Almost four years after North KoreaÆs covert uranium programme has been exposed, markets have become blasT with the countryÆs belligerent antics. But complacency could be dangerous for this weekÆs nuclear test and the July missile test may well be the first clear signs that a weakened North Korea is starting to make mistakes.
Up to the July missile test, North Korea had been receiving aid and investments as enticements for not carrying out its threat of producing nuclear weapons. This brought economic breathing room to the regime as well as enhanced its credibility and prestige
at home.
By contrast, the July missile test and this weekÆs nuclear test have dealt two blows to North KoreaÆs credibility. The July test failed with the long range missile exploding 40 seconds into flight. Preliminary indications are that the nuclear test was also a failure: even if, as North Korea claims, the blast was caused by a atomic bomb, its yield was so small that it probably fell short of North KoreaÆs own goals. And most importantly the low yield of the explosion shows the North Koreans have not yet been able to fully weaponise whatever quantity of uranium they have managed to enrich.
In addition, the missile and nuclear tests will reduce aid and investment even if China and South Korea, North KoreaÆs neighbours, are unlikely to support sanctions that could bring about the regimeÆs downfall. Political instability in North Korea could see large inflows of refugees into South Korea and China. In addition China stands to lose substantial investments in North KoreaÆs mining sector and a buffer state against US military influence in North East Asia. And political collapse in North Korea could leave the South with a huge reunification bill.
But, in a marked departure with previous policies, China has for the first time announced it would support economic sanctions. And South Korea has announced it would review the sunshine policy of economic engagement with the North. Meanwhile the US is circulating a list of economic sanctions that could potentially shut out the North Korean economy from the rest of the world.
North Korea not only emerges weaker strategically and economically from the test, it has also spent its trump card. After the nuclear test, it is difficult to think what additional step, short of military conflict, North Korea could take to further escalate the tension. And military conflict is not an option for North KoreaÆs leaders since it would mean defeat and regime change.
With PyongyangÆs overriding concern likely to be regime survival, the escalation of tensions by the regime could reflect its political and economic insecurities. The market may well be underestimating the economic and political fragility of the NorthÆs regime, possibly because it is also underestimating the level of its dependence on the global economy.
The missile and nuclear tests follow the imposition of financial sanctions last September by the US that have effectively cut off North Korea from the international financial system. The intensity of North KoreaÆs reaction to the sanctions is surprising since North Korea is still a fairly closed economy, even after several years of economic reforms. It may well be that the regime requires a steady supply of dollar in order to maintain support from the upper echelons of the army and the communist party. Without access to foreign currency, the regime may be worried about its survival and is starting to make mistakes.
For the first time since North Korea engaged in nuclear blackmail, it appears to have taken steps that have weakened its bargaining position. Perhaps more than the test itself, that is what market participants should start worrying about.
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