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2017-09-19 10:19:26
The markets have concluded Kim Jong Un and Donald Trump are blusterers
A ROGUE state has tested what may be a hydrogen bomb and has sent a missile
over the territory of a neighbouring country. The American president has
promised fire and fury if threats continue. The Security Council of the
United Nations has been locked in debate. This sounds like the plot of a
Hollywood thriller or a paperback potboiler in which the world is heading for
conflagration.
But international investors are not thrilled, and seem barely disconcerted, by
the crisis on the Korean peninsula. Gold has risen a bit, the yield on Treasury
bonds has dropped and the MSCI World equity index has fallen since the start of
August. However, the moves have not been huge. Even the South Korean
stockmarket, surely the most sensitive gauge of war risk, is well above its
level at the start of the year.
What explains this remarkable insouciance? One possibility is that the markets
may simply not be very good at assessing political risk. After all, investors
failed to foresee either the result of the Brexit referendum in Britain or the
election of President Donald Trump.
Another possibility is that investors have learned in recent decades that
geopolitical events from the September 11th attacks and the invasion of Iraq to
countless presidential elections tend to have only very short-term impacts on
the markets. Economic growth and corporate profits are far more important
factors. For investors who use algorithms to trade, political risk probably has
very little bearing on their calculations.
Go back far enough, however, and it is possible to find political events with
huge financial ramifications after revolutions in their countries, the Russian
and Chinese governments defaulted on their debts, for example. A war that
engulfed the Korean peninsula, dragging in China and Japan as well, would
surely be one of those fat tail events that the models struggle to assess.
But a few brave analysts are now trying to contemplate the effects.
Besides the terrible humanitarian cost in both North and South Korea, there
could be immense damage in certain industries. The global economy is a lot more
integrated than it was during the Korean war of 1950-53. Capital Economics
points out that South Korea produces 40% of the world s liquid-crystal displays
and 17% of its semiconductors. If Japan was the target of missile strikes from
North Korea, as it might be, the disruption would be even greater. A war with
conventional weapons would be bad enough; the lasting impact of nuclear weapons
use would be immense.
The limited reaction of investors to this terrible possibility suggests that
they do not believe it will happen and that they feel the heightened rhetoric
on both the American and North Korean sides is simply bluster. A recent example
was a tweet from Mr Trump on potential trade sanctions. Rabobank, a Dutch bank,
says that American counter-threats are not perceived to be credible. The
distinctly limited likelihood of the US cutting all trading links with China
should the country continue to do business with North Korea is a case in point,
the bank adds.
Just because a war would have disastrous economic consequences may not prevent
political leaders from stumbling into conflict, either by accident or because
they have other priorities. In 1909, Norman Angell wrote a book called The
Great Illusion which posited that war between nations would be futile because
of their economic interdependence. Five years later, war broke out anyway.
But in the early 20th century, many nations were still ruled by hereditary
monarchs, for whom economic issues were not the highest priority. By the late
20th century, most developed countries were ruled by professional politicians
who recognised that economic success was their surest route to staying in
office. Recent conflicts in Afghanistan and Iraq did not involve the same level
of commitment as either the Korean and Vietnam wars, and thus did not have big
economic consequences. This may help explain investors confidence that
geopolitics will not interrupt the flow of goods and capital.
It is possible, in an age of populism and greater nationalism (and at a time
when American hegemony is being challenged by China), that the calculations of
political leaders have changed again, making conflict more likely. But no
amount of number-crunching based on past data can properly assess whether this
is the case; it is a judgment call. Investors have decided that a Korean
conflict will not happen. Cross your fingers that this is one case where the
wisdom of crowds will be proved right.