North Korea, the ultimate Black Swan
But there’s no doubting what’s at stake as investors mull how a rhetorical arms race between Kim Jong Un and Donald Trump might play out
Next month’s International Olympic Committee meeting will be a uniquely dramatic affair as officials mull new risks to the Pyeongchang winter games to be staged in South Korea, 80 kilometers from North Korea.
That event is five months out, but the sudden focus on missiles rather than medals speaks to the geopolitical threats emanating from Pyongyang. Economic ones, too.
In recent years, Pyeongchang has gone to great pains — and marketing expense — to stress it’s not the similar-sounding North Korean capital. That didn’t stop a Kenyan official from flying to Kim Jong Un’s biggest city in 2014 by accident.
But there’s no confusing what’s at stake as investors from Seoul to New York mull how a rhetorical arms race between Kim and newish US President Donald Trump might play out. There are two scenarios to consider.
The first — war — has some economists assessing the worst. One such appraisal from Capital Economics Ltd. is garnering interest.
Authors Gareth Leather and Krystal Tan warn of growth shocks, devastated supply chains, sharp currency gyrations and skyrocketing US debt that alters the trajectory of global living standards.
This is the Black Swan scenario, in which an erratic US leader does what everyone says he can’t and wages pre-emptive war, Iraq-style (or it’s Kim that fires first).
The second, and most likely eventuality, is a proxy war on the economic front between Trump’s “America First” policy and a Chinese president calling Washington’s bluff.
The odds of the Black Swan risk that Leather and Tan explore rose last week with Trump’s “fire and fury” warning and Kim threatening to lob missiles Guam’s way.
Obviously, the biggest cost of conflict is humanitarian. More than 1.2 million South Koreans died in their last battle with the North, when gross domestic product fell more than 80%.
Though it now accounts for 2% of world GDP, South Korea plays an outsized role in supply chains. It produces 40% of the global share of liquid crystal displays, 17% of semiconductors and it’s home to the three biggest shipbuilders and major smartphone and auto companies.
While war is man-made, natural calamities such as the massive Japan earthquake in 2011 and devastating floods in Thailand in the same year offer a window into how a disaster can disrupt an economy and global supply chains.
In the Thai example, “the impact on the economy was considerable,” said Leather and Tan.
“GDP in the final quarter of 2011 fell by 4% y/y, led by a 16% contraction in manufacturing output.” Yet the “impact of a war in Korea would be much bigger” because “South Korea exports three times as many intermediate products as Thailand.”
Global prices, it goes without saying, would skyrocket. US debt also would explode when reconstruction begins. If Washington’s tally of costs on the Korean peninsula are proportional to Afghanistan and Iraq, American debt could soar by another 30%, hitting the dollar and boosting the yen.
The more plausible scenario is war averted. But even that could have Trump and Chinese President Xi Jinping waging a proxy war.
Trump is frustrated that Xi hasn’t done more to curb’s Kim’s nuclear blackmail antics. To be sure, Trump exaggerates Xi’s ability to snap his fingers and tame Pyongyang. But Xi could do considerably more to use Beijing’s financial leverage.
Last week, Trump’s team announced tariffs on Chinese aluminum foil of between 16.5% and 81%. It could be a harbinger of bigger actions to come.
On the campaign trail, Trump’s pledge to tax mainland imports at 35% or 45% played very well. Desperate for a perceived win on the international stage, Trump may indeed start a trade war.
Part of this is testosterone. Trump, naively, thought inviting Xi to his Mar-a-Lago compound in Florida forged a trusted friendship. As Trump seethes and looks to distract attention from Russia scandals, America’s trade deficit could be just the target.
Then Beijing would retaliate: a big yuan devaluation; dumping $1.1 trillion of U.S. Treasuries; canceling all orders for Boeing planes; levies on the operations of companies from Apple to General Motors to Walmart; making it even harder for western tech giants to operate in Asia’s biggest economy.
Such steps would boost U.S. borrowing costs and send the yen surging, complicating Japan’s deflation fight. Any of these steps, be they from Trump or Xi, could push China’s debt-and-bubble-wracked financial system off-balance, putting the rest of Asia in harm’s way.
It’s worth noting, too, that markets from New York to Tokyo to Mumbai have been on powerful bulls runs. The coming selloffs could be epic.
If geopolitical bluster were an Olympic sport, Kim and Trump would both be clear medal contenders. All investors watching uneasily from the sidelines can do is hope it’s all talk.
(William Pesek is a Tokyo-based journalist, former columnist for Barron’s and Bloomberg and author of “Japanization: What the World Can Learn from Japan’s Lost Decades.” Twitter: @williampesek)
