2017/08/13 WEEKEND: NOKO Crisis Redux
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WEEKEND: August 13, 2017
NOKO Crisis Redux
Market responses to the US-North Korea (NOKO) confrontation have run a bit farther than we might have originally expected, yet not in any way changing overall trends. There will be more below on US equities overrunning initial support, yet with much heavier up trend support remaining at lower levels. In terms of the potential for the NOKO crisis to reach a truly tragic end on a human and commercial and financial level, there is a very good question on why a US dollar that was already recovering from its extended selloff is not only not exhibited any sort of a ‘haven’ bid; it has reverted to weakness. Possibly the answer is the same as the extended bid in the govvies: reversion to weak US inflation data last week.
This fits right in with the Fed’s recent more sanguine federal funds rate increase language, with a shift to concentrating on reduction of its Brobdingnagian balance sheet as the right way to ease back on accommodation. [For much more see our July 27th Commentary: Balance Sheet Chicanery post.) That lack of any imminent Fed rate hike weighs on the US dollar, underpins equities and allows govvies to continue a month-long rally.
Yet before we return to that and the still open wound that is the Greek Debt bailout funding conundrum next week, any orderly continuation of the projected market trends requires a less than belligerent end to the NOKO confrontation. On current form, hostile statements of both Kim Jong-un and President Trump seem to leave that a marginal possibility. [More background in last Wednesday’s North Korean Crisis? Or What? post.]
Yet there is cause for hope if the US (a super power facing a much smaller and otherwise defective North Korea) can mute its rhetoric, and rely on quietly confident statements that reflect a steady, strong stance. The fly in that particular ointment is the degree to which the US President would need to tone down provocative statements on potential future US actions. A geopolitically savvy friend said last week that maybe we can hope for a miracle, where Mr. Kim comes to his senses. I responded by saying that might not be necessary if President Trump can revert to limited, more subtle communications that merely reconfirm America’s commitment to act. And my friend’s visceral response? “Well, that isn’t going to happen.” And yet, under geopolitical ‘war games’ alternatives…
Authorized Silver and Sterling Subscribers click ‘Read more…’ (below) to access the balance of the opening discussion. Non-subscribers click the top menu Subscription Echelons & Fees tab to review your options. Authorized Gold and Platinum Subscribers click ‘Read more…’ (below) to also access the Extended Trend Assessment as well.
NOTE: Given the likelihood the US economy will now get the structural reform that we (along with Mario Draghi and others) have been loudly complaining was not forthcoming since our dual It’s Lack of Reform, Stupid posts in January 2015, we need to adjust our view that a potential economic and equity market failure is coming. We previously referred you back to our December 8, 2015 post for our major Extended Perspective Commentary. That reviewed a broad array of factors to consider Will 2016 be 2007 Redux? While a continued regime of higher taxes and more regulation (i.e. under Clinton) might have fomented a continued weak or even weaker US economy, the tax and regulation changes proposed by the Trump administration will hopefully still be approved by the Republican Congress and diminish the similar fears we had to what transpired in 2007-2008.
▪ …that is likely exactly what the President and US diplomatic-military complex should be doing to achieve the optimal outcome. (While the combination of ‘diplomatic’ and ‘military’ in one term may seem odd to some, it is a longstanding precept that warfare is merely commerce and diplomacy with the gloves off. The lack of military alternatives if diplomacy failed is the basis for the major fiascos of the previous US administration.)
Let’s consider the most prominent alternative scenarios prior to their further dissection of their specifics below:
- There is the ‘US first strike scenario’, with it being so upset and scared at present it is considering a knockout blow to the North Korean nuclear program and military. That would be even though the North Koreans getting this far was based on the failures of multiple previous US administrations and their allied powers.
- Then there is the ‘NOKO first strike scenario’ that includes a North Korean attack on either a US ally or even US territory, such as the threatened mid-August attack (i.e. right around the corner) on Guam.
- Yet possibly China (a very key player in all of this) has impressed on Mr. Kim that the US is serious this time, which would be a major shift from the lame actions of the past 23 years (since Bill Clinton signed the first weak, unenforced agreement.) Implicit in that would be the clear signal to Kim Jong-un directly from Chinese President Xi Jinping that any attack will indeed be met with massive retaliation that would result in the end of Mr. Kim’s rule, and likely the entire North Korean state. This could lead to the ‘NOKO keep testing scenario’.
There are of course subtle cross currents in each of those scenarios, and (as usual any time warfare is involved) a range of potential unforeseen consequences. Yet there are some basic tenets which can be constructively explored to consider how the basic scenarios might play out with all other things being equal.
US First Strike Scenario
This is the most unlikely scenario. That is due to the limitations of any conventional weapons attack, and the longstanding US proscription on ever launching a nuclear first strike attack regardless of the circumstances. The latter is realistic due to the still massive US retaliatory capacity in spite of decades of nuclear force reduction agreements with the other major powers (more below.)
The fact is that the US cannot possibly guarantee anything remotely resembling ‘success’ under a ‘US first strike scenario’. In fact, the likely outcome of anything short of full nuclear obliteration of the entire North Korean state (which would also have major negative implications for our allies in the western Pacific and elsewhere), the ability of even a damaged North Korea to rain destruction down on South Korea (SOKO) would be highly devastating.
While most are familiar with these stats by now, SOKO capital Seoul is a mere 35 miles from the highly militarized border with NOKO. As a city of close the 10 million souls, any extensive cannon or missile bombardment would result in millions of casualties that would be a US responsibility if it were to launch a first strike. As horrific as that would be, consider the commercial implications for the entire Western economic infrastructure.
SOKO is a major supplier of all manner of electronics and machinery finished products and components to the rest of the developed economies. Much has been made in recent decades about the advantages of the ‘global supply chain’. Well, in the case of any major death of SOKO professionals and factory workers and destruction of production facilities, there would likely be significant production bottlenecks throughout world.
The ‘China Factor’
Then there is the ‘China factor’ on our frenemy in Beijing’s very well crafted message on its sentiment toward any hostilities. It is clear that NOKO’s benefactors have also become more exasperated than at any previous junctures with Mr. Kim’s bellicose rhetoric and behavior. There had to be something more than the very talented US Ambassador to the UN Nikki Haley being so persuasive she convinced both Russia and, almost amazingly, China to go along with the latest round of heavy NOKO trade restrictions.
Yet they did, and that probably signals some shift in China’s view of the utility of Mr. Kim pushing his rhetoric and actions any further than he already has. However, a Thursday editorial in the Chinese government supporting Global Times laid out what might be considered China’s remaining de facto determination to not have NOKO’s fate determined by the US and South Korea. Rather than cite sections, here is the key section:
“China should also make clear that if North Korea launches missiles that threaten US soil first and the US retaliates, China will stay neutral. If the US and South Korea carry out strikes and try to overthrow the North Korean regime and change the political pattern of the Korean Peninsula, China will prevent them from doing so.”
This is a very sensible, and crystal clear, de facto signal from a government that has both internal and regional pressures to not abandon a longstanding ally… unless it crosses a very clear belligerent line. And when China says it “…will prevent them from doing so...” nobody should be confused about its ability to intervene, just as it did with a 300,000 man force when North Korea was on the verge of defeat in late 1950.
Aside from all of the other humanitarian, commercial and financial negatives noted above, we are sure that nobody on the US-SOKO side wants to be at war with China under any circumstances. So much for the ‘US first strike scenario’.
NOKO First Strike Scenario
As noted in last Wednesdays post, the key question is whether Mr. Kim is truly crazy, or just ‘crazy like a fox’? For now his aggressive bombast and extreme actions (including assassination and execution of members of his inner circle) have served him well in establishing his dominance as ‘supreme leader’ since the end of 2011.
Yet is he really crazy (or dumb) enough to think he can attack the US mainland, or a territory (like Guam) or a US ally without extreme repercussions? For all of his outrageous behavior and the aggressive pursuit of nuclear weapons and missile technology, does he really believe he can prevail against any massive retaliation by the US?
There are various estimates of his current nuclear arsenal and the degree to which it can be delivered on his latest, most powerful intercontinental ballistic missiles (ICBMs.) Yet at the very high end, it is not likely any more than 30 long range deliverable ICBMs (with a low end estimate of not many more than 10 at best.) That compares to the US having 6,800 nuclear warheads with individual targeting potential. And we can bet that some significant portion of them are now retargeted at key locations in North Korea.
Guam Wild Card
The ‘wild card’ is possibly what transpires from Mr. Kim’s threat to attack the US Territory of Guam in the South Pacific. Yet there is what NOKO considers a bit of a ‘fudge’ in that threat. That is because it is asserting that while it will launch up to four missiles at Guam, they will be targeted to land in the ocean roughly 20 miles outside of the island.
They are attempting to make this sound strong by claiming it would result in “historic enveloping fire” for the US Pacific territory. Well, if it were saying that it was launching missiles with ‘dud’ warheads to simply demonstrate targeting ability, that would be one thing. However, the use of that “historic enveloping fire” phrase is another matter entirely. This would seem to indicate that while they are not going to hit Guam directly, they are going to set off nuclear weapons close enough to a US territory to still make it an attack.
In the first instance, how can they be sure a fledgling ICBM program can be so accurate as to miss Guam by roughly 20 miles instead of hitting it? Secondly, that isn’t going to really matter to the US President and military. Any signs there has been a missile (or multiple missiles) launched in the direction of Guam will be considered the start of an attack, and for good reason:
As the well-informed US Representative Darrel Issa (R-CA) said on Fox News Sunday this morning, there is no way to know (and certainly nobody is going to take the North Koreans’ word for it) whether or not the missiles are armed with nuclear weapons.
So here is our hope on that front: We hope that Mr. Kim and his generals are not trying to be ‘too clever by half’ in assuming they can launch missiles toward Guam and try to explain they are not actually armed. If you launch missiles toward any US state or territory or any ally that appear to be targeted to land on that territory or even close, it’s an attack.
We hope NOKO benefactor China has been able to make it eminently clear to Mr. Kim and his generals that after ratcheting up tensions they shouldn’t try anything ‘too cute’. Hopefully that is the end of the ‘NOKO first strike scenario’.
NOKO Keeps Testing Scenario
If indeed they stand down from the allegedly imminent attack on Guam, the tangential comment on that is it might act as the first weakening of Mr. Kim’s internal position within North Korea. More on that below.
Yet for now any lack of a NOKO attack on Guam after so much sabre rattling would seem a bit weak, and would call for some sign of strength from Mr. Kim to keep his domestic audience in line. Of note, Central Intelligence Agency Director Mike Pompeo had his first Sunday political show appearance since being confirmed on Fox News Sunday this morning. While much was discussed, his specific response to the question of what North Korea was most likely to do next even if it doesn’t attack the US or any allies was…
“I am quite confident that (North Korean leader Kim Jong-un) will continue to try to develop his missile program, so it wouldn’t surprise me if there was another missile test.”
The Ultimate Solution?
And therein lies both a risk and an opportunity for the US and the rest of the more rational developed world. The risk is that any counter to the next NOKO ICBM (or other somewhat longer range missile) test might fail. That would empower Mr. Kim further at the very time it would be much better to weaken his standing.
However, considering that especially our allies in the western Pacific (and behind the scenes possibly even China) would like to see more pressure applied to Mr. Kim to de-nuclearize the ‘Hermit Kingdom’, the opportunity should be very tantalizing…
…regarding the potential for the US Anti-Ballistic Missile (ABM) system to shoot down the next NOKO long range missile test. As noted above, any failure of that ABM launch to knock out the NOKO missile would be a feather in Mr. Kim’s cap. That would certainly raise his standing at home, and possibly encourage more aggressive behavior.
However, if it succeeds, it will be at least partially diminish a primary source of Mr. Kim’s internal status, and would have even more impact on his ability to hold the wider world hostage to NOKO’s bizarre yet ultimately real threats. What if the entire psychology around NOKO became, “OK, so you have nuclear bombs and some ICBMs. So what? The West (in the form of the US along with the other missile defense systems in its allies) has the ability to neutralize that threat, so we suggest you stand down.”
That may be wishful thinking. Yet there are ways to ensure the ability to knock down that ICBM test (or perish the thought any launch against Guam) can be effectively neutralized. Launch multiple ABMs against each NOKO missile. This would not likely be an effective tactic against a more major nuclear power like China or Russia based on sheer numbers.
However, against an adversary with a limited number of missiles and nuclear weapons, it should be effective. At least we hope that over 30 years after President Reagan initiated the Strategic Defense Initiative (aka Star Wars) ABM program the US can shoot down any missile by launching multiple ABMs. If each ABM has a reliability of between 50% and 70%, it is likely reasonable that three of them can knock out one ICBM. And if that is so, then embarrassing Mr. Kim with the loss of his next test missile is a likely scenario.
Basis for Regime Change?
One NOKO missile being knocked out by the US or another allies ABM system would not likely Mr. Kim to immediately lose so much face that he would be deposed. His grip on the ruling elite that has many other reasons to not immediately depose him is still strong. Who among them wants to actually topple an entire system that has prevailed through overt suppression and starvation of the North Korean people?
However, any initial US success in destroying a NOKO ICBM during a test launch will leave Mr. Kim in the proverbial ‘box’. What is he to do next? Actually launch an attack on the US or one of its allies? Revert to more testing of nuclear weapons that the US has demonstrated it and its allies can prevent him from delivering to any target? Another big “so what?” There are another several variations of possible alternatives.
To cut to the bottom line, history is filled with dictators and international bad actors who played out their string as far as they could prior to running up against the wall of the broader reality of their real place in the world. Is it possible that any sign that all of Mr. Kim’s and his elite’s efforts (that included spending huge sums on weaponry while the North Korean people starved) will hit their end game as and when the US demonstrates it was all for naught because they can’t really do anything against larger, more sophisticated powers?
We can only hope. And that doesn’t mean that even that will be painless. Failing illicit regimes have a long history of taking even more repressive measures in their final death throes. Yet unless that includes going out in a blaze that includes an international attack which brings the massive US response, then the best bet in the current scenario is that Mr. Kim is incrementally diminished.
It was certainly a mistake for Barack Obama to pursue ‘strategic patience’ regarding obvious NOKO efforts in this area. It was just one more component of his generally lame and misguided international approach that embraced US enemies while rejecting friends. Note how little he wants to counter Mr. Trump’s assertions that Trump “inherited a mess”, because it is true.
And the worst situation that Obama actually warned Trump about as Obama was leaving office is the North Korean nuclear and missile program advances. It is now up to Mr. Trump to travel a very narrow and somewhat restrained path toward a resolution that will demonstrate to the rest of the world that the US is up to the task of resolving this crisis.
Residual Benefits
Yet that will take some real discipline on the part of the President to let the diplomats and generals effectively manage the situation. President Trump has already been very aggressive in his expressions of the potential harm to North Korea if they become literally belligerent (‘belli’ is Latin for ‘war’, as in casus belli.) Maybe any further communications from him would likely better serve the cause of peace and the developed world if they were merely reconfirming his previous stance in lower key terms, such as…
“I’ve made the US position clear, and we remain strong.” “Any further steps rest with Kim Jong-un and how our generals choose to respond to what he does.” As my friend said, maybe thinking the US President can restrain himself to that extent is the real fantasy.
The first residual benefit is that any lower key communication from President Trump will remove any chance the US can be blamed for any hostilities, even shooting down a NOKO missile test that is ostensibly for the purpose of future attacks on the US or its allies. Extended residual benefits would flow from the lesson to Iran, which across time is the far greater Middle East and international threat to the US and its allies.
As the payments to Iran in the wake of the Obama administration’s misguided nuclear weapons deal emerged, one fear was the degree to which the $1.7 billion the Iranians received could be used to purchase either nuclear weapons or missiles from North Korea. What if the missile technology that Iran is likely buying from North Korea is shown to be ineffective in the face of the ABM systems of the US that it can also provide to its allies?
Missile sales are also a major source of NOKO foreign exchange earnings, and any falloff in those external earnings may end up being a source of internal NOKO dissention.
We Can Only Hope
Who knows? For now all we can hope for is Mr. Kim being taken down a notch in the wake of his threats possibly reaching their end game, and enough steely (as in ‘quiet and low key’ Mr. Trump!!) yet strong action by the US to demonstrate that he is nothing more that the ‘tin pot’ dictator informed individuals have always known he and his predecessors have always been.
Quick Market Take
The Evolutionary Trend Views in some markets (especially equities) have gone beyond nominal swings to near term levels suggested in previous analysis. Yet as noted above, this is still also within parameters that are reasonable with the continued up trend in US equities (for example.) As part of the post-Yellen testimony push to a new high, the September S&P 500 future exceeded the June 2,451-46 congestion and held it as support three weeks ago. While that support was violated on Thursday’s extended NOKO confrontation-inspired selloff, there always were more major lower supports of more consequence which we have not mentioned in a while due to the pre-NOKO situation not necessarily leaving much chance they would be tested.
And most prominent among them is the 2,405-00 late-February through mid-May congestion, which was also a retest of the major top from the March trading high. Along the way there is also specific weekly chart up channel support (from the late-March 2,317.75 selloff low) at 2,410 next week. The one troubling aspect might be last week’s fall also being into the weekly MA-13 in the 2,437 area. However, it is possible for markets to trade temporarily through weekly MA-13 as long as trend support is respected and the average is exceeded again after not too long a spell below it (as occurred on the selloff back in April.)
That said, there is also more meaningful higher resistance from last week’s activity now in place as well. Last Tuesday’s failure from a temporary new high above the previous 2,475-80 sustained resistance left a fresh weekly DOWN Closing Price Reversal (CPR.) Thursday’s slide made it that much more prominent, reinforcing the importance of the 2,475-80 resistance at which it has failed repeatedly in the short term, with the previous week’s 2,472 Close as the DOWN CPR signal level (with a Tolerance to the 2,480.50 trading high from three weeks ago.)
The govvies remain very firm. In addition to the NOKO ‘flight to quality’ there has been soft US PPI and CPI data late this week. That reinforces our previous indications of why the Fed will pursue balance sheet adjustment, and is very likely done raising rates for now. The September Bund future remains upside leader on its rally above 162.00-.50 congestion that indicated the retest of 164.00-.50 higher congestion that was modestly exceeded on last week’s Close was possible. If it remains strong, next resistance is the 166.00-.50 last fully tested in February and missed by a bit in June.
The previously weaker September Gilt future also finally pushing above its 126.00-.50 resistance in early August is headed for its more prominent 128.00-.50 resistance with 129.50-130.00 (last seen in mid-June) above that. The September T-note future remains the laggard in its continued churn even though it is nominally above 126-00/-16 resistance. However, as was the case back in mid-June, the 127-00 area is more critical above that.
As noted for the past couple of weeks (i.e. the post-ECB meeting), the notable exception to steady trends is the foreign exchange is the evolution of the EUR/USD and US Dollar Index trends. Those have become so critical due to the EURO being the most heavily weighted currency in the US Dollar Index, with EUR/USD pushing to a new two-and-a-half year high two weeks ago above the 1.1710 August 2105 high. While it suffered a reaction late last week, only back below the 1.1700 area (tested and held so far) is there any potential trend reversal. In fact, the weaker US inflation numbers have overshadowed the geopolitical flight to safety that would normally favor the greenback. At present EUR/USD is back above 1.1800 while the US Dollar Index is weakening again toward .9300 without ever having challenged .9400.
While the US dollar is generally continuing to recover against emerging currencies, this still appears more of a correction than trend reversal, for now. The most interesting is the USD/ZAR rallying back up above 13.15-.20 and the 13.30 area previous failed UP Break. Yet previous rallies above that area have stalled into the 13.50-.60 area.
And after rallying for the past month USD/MXN is finally back above its failed 17.90 support (August 2016 trading low.) It is going to be interesting to see if it can get back above the heavier congestion and weekly MA’s just above it in the 18.00-.10 area. The balance of emerging currencies are stuck around previous trend and congestion levels.
▪ The Extended Trend Assessment with full Market Observations will be updated after Monday’s Close to fully assess how various markets perform coming back in from any weekend comments by the various parties involved in the stressed geopolitical situations. In the meantime, the Market Observations in our August 2nd Commentary: Summer? Must Be Kool-Aid Time! post that were updated after that Friday’s Close remain the operative trend views outside of the specific updates in the Quick Market Take above.
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