Showdown Brewing on the Korean Peninsula

Conclusion: Geopolitical risk in the region remains substantially higher than U.S. consensus is aware of and the threat of full-out military conflict continues to escalate as diplomacy has taken a backseat to posturing and bravado.

 

Position: We remain bearish on Korean equities for the intermediate term trend, primarily due to slowing economic growth which is being exacerbated by inflationary headwinds.

With the whole world seemingly focused on Trichet’s announcement this morning, we thought we’d have your back by keeping our Global Risk Management Eye on the Korean Peninsula (among other things) for you. Markets wait for no one and risk doesn’t abate because we fail to focus on it.

Considering, it’s important to highlight some of the latest military posturing and rhetoric by political leaders regarding the situation brewing in Korea.

Earlier this week, South Korean President Lee Myung Bak vowed to make Kim Jong Il’s regime pay for additional attacks, saying, “It’s become clear that more patience and tolerance only leads to bigger provocations… North Korea will be made to pay for further provocation no matter what”.

This latest shift in tone follows a survey that shows over 80% of South Koreans believe the government should have “displayed a stronger military response” to North Korea’s recent attack on the disputed island of Yeonpyeong . Moreover, 33% of respondents said they were willing to risk war to do so going forward.

Accordingly, South Korea has doubled its’ artillery strength on the island, which coincided with the North installing surface-to-air missiles in the area. Let the arms race begin…

International Involvement

The U.S. and Japan have initiated military exercises in the region to the tune of over 44,000 combined troops, and South Korea is planning to join in on the “fun” shortly. This step heightens the risk of further military conflict when taken in the context of the North’s latest aggressive commentary:

“North Korea will deal a merciless military counter-attack at any provocative act of intruding into its territorial waters.”

It’s important to keep in mind that the North doesn’t recognize the maritime border laid out after the 1 Korean War. Additionally, the North regime has urged its Southern counterparts to call off the exercises, yet anonymous South Korean officials said today that its military may carry out further artillery drills next week – similar to the drills that started this conflict last Tuesday.

At the very least, it appears the South has been emboldened by U.S. and Japanese support, which doesn’t bode well for peace in the region.

Another headwind for conflict resolution is U.S., Japanese and South Korean reluctance to enter six-party talks with China, North Korea and Russia. Originally proposed by China on Nov. 28th, the talks have been met with steep resistance, particularly from the U.S. and Japan: 

  • U.S. Admiral Michael Mullen yesterday: “Beijing’s call for consultations will not substitute for action. I do not believe we should continue to reward North Korea’s provocative and deeply destabilizing behavior with bargaining or new incentives.”
  • Japanese Foreign Minister yesterday: “Talks can’t be held only because North Korea has run amok.”
  • South Korea’s Ministry of Foreign Affairs and Trade said it would “consider China’s call for talks very cautiously”. 

The resistance to further negotiation is born out of two key factors: 

  1. North Korea has a history of rattling its saber to force diplomatic discussions whereby they wind up exchanging promises of good behavior for additional foreign aid (email us if you’d like to receive a podcast of our May call with Charles Hill regarding North Korean tactics, etc.); and
  2. The U.S. is concerned that North Korea poses a substantial nuclear proliferation threat. Last week it confirmed it has a uranium-enrichment facility and South America intel has concluded that North Korea recently shipped Iran 19 advanced missiles. The country is already under current UN sanctions for previous nuclear tests. 

Of course, it comes as no surprise that China, a long-time ally of North Korea, is criticizing the ongoing military exercises and rejections of diplomacy as both dangerous and unproductive. Today, Chinese Foreign Ministry spokeswoman Jian Yu said, “Brandishing of force cannot solve the issue. Some are playing with knives and guns while China is criticized for calling for dialogue – isn’t that fair?”

 

Further, Chinese opposition has stalled UN Security Council negotiations condemning the recent attack and North Korea’s expanding nuclear program. This is noteworthy, given that the council needs to reach consensus before making accusatory statements. Earlier this year, it took roughly four months to agree on a statement that only implicitly condemned North Korea for sinking the South Korean warship Cheonan.

China’s posturing has been met with more stringent international resistance this time around, as evidenced by U.K. Ambassodor Mark Lyall Grant’s recent comments: “We are not prepared to have a weak response by the council. These are serious violations on the nuclear side and the shelling should be condemned if we are to make any statement at all.”

At any rate, the situation on the Korean peninsula is increasingly shaping up as an international game of “Us vs. Them” and the rift could be far-reaching if the conflict isn’t resolved quickly. Unfortunately for sake of conflict resolution, neither side appears willing to back down at the current moment, leaving as situation of “high alert” as the best-case scenario for the region. Worst case, the conflict could heat up if certain lines (both physical and rhetorical) are crossed.

From a quantitative perspective, Korea’s KOSPI 100 remains broken from a TRADE perspective and bullish from a TREND perspective.

Darius Dale

Analyst

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