US and North Korea: Escalation in threatening rhetoric - BBH
An escalation of threatening rhetoric by the United States and North Korea emerged as the key driver last week, according to Marc Chandler, Global Head of Currency Strategy at BBH.
Key Quotes
“The US was unable to build on the success it enjoyed at the UN on August 5 when the Security Council unanimously voted to impose the stiffest sanctions to date on North Korea. Even if President Trump's "fire and fury" threat was more visceral than strategic initially, there have been several opportunities to backtrack, and instead, the administration seemed to double down.”
“Many observers in the US draw parallels with the Cuban Missile Crisis when the Soviet Union tried to install nuclear missiles in Cuba. The takeaway is the need for a forceful US response. However, the alternative analogy is Iran, as well as a few other countries, that surrendered its nuclear weapons capability and/or development. It is a negotiated settlement, not one dictated by military superiority. This is what US allies, such as Germany, and China and Russia will support.”
“The US strategy was to deny North Korea nuclear capability. It did not work. The US sought to deny North Korea the delivery mechanism. This did not work either. It is unfortunate, but the human cost of trying to turn by the clock is significant. As sour as it tastes, the US must accept a fait accompli and go from there.”
“Some military experts argue that North Korea may not only use its nuclear capability to deter a US (and/or South Korean), but it can be used offensively. One such scenario imagines North Korea invades South Korea to unite the country and threatens to its nuclear weapons if US forces join the conflict. Of course one can create all sorts of scenarios, but this one and many like it, seem to misunderstand the role of US forces in South Korea (23.5k). They cannot withstand a full fledged assault by North Korea. Their function is as a tripwire. Moreover, the US has a large military footprint in Asia, including 39k troops in Japan, and bases in Singapore and Guam. On top of this, add US naval power, including submarines, and aircraft carriers.”
“The point is that US forces dominate the escalation ladder at every rung. Yet the Tet Offensive, nearly 50 years ago, taught that even in defeat, victory was to be found for the North Vietnamese. Their military defeat was offset by moral and propaganda victories, that some credit with turning the tide in the war. What has changed now is that 1) North Korea's capability continues to increase, 2) pressure on other countries, like China, to do more, has yielded limited results, and 3) the Trump Administration sees this as a test of its resolve.”
“We suspect that at least for the medium term, investors will have to live with a heightened degree of dramatic rhetoric by the US and North Korea. There are a few dates that may be noteworthy. First is August 15, when North Korea implied a potential plan to shoot some missiles into the waters off Guam as a display of force. One of the technical challenges for North Korean missiles is thought to be their accuracy. The risk of miscalculation is grave if a missile lands in the territorial waters of Guam as that could be seen as an act of war. The other is the joint US-South Korean exercises that run between August 21 and August 31. In the past, these exercises included a "decapitation strike" aimed at the political and military leadership.”
“Foreign investors were significant sellers of South Korean shares. They sold $810 mln of Korean shares. It was the third week of net sales, the first such streak since last November. Over the past three weeks, foreign investors sold $3.1 bln of Korean shares. In three weeks of liquidation in November, foreign investors sold about $1.3 bln of Korean shares. Foreign investors appeared happy to take on Korea's credit risk and were net buyers of nearly $495 mln of Korean bonds last week. Foreign investors have been net buyers of Korean bonds for five consecutive weeks for a cumulative total of nearly $2.4 bln.”
“The takeaway is that although foreigners have pared this year's purchases of Korean shares, they have continued to buy Korean bonds, arguably blunting the full impact on the currency. The Kospi gapped lower before the weekend, but technical indicators suggest the market may be near exhaustion. The won seems to be suggesting the same thing. The won was under pressure all week. The dollar recorded its high earlyFriday but then trended lower and closed on its lows before the weekend.”