The floating money in the market will increase as a result of the uncertainty of the market followed by Korea-Japan trade dispute and its pre-reflected circumstances such as the downturn of the stock market, the foreign exchange depreciation, and the interest rate cut. As the government’s policy on the real estate market would prevent the money to flow into the real estate market, most of the floating money may flow into the cryptocurrency market.
The capital inflow to the cryptocurrency market would verify the importance of the cryptocurrency’s feature in the hedging side.
□ The Korea – Japan dispute & the U.S.-China trade dispute will have a negative influence on the Korean electronics industry
The U.S.-China trade dispute has finally somewhat settled. However, the concern is now on the exports regulations that Japan is enforcing against Korea.
The value chain in the global semiconductor market is directly influenced. The experts diagnosed that if the value chain is damaged, the supply network of various electronic devices around the world will be influenced, triggering another trade war. Korean exports have already declined in the first half, followed by the U.S.-China dispute. The exports have been declining for straight seven months since last December. The exports in June is 13.5% lower than that of the previous year, which is the most significant decrease in three years and five months.
Especially as the U.S. has blacklisted Huawei, the tech giant of China, consumer sentiment in the electronics market has frozen to intensify the export frustration of semiconductors. Under the circumstances, if Japan’s regulation on exports affects Korea’s semiconductor manufacture and exportation, the global electronics industry will be in a shock as a chain reaction. The global value chain of the electronic device market has been closely woven by the exchanges of raw materials, intermediary, and consumer goods.
Rajiv Biswas, the executive director and Asia-Pacific chief economist at IHS Markit analyzed in his report ‘Will Japan-South Korea trade tensions trigger a new trade war?’ that “Even as the US-China trade war and downturn in global electronics sector new orders have hit East Asian exports, opening skirmishes in what could be a new trade confrontation between Japan and South Korea have commenced.”
The effect may be more apparent and prominent if we see the stock market of Korea. The chart shows the market capitalization ratio by industry in July 2019. As the electronics industry, which is currently in dispute between Korea and Japan has 30.65% market share, the relevant stocks would be decreased from the portfolios of the investors, if the market uncertainty keeps going.
□ As major industry lose Competitiveness, economic growth and FX rate of Korea declines as well.
The annual average economic growth rate of Korea in 2019 is expected to be adjusted to 2.0%. Internal and external factors such as the remainder effects of the U.S.-China trade dispute and recession in the semiconductor market are unfavorable toward Korea. Plus, Japan has removed Korea from its whitelist. It is expected that these factors will lead to the slumps on the capital investment and export-import index. Some expect the partial agreement of the U.S.-China trade friction may work as a positive factor for Korea, though the agreement process is still blurry. The corporate behavior on slumps seems to continue, which may result in a further decrease in investments. In addition to these, Japanese trade regulation will work as another uncertainty in the semiconductor and electronics industry that may further postpone the turning point in the industry. Therefore, the exports is expected to recover at least after 4Q 2019.
Considering the possibilities of soft-land on global economy, intended depreciation of USD, and carry-trade demands, the USD/KRW FX rate would naturally decline. However, additional declination is also likely due to the continuing stagnancy in Korean economy fundamentals and the recent base rate cut by the Bank of Korea.
□ Increase in Net Capital Outflow and Uncertainty followed by the Stagnant Economy
As the Korean stock market remains relatively stagnant, the foreign securities transactions of domestic investors in the first half of 2019 have increased to 60.3% compared to that of the second half of 2018. It seems that the floating money will keep on going abroad as the domestic stock market is unlikely to rebound anytime soon.
On July 29, Korea Securities Depository announced that the total settlement amount of foreign securities in the first half of this year is 84.06 billion USD (approximately 99.5 trillion KRW), which is 60.3% higher than that of the last period. The foreign stock payment increased by 23.6% to 18.07 billion USD, whereas the foreign bond payment increased by 74.4% to 65.99 billion USD. The foreign bond preference may be explained by the increased popularity of the government bonds from major developed countries, due to the global trend of low-interest rate.
On the other hand, according to the Bank of Korea, the official floating money almost reached 1000 trillion KRW, meaning that the 99.5 trillion KRW of foreign investment is only 10% of the floating money. When the uncertainty is much heightened, it is only natural for the floating money to increase in order to find a better investment. However, the floating money currently is unable to find investment and is tied up on demand deposits, short term time deposits, and MMFs.
Picture three and four well demonstrate the situation in statistics. The net capital outflow has been continuing for months, and the EPS is -22.7%, which is the lowest among the MSCI countries. Under the situation, the funds should have flown into safe assets such as bonds and real estates. However, the Korea-Japan trade friction and the government’s intervention on the real estate market are the factors preventing the inflow from happening.
If the situation continues, the uncertainty of the Korean economy will exceed 400P, which is the highest since 2017, making riskless assets meaningless, leading the market to consider the cryptocurrencies as the proper investment windows.
□ Time to turn head to cryptocurrency – The stable coin may work as the hedging strategy and bring positive effect as a liquidity provider in the cryptocurrency market of Korea
In the stagnant market, the critical point to allure the floating money to the investment windows is the return on investment. The cryptocurrencies such as Bitcoin so far have been too unstable and volatile to function as the goods and to be invested. However, these criticisms were relevant only when the market was stable, and there were many other investment windows. The cryptocurrency in the current situation may be the proper investment window. Another critical factor is the release of the stable coin, which has the hedge function.
Stable coins such as Tether is designed to solve the problem of volatility which other cryptocurrencies such as Bitcoin had, to secure price stability. The main issuance agent of the stable coin entrusts collateral reserve consists of various stable assets such as legal currencies, government bonds and raw materials to the third party, mainly the banks and central bank, to match the issued coin for securing price stability.
Considering hedge trading used in the futures and options trades, the role of the stable coin is apparent. Traders will usually buy cryptocurrencies in the exchange platform. However, under intense market volatility, they will also purchase a stable coin as a stable asset. This is the same principle of how the hedge trading works, and this is why many investment institutes are focusing on the stable coin before investing on the cryptocurrencies. Especially in the Korean cryptocurrency market, traders and institutes are focusing on futures and options instruments.
According to the research of the U.S. cryptocurrency analysis provider, Chainalysis on the big four stable coins, the transactions had increased from 12.5 billion USD in 2017 to 82 billion USD in 2018. Another cryptocurrency specialized media, The Block, released on Apr. 2019 that the transactions of stable coins have increased four times over a year.
Though the stable coins are mostly used in arbitrage, many analyst and proprietary traders are using them for the hedge trade which may work as the domestic liquidity provider to bring positive effects.