On the 27th, when the Bank of Korea (BOK) held its benchmark interest rate steady, Rhee Chang-yong, the BOK governor, gave weighty remarks on "broad money (M2)." Reporters first asked, "At the current level, how do you view the pace and scale of liquidity growth?" Rhee replied, "There is a statistic that M2 increased 8.5%, but if you exclude exchange-traded funds (ETFs), which are not included in M2 in the United States and Europe, it would be about 5.5%."
◇ Korea's M2 growth rate 8.5% > U.S. 4.5%… cited as a cause of "won weakness"
M2 can be seen as a concept of money supply that combines cash, cash equivalents, and short-term financial products. In September this year, Korea's M2 increased 8.5% from a year earlier. This can be seen as higher than in major overseas economies. Over the same period, the U.S. M2 growth rate was 4.5%. Europe (2.5%) and Japan (1.6%) had lower M2 growth rates.
Some also point to Korea's relatively high M2 growth rate as a cause of the "weak won." They argue, "Because Korea's liquidity growth is close to twice that of the United States, it led to a sharp rise in the exchange rate," and "the government's expansionary fiscal policy, supplementary budget allocations, and distribution of consumer coupons excessively increased liquidity."
The M2 growth rate is also used to support the claim that "it is not true that the exchange rate rose because demand for dollars increased due to Korean retail investors trading U.S. stocks." The view is that as won liquidity increased, the won's value fell and the exchange rate rose.
◇ If investment trust certificates are excluded, M2 growth rate is 6.3%… "there is an optical illusion"
On this, Rhee Chang-yong, the BOK governor, said, "Korea's M2 components differ from other countries." Korea includes investment trust certificates such as stock ETFs, bond ETFs, equity funds, and bond funds in M2. In contrast, the United States, Europe, and Japan exclude them from M2. That is because they have high price volatility and low liquidity. The International Monetary Fund (IMF) has also for years recommended that Korea not include investment trust certificates in M2.
It is true that the growth rate falls if investment trust certificates are excluded from Korea's M2. In September this year, the M2 growth rate including investment trust certificates was 8.5%, but excluding them, the growth rate drops to 6.3%. The domestic balance of investment trust certificates was 380 trillion won in January this year and steadily increased to 465 trillion won in September. Investment trust certificates account for around 10% of M2.
Rhee Chang-yong, the BOK governor, also said, "If you take investment trust certificates out of M2, the growth rate seems to be 5.5%." In effect, he suggested there is an "optical illusion" in Korea's M2 growth rate.
◇ "If M2 keeps rising, it will weigh on prices, household debt, and the exchange rate"
However, even if investment trust certificates are excluded from Korea's M2, the growth rate is higher by at least 1.8 percentage points and as much as 4.7 percentage points than in the United States, Europe, and Japan. Liquidity growth can be seen as relatively large.
Rhee Chang-yong, the BOK governor, also said, "It is true that a lot of liquidity has been supplied." However, he added, "The newly supplied amount is not that large, and there has been a substantial compositional shift of liquidity that used to be very abundant in medium- to long-term products into M2, which is a cash-equivalent asset."
Markets are finding the cause of the M2 increase in looser financial conditions after interest rate cuts. Baek Yoon-min, a researcher at Kyobo Securities, said, "Rate cuts expanded inflows of investment-oriented funds, and as the government encouraged investment by expanding lending, M2 increased further," adding, "In this process, the money multiplier (an indicator showing how much money supply is created from the monetary base) also appears to have risen."
Moon Hong-cheol, a researcher at DB Financial Investment, said, "If M2 increases, it can lead to higher inflation, expanded household debt, and a rising exchange rate due to increased won supply," adding, "Given these risk factors, the government and foreign exchange authorities need to watch M2 trends more closely."