Monday, October 6, 2014

More tail-risk from Asia

There is another newly emergent tail-risk that investors should start to keep an eye on in Asia. No, it's not Hong Kong, which is already in the headlines, but Korea. Over the weekend, a high level North Korean delegation paid a visit to South Korea, ostensibly to attend the closing ceremonies of the Asian Games. Here is the report from the Washington Post [emphasis added]:
North and South Korea have agreed to hold another round of high-level talks after a top-level Northern delegation, including the men thought to be second and third in command behind Kim Jong Un, paid a surprise visit to the South on Saturday.

The unusual and unannounced trip — the first such high-level visit in more than five years — comes at a time of intense speculation about North Korea’s leadership, given that Kim, the third-generation leader of the communist state, has not been seen in public for a month.

It also comes amid a steady stream of disparaging comments from both sides, with South Korean President Park Geun-hye recently calling for the international community to help in “tearing down the world’s last remaining wall of division,” and the North calling Park an “eternal traitor” in response.

It’s a big deal, it’s really a big deal, because it’s completely unprecedented,” said Andrei Lankov, a North Korea scholar who studied in Pyongyang and now teaches in Seoul.
 This was in all respects a high level North Korean delegation:
The 11-strong group from North Korea was led by Hwang Pyong So, widely considered Kim’s deputy. He’s the top political official in the Korean People’s Army and vice chairman of the National Defense Commission, which is led by Kim.

Another member of the delegation was Choe Ryong Hae, who has performed both of the roles currently performed by Hwang and is chairman of the State Physical Culture and Sports Commission. That job was previously held by Jang Song Taek, the influential uncle that Kim Jong Un had executed last December, according to NK News, a Web site that monitors the North.

It is virtually impossible to speculate about the intentions of the North Korean delegation, but the likelihood of Korean reunification ticked up with this visit, particularly in light of reports that North Korean leader Kim Jong Un has not been seen in public since September 3. Rumors of coups have swirled around the so-called Hermit Kingdom (via The Independent):
On Friday, Vice News reported that Jang Jin-sung, formerly a key member of Kim Jong-il's propaganda machine, counter-intelligence official and personal poet laureate, had claimed that North Korea was "in the midst of a civil war" in September.

Jang, a defector, was reported to have said members of the OGD had stopped taking orders from the younger Kim. The OGD, Jang said, had effectively taken control of the country, with some seeking to gain wealth through increased foreign trade and open markets. "It's not actually consciously civil war, but there are these two incompatible forces at play," he reportedly said.

The alleged coup is said to have begun last year with Kim Jong-un only serving as a puppet leader while officials from the OGD, including Hwang, pulled the strings. It was, Jang claimed, triggered by the execution in December of Jang Sung-taek, Kim's uncle by marriage, who was a political rival of the OGD.

News of Jang Sung-taek's execution was accompanied by a string of extraordinary insults, branding him a "traitor for all ages" and "despicable human scum" who was "worse than a dog". A 2,700-word state-media report of his trial in a special military tribunal said he had admitted to plotting insurrection and a string of other crimes.

"By Jang dying, Kim Jong-un is now surrounded by the OGD," said Jang Jin-sung of the purge of Kim's uncle.

Upsetting the status quo
Should Korean reunification were to happen, it would upset the current status quo in North Asia and amount to an economic and geopolitical earthquake felt around the world.

First, what would be the cost? Remember the burden to West Germany as it integrated East Germany into a united country? Wikipedia reports that the economic disparities between the two Koreas is much worse than the two Germanys [emphasis added]:
Economic differences between North and South Korea are also a cause of concern. Korean reunification would differ from the German reunification precedent. In relative terms, North Korea's economy is currently worse than that of East Germany in 1990. The income per capita ratio (PPP) was about 3:1 in Germany (US$25,000 for the West, about US$8,500 for the East). The ratio is close to 18:1 in Korea (in 2011: US$31,700 for the South, US$1,800 for the North). While at the moment of German reunification the East German population (around 17 million) was about a third of the West German (more than 60 million), the North Korean population (around 24.5 million) is currently around half of South Korea's (around 49 million).
A recent report states that the cost of unification could amount to 7% of GDP for a decade (via Reuters):
Unification of the two Koreas could cost the South up to 7 percent of annual GDP for a decade though the South would benefit in various ways such as cheap labor and the North's resources, South Korea's Finance Ministry said on Wednesday.
Investors can kiss the Korean growth miracle goodbye for the foreseeable future.

The geopolitical dimensions could be just as ugly. Here is China's view of Korean reunification (via Wikipedia):
In 1984, the Beijing Review provided China's view on Korean unification: "With regard to the situation on the Korean peninsula, China's position is clear: it is squarely behind the proposal of the Democratic People's Republic of Korea for tripartite [between the two Koreas and the United States] talks to seek a peaceful and independent reunification of Korea in the form of a confederation, free from outside interference. China believes this is the surest way to reduce tension on the peninsula."

The Chinese strategic goal of opposing any foreign domination of the Korean peninsula, to prevent an attack on northeast China, resulted in intervention against America and South Korea in the Korean War as "self-defense." The reformist Chinese leader Deng Xiaoping was at times skeptical of Korean unification, remembering that after Vietnamese reunification, Vietnam sided with the Soviet Union in the Sino-Soviet split. However, China's support for North Korea, to prevent it from becoming too pro-Soviet, meant supporting their proposals for reunification, including Kim Il Sung's "Democratic Confederal Republic of Koryo" and Ten-Point Policy.
Translation: China would freak out if American troops were stationed in a bordering country. It would undoubtedly create fresh geopolitical tensions. Consider this account of the friction between a "friendly" China and North Korea, where North Korea referred to the tomb of a Korean king located in modern day China, with implications that it is Korean territory. Now imagine a reunified Korea and raise the level of tension by an order magnitude.

At this point, any speculation about possible coups and Korean reunification is just that, speculation about a low probability event. Nevertheless, investors should keep an eye on how the situation may develop, as it represents a level of tail-risk that's unlikely to be in too many analysts' spreadsheet models.

Meanwhile, despite talk about reunification, the news about the latest incident shows that the status quo remains unchanged.

Carry on, but be aware of the possibility of earth-shattering developments.

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