Last night the Shock Exchange reported on how North Korea claimed to have had a hydrogen bomb it attached to a long range missile, capable of striking the United States. News later broke that not only did North Korea have a hydrogen bomb, it tested it Sunday morning:

North Korea on Sunday tested its sixth and largest nuclear device, a demonstration of power that triggered a magnitude 6.3 earthquake around the area of its test site.

The “perfect success” of what Pyongyang claimed was a hydrogen bomb capable of being mounted on a ballistic missile marks the latest show of defiance to the international community, particularly the US, amid a tense stand-off over the regime’s rapidly developing weapons programmes.

The China Earthquake Administration and the US Geological Survey both measured the quake at magnitude 6.3, with the Chinese body saying it had occurred at a depth of zero km. Officials in South Korea and Japan also confirmed they believed the earthquake was the result of a nuclear explosion.

North Korea’s Parliamentary Defense Committee estimated the bomb had a yield of 100 kilotons. If true, that would make it seven times more powerful than the bomb hydrogen bomb dropped on Hiroshima (13 kilotons) and five times more power than the one dropped on Nagasaki (20 kilotons).

North Korea launched its first missile of 2017 in mid-February – a month after President Trump was elected. Experts believed it was meant to test the Trump administration’s preparedness. A war of words followed between Trump and North Korean leader Kim Jong Un. In July Kim Jong Un launched an intercontinental ballistic missile that it said was capable of hitting the heart of the United States. In previous launches North Korea had shown off its short to intermediate range capabilities. President Trump promised to meet President Trump promised to meet any North Korea threat with fire and fury if need be. Undeterred, last week Kim Jong Un launched a missile over Japan and into the Pacific Ocean. The unprecedented provocation appeared to be another show of force from Jong In, and proof that he had the capability to strike the U.S. territory of Guam if he so chose.

Will Diplomacy Work?

President Trump took to Twitter (TWR) this morning to respond to the missile test, calling North Korea “hostile and dangerous to the United States,” and partly chastising China for its lack of help in the matter.

The U.S. has issued sanctions against North Korea in the past. China – North Korea’s largest trading partner – banned coal imports from Pyongyang after missile tests in mid-February. Trump is now suggesting that the U.S. and its allies ban oil shipments to Pyongyang. I find it hard to believe that Jong Un had not factored such sanctions into the equation before the hydrogen bomb test. Sanctions and back channel talks have not worked in the past to stop North Korea’s provocations, and I doubt they will work now. Furthermore, China could be a wild card. It does not want a beefed up U.S. military presence on the Korean peninsula out of fear the U.S. could use its Terminal High Altitude Area Defense system (“THaad”) defense weapons systems (or other measures) to spy on China. A de-stabilization of the Koreas would also not be attractive as it could create knock-on effects for China’s economy.

Terminal High Altitude Area Defense system (“THAAD”)

Either the U.S. or North Korea has to make a good faith effort at diplomacy. Stopping Jong Un’s nuclear ambitions does not appear likely. According to Bong Young-shik, an authority on North Korea at Seoul’s Yonsei University, Jong Un might even seek a larger role on the world stage:

“Kim Jong Un now understands that Washington does not have the ability to crank up its maximum pressure strategy any further,” he said. “He understands Washington does not realistically have a military option. The only option is for Washington to recognise North Korea as a nuclear state and hope to contain it like with the Soviet Union.”

Based on Trump’s prior rhetoric, recognizing North Korea as a superpower on par with Russia could be untenable in the short-term. However, somebody has to give. It will be interesting to see who blinks first.

The Play For Investors – Reduce Exposure To Equities

Last week’s unprecedented provocation by North Korean sent markets lower initially, but they recovered to end the week in positive territory. Over eight years of central bank stimulus has buoyed financial markets to record highs. That stimulus could come to an end if the Fed unwinds its $4 trillion balance of fixed income instruments as promised. Future Fed actions create uncertainty, and the actions of North Korea or social unrest around the global could amplify that uncertainty. I recommend that investors reduce exposure to the equity markets due to unexpected problems from the Fed’s unwind of quantitative easing (“QE”), and rising tensions with North Korea and/or China.

On Shock Exchange

Shock Exchange: How Inner-City Kids From Brooklyn Predicted the Great Recession and the Pain Ahead explains the stock market and U.S. economy through the eyes of the New York Shock Exchange, a financial literacy program Ralph Baker started in 2006 to share his passion for investing and basketball with his 11-year-old son and other boys his age. The book predicts the “pain ahead” for the U.S. economy, the demise of China, the pending stock market crash and social unrest.

Shock Exchange has been trumpeted by President Obama, the Senate Finance Committee and House Ways and Means Committee. However, they conveniently forgot to cite the source. Critics try to make and unmake authors, but the market always decides. The book was also recently added to Trump Syllabus K12, crafted by Dr. Kaye Wise Whitehead of Loyola University Maryland. Shock Exchange is the best book on Wall Street in the past 20 years, and on economics, it may be the most important book since the Great Depression.

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