Author: David R. Kotok, Post Date: August 11, 2017

First to markets: We have raised a cash reserve in US ETF portfolios, and we are realigning bonds now that credit spreads are tightening and yields are low as quality flight occurs. We have rebalanced gold miners using an ETF. We remain overweight the financial sector and defense sector using selected ETFs. That strategy was underway before the North Korea story made the top of the news, and that strategy is validated by it.

Now let’s offer some commentary about North Korea and war risk.

It was a coincidence of timing that had me seated with Alix Steel and David Westin on the set at Bloomberg TV on Wednesday morning, August 9, after the POTUS versus North Korean dictator Kim Jong-un bellicosity ripped up the script. Here is the TV clip link about markets and war: (bloomberg.com/news/videos/2017-08-09/cumberland-ceo-warns-of-great-n-korea-market-risk-video).

Right before this clip the anchors had posted the similarly dire warning President Harry Truman made regarding Japan on August 6, 1945, some 16 hours after the US had dropped an atomic bomb on the city of Hiroshima: “If they do not now accept our terms they may expect a rain of ruin from the air, the like of which has never been seen on this earth.” (newsweek.com/trump-north-korea-threat-truman-hiroshima-648304)

Though Trump’s message to North Korea, promising to meet North Korean threats “with fire and fury like the world has never seen,” is similar in intensity to Truman’s language directed toward Japan at the culmination of WWII,  the circumstances are vastly different. In 1945, the United States had spent years engaged in a world war, had secretly developed the world’s first nuclear weapon, and had used it at Hiroshima. President Truman’s threat was credible because he had taken action.

President Trump, however, is in an entirely different place. He has, as president, established a pattern of tweeting bellicosity and messaging without consistency, and his administration was clearly unprepared for Trump’s ad-libbed threat. Secretary of State Tillerson tried to walk back the Trump statement by saying, “I have nothing that I have seen and nothing that I know of would indicate that the situation has dramatically changed in the last 24 hours. Americans should sleep well at night.” (cnn.com/2017/08/09/politics/north-korea-donald-trump/index.html)

Senator John McCain, who chairs the Armed Services Committee, reacted to the Trump statement with concern: “I take exception to the President’s comments, because you’ve got to be sure that you can do what you say you’re going to do…. The great leaders I’ve seen don’t threaten unless they’re ready to act, and I’m not sure President Trump is ready to act.” (axios.com/mccain-trumps-threat-to-north-korea-very-very-very-serious-2470752413.html)

Trump’s warning to North Korea put US Defense Secretary James Mattis in a particularly difficult position. Mattis has long advocated a diplomatic approach to dealing with North Korea because of the potential for catastrophe should conflict escalate. He issued a follow-up warning to North Korea on Wednesday, August 9, to discourage an overreaction: “The DPRK should cease any consideration of actions that would lead to the end of its regime and the destruction of its people,” Mattis said. Here is a link to his entire written statement: defense.gov/News/News-Releases/News-Release-View/Article/1273247/statement-by-secretary-of-defense-jim-mattis/.

Meanwhile, North Korea dismissed Trump’s warning as “a load of nonsense” and said it was pushing ahead with its plan to launch four missiles that would overfly Japan and land near Guam. North Korean media released the following statement:

“General Kim Rak Gyom, commander of the Strategic Force of the Korean People’s Army (KPA), released the following statement on 9 August.

“As already clarified, the Strategic Force of the KPA is seriously examining the plan for an enveloping strike at Guam through simultaneous fire of four Hwasong-12 intermediate-range strategic ballistic rockets in order to interdict the enemy forces on major military bases on Guam and to signal a crucial warning to the US….

“On Tuesday, the KPA Strategic Force through a statement of its spokesman fully warned the US against its all-round sanctions on the Democratic People’s Republic of Korea (DPRK) and moves of maximizing military threats to it.

“But the US president at a gold [should be “golf”] links again let out a load of nonsense about ‘fire and fury,’ failing to grasp the on-going grave situation….

“Sound dialogue is not possible with such a guy bereft of reason and only absolute force can work on him. This is the judgment made by the service personnel of the KPA Strategic Force.

“The military action the KPA is about to take will be an effective remedy for restraining the frantic moves of the US in the southern part of the Korean peninsula and its vicinity….

“The Strategic Force is also considering the plan for opening to public the historic enveloping fire at Guam, a practical action targeting the U.S. bases of aggression….

“The Hwasong-12 rockets to be launched by the KPA will cross the sky above Shimane, Hiroshima and Koichi Prefectures of Japan. They will fly 3 356.7 km for 1 065 seconds and hit the waters 30 to 40 km away from Guam.

“The KPA Strategic Force will finally complete the plan until mid-August and report it to the commander-in-chief of the DPRK nuclear force and wait for his order.

“We keep closely watching the speech and behavior of the US.” (NightWatch)

Having issued his warning and seen a response, Trump now faces a daunting task. Doing nothing invites more threatening behavior from Kim Jong-un, who is an unpredictable despot. Doing something has risk attached no matter what the something is. For the United States this issue of North Korea and nukes is a classic Hobson’s choice of the worst kind. Yet today Trump affirmed his tough talk, saying, “If anything, maybe that statement wasn’t tough enough” (cnbc.com/2017/08/10/trump-maybe-fire-and-fury-statement-on-north-korea-wasnt-tough-enough.html).

Clearly, America is building the military coalition it needs to respond to Kim’s threat, as demonstrated by this report from Guam:

PACIFIC (GUAM) DAILY NEWS: “The U.S. Air Force has said that members of the 37th Expeditionary Bomb Squadron, deployed to Guam from Ellsworth Air Force Base in South Dakota are ready to ‘fight tonight’ from Guam. During a 10-hour mission from Andersen Air Force Base, Guam, on Monday, two B-1s were joined by Japan Air Self-Defense Force F-15s as well as Republic of Korea Air Force KF-16 fighter jets. ‘These flights with Japan and the Republic of Korea (ROK) demonstrate solidarity between Japan, ROK and the U.S. to defend against provocative and destabilizing actions in the Pacific theater,’ according to a release from the Air Force.” (Politico)

Meanwhile, Iran, a longtime North Korea ally, is paying close attention to the unfolding of events. See nydailynews.com/opinion/player-north-korea-crisis-iran.

So what happens next? A good outcome is a China intervention and a Kim Jong-un exit and regime change. But we all know hope is not a strategy, and waiting for China or depending on China’s assistance is fraught with complications and additional risks.

Do we utilize a naval blockade?  Shoot down missiles when they’re launched? Engage in other limited actions? All options risk a full shooting war, with South Korea in range of North Korean artillery.

Do we do nothing and hope that a nuclear-armed North Korea would restrain itself, as Pakistan and India have? What evidence do we have that supports such a hope?

Our view is that hope fails as a strategy. And allowing North Korea to advance its missile and nuclear capabilities raises the odds that it will sell them to other rogue nations or terrorist organizations.

We in America face a serious risk and a Hobson’s choice — an awful combination that requires all the collective wisdom and leadership our nation can assemble.

We will close this note with the full situational analysis offered by George Friedman, who graciously gave us permission to reproduce it.  His website is https://geopoliticalfutures.com/.

We thank George for allowing us to share this piece in its entirety with our readers.

North Korea, Nukes and Negotiations


By George Friedman

The narrative about North Korea, a narrative I believe to be true and have since early March, is simple: The North Koreans have reached a point in their nuclear and missile programs where they could soon have the capability to strike the United States. The U.S. isn’t prepared to let itself be vulnerable to the whims of what is seen as a dangerously unpredictable regime in Pyongyang. Therefore, the U.S. is prepared to strike at North Korea’s nuclear and missile facilities.

At the same time, the U.S. is extremely reluctant to attack. The nuclear program sites are dispersed and hardened, making airstrikes difficult, and North Korean artillery concentrated near the demilitarized zone could devastate Seoul. So as it considers not just whether a strike should be made, but whether one is even possible, the U.S. has been trying to motivate China to use its influence in North Korea to get Pyongyang to halt its weapons development. The U.S. position is that a strike will take place if diplomacy fails, but also that a conflict with North Korea would be difficult, dangerous and potentially devastating to allies. Thus, the U.S. is postponing such an action as long as possible.

As time passes, it is important to re-examine old assessments. The United States didn’t suddenly in the last few months conclude that an attack on North Korea was dangerous. The Americans had to have known the North Korean nuclear development program was dispersed and hardened, and they have publicly spoken about the artillery threat to Seoul. But they might have been galvanized by indications that the North Koreans had a miniaturized and ruggedized warhead and were close to having an intercontinental delivery capability. Given the degree of U.S. focus on North Korea, however, the appearance of sudden apprehension is odd.

One way to look at this is that the North Koreans were also aware of the hurdles involved in attacking them and knew that the U.S. would hesitate. They therefore decided to rush forward to complete a weapon that would threaten and deter the United States at a time when U.S. relations with Russia and China were unstable and the new American president hadn’t yet settled in. They saw an opening they could push through to complete their weapon and hold the United States at bay.

The problem with this theory is that North Korea didn’t really need to keep the U.S. at bay. The U.S. has no real interest in North Korea. It has no desire to overthrow the regime, to reform it, to trade with it or to visit it. The idea that a nuclear weapon would make North Korea safer was dubious, and the regime must have known that. Since 1953 and the armistice, the U.S. was formally hostile and practically indifferent toward North Korea. On the surface, it would seem that North Korea had more to fear from actually threatening the United States.

In thinking about this, I have begun to reconsider a model that I had used to explain U.S.-North Korea relations since the 1990s until this past March and the beginning of this crisis. That model is what I call North Korea’s “ferocious, weak and crazy” posture.

Ferocious, Weak and Crazy

This strategy emerged after the fall of the Soviet Union and the transformation of China from a nation hostile to the United States into one that depended on it for trade. North Korea found itself in an extraordinarily dangerous position. Japan and South Korea were seen as hostile toward it, if passive. Russia was incapable of protecting it, and China had bigger fish to fry. The U.S. was emerging as a global power, no longer challenged by other great powers. North Korea was isolated, and in its mind, the U.S. was rampaging and toppling regimes of which it didn’t approve. There was no reason for it to think North Korea wouldn’t be a target. Pyongyang’s goal was regime survival, and guaranteeing that was enormously different.

The solution was to position itself, at least in perception, as something not to be disturbed. First, the North Koreans sought to appear ferocious. At the beginning, they accomplished this with their massive military (however poorly armed) and by zeroing their artillery in on Seoul. True, they had limited resources, but the fanatical nature of the regime and its forces made the country appear dangerous and powerful beyond its means. Fanaticism was its force multiplier. No one wants to mess with a fanatic unless they have to, and no one had to.

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