Is North Korea bluffing and what does it mean for markets?

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As if the global economy hasn’t got enough to worry about, we can now add to the list, renewed tensions on the Korean peninsula.  An increasingly desperate (and wacky?) North Korean regime has started making bellicose threats to launch nuclear strikes on the South.

Of course, should the North carry out its threat it would likely spark retaliation by both the South and the United States.  It goes without saying that a nuclear tit-for-tat in the Asian region would not be helpful for global markets, and we’d likely witness a major slump in risk markets worldwide – perhaps not unlike that seen following the September 11, 2001 US terrorist attacks, Peal Harbour in 1941, or even the September 1987 collapse.

Markets nonplussed

But what’s remarkable about the stock market, is its ability to bounce back in the face of seemingly serious setbacks. Note that following the 2001 terrorist attack, the S&P 500 slumped by 4.9% when markets re-opened on September 17, and by a total of 11.6% before bottoming a week later. But those losses were soon recovered, leaving the market to re-focus on the dotcom crash and the gathering recession.

Back in October 1987, the market dropped by almost 30% in a few days, but recovered its losses within two years. Even the 1941 attack on Pearl Harbor saw US stocks slump over the two following days, only to then recover.

In a Korean worst case – though still remote – scenario, the likely knee jerk slump in world markets would probably also represent a great buying opportunity, providing the North’s attacks did not extend beyond the South. And any losses investors faced should be quickly recovered.

After all, despite its threats, North Korea remains a relatively small and impoverished economy that would be quickly annihilated in any stoush with the South and its American ally. It has a population of 24 million, which eke out an existence with average annual per-capita incomes of only $US 2000. By contrast, South Korea’s population is twice as large and its economy 40 times larger – South Koreans enjoy annual per capita incomes of just over $US 30,000. The North would be crushed, probably even more quickly than Iraq in the two wars with the US since 1990.

Considering that North Korea’s per capita GDP was once higher than that in the South following the Korean war, their growing income divergence is yet another example of the failures of communism.

Of course, an attack on South Korea could be devastating for its economy and populace. But it would not necessarily be devastating for the rest of the world. South Korea’s economy is the 13th largest in the world, accounting for 2% of global GDP. Its economy is about a tenth the size of the US economy, and 50% larger than Australia’s.

Sticks and stones

Any thinking North Korean in a position of power, likely knows any attack on the South would quickly mean obliteration of the still comfortable lifestyle of the ruling clique that runs the country. It would be mutually assured self-destruction. Indeed, it can’t be in the interests of the North Korean power elite to make good their threat, which is why global markets and the US and Korean Governments are taking the taunts in their stride.

More likely, North Korea is once again angling for re-instatement of concessions lost following recent missile tests – such as food aid and global financial transactions. There’s also a suspicion it reflects attempts by its new young leader Kim Jong-un to consolidate his power, and test the openness of newly re-elected US President Barack Obama to direct talks and greater recognition of the North’s nuclear might.

Historically, North Korea has usually managed to wrangle new talks and concessions from the United States following an escalation in verbal threats.  In a game of bluff and brinkmanship, America is perhaps hoping to stand firm this time around. But the US may well eventually conclude some concessions are the least bad option – given one can never underestimate the possible irrationality of the opposing side.

While common sense should eventually prevail – with a de-escalation of threats on both sides – we should not forget Iraq was stupid enough to goad the US (and its allies) into invading it back in 2003.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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