Heightened risk on the Korean Peninsula - BBH

Economists at BBH explain, "reports suggest the US and South Korean intelligence have detected the movement of equipment that is often associated with the firing of a missile."

Key quotes:

"Reports suggest that China has been boosting its border defense.  It shares a nearly 900-mile border North Korea.  According to press reports, recent measures have included a new border defense brigade, 24-hour video surveillance of the border, and some protection from nuclear and chemical weapons."    

"The US strategy initially sought to prevent North Korea from acquiring nuclear capability.  When this failed, it sought to deny it delivery mechanism.  This too has failed.  There has been no formal program since 2002, and the so-called six-party talk has not proven effective."   

"Two things have changed that have escalated the tensions.  First, there was the election of a new US President.   We have argued against claims that the Trump Administration is isolationist.  It is true that the administration has expressed skepticism about the emergence of a global community, which previously the US helped create.  The US did pull out of the Paris Accord, but previously the US left the Kyoto Agreement, without being isolationist.  President Trump has made it clear that he prefers bilateral rather than multilateral trade agreements.  Reports suggest Trump has increased US drone activity and has challenged China claims in the South and East China Seas.    North Korea represents among the first and most pressing foreign policy challenges."

"Even if a surgical strike could neutralize North Korea's nuclear capability, it would likely preserve a second strike capability that could wreck havoc on South Korea. Moreover, a US strike on North Korea, which is unilateralist risks antagonizing China, Japan, and Russia.   Being censored by the UN may be more embarrassing than substantive, the more profound risk lies in the precedent that it establishes for others.  Russia used the precedent of the reunification of Germany and the establishment of the Palestinian Authority to justify the fiction of an independent Crimea (which later had a referendum to merge with Russia)."

"Later today, the US House of Representatives is expected to vote on the bill that will put more economic sanctions on North Korea (alongside Russia and Iran).  Although the measure is partly designed to prevent the President from lifting sanctions against Russia, the report suggests that Trump may sign the bill.  Nevertheless, the sanctions are unlikely to be a sufficient force to persuade the North Korean regime."   

"Military action by the US is talked about as a last resort.  However, last summer North Korea tested a submarine-launched ballistic missile (SLBM).    There appear to be some signs that another SLBM may be tested again in the next couple of days.  Such a capability may be just as important as North Korea’s ability to project its military might.  SLBM may be considerably harder to detect and therefore ensures a second strike capability. "  

"The capital markets seem fairly complacent about the approaching anniversary and the risk that it prompts an escalation of hostilities with the US.  Over the past five sessions, the Korean won is the strongest currency in Asia, rising about 0.7% against the US dollar.  Korean equities have underperformed most other emerging market equities in the regions, rising 0.6% (only Taiwan and Indonesia has done worse).  If there is no military response from the US to a North Korean missile test, the knee-jerk reaction is likely to be quickly unwound.  Gold has rallied 3.4% over the past two weeks, but the driver is the more likely the decline in interest rates and a weaker dollar.  Gold is off 0.25% this week."