Saturday, 21 of October of 2017

Economics. Explained.  

War Talk – Real?  Or Rhetoric?

August 11, 2017

This is an economics column and for the most part we shy away from political events — unless they are likely to have a significant impact on the U.S. economy.  The threats of war emanating from both Pyongyang and Washington are clearly disturbing and could have dire consequences around the globe.  This is not the same discussion as whether President Trump’s proposed tax cuts, repatriation of earnings, and de-regulation can boost GDP growth by a couple tenths of a percent.  Or whether the Fed will continue it glacially slow pace of raising interest rates.  This is about an event that could potentially leave millions of people dead and quickly spread around the globe.  We would be remiss in not discussing the possibility.

We do not expect a war outcome.  Our sense is that there is a lot of political posturing on both sides.  But the reality is we know nothing.  We do not know what is in the heart of either Kim Jong-un or President Trump.  Mr. Kim has been referred to as “a total nut job” by President Trump.  But, then again, our own president has made some rather outrageous statements in the seven months he has been in office and may be viewed similarly by others.  Both men are prone to exaggerated rhetoric.

Mr. Kim took office six years ago at the age of 27 and most people viewed him as an inexperienced leader and thought he would not last long.  They significantly underestimated him.  Now he has nuclear missiles that can strike the United States and he is not going to give them up.  Our view (or perhaps our hope) is that he is willing to contain his nuclear arsenal in exchange for an end to the sanctions that limit North Korea’s ability to trade with the world.  But the quid pro quo  is that the United States and the rest of the world will have to accept the fact that North Korea has nuclear weapons.

Given the current war of words between North Korea and the United States we do not know how we get from where we are to the less threatening outcome described above.  Should the U.S. establish a naval blockade?  Should it perhaps shoot down missiles launched by North Korea? Should it launch a limited strike against nuclear launching missile sites?  What would be the consequences if it chose any of those options?  All of them carry the risk of escalating the crisis into a full blown military confrontation.  Who is going to blink first?  The best hope is that China will intervene and use its influence to get North Korea to halt its nuclear weapons agreement.

The threat by Kim Jong-un to launch four missiles that would fly over Japan and land near Guam by mid-August is impossible to retract without losing face.  President Trump’s threat to respond with “fire and fury like the world has never seen” is equally troublesome.  Such threats cannot be taken lightly give the potential consequences.  Neither side will “win” if nuclear missiles are launched or even in the event of a non-nuclear confrontation.  Large portions of the Korean peninsula – both North and South Korea – will get flattened.  Damage could further spread to Japan, U.S. military bases in the region or even Guam, Hawaii, or Alaska.

What strikes us is the lack of concern around the globe.  The Korean Stock Exchange has declined 4.5% since the beginning of August which strikes us as a rather modest selloff.  South Koreans are apparently so used to living under constant threat from the North that they are not particularly disturbed by the current war of words.

The S&P has dipped only about 1.5% from a record high level earlier this month.

The decline in the Shanghai Composite Index has been largely imperceptible.

We certainly hope these various stock exchanges are correct in their apparent conclusion that the current war of words will, in the end, be nothing more than that.  We share the same conclusion, but are well aware that the downside risk if that view is wrong is enormous.  The downside risk that would occur if Trump cannot pass his tax cuts or is frustrated by his inability to simply the federal regulatory process is minuscule by comparison.  Given the enormous downside risk of war we would suggest that stock investors pare their positions slightly to guard against the possibility of a near-term adverse event.

We are well aware that hope is not a strategy.  Having said that, we hope that President Trump and his advisers as well as world leaders everywhere can find the wisdom to peacefully resolve this crisis.  In the meantime, a somewhat more cautious investment stance is warranted.

Stephen Slifer

NumberNomics

Charleston, S.C.


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