Black Swans Abound as North Korea Lobs Shells: William Pesek

Psychological denial is a powerful thing. Politicians fall prey to it before big elections, investors do at the peak of asset bubbles and entire populations do when a grave, shadowy danger looms.

Jared Diamond summed it up as well as anyone in his 2005 book “Collapse.” The Pulitzer Prize-winner wrote of a large dam sitting high above a river valley and the counterintuitive feelings of local inhabitants. Polls often show that those residing miles away from the dam fear it breaking more than those living at its base. Talk about denial.

I often recall his observations while walking the streets of Seoul. Isn’t it odd that we in Tokyo or folks in Washington tend to fear Kim Jong Il’s missiles more than those residing 35 kilometers (22 miles) away from North Korea?

That denial was shattered yesterday when North Korea lobbed artillery shells at South Korea. It showed that the fallout from North Korea’s crazed action is coming to a market near you soon.

If there’s anything we know about Kim’s regime it’s how little we know about what’s going on within it. We don’t even know whether Kim approved the attack that killed two soldiers and set hundreds of houses ablaze. Some observers argue it may be the work of rogue generals with little interest in Kim’s son, Kim Jong Un, replacing his ailing father. It’s anyone’s guess.

Three Considerations

Here are three early implications of yesterday’s skirmish worth considering. One, this is a blow to South Korea’s otherwise booming economy, one that might have credit-rating consequences. Two, it puts China on the hot seat as rarely before to rein in officials in Pyongyang. Three, it’s a reminder that geopolitical risks abound in Asia.

South Korea’s finance ministry set up a 24-hour emergency financial market monitoring system. Officials said they are scrutinizing Korean indexes and any moves by credit-rating companies and foreign investors. Really, how many nations need to run an economic war room? That offers some insight into where Lee Myung Bak finds himself.

The South Korean president was on such a high earlier this month after the impressive staging of the Group of 20 summit. And now, just days after U.S. and Chinese presidents Barack Obama and Hu Jintao left town, Lee is grappling with a crisis that may be more serious than the March sinking of a South Korean warship that killed 46 sailors. This latest attack was on a civilian-occupied island near the border with the North.

Bad Timing

For Hu, the timing couldn’t be worse. China is struggling to keep its overheating economy on track. Officials in Beijing must slow growth, while making sure those efforts don’t antagonize hundreds of millions of Chinese seeking higher wages. You would think Hu’s regime has enough on its hands and it’s high time it put North Korea on a shorter leash. It has great financial leverage over Pyongyang.

You can bet Hu will get an earful from world leaders, including Obama. At the Seoul G-20, China was vocal about America’s stimulative monetary policies. It urged the U.S. to act responsibly for the good of the world economy. Now Obama can turn the tables and ask Hu to do the same with Kim.

Our intelligence on North Korea is rather lacking. Media stories focus on chronic food shortages and how sanctions inflict pain. Then we learn about Siegfried Hecker’s visit this month to a nuclear plant. The Stanford University professor speaks of “astonishingly modern” technological advances at the Yongbyon reactor site. Clearly, efforts to squeeze Kim are failing.

Kim’s Allowance

China owes it to the world to dock Kim’s allowance and restore some sobriety to the Korean peninsula. Lee has a very short list of options here. It also seems clear that North Korea had outside help and equipment to build its new uranium- enrichment facility so quickly. China really does need to read North Korea the riot act.

The geopolitical-risk angle here is terrible news for investors everywhere. This isn’t a straight-forward Black Swan moment. Yes, it will have an impact on markets, yet Asians are rather accustomed to Kim lobbing volatility bombs their way. Even so, this is a warning that something big and destabilizing -- beyond anything investors have contemplated -- could come from Pyongyang at any moment.

A sudden coup, for example, might unnerve investors. Ending the disastrous Kim dynasty has a certain appeal to many of us. Yet some rogue, unknown general with lots to prove might not be an improvement. With Europe’s debt crisis unfolding and the U.S. dollar shaky, missiles shot in the direction of, say, Tokyo can’t be ruled out.

Along with causing untold pain and suffering for Japan’s populace, an attack would devastate stocks, send bond yields soaring and cause havoc in currency markets.

Geopolitics in Asia often trumps economics, and events in Korea are convulsing markets that are already off balance. North Korea is Exhibit A of the potential Black Swans out there. Denial is no longer an option.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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