Geopolitics Briefer: North Korea

Genevieve Signoret

North Korea is a tail risk

All three of our forecast scenarios assume that North Korea and the USA will avoid violence. Our decision to explicitly include this in our list of assumptions underlying all three scenarios is our way of telling you that we see its breakdown (violence breaking out between North Korea and the USA) as a tail risk—an event unlikely to occur but one that, if it does occur, could cause our entire forecast structure to break down and wreak havoc on markets. So we’re watching this risk, despite its wee size, with a keen eye. In today’s Timón Económico, we brief you on it.

We refer to the risk that, owing to unduly inflammatory rhetoric or other diplomatic bungling by U.S. President Donald Trump or North Korean leader KIM Jong Un, violence will erupt.

Violence could escalate into a conventional or nuclear exchange, a ground invasion of North Korea by the United States, mass North Korean migration to China, and untold death and destruction in the entire Korean peninsula, Japan, China, Russia, and the USA.

Actors

North Korea wants security guarantees, sanctions lifted, (possibly) foreign aid, and the return of defectors. To feel completely secure, it would need the USA to remove South Korean from its nuclear umbrella.

South Korea wants security, the return of citizens kidnapped by the North, and reunion of families split by the War.

While China would love the U.S. military presence in South Korea to end, it will settle for continuation of the status quo. It especially does not want the USA to invade North Korea. Even if a nuclear exchange could be avoided, China would be swarmed with refugees and, unacceptably, would have U.S. troops just across its border.

The USA wants North Korea ultimately to totally denuclearize and in the short run stop developing and testing nuclear weapons and missiles from which to fire them. President Trump, additionally, seeks to restore “respect” for the USA worldwide, which he perceives to have been diminished by what he sees as decades of U.S. softness. This, in his world view, is a major reason why countries such as North Korea think they can get by with destabilizing misbehavior.

Geography

North Korea’s 23.1 million citizens live on 120,536 square kilometers. By comparison, in Mexico, 5.5 times more people share an area 16 times larger; in the USA, 14 times more people live in an area 82 times larger.

North Korea is bordered to the north mostly by China but also for a few (18.3) kilometers by Russia, to the south by South Korea, to the east by the Sea of Japan (also called The Korea East Sea) and to the west by the Korea Bay.

Map of the North Korea (DPRK)

Source: CIA World Factbook, distributed under a CC-BY 2.0 license.

North Korea’s southern border is a mere buffer strip called the Korean Demilitarized Zone (DMZ) drawn under the Korean Armistice Agreement, which, in 1953, ended hostilities between the two Koreas but not, officially, the war.

Government

North Korea is a one-party state described in its 2009 constitution as revolutionary, socialist, and guided by Juche, roughly translated as “national self-reliance”. Since 2011, its head of state is KIM Jong Un.

History

We share this compressed history of North Korea through early 2017 from the CIA World Factbook:

An independent kingdom for much of its long history, Korea was occupied by Japan beginning in 1905 following the Russo-Japanese War. Five years later, Japan formally annexed the entire peninsula. Following World War II, Korea was split with the northern half coming under Soviet-sponsored communist control. After failing in the Korean War (1950-53) to conquer the US-backed Republic of Korea (ROK) in the southern portion by force, North Korea (DPRK), under its founder President KIM Il Sung, adopted a policy of ostensible diplomatic and economic “self-reliance” as a check against outside influence. The DPRK demonized the US as the ultimate threat to its social system through state-funded propaganda, and molded political, economic, and military policies around the core ideological objective of eventual unification of Korea under Pyongyang’s control. KIM Il Sung’s son, KIM Jong Il, was officially designated as his father’s successor in 1980, assuming a growing political and managerial role until the elder KIM’s death in 1994. KIM Jong Un was publicly unveiled as his father’s successor in 2010.

Following KIM Jong Il’s death in 2011, KIM Jong Un quickly assumed power and has now taken on most of his father’s former titles and duties. After decades of economic mismanagement and resource misallocation, the DPRK since the mid-1990s has faced chronic food shortages. In recent years, the North’s domestic agricultural production has increased, but still falls far short of producing sufficient food to provide for its entire population. The DPRK began to ease restrictions to allow semi-private markets, starting in 2002, but has made few other efforts to meet its goal of improving the overall standard of living. North Korea’s history of regional military provocations; proliferation of military-related items; long-range missile development; WMD programs including tests of nuclear devices in 2006, 2009, 2013, 2016, and 2017; and massive conventional armed forces are of major concern to the international community and have limited the DPRK’s international engagement, particularly economically. The regime abides by a policy calling for the simultaneous development of its nuclear weapons program and its economy.

For events since early 2017, we the following from International Crisis Group (ICG):

Developments on the Korean peninsula have been dizzying, from talk of war, to hints of diplomacy, to symbolic gestures and now this: the acceptance by U.S. President Donald Trump of Democratic People’s Republic of Korea (DPRK) leader Kim Jong-un’s invitation to direct talks. Coming on the heels of the announcement of the first inter-Korean summit in a decade and of Pyongyang’s decision to freeze nuclear and missile tests, this represents an important opening for diplomacy that should not be wasted.

At a minimum, prospects of a meeting (the first between an incumbent U.S. leader and his North Korean counterpart) can lower tensions on the Korean peninsula and, critically, mitigate risks – for the time being at least – of the U.S. and North Korea sliding toward a catastrophic confrontation. In the best-case scenario, it might pave the way for a longer-term solution to the decades-old Korean crisis. But optimism and hope must be tempered by caution: serious preparation by all sides will be required ahead of talks to calibrate and align expectations, and to prevent a failed summit that could quickly take the crisis back to the brink.

(…)

The 8 March announcement follows the latest round of talks between North and South Korean officials, including a dinner hosted by Kim, during which he expressed willingness to meet the U.S. president and in return freeze tests of nuclear and ballistic missiles, while turning a blind eye to U.S.-South Korean joint military exercises. South Korean National Security Adviser Chung Eui-yong, who led the South Korean delegation to those talks, conveyed Kim’s message to U.S. officials, including President Trump himself.

The North Koreans’ willingness to meet a U.S. president is not new; that long has been their goal. Nor is their willingness to put denuclearisation on the table novel; part of the regime’s mantra for years has been that denuclearisation is tied to an end to U.S. threats, a standard as hard to define as it will be to meet.

Rather, what is new is that the U.S. president accepted the invitation, and that North Korea appears willing to take several steps to make this happen. The announcement was all the more unusual insofar as it appears to have been preceded by little direct diplomacy between U.S. and North Korean officials – indeed, by little preparation within the U.S. administration itself, where most officials seem to have been taken by surprise.

What to watch for

In the same article we just quoted, the ICG lays out preparatory steps that would raise the odds of a successful summit:

• That Washington consults with China, Japan, and Russia
• That the USA appoints a credible team to help prepare
• That both sides reestablish contacts and rebuild relations
• That both adjust and align expectations, moving toward a shared definition of a successful summit
• That both quickly make goodwill gestures

And it defines summit risks:

• “That Kim will offer little in return for the meeting, while portraying it as evidence that his nuclear weapons programme has forced the U.S. to treat him as an equal”
• That “Trump will expect too much from the meeting, notably steps toward immediate denuclearisation, which will set the stage for a return to sabre-rattling and brinkmanship when that goal is unmet”

Our action plan

In tracking unfolding events related to North Korea, we the portfolio strategy team are using that ICG list of upside and downside risks[1], poised to adjust if necessary our classification of the risk that violence will break out between the USA and North Korea as a tail risk.

[1] Upside risk is market jargon for upside potential. Downside risk is market jargon for risk.