Why this geopolitical event is worrying
Throughout history when nations build-up their weaponry they almost feel emboldened to fight someone. North Korea has been building its military spending for some time. It spends a massive 22% of GDP on its military, thought to be the highest in the world relative to the size of the country. Donald Trump’s budget request for 2017 envisaged spending of $639bn a 10% increase year-on-year.
Unfortunately, the world also has to face the fact that the country with the largest military spending in the world has one of the world’s least diplomatic leaders. Conducting bellicose dialogue with other global leaders through twitter is not a strategy to defuse this extremely dangerous situation.
The situation could lead to a stand off between the superpowers of the United States, China and possibly Russia. China sees North Korea as an important buffer on its border from the US and its military allies of South Korea and Japan. Premier Xi doesn’t want a crisis as he heads into the People’s Congress later this year. He will be under internal pressure to stand up to any challenges from the US. The crisis could also draw in Russia. Not to be forgotten is that were the US was to gain some control over North Korea, Russia would feel that their important port of Vladivostok would be at risk.
China would prefer that the status quo is maintained where North Korea for all its failings remains an independent country but that it would back down from seeking to have a credible nuclear bomb threat. China fears that were the North Korean regime fall then China would be facing a serious influx of refugees and potentially nuclear material falling into the wrong hands. Hence China might be considering in the event of the North Korean regime falling that they invade the northern border of North Korea to stop the refugees and to secure any nuclear material.
Why this is dangerous for investors
The markets can’t easily classify this crisis and come to any strong conclusions as to how it might play out. The crisis has a nuclear angle; it is not similar to a Middle Eastern conflict as played out in Suez crisis, Kuwait or Iraq. It is potentially nuclear with the only comparison ‘the Cuban crisis’ in the 1960’s. It was easier to beat up on Cuba in 1962 than it will be to push the North Korean regime back from the brink.
Too many investors just couldn’t wear another serious setback to the value of the wealth. 10-years on from the 2007-2009 world financial crisis, investors are even more risk averse as baby-boomers are 10-years closer to retirement and even more sensitive to investment losses. Even with the recent rise in asset prices, baby boomers are thought to have only half of the necessary savings to see them through their retirement.
Central banks may be impotent to stimulate the global economy in any significant downturn. They may have sufficient tools to bring some order to the financial markets. However, they have limited powers to reinvigorate confidence in the aftermath of whatever form of crisis possibly transpires. Amongst the major central bank’s policy interest rates are at zero or barely above. Cutting interest rates will possibly provide very limited stimulus to the global economy.
Governments are already highly indebted and would rather not have to rescue their economies with a ramping up of tax cuts and spending increases. G7 Government debt to GDP has already risen from 50% to 90% over the past decade due to the world financial crisis.