The Demise of Dollar Diplomacy?

Barry Eichengreen

WASHINGTON, DC – Mark Twain never actually said “Reports of my death have been greatly exaggerated.” But the misquote is too delicious to die a natural death of its own. And nowhere is the idea behind it more relevant than in discussions of the dollar’s international role.

Pundits have been saying last rites for the dollar’s global dominance since the 1960s – that is, for more than a half-century now. The point can be shown by occurrences of the phrase “demise of the dollar” in all English-language publications catalogued by Google.

The frequency of such mentions, adjusted for the number of printed pages per year, first jumped in 1969, following the collapse of the London Gold Pool, an arrangement in which eight central banks cooperated to support the dollar’s peg to gold. Use of the phrase soared in the 1970s, following the collapse of the Bretton Woods system, of which the dollar was the linchpin, and in response to the high inflation that accompanied the presidencies of Richard Nixon, Gerald Ford, and Jimmy Carter in the 1970s.

But even that spike was dwarfed by the increase in mentions and corresponding worries about the dollar starting in 2001, reflecting the shock of the terrorist attacks that September, the mushrooming growth of the US trade deficit, and then the global financial crisis of 2008.

Yet through all of this, the dollar’s international role has endured. As my coauthors and I show in a new book, the share of dollars in the foreign-currency reserves held by central banks and governments worldwide hardly budged in the face of these events. The greenback remains the dominant currency traded in foreign-exchange markets. It is still the unit in which petroleum is priced and traded worldwide, Venezuelan leaders’ complaints about the “tyranny of the dollar” notwithstanding.

To the consternation of many currency traders, the value of the dollar fluctuates widely, as its rise, fall, and recovery in the course of the last year have shown. But this does little to erode the attractiveness of the dollar in international markets.

Central banks still hold US Treasury bonds because the market for them is the single most liquid financial market in the world. And Treasury bonds are secure: the federal government has not fallen into arrears on its debt since the disastrous War of 1812.

In addition, US diplomatic and military links encourage America’s allies to hold dollars. States with their own nuclear weapons hold fewer dollars than countries that depend on the US for their security needs. Being in a military alliance with a reserve-currency-issuing country boosts the share of the partner’s foreign-exchange reserves held in that currency by roughly 30 percentage points. The evidence thus suggests that the share of reserves held in dollars would fall appreciably in the absence of this effect.

This under-appreciated link between geopolitical alliances and international currency choice reflects a combination of factors. Governments have reason to be confident that the reserve-currency country will make servicing debt held by its allies a high priority. In return, those allies, by holding its liabilities, can help to lower the issuer’s borrowing costs.

Here, then, and not in another imbroglio over the federal debt ceiling this coming December, is where the real threat to the dollar’s international dominance lies. As one anonymous US State Department official put it, President Donald Trump “does not seem to care about alliances and therefore does not care about diplomacy.”2

South Korea and Japan are thought to hold about 80% of their international reserves in dollars. One can imagine that the financial behavior of these and other countries would change dramatically, with adverse implications for the dollar’s exchange rate and US borrowing costs, were America’s close military alliances with its allies to fray.

Nor is it hard to imagine how this fraying could come about. President Donald Trump has painted himself into a strategic corner: he needs a concession from North Korea on the nuclear-weapons issue in order to save face with his base, not to mention with the global community. And, for all of Trump’s aggressive rhetoric and posturing, the only feasible way to secure such a concession is through negotiation. Ironically, the most plausible outcome of that process is an inspections regime not unlike the one negotiated by Barack Obama’s administration with Iran.

To get there, Trump’s administration will have to offer something in return. The most obvious bargaining chip that could be offered to make the North Korean regime feel more secure is a reduction in US troop levels on the Korean Peninsula and in Asia in general, With that, the US security guarantee for Asia will weaken, in turn providing China an opportunity to step into the geopolitical breach.

And where China leads geopolitically, its currency, the renminbi, is likely to follow.

Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His latest book is Hall of Mirrors:The Great Depression, the Great Recession, and the Uses – and Misuses – of History.

How a Fractured Election Outcome in Germany Will Impact the EU

Germans on Sunday voted themselves into a tricky political environment that could leave the country torn between the far left and the far right – without a good in-between alternative.

Chancellor Angela Merkel’s center-right Christian Democratic Union (CDU) led the pack in the federal elections to the Bundestag, the German Parliament, with about 33% of the vote. But it lagged behind the mark it set four years ago, as did the results for the party’s coalition partner, the center-left Social Democrats (SPD), which had just a little more than 20% of the vote.

Merkel’s victory was tempered by the SPD immediately announcing that it would not work with her to form a coalition. That leaves Merkel and the CDU with just one possibility for forming a functional government — the so-called “Jamaican” option (the colors of three parties involved are the same as the Caribbean nation’s flag) – which in this case would mean a three-way coalition with the libertarian Free Democrats (FDP) and the progressive Green party.

Also troubling for Merkel were the gains made by the far-right anti-Islam AfD party, which came in third with 12.6% of the vote – nearly triple its support four years ago. Alexander Gauland, the co-leader of the AfD, pledged that the party will “hunt” Merkel and investigate her policies on refugees and immigration.

The changes to the political landscape in Germany – Europe’s largest economy — has implications both for the country and also for the European Union as a whole. It also brings up serious questions as to whether Merkel will be able to end her political career on a productive note – and about who will succeed her as de facto leader of the EU.

Has the Tumult Come to an End?

“We’re done with the big elections in Europe, thank God – it was a tough year,” said Wharton finance professor Joao Gomes. “You can interpret the French election [of President Emmanuel Macron in May] in different ways, but neither one of these leaders comes up with a very strong mandate.”

The good news, according to Wharton adjunct management professor Saikat Chaudhuri, is that the election of Macron in France, Merkel in Germany and Prime Minister Mark Rutte in the Netherlands means that the wave of far-right populism on the rise in Europe and the U.S. has been kept at bay to some extent. He noted that while the AfD gained ground in Germany, the party itself is in turmoil, as evidenced by co-leader Frauke Petry’s decision to quit hours after the election. “The most important result for me is that, despite all the disappointments suffered by the major parties, Angela Merkel is back,” said Chaudhuri, who is also executive director of Wharton’s Mack Institute for Innovation Management. “It will be very, very important for her to at least try to create the right footing for Germany and for the EU together with other partners, even though they’re weakened.”

The German elections close a “very tumultuous” period of 16-18 months that saw the effects of Brexit, the U.S. presidential election and high-stakes elections in the EU.

“Now maybe we can have a phase where no one will be complaining, and we can get things done at the European level,” said Olivier Chatain, a professor of strategy at HEC Paris and senior fellow at the Mack Institute. “But that will depend a lot on the eventual composition of the coalition and the type of balance of power,” he added. Chatain and Daniel Kelemen, a political science professor at Rutgers University, appeared on the K@W SiriusXM show days before the election to discuss its likely impacts.

“You can interpret the French election [of President Emmanuel Macron in May] in different ways, but neither one of these leaders comes up with a very strong mandate.”–Joao F. Gomes

Kelemen saw a “trade-off” between the German people’s desire for stability and the “extremism” that could come about with stronger parties on both the far-right and the far-left.

“A lot of people would like to see the same government return to power, and the same grand coalition [between the CDU and the SPD] that brings stability, and with their big majority they could pursue their mandate,” he said. “But in the long term that kind of a grand coalition of the two major parties’ breeds extremism, because people feel like they don’t have an alternative between the left and the right between elections.”

The SPD’s decision not to continue the “grand coalition” leaves Merkel and the CDU having to find a way to work with the Free Democrats, who are “socially liberal, but very much pro-business,” Chaudhuri said, and the Greens “who in many ways are seen as a detriment to pro-business.

“Undoubtedly the coalition dynamics are going to be complex,” he added. “Angela Merkel is very seasoned and right now she will be able to put something together. But whether she can sustain that momentum is really the question. At a time when Europe needed to come back strong, I think everyone is hoping it will be that way.”

Gomes predicted that three-way coalition may not have staying power for an entire four-year term. “At some point the Upper House of Parliament may be lost and maybe the Greens will bail out and we’ll have an early election and the SPD will win,” he said. “They want to be on the outside, they want to be in the opposition.”

The End of an Era

The election results leave Merkel without a clear mandate going into her fourth and final term. How that will impact her policy efforts remains to be seen, but Gomes doesn’t seen Merkel as the type of leader who feels like she needs to go out with signature wins.

“She’s not as driven by ego as you might see in other leaders,” Gomes noted. “One goal she laid out in her last term was that she is acutely aware of the aging of Germany and the need for renewal in Germany and the need for some sort of transformation. I don’t know how much she feels like he still has the time and energy to do, but I don’t think she has ambitions to make some big Eurozone reforms – if she does, I think she’ll be very frustrated.”

“Angela Merkel is very seasoned and right now she will be able to put something together. But whether she can sustain that momentum is really the question.”–Saikat Chaudhuri

But the outcome of the German elections will undoubtedly have major impacts on the Eurozone, and Macron’s ambitious plans to reform the economic and monetary union. Macron has called for the appointment of a Eurozone-wide finance minister, a budget for the currency bloc and even a micro-parliament.

Chaudhuri and Gomes noted that the urgency for wide-ranging reforms has waned as the economic fortunes of the countries in the Eurozone have improved.

“What characterizes Merkel is that she’s a pragmatist. So from that point of view, she won’t start with unrealistic ambitions,” Chaudhuri said. “That’s one of the reasons for her success; she’s been able to adjust for what the needs were during each election and if that happened to be different needs from her party and from her personally, she’s adjusted to that pretty well.”

He added that if Merkel doesn’t envision that big reforms for the EU are possible, “she’s not going to push for it. But she’s going to do things she believes need to be done and move it forward perhaps in a smaller way.”

One issue that isn’t going away for Merkel is how best to shape immigration policy for Germany and the EU and how that interacts with concerns over security. “What’s going to be critical for Merkel is to balance an ability to be somewhat open-minded, or send the signal that Germany is open, that the EU is open, while being pragmatic and saying the plans she had earlier are not going to work in terms of immigration.”

He noted that one way to undermine the security threat from terrorism and usurp the far-right’s anti-immigrant agenda would be to seek a milder policy. “We want to be open, but we need to be careful; you want to find a balance of the two – not anti-immigrant, but we need security.”

“Now maybe we can have a phase where no one will be complaining, and we can get things done at the European level.”–Olivier Chatain

Merkel’s Successor

As Merkel enters her final term, it’s not clear who will be her successor – both as the leader of Germany and as a strong force within the EU. Chaudhuri noted that SPD leader Martin Schulz has greater ambitions and, by opting not to form a coalition with the CDU, is gambling that he’ll be able to gain more prominence by going it alone.

On the European side, “I’m very hesitant to say that Macron will take the mantle,” Gomes said. “French presidents tend to have a peak that doesn’t tend to last and we’re already seeing the beginning of some unrest in France. I’m not sure how long [Macron’s] moral authority will carry him.”

Macron’s ability to enact reforms in France were dealt a blow over the weekend when his party won fewer seats than expected in the French Senate elections. “Macron and Merkel realize they need each other to some extent, given their mandates and situations,” Chaudhuri said.

“Macron is new, he wants to get a lot of things done, he comes from a totally different background and he’s shaken up the French system. Merkel, while continuing her winning streak, has been considerably weakened. Germany and France have to find ways to bond – a lot of that will determine the future of the EU and the future of succession at the EU level.”

The Rentiers are Here

Stephanie Blankenburg , Richard Kozul-Wright

GENEVA – Since the 2008 financial crisis, policymakers and international institutions have regularly expressed concerns about widening income inequality and its unwelcome political consequences. More often than not, they attribute the problem to “exogenous” factors such as global trade and new technologies. 

While policymakers have intensified their focus on trade and new technologies, they have missed an even more potent driver of inequality: the endemic rent-seeking that stems from market concentration, heightened corporate power, and regulatory capture.
Rent, broadly defined, is income derived solely from the ownership and control of an asset, rather than from innovative, entrepreneurial deployments of economic resources. When the British economist John Maynard Keynes anticipated the “euthanasia of the rentier” in his 1936 book The General Theory of Employment, Interest and Money, he was referring to a financial class that served no purpose other than to exploit scarce capital for its own benefit. But over the last three decades, financial rentiers have taken their revenge. Through private credit creation and financial alchemy, they have amassed huge gains that are wildly disproportionate to the social return of their activities.
Moreover, in our age of hyper-globalization, large non-financial corporations have also emerged as a rentier class. Owing to their substantial market power and lobbying prowess, they now regularly engage in the kind of rent-seeking activities that were once the exclusive preserve of the financial industry. As a result, large non-financial firms have become a pervasive source of rising income inequality.
Non-financial corporations have entered the rent-seeking game through a number of channels.

They have systematically abused intellectual-property laws to achieve market domination, rather than to protect genuine innovations. They have looted public-sector resources through large-scale privatization schemes, and by securing public subsidies that rarely require them to deliver benefits to taxpayers. And they have engaged in far-reaching market manipulation, by turning themselves into debt collectors, using share buy-backs to boost executive remuneration, and so forth.
In addition to the sheer range of rent-seeking schemes operating today, lax corporate reporting requirements around the world make it difficult to estimate the scale of the problem. Much of the existing research focuses on the US economy, where some studies have measured the growth of dominant firms’ market power through the steep upward trend in mark-up pricing; and others have examined the role of proliferating information technologies in the accumulation of “surplus wealth.”
At the United Nations Conference on Trade and Development (UNCTAD), our research looks beyond the US economy, relying on a newly constructed database for publicly traded companies in 56 developed and developing countries. We used these data to estimate the extent to which large non-financial corporations’ profits exceeded typical annual sectoral profit performance since 1995.
Surplus profits, we found, rose markedly over the past two decades, from 4% of total profits in 1995-2000 to 23% in 2009-2015. For the top 100 firms, that share increased from 16% to 40%, on average.
The same multi-country database also confirms that market concentration has risen significantly over the past two decades, particularly among the top 100 firms. In fact, large inter-firm disparities have become a key feature of the corporate rent-seeking age. In 2015, the top 100 firms had a combined market capitalization (the total value of a company’s outstanding shares) that was 7,000 times that of the bottom 2,000 firms. Twenty years ago, that multiple was just 31.
Making matters worse, this trend has not extended to employment. Between 1995 and 2015, the top 100 firms increased their market capitalization fourfold, but did not even double their share of employment. This implies that market concentration and corporate rent-extraction are feeding off one another. The result is a “winner-takes-most” market environment that strongly disadvantages start-ups, entrepreneurial innovation, and sustained creation of high-quality jobs.
Consider, for example, the proliferation of wide-ranging patent-protection powers through bilateral and multilateral trade and investment agreements. These powers have been extended to new activities that were not previously considered areas of technological innovation, such as finance and business methods. As a result, the tech giants, in particular, have achieved a new level of regulatory capture, allowing them to limit free speech when it serves their interests, expand into non-high-tech markets, and shape emerging global policy agendas, such as financial inclusion and e-commerce.
It is not too late to check the trend toward rentier capitalism. The “endogenous” factors contributing to wide-scale regulatory capture and corporate rentierism can be addressed with stronger antitrust legislation, policies to empower organized labor, revisions to existing trade agreements, and better monitoring, at the international level, of transfer pricing and tax evasion. Some policymakers have already started to take action on these fronts. But success will require a more concerted effort. It is time to force big business back into the business of productive investment and job creation.

Stephanie Blankenburg is Chief of the Debt and Development Finance Branch, UNCTAD.

Richard Kozul-Wright, Director of the Division on Globalization and Development Strategies at the United Nations Conference on Trade and Development, is the author, most recently, of Transforming Economies: Making Industrial Policy Work for Growth, Jobs and Development.

Predicting The Direction Of The Stock Market And The U.S. Economy

by: Centaur Investments

- All major stock indexes hover near record highs, and retail investors are more optimistic than at any time since the dot-com bubble.

- Household debt balances are now $164 billion higher than the Q3 2008 peak of $12.68 trillion, while the U.S. unemployment rate stabilizes below the long-term natural rate.

- Broken legislative promises of tax cuts, healthcare, and government spending justify skepticism.

- Threats of a nuclear war between U.S. and North Korea have been shrugged off by financial markets, as the VIX declines to historic lows.

- U.S. financial markets approach a pivotal point in history where confidence can erode quickly.

In November 2016, Centaur Investments published a series of market outlook articles under the attention-grabbing title of “Trumped-Up Economics.” The article series was more of an economic outlook rather than an assessment of the Trump Administration. In the article series, the reader was briefed on U.S. economic history, recent political and macroeconomic developments, and concluded with a prediction of the future performance of individual market sectors. As goes with most market predictions, the warnings presented in the article series were mostly ignored by the market, which continued trend higher. Yet somehow, the points laid out in these articles are quite still relevant. This article will recap those important points and, once again, attempt to project how the market is going to perform.
As the third quarter approaches, and the calendar year comes to a close, the market outlook is still highly uncertain. The American public has yet to see realistic public policy reach the floor for debate in Washington. Promises of legislative action to improve healthcare, infrastructure, and tax code have gone unfulfilled. The legislative attempts that were made took place after being rushed through impossible deadlines. So far, the legislative process has consisted of putting documents together in a matter of weeks with little research or consideration given.

When thinking about the current political environment, it becomes evident that U.S. financial markets have performed well largely because of decade-long efforts to spur economic activity in the post financial crisis era. President Trump has been extremely fortunate to walk into the oval office just as corporate earnings grew moderately, employment continued to expand robustly, and the nation’s gross domestic product maintained its positive trajectory.
(Source: Bureau of Economic Analysis & St. Louis Fed, chained 2009 USD)

But, obviously, this economic activity is not attributable to the Trump Administration, rather directly attributable to the collective efforts of market participants; hard-working individuals and businesses.

It goes without saying, if the bull market is to continue, it will continue to be driven by these economic forces. If the market stalls or pulls back, it will be due to the ongoing geopolitical climate or a threat of war.
Looking at where the U.S. economy stands today, the market outlook appears promising. In more recent measures of business and consumer confidence, optimism is still at the highest level seen in years. Both inflation and interest rates remain near the decade lows. The level of confidence has continued to spill over into financial markets. Per The Wall Street Journal, retail investors are “more optimistic than at any time since the dot-com bubble.” SPDR Dow Jones Industrial Average ETF (DIA) and SPDR S&P 500 Trust ETF (SPY) are two ETFs closely tracking the Dow Jones and S&P 500 indexes, respectively. The PowerShares QQQ Trust ETF (QQQ) is one of the more popular ETF names for tracking the Nasdaq 100. The performance of these three ETFs is indicative of optimism translating to investor euphoria, as reflected in the next two graphs.

In recent trading sessions, all three major U.S. stock market indices closed near record highs…
…and the Chicago Board of Options Exchange ((NASDAQ:CBOE)) Volatility Index (VIX) declined to historical lows.

Shorting the VIX has turned out to be one of the most profitable trades of the year. In order to gauge where this market is heading, let us recap individual sector performance while focusing more on the lagging sectors. In the first half of this year, lower oil prices continued to hit corporate earnings, causing energy shares to stumble for most of the year. Recently, efforts from Oil Producing Economic Countries (OPEC) to curb production, along with an unexpected number of tropical storms, managed to elevate energy prices higher. As you will see in the next chart, energy sector returns have started to make a sharp turn upward.
Conversely, price deflation in the telecommunications sector held company share prices down, as competition intensified among carriers. Mobile phone and data plan prices have declined aggressively this year. Additionally, growth has also plateaued in automobile manufacturing volumes and dealership sales. Despite declining new automobile sales and used automobile prices, shares of auto and subprime lenders have shown resilience, advancing right along with the financial sector. See the sector breakdown in the next image.

Per Bloomberg, both Energy and Telecom have been this year’s worst-performing sectors.

Evident from the illustration above, Energy and Telecom are now racing to catch up with the rest of the market. From a price-to-earnings valuation, the Energy sector appears overvalued. However, if oil prices continue to rise, earnings growth should offset this measure. The upward trend in Telecom on the other hand is questionable. The decline in mobile phone and data plans will continue to put downward pressure on top-line growth among carriers. Recently, disappointing news about the new iPhone’s sales forecast caused shares of Apple Inc. (OTC:APPL) to pull back some. This may have some effect on carriers looking forward to a holiday sales boost from the new device. From a value investor perspective, AT&T Inc. (T) and Verizon Communications Inc. (VZ) offer attractive dividends, and it is unlikely that consumers will ever put their mobile phones away or forgo upgrading to new devices.

Will Peaking Household Debt Spark A Fire Sale?
Moving now to the economic indicators, let’s start with household debt, which has continued to grow to record levels. In August, the New York Fed published the “Quarterly Report on Household Debt and Credit,” for the second quarter. The report noted that:
Aggregate household debt balances increased in the second quarter of 2017, for the 12th consecutive quarter, and are now $164 billion higher than the previous (2008Q3) peak of $12.68 trillion. As of June 30, 2017, total household indebtedness was $12.84 trillion, a $114 billion (0.9%) increase from the first quarter of 2017. Overall household debt is now 15.1% above the 20 13Q2 trough.”

There are a few interesting takeaways from this report, mostly regarding the non-housing debt balance, which still appears to be reaching a peak. During the second quarter of the year, household credit card balances grew by more than enough to offset the first quarter declines.

Further, the expansion in subprime auto loan origination was the highest observed in the last four quarters.


When you look at data from auto lenders, the measure for tightening standards implies that some lenders may be starting to loosen up lending standards again. It is not certain if this loosening in lending standards is due to tepid demand for new autos, increased lender competition, or because perhaps lenders perceive that loan default risks have receded. This last comment is appealing because in the most recent loan data from both the New York Fed and lenders themselves, loan and credit card delinquencies continue to rise. Even with all this publicly available insight, the market capitalization's of financial services companies have continued to rise. Lenders Ally Financial Inc. (ALLY) and Santander Consumer USA (SC) have reached 52-week highs, though some lenders like Capital One Financial (COF), Discover Financial Services (DFS), and Synchrony Financial (SYF), were mostly flat year to date.

Nevertheless, market pricing of this industry continues to appear inefficient.

S&P 500 Year-To-Date Returns Vs. ALLY, SYF, COF, and DFSFinancial Services (Source: The Wall Street Journal)

Conclusions from Inflation, Unemployment, and Interest Rate
Will U.S. equities continue to rise and the VIX continue to trend lower, or are stocks overvalued? It is the writer’s belief that the economy is still about two or three years away from the next recession. A major crash in stock prices is likely also years away, but a correction may be overdue. The economic indicators in this concluding section support the view that a recession is still years away.


The Federal Reserve’s Open Market Committee (FOMC) plans to continue its course towards interest rate normalization despite the sluggish rate of inflation. The image above illustrates the Dallas Federal Reserve Bank’s Trimmed Mean PCE Inflation. This measure is presented instead of Consumer Price Index ((NYSEARCA:CPI)) or Core-CPI, because it filters out singularities such as a cyclical decline in energy, mobile phone plan, or pharmaceutical prices.

Ideally, this would be a strong indicator if inflation were becoming a threat to the economy. As you can see from the chart, there is no imminent threat observed. The Federal Reserve Board has projected for several years now that inflation would increase dramatically. The Fed’s projections have served as a base argument for raising interest rates in the past. While inflation measures may not be indicating any immediate threats, the current unemployment rate (4.4%) has stabilized below the long-term natural rate (5.8%) for over a full year now. This is one measure that may likely start to reverse in the near term. Take a look at the historical unemployment rate data in the image below.

While the current measure of inflation may not justify the Fed’s interest rate decisions, financial market performance and unemployment do. Additionally, if you observe inflation and unemployment data in close detail, there are usually two or three years of flat activity before a trend reversal becomes apparent.
Studying the U.S. treasury yield curves can also help grasp a little more of what market participants see on the horizon. Near-term treasury yields have followed Federal Reserve’s interest rate decisions closely. On the other hand, treasuries with long-term maturities show strange behavior as geopolitical and economic risks are priced in. This observation further supports the idea that while the market may continue to outperform in the near term, the economy has only a couple more years of growth ahead.

The main conclusion to draw from this article is that investors should be cautious moving forward.
The list of uncertainties felt at this time last year are still the same today. There are plenty of reasons to be skeptical about legislative promises of tax cuts or government spending. In addition, the impact that these policies will have on the economy is also uncertain. There may be inflation or there may be a prolonged period of growth. Also, keep in mind that the Federal debt ceiling has only been temporarily increased through December. Expect for this debate to resurface in the not so distant future. Regulation of industries such as healthcare and pharmaceuticals has been clouded by infighting between political parties. Finally, there is this looming threat of war with North Korea.

U.S. financial markets are approaching a pivot point in history where confidence can erode quickly. The best thing to do here is to only add investments which have a considerable margin of safety. In the event that the market does pull back, the worst thing to do is panic sell. History shows that portfolios are capable of recovering from a correction rather quickly. Lastly, in a market environment where institutional investors start to underweight cash, doing the opposite is probably a safer bet. When closing a position whether for gain or loss, the cash collected may be far more useful when markets fluctuate, rather than immediately adding a new name to the portfolio at current valuations.

South Korea and the Wisdom of War

By Xander Snyder

For all the attention rightly paid to the nuclear weapons program of North Korea, any country considering a military strike against Pyongyang needs to account for its artillery. Eliminating these conventional weapons, fixated as they are on civilian populations in South Korea, is critical, since Kim Jong Un has threatened to use them to turn Seoul into a “sea of fire.” It’s enough to make its potential targets question the wisdom of war.

There’s no question that the North can strike Seoul. There are some questions, however, over just how much damage it can inflict. And the answers to these questions lie at the heart of the political exchange between South Korea, which wants to avoid war, and the United States, which is more disposed to attack. Each side is trying to convince the other that its course of action is correct. Understanding the dynamics at play requires understanding what exactly is at stake if the North, as it has long pledged to do, fires its artillery at the South.

To Bring an Enemy to Heel

At its closest point, Seoul, the city most at risk from an artillery barrage, lies about 24 miles (39 kilometers) from the demilitarized zone. There’s a spot on the DMZ, near the southwestern part of the Imjin River, that dips just a little farther (about 15 miles) toward South Korea, a tract of flat land that would be relatively easy for an invading force to pass through. It is here that North Korea has fixed its closest artillery on the South Korean capital. But the DMZ is long, and Pyongyang can’t afford to put all its artillery in the areas in which it would do the most damage to Seoul. It must defend its entire border, so its artillery is spread more thinly than perhaps it would like.

(click to enlarge)

More important than the placement of these guns, however, is the sheer number of them that can reach their target. The International Institute for Strategic Studies estimates that North Korea has more than 21,000 artillery pieces and multiple rocket launchers aimed at Seoul. But only three types of them have the range to hit Seoul: the 170 mm Koksang self-propelled guns and the 240 mm and 300 mm MRLs. The 170 mm Koksang has an effective range of approximately 25 miles (which can be boosted to approximately 50 miles with rocket-propelled shells); the 240 mm and 300 mm MRLs have a range of about 50 miles and 95 miles, respectively. It’s unclear exactly how many pieces of this artillery North Korea possesses, but estimates put the number at about 700-1,000, some of which are probably stationed closer to Pyongyang to defend the capital.

(click to enlarge)

What works against North Korea is that the bigger, longer-range artillery pieces tend to fire more slowly. As soon as they begin to fire at Seoul, their positions would be revealed and would therefore be subject to U.S. and South Korean counterstrikes – and quickly, by notably superior equipment. Self-propelled artillery such as the Koksang is designed to mitigate this problem, and though it can be fired and relocated comparatively more quickly than towed artillery, it still cannot evade U.S. and South Korean targeting systems forever. The only way it could is if it is placed in fortified positions in the mountains or beneath the ground, but such positions clearly obstruct the firing path. MRLs can fire several projectiles at once, but they are easier to shoot out of the air by counter-artillery systems. Seoul might not be able to intercept all of them, but it could intercept some of them, thereby reducing the amount of damage Seoul would take. In other words, North Korea may have as many as 1,000 guns aimed at Seoul in a geographically advantageous position, but there are only so many rounds Pyongyang could fire before its guns would be destroyed or moved.

Then there is the question of strategy. If the North has only a small window of opportunity to hit Seoul, why would it waste precious time exclusively attacking civilian populations? If the North believes that winning the war requires destroying the South’s military, then it would want to strike military installations, not civilians. Based on the size of the North’s crude oil reserves, moreover, many experts believe that North Korea can wage war only for a few months at most. So if Pyongyang believes it has only a little time to attack, it might optimize its time by attacking military targets.

Still, there is more than one way to bring an enemy to heel. One strategy North Korea has likely explored is targeting South Korean infrastructure – power plants, water and sewage treatment facilities, and so on – that makes life in Seoul possible. If North Korea could strike these facilities, firing fast enough to prevent rapid repair, then it could kill many more civilians than it could by directly targeting civilians. Put simply, it is possible for Pyongyang to render parts of Seoul uninhabitable without completely leveling the city.
No Comfort

For these reasons, it seems unlikely that North Korea could turn Seoul into a “sea of fire.” The Nautilus Institute, a think tank that studies North Korea, reached a similar conclusion in a report published in 2012. Based on the range, fire rate and rate of attrition – how quickly artillery pieces will be taken out once they’ve been fired – roughly 30,000 residents of Seoul would die in the initial volley, with as many as 35,000 more dead by the end of the day and 50,000 more dead by the end of the week, according to the report.

But these figures are based on a deliberately outlandish assumption: that North Korea uses every piece of capable artillery it has to fire on cities like Seoul at optimal fire rates with a limitless supply of ammunition – with no misfires or misses. If Pyongyang attacks military installations instead, Nautilus estimates the causalities to decrease dramatically to 2,800 from the initial barrage, and most of them would be soldiers.

Notably, the report was written before North Korea tested the 300 mm MRL, so the figures could be somewhat higher. They could be higher still if Pyongyang used chemical or biological weapons on the South. The South Korean Ministry of Defense estimated that North Korea has 5,000 tons of chemical weapons, with the ability to produce up to 12,000 tons (an annualized rate of production) during wartime. It’s unclear, however, if North Korea has the capability to affix these weapons to its short-range artillery rockets. Nor is it clear what kind of biological agents Pyongyang has, but it’s safe to assume casualties would increase if it had them and chose to use them.

None of this, of course, is any comfort to Seoul. To say that tens of thousands, as opposed to millions, will die in the opening salvo of a war is to offer no solace to its residents or its leaders. It justifies Seoul’s aversion to war absolutely. The desire to avoid casualties of any magnitude is central to South Korea’s imperatives, and it’s difficult to imagine a scenario in which the United States persuades Seoul to act against its own interests.