Enzio's Clock

We have run across two particularly trenchant articles that are important background knowledge for anyone seeking to trade off the North Korean (NK) story.  I liberally sprinkle  two trenchant editorials with my own thoughts:

• Donald Kirk's (DK) "China's dangerous game" in the South China Morning Post of 25th April 2009,and
• Andrew Gilholm's (AG) "Beijing won't push Pyongyang" in the Wall Street Journal Asia of 5th June 2009

1. How China is North Korea's big brother

China is NK's chief lifeline in numerous respects. According to DK and AG,

• China provides NK with US$ ($) 1.5 billion (bn) in aid each year, about four times what she donated to NK in 2004. (Perhaps NK is to China what Israel is to the USA? With a population less than that of New York City's, Israel is the single largest recipient of American foreign aid world wide),

• China accounts for 75% of NK's international trade

• NK runs a huge trade surplus with China, with a further "black" trade surplus running "beneath the books" across the NK's northern border - the Yalu river on her  north west and the Tumen river on her north east, and
• China supplies the bulk of NK's oil.

2. Does China "just stand there"?

No. She is pretty annoyed with NK's shrewd antics. NK's first nuclear bomb test in 2006 fortified one group in Beijing who thinks that NK has become more of a liability than an asset; that view was propelled by NK's second nuclear bomb test on 5th April, 2009.

The NKs have China in their pocket, however:

• if NK were just allowed to implode, the ensuing insecurity would ricochet throughout the whole Korean peninsula and, indeed, throughout particularly northeast Asia, not to forget southeast  Russia. So the NKs have equated regime change with domestic instability, something that the Chinese understandably are scared of;
• by allowing NK to explode her bombs, she makes all of the other powers involved with NK re-arm, thereby forcing China's hand to pay even more money to NK.... Don't forget that Japan and Russia as well as China have fought over Korea in the past, so you have centuries of enmity being stoked by current events. So the NKs have cornered China into paying them even more money so that NK can remain a well-financed threat to the other five powers;
• the more that NK re-arms, the more worried China has to be about a nuclear calculating nut case on her southeastern flank, so China has to tread a carrot and stick tightrope with NK, and
•  just by proliferating, by sending her weapons abroad, the Chinese have to fear reactions from the West. America's Proliferation Security Initiative (PSI) is one such reaction. The Americans have spurred international efforts to block NK's shipments of nuclear weapons and delivery systems to her clients. This is where the week end's news concerning Singapore comes into play..,So if China does not keep NK under her shield, other powers could attack her overseas vessels within the framework of the PSI.

3. Why China is North Korea's big brother

• Since China's unification under the Chin in the 3rd century BC, China has wanted hegemony over the whole Korean peninsula, so it wants NK back, but only on China's terms. This means that China has a vested interest in NK continuing to "act up" - until the other five powers give up and tell China to take over the whole Korean peninsula. This cannot happen, of course, because of the other powers' interests in this strategically important peninsula
• just like America's GM and AIG were too big to fail, NK is too weak to fail. Were she to fail, China would have to host  a whole flood of refugees; conversely,to keep NK from failing, China would have to pump billions of dollars of aid into NK. But China has enough social issues within her own borders, so she cannot open them to yet more expensive responsibilities, and
• if the PSI is enforced, then China will  imagine that the other five powers are ganging up against her. So she will support NK to the hilt as her "ally" versus the other five. (Of course, if China told NK to back off re. nuclear proliferation, there would be no need for a PSI...)

In short, China is protecting NK because China China fears that any regime change in NK would spawn instability, which in turn would lead to a mass exodus of NK refugees to China. Also, instability in NK would spawn interventions by the other five powers who are worried about NK instability. Finally, China wants the whole Korean peninsula to herself. But under present circumstances, were a settlement to be mutually agreed, she would not get (back) the whole peninsula to herself. So she may as well just go with the flow and allow NK to keep acting-up.

None of this has got lost on NK's shrewd leaders. They keep ramming  a huge truck straight through the divisions within the five non-NK parties - and getting away with it. Let's see what their most recent foray en route to Singapore yields by way of tensions... 

4. How to make money off this

The key threat in all of this is that NK is proliferating her weapons to the likes of Iran: by thumbing her nose at China and the other 5 powers involved with NK, Pyongyang  is stoking Iran's confidence in doing her own "nuclear thing". We see what tragedies this is leading to daily. 

Having written this, I firmly believe that nobody wants peace in Korea or, as a parallel, in Israel - except on their very own, monolithic terms. So expect incessant blow-ups in Korea, followed by interludes of strained peace.

So I'll stick with the recommendations made in my last piece:

1. Sell the yen.  With rising markets since March, the yen has fallen. This makes sense: people are putting on carry trades using the yen as their zero-finance vehicle. If tensions were to keep mounting, so my guess is that markets will drop. That reduces risk, so people put on more market shorts, using the yen to finance these, and that depresses the yen even more.
2. Buy Swiss Francs. Here is a safe haven play in the currency arena. You all know about it. Since we recommended buying this ETF on 27th October 2008, it has risen by 7.2%
3. Buy gold. You know that when tensions rise, gold is a favoured haven. The same goes for this time. Since we recommended the ETF, PHAU:LN, on 15th November 2007, it has risen by 17.3%. 
4. Buy aerospace and defense stocks. One relevant  ETF is ITA:US. It has outperformed the S&P500 since the more recent bull run of 3rd March 2009 and - sadly - should continue outperforming.