The markets were rattled this week after news that North Korea
tested a nuclear weapon as powerful as the one that destroyed Hiroshima, but have proven unfazed.
Political instability clearly exists in the region and in various spots in the world (including Iran which has its own nuclear game going on with the West), but what does this mean to the current economic recovery? Nothing.
What is important is the role China will play in the region. It has been unwilling to take a strong stand against North Korea despite its necessary role as regional police. If China does not lead the charge, this will be a greater signal to where China will engage and work with the West on the issues that do matter, i.e., its currency appreciation and the impact its under valued status has had on the liquidity bubble created globally as well as its way of handling a gradual transition away from the U.S. dollar as a global reserve currency.
The U.N. Security Council has reacted within a day, faster than they did during the April rocket launch. Sanctions/actions should come fairly quickly. If you are looking for a harsh reaction, don’t expect to get it from NATO whose secretary said they should stop these tests "as soon as possible" and get back to six party talks.
Some other thoughts on the testing and political/economic implications:
- This event complicates President Obama’s efforts to reign in Kim Jong-il as North Korea has fulfilled a threat to retaliate for U.S. led sanctions after April.
- Depending on how you measure the region, it is potentially 15%-20% of the global economy.
- There is grandstanding by Jong-il to cement power to engineer succession, and he wants his third son to take over.
- The testing raises concerns about nuclear proliferation and Obama's ability to stop it or prevent a sale to Syria or Iran.
- Tough resolutions are necessary as the credibility of the U.N. Security Council is at stake, but don’t make threats you can't keep or you risk losing more of that credibility.
- China won’t support anything tough on U.N. Security Council. China wants to get North Korea back to the six party talks on which they previously bailed. Give up nuclear weapons in exchange for massive aid and food, and end the pariah state status.
- So far, no threats have been thrown out that can not be kept. North Korea is already impoverished, so economic sanctions are almost meaningless.
- The launch was same place North Korea fired on Japan in April.
- China's response was stronger than in April and the same as stated in the 2006 test blast.
- Meanwhile, Iran’s nuclear program trudges onward.
This is an early test for Obama, and the U.S. cannot attack North Korea because of the South. Obama's policy needs to speak swiftly and strongly by holding the big stick but not threatening and letting China take the lead.
