Despite being geographically very distant from each other, South Korea and Germany are, in reality, more similar economically speaking than everyone thinks.
Both countries appear “very safe” considering the very low public debt-to-GDP ratio they both showcase: 46% for South Korea and 62% for Germany. What if we add private debt to the ratio? South Korea’s private debt-to-GDP stands at an incredible 283%, while Germany’s is at 170%. How is it possible that the population could pile up such an incredible amount of leverage? Because of the “very safe” credit ratings both countries have been assigned.
As of today, despite all that’s happening, South Korea, for example, is still rated Aa2 by Moody’s, AA by S&P, and AA- by Fitch. What about Germany? Of course, the country continues to be rated AAA by every agency out there since that’s what a myopic review of the country’s finances dictates, as it does for South Korea. What is the relationship between a country’s credit rating and the leverage accommodated to its population? The answer lies in how banks calculate risk and RWA (risk-weighted assets). To keep things simple, the higher the “sovereign rating,” the lower the risk parameters used in banks’ models to project potential losses. Consequently, also thanks to bank regulations tailored to this principle, banks can lend hundreds of billions of USD while setting aside minimal capital in countries with a high sovereign rating. What does easy money end up creating every single time? Asset bubbles. On this point, things are different between Germany and South Korea.
In the case of South Korea, all this money borrowed by private individuals has been mostly directed to buy foreign assets such as US stocks (Shunning home markets, South Korean retailers pile-up on US stocks), Indian stocks (S.Korean retail investors rush to buy Indian stocks on dips), and double or triple leveraged ETFs on foreign assets (Increasing number of retail investors pursue triple-leveraged daily returns abroad). What about their domestic economy? South Koreans would rather prefer to trade cryptocurrencies than their very own stocks: South Korea retail crypto trading hits $18B, beating local stock market.
In the case of Germany, most of the money borrowed by private individuals has instead been mostly invested in what everyone perceives as the safest asset class in the country: real estate. Unfortunately, this created a bubble of epic proportions both in the Commercial and Residential real estate sectors:
- HOW DO YOU SAY “NINJA MORTGAGE” IN GERMAN? THE BREWING CRISIS NO ONE IS FORESEEING
- THE INCOMING GERMAN REAL ESTATE MAYHEM
- CRE CRISIS: HIDDEN LOSSES AND QUESTIONABLE OPTIMISM IN DEUTSCHE BANK’S Q3-24 REPORT
What do you think lenders are going to do when the aforementioned private debt becomes unsustainable? They will have to take possession of the collateral and liquidate it to recover as much money as possible. However, since banks are aware this will translate into heavy losses (if not bankruptcies for some of them), what everyone prefers to do nowadays is either to accommodate longer time for borrowers to repay or even to lend them more money to repay what’s due in a perverse vicious circle I described last week in “HOW A FIAT CURRENCY SYSTEM DIES OF A THOUSAND CUTS” and that not only does not solve the problem but makes it an even larger one to deal with in the future.
On the other side, what is going to happen to borrowers once they are stripped of assets they could not afford to buy in the first place? Not only will they be financially broken, but they will also have a hard time earning an income considering the situation of the job market in both countries:
- Korea: 1 in 5 out of work for at least 6 months due to expectations mismatch: “One in five jobless people failed to find employment despite putting in efforts for over six months, the highest figure since 1999 at the height of the Asian financial crisis, government data showed Tuesday“
- Germany: German Fortune 500 companies have announced over 60,000 layoffs this year, but the biggest employee cull is still to come: “Major German employers, including Bosch, Thyssenkrupp, Deutsche Bahn, and Siemens, have this year announced plans to lay off thousands of workers in a bid to combat falling profits following a rocky post-COVID economic landscape”
I believe that many of you now might think: “With such a low amount of public debt to GDP, the country can start distributing stimulus checks and bail out its own people, no?” I am afraid the “true” amount of public debt both countries carry is much higher than what’s reported in the public data since both used a rather popular trick to pile up debt while keeping this off their balance sheet: “state-sponsored,” but not “explicitly guaranteed” development banks.
The German KFW Group (“Kreditanstalt für Wiederaufbau”), which describes itself as “is one of the world’s leading promotional banks“, for example, lent ~600bn EUR through various programs aligned with the German government policies, funding itself by issuing notes and bonds for a total of ~500bn EUR that are guaranteed by the country but, wink wink, as such this stack of debt does remain out of the scope of what’s considered public debt. Along with KFW Group, other notorious development banks in Germany are: NRW.BANK (the development bank of the German state of North Rhine-Westphalia), Landeskreditbank Baden-Württemberg – Förderbank (L-Bank), Landwirtschaftliche Rentenbank, LfA Förderbank Bayern, and Investitionsbank Schleswig-Holstein. If you put all these together, you have a total of ~1 trillion EUR of off-balance-sheet debt for Germany. Shocking, isn’t it?
What about South Korea? Very similar setup here:
- Korea Development Bank (KDB) focuses on financing large industrial and infrastructure projects, supporting corporate restructuring, and fostering innovation. It serves as a critical institution for advancing South Korea’s economic strategies, particularly in emerging industries.
- Industrial Bank of Korea (IBK) is dedicated to supporting small and medium-sized enterprises (SMEs). With government ownership of 57.7%, IBK offers financial products and services tailored to SME growth, including loans and credit facilities. It is one of the largest providers of SME loans in the country, constituting about 81% of its lending portfolio.
- Export-Import Bank of Korea (KEXIM) serves as South Korea’s official export credit agency. Its mission includes promoting international trade and investment by providing export credit, guarantees, and overseas project financing. It also plays a crucial role in facilitating South Korean companies’ expansion abroad
These 3 policy banks alone have ~600bn USD in total liabilities that are not even explicitly guaranteed by the government (hence not accounted for in the national debt) that is only committed, but not obliged, to inject capital into them in case they go bust.
As I write, the KRW is at multi-year lows against the USD, and the Bank of Korea is quickly burning through the ~420bn USD of foreign reserves to support it. Expect Germany to trigger something similar for the EUR in the not-so-distant future in something I already warned about months ago: HOW LOW WILL THE EUR SINK THIS TIME?
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