Seeking Alpha

Macro Investing Opportunity Brewing In South Korea

by: Alan Longbon
Alan Longbon
Macroeconomics, long/short equity, Deep Value, long-term horizon

Local stock market has fallen lately due to the market factoring in potential new taxes on companies and the wealthy.

As a monetary currency sovereign, the South Korean government does not need to tax to spend as it is the source of the unit of account.

The neoliberal economic-driven government is appointed by and runs the government on behalf of big business and so the tax proposals are unlikely to pass.

At present, the South Korean stock market has been shaken by the expectation of business profits being negatively impacted by a new tax that targets big business and wealthy individuals.

The premise of this report is that these tax proposals will fail and business, as usual, will resume in an economy that has some of the largest and strongest fiscal flows on the planet.

Having failed, the local stock market will continue its upward ascent.

This report was produced using a balance of national accounts assessment of South Korea.

One can summarize the national accounts in the following formula:

Private Sector [P] = Government Sector [G] + External Sector [X]

And similarly:

GDP = Private Sector [P] + Government Sector [G] + External Sector [X]

See the methodology section below for more detail on these formulae.

Each sector will be examined in turn starting with the private sector.

Private Sector

The private sector is where the stock market is and we as investors want the stock market to go up. The stock market can only go up if the flows into it are positive. The private sector derives income from three sources:

  1. Credit creation from banks - More loans are created than are repaid.

  2. Externally from overseas commerce - More is exported than imported.

  3. Government spending - more is spent than taxed out.

In an ideal scenario, the private sector would receive large and growing income flows from all three sources, and at the very least, the overall impact should be a positive flow overall even if one or two of the three flows are negative. The stock market in the private sector as well as all other private financial assets should rise if the overall income flow into the private sector is positive. Certainly, the stock market would be unlikely to rise if the income flows were negative. Even in a shrinking economy, some sectors can grow while the rest of the pie shrinks.

Certainly, the stock market would be unlikely to rise if the income flows were negative. Even in a shrinking economy, some sectors can grow while the rest of the pie shrinks. One has the best chance of earning a positive return in a private sector that is growing rather than shrinking and this should be a macro investing consideration for any investor.

The chart below shows the level of private credit creation entering the private sector through commercial banks.

The chart shows that private credit creation was growing at a healthy pace up until October 2016 and has been flat since then. Zero growth from net inflows into this stock of funds.

External Sector

The external sector captures trade and commerce with other countries and is best captured by the current account. The current account is exports less imports, and it also captures capital flows in and out of the country from financial transactions and investments. A positive overall result is best.

The chart below shows the current account balance. The chart shows the current account is both positive and trending upward. Year-end traditionally sees a peak in the current account. At present, Korea is experiencing a normal mid-year flat growth trend in an overall secular up trend dating back to the end of the GFC stock market crash in 2008.

Government Sector

The government budget is in the charts below.

The chart shows the government adding to the private sector. Since the GFC boom-bust in 2007, the government has been injecting money into the private sector, and one can see that since 2010 the injection has been growing year on year. It is rare to see such a chart where the government is helping the private sector by spending money into it rather than taking it out or decreasing participation.

More recently the trend appears to have changed for the worse. The lower of the above two charts show that over the last twelve months the government has been taking money out of the economy, draining it of funds by taxing more than it spends.

The table below shows taxes before the recent changes and not including the proposed changes. Taxes drain money out of the private sector and destroy financial assets.

(Source: Trading Economics)

Thanks to changes brought in January 2017, the maximum personal income tax rate is now much more as the KPMG bulletin below explains.

(Source: KPMG)

Korea's Strategy And Finance Ministry Proposes Tax Law Changes For 2017 - Tax - South Korea

The tax rates compared with the rest of the world are high, especially for workers at 44 percent of income. 38 percent of internal aggregate demand is taxed away and destroyed together with the 10 percent sales tax. That makes a dent in aggregate demand of 54 percent of income flows from wage earners who are also customers.

Social security further erodes aggregate demand by 16.76 percent. This is money that an income earner cannot spend now. In total, domestic aggregate demand is dampened down by over 70 percent for the highest income earning workers.

The South Koreans have further complicated business with a value added tax that is notoriously hard to administer and favors larger firms with more bureaucratic administrative muscle over smaller ones.

The yawning disparity between the corporate tax rate and the personal tax rate is a scandal and shows who controls the political agenda and government. Note that the 10 percent sales tax is a value added tax on domestic purchases and does not apply to exported goods.

This disparity is something the government plans to fix by also increasing this tax as well. The two main changes are:

  1. New limit on utilization of Net Operating Losses ("NOL") carryforwards for foreign companies.
  2. County-by-Country ("CBC") reporting requirements for Multinational Enterprises ("MNEs") Introduced

The headline corporate tax rates stay the same; however, new penalty rates apply for not paying out profits or re-investing funds as the following bulletin from PwC shows.

(Source: PwC)

As a net exporter (unstated), neoliberal economic policy is to promote international competitiveness with low taxes for export companies and high labor taxes to suppress internal demand for imports. This policy mode tends to stop the currency exchange rate rising but also stops the standard of living and well-being rising as well. Such a policy setting benefits business owners at the expense of the rest of the population.

Given that the large corporations install and support politicians that further business interests, it is likely that the above new corporate tax proposals will be defeated. This defeat will allow corporate profits, dividends and capital gains in local stocks and bonds to continue.

The only successful tax increase proposal has been that on workers who now pay a higher marginal rate of tax on their earnings. This lowers domestic internal demand for imports, thus taking pressure off the local currency that might otherwise have risen given that the demand for imports drives the demand for the currency upwards.

South Korea is a monetary currency sovereign and does not need to tax or borrow money from the private sector to fund itself as it is the source of the money. Draining the private sector with taxes or borrowing from it is akin to putting seawater back into the sea. Public taxation policy uses an obsolete gold standard mentality. The gold standard has not applied internationally since 1971, and yet its legacy remains.

Sectoral Analysis Methodology

Each nation state is composed of three essential components:

  1. The private sector

  2. The government sector

  3. The external sector

The private sector comprises the people, business and community, and most importantly, the stock market. For the stock market to move upwards, this sector needs to be growing. This sector by itself is an engine for growth and innovation; however, it only needs income from one or both of the other two sectors to grow.

The government through its Treasury also sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine and can put in as much as its target inflation rate allows. It is not financially constrained. For a sovereign government with a freely floating exchange rate, any financial constraint such as a matching bond issue is a self-imposed restriction. A debt ceiling is also a self-imposed restriction as is a fiscal brake.

The external sector is trade with other countries. This sector can provide income from a positive trade balance, or it can drain funds from a negative trade balance.

For the stock market in the private sector to prosper and keep moving upwards, income is required to be put into the flow. Otherwise, the sector can only circulate existing funds or is being drained of funds and is in decline.

The ideal situation is that the private sector has a net inflow of funds and is always growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.

The following formula can express this relationship:

Private Sector = Government Sector + External Sector


GDP = Private Sector + Government Sector + External Sector

These are accounting entities and correct by definition.

For the best investing outcome, one looks for countries with stock markets located in private sectors that are receiving positive income flows overall. Top marks come where private credit creation, the government sector, and external sector are both in plus and trending upwards.

Conclusion, Recommendation and Summary

When we take our inputs and place them in our formula, we can calculate the following sectoral flow result based as a percentage of GDP.

Private Sector Credit Creation


External Sector


Government Sector










2016 1.5% 7.7% 3% 12.2%

(Source: Trading Economic and Author calculations based on same)

One can see though that the external sector does the heavy lifting with no help from the other two sectors whose growth is flat.

The government needs to help the private sector deleverage to maintain domestic aggregate demand, best done by eliminating those high taxes that have been draining away the capacity to repay private debt. Business owners must realize that it is a zero sum game and that taking too large a share of profits at the expense of workers results in a collapse in domestic aggregate demand and sales. Business owners too must help wage earners lower their debts by paying them a larger share of the profit take at least in line with the rise in productivity.

The combined flows into the private sector were over 12% last year. Since then they have fallen almost in half and explain why GDP has flatlined. The fall in fiscal flows comes largely from a retreat by the government which appears to be taxing the economy into a recession.

Investment access to South Korea when one is not there can be made via the following ETFs.


iShares MSCI South Korea Capped ETF


Deutsche X-trackers MSCI South Korea Hedged Equity ETF


AdvisorShares KIM Korea Equity ETF


Direxion Daily South Korea Bull 3X Shares ETF


First Trust South Korea AlphaDEX Fund


iShares Currency Hedged MSCI South Korea ETF

If one believes that the government will lose its battle to increase taxes on corporations in South Korea, then one could invest in the above-listed funds for exposure to this likely event.

Even though short term there might be a positive market reaction to a cessation of corporate tax increases, the overall fiscal flow situation in South Korea has dimmed markedly since last year, and longer term prospects appear flat at best.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.