Political Shakeup in N. Korea Rattles Markets

The unexpected death of North Korean leader Kim Jong Il has shaken the global market, and the sheer unpredictability of the situation is likely to instill lasting unease …

The unexpected death of North Korean leader Kim Jong Il has shaken the global market, and the sheer unpredictability of the situation is likely to instill lasting unease among investors. Jong Il’s son and successor Kim Jong Un is unknown and untested, leaving questions about who will control the country’s nuclear arsenal. The South Korean market has already suffered due to a lack of confidence in the stability of the area. Meanwhile, a likely buildup of U.S. forces in the area may increase tensions as China shifts to more involvement in reshaping the future of the now headless regime, all of which amounts to too many variables to consider when predicting market outcomes. For more on this continue reading the following article from Money Morning.

All eyes are on North Korea and its repressed economic system this week after the country announced early Monday that Kim Jong Il, the ruling dictator for 17 years, died Saturday. The political instability to follow Kim Jong Il’s death could ripple through the global economy, weighing on confidence and growth.

Kim Jong Un, the third son of the deceased leader, will take his place. Kim Jong Un is only in his late-twenties, and has only been groomed for the role since 2008, compared to his father’s 14 years of training.

While North Korea has remained economically isolated from much of the world, its military aggression, volatile relationship with South Korea and the United States, and the uncertainty surrounding Kim Jong Un’s readiness to lead has put the world on alert.

“This is a tinderbox situation,” said Money Morning Chief Investment Strategist Keith Fitz-Gerald. “Almost nothing is known about Kim Jong Un, this “Great Successor.’ The deeper questions are the longer-term issues related to a potential power struggle within the ruling elite, given that Kim Jong Un may not have the training nor the power base from which to assume control. Now is the time to watch carefully.”

That said, here’s what to monitor in the global economy as North Korea rebuilds after Kim Jon Il’s death.

North Korea’s economic future: North Korea is a notoriously closed society and has shunned foreign investment. Kim Jong Il had started to show signs of possibly being open to economic reform. He even toured Chinese factories to learn about their rapid economic growth, and visited Russia to discuss building a gas pipeline across North Korea.

Of course, that’s unlikely to change at least until the country’s new leader gets established.

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Still, there’s hope the long-term outlook for North Korea will change since Kim Jong Un has more Western world exposure than his father, having attended school in Switzerland. That could encourage him to reach out more to other countries to help improve his impoverished nation.

“With China as its example, I am hopeful that North Korea comes out of its shell and slowly crawls to its borders to see who is willing to start a dialogue and trading with the rogue robot nation,” said Money Morning Capital Waves Strategist Shah Gilani. “If it’s going to be a scary and not a salutary coming out party, all bets are off; but I’m a betting man, and I’m betting North Korea will emerge from its cocoon.”

South Korea’s economy: South Korea faces the biggest economic disruption. The country already forecast a drastic export slowdown for 2012, with shipments growing only 7.4% next year, compared to 19.2% in 2011. The threat of North Korean instability could also slam consumer confidence, and cause the economy to grow even slower than the 3.7% gain predicted for next year.

However, there is hope the markets will regain their footing. While South Korea’s Kospi stock index fell 3.4% after Kim Jong Il’s death was announced, its market typically rebounds about a week after a major North Korean event. South Korea does have contingency plans to protect from North Korean trouble, and the initial market reaction is mostly stemming from uncertainty, which could clear soon.

U.S.-China relations: China is the most likely country to aid North Korea, its only military ally in the region, as it adjusts to the new leader. North Korea relies on China for foreign food aid and most of its trade, providing 83% of North Korea’s international commerce in 2010.

“The Chinese will, if anything, up the amount of money and support they give to North Korea…They have a greater interest than anyone to keep this show on the road,” Shaun Cochran, head of research at a unit of Credit Agricole SA (PINK: CRARF), told The Wall Street Journal.

Meanwhile the United States will likely increase its military presence in the Korean peninsula to support South Korea against an unpredictable new Northern regime. Ian Bremmer, president of Eurasia Group, said the “potential for U.S.-Chinese relations to deteriorate significantly in the [event] of a bad North Korean outcome is very great.”

Currency: The South Korean won fell to a two-month low in the first day of trading after Kim Jong Il’s death. South Korea’s central bank pledged to step in and stabilize markets if needed. The U.S. dollar jumped to 1,176.35 won, up from 1,158.50 won before the news.

The won will likely face more weakness over the next couple weeks, and the dollar could strengthen due to short-term uncertainty.

“Should anything troublesome develop on the Korean peninsula, I would expect a flight to the dollar to immediately intensify,” said Fitz-Gerald.

Defense spending: Kim Jong Il’s aggressive military stance, especially regarding nuclear weapons, has put neighboring countries’ on high alert. South Korea and Japan both called national security group meetings immediately after news broke of Kim Jong Il’s passing.

A South Korean news agency reported that North Korea tested short-range missiles Monday morning before reporting Kim Jong Il’s death.

While North Korea has failed to prosper in many respects, it’s made significant progress with nuclear weapons. It conducted tests of nuclear explosives in 2006 and 2009, and is believed to possess a small number of nuclear bombs. South Korea, Japan, and the United States will likely increase military efforts in the region as Kim Jong Un takes control.

U.S. trade: A major North Korea distraction for South Korea could restrict the benefits of a recent development for the United States. The U.S. government approved a free trade agreement with South Korea in November. South Korea is a trillion-dollar economy and one of the United States’ most important trading partners, with two-way trade totaling $74 billion in 2008.

The South Korean deal offers the most potential to U.S. exporters, expecting to add about $10 billion to U.S. exports and gross domestic product (GDP). U.S. exporters of agricultural products, which are projected to double from their current $2.8 billion, will be the primary beneficiaries. However, U.S. auto manufacturers and banks will also have a chance to break into the market.

U.S. exporters could find demand soured if Kim Jong Il’s death fuels North Korean conflict and dampens South Korea’s consumer confidence.

This article was republished with permission from Money Morning.


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