges. Seoul needs to do all it can to avoid that fate -- for its own sake, and the region's.
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