Peace Dividend and Fiscal Policy Debate

Peace Dividend and Fiscal Policy Debate
David R. Kotok
January 27, 2013

“The Obama administration’s fiscal plans anticipate a peace dividend after withdrawals from wars in Iraq and Afghanistan. The Republican Party has reasonably argued that it is unrealistic to expect this quiet to last. At the very least, if military expenditures continue to fall, it becomes more important to have the fiscal capacity to ramp them up in response to new threats. It is also worth noting that if the US were ever forced to surrender the mantle of the world policeman to, say, China, foreigners may no longer have quite the same desire for [US] debt.”

-Ken Rogoff, Financial Times, January 25, 2013

History suggests that peace dividends are elusive. Markets have been anticipating one as an outcome of the US fiscal policy debate. We are wary of that assumption.

At this writing, we are still fully invested in the US stock market but have reached our intermediate target levels faster than we anticipated. Meanwhile, we see a rising risk in the fiscal negotiations and their dependency on the so-called peace dividend. That keeps us invested in the energy sector and maintains our exposure to the US industrials.

We do not think the world is a safe place. The planned downsizing of the US Defense Department will leave power vacuums to be filled by folks we will not like.

We see trouble growing in Mali, Algeria, Libya, Syria, and numerous other African and Middle Eastern addresses. There is also a growing, festering confrontation between Japan and China. It is not clear that the US has any policy direction to deal with these issues. The second-term Obama administration would like them to go away so the president can focus on his domestic funding fight. We worry that the world will not give Obama that luxury. We expect that Senators Kerry and Hagel will be busy in their new roles as State and Defense secretaries.

Now we have a new development in North Korea. It shows that the young leader is consolidating his power and ratcheting up the risk. North Korea is dangerous. It is developing rocketry, and it sells the output to very unfriendly places like Iran.

We were able to obtain permission to publish the following extensive analysis of the North Korean actions and positions. We thank NightWatch, a publication we read regularly. Interested readers may find it at www.kforcegov.com .

North Korea: In the past two days, both the North Korean Foreign Ministry and the National Defense Commission have issued statements denouncing the UN Security Council resolution on North Korea’s space launch last month. The National Defense Commission (DPRK NDC), the most powerful entity in North Korea, threatened the United States in the statement it issued on 24 January. Excerpts follow:

“The UNSC resolution this time, framed through bargaining behind closed doors led by the United States and adopted by rubber-stamping member countries with inveterate blind obedience, clearly demonstrates that the hostile US policy toward the DPRK has entered a new, dangerous phase.…”

“In connection with the adoption of the utterly unjust resolution against the DPRK, the DPRK NDC solemnly declares the following:”

“1. The DPRK NDC totally rejects all of the illegitimate and outrageous resolutions against the DPRK adopted by the UNSC.…”

“The United States should clearly know that the times have changed and that our people and army have also changed. Amid a nation-wide struggle to defend the sovereignty, our peaceful artificial earth satellites will more continuously and vigorously soar into outer space. ”

“2. For as long as the United States’ hostile policy toward us is entering a more dangerous stage, all might should be concentrated on achieving the denuclearization of the United States and other big powers, not that of the Korean peninsula.”

“Therefore, the final conclusion of our army and people is that not only will the denuclearization of the Korean peninsula be achieved, but also our peace and security can be guaranteed when the denuclearization of the world — including the denuclearization of the United States — is first completely and perfectly accomplished.”

“In this situation, where the UN Security Council has been completely labeled as an organization that has lost its impartiality and fairness because the United States has led the way in trampling on our sovereignty and its following forces collaborated in it, we declare to the world that both the Six-Party Talks and the 19 September Joint Statement no longer exist.”

“In the future, too, there will be dialogue and negotiations for guaranteeing the peace and security of the region, including the Korean peninsula, but there will no longer be any dialogue with the agenda of the denuclearization of the Korean peninsula.”

“3. We will enter an all-out war of confrontation to crush the anti-DPRK hostile maneuvers of the United States and its insidious following forces and safeguard the sovereignty of the country and nation.”

“We do not conceal the fact that, in this all-out war of confrontation, which is a new stage of the anti-US struggle century after century, various satellites and long-range rockets which we will launch one after another and a high-level nuclear test that we will conduct will all target the United States, our people’s arch-enemy.”

“We should settle accounts with the United States only with the gun barrel, not with words, as it regards jungle law as the rule of its survival.”

“The world will clearly see how our army and people who, with confident faith in the justness of their cause, storm through along the road of justice for defending sovereignty, punish hostile forces of all sorts, and become victors in the end.”

Comment: The tone of the statement is almost personal in the frustration it vents. It is tempting to infer that the UN Resolution has thwarted a key program of Kim Jong-un aimed at modernizing North Korea – one of his big ideas. Kim is the leader of the NDC. The language is straightforward, with less communist jargon than is usual. It might be the first statement of its kind to threaten the US directly, albeit generally.

The threat is specific about the means that will be used to target the US, but not the timing or any actual target. Missile launches, nuclear tests and other provocations fit within the meaning of “will all target the United States” and “this all-out war of confrontation.” The statement ends the Six Party Talks with finality. North Korea expects to participate in future talks about security, but its agenda will not include denuclearization.

China-North Korea: China’s foreign ministry reacted typically. In the daily press conference the spokesman said, “It is in the common interests of all sides to maintain peace and stability on the Korean Peninsula and to achieve the denuclearization of the peninsula. The current situation on the peninsula is complex and sensitive. China hopes that the parties concerned will remain calm, exercise caution in their actions and statements, and refrain from making moves that could lead to the escalation of tensions in the region.”

He also said, “China thinks that the Six-Party Talks are an effective mechanism for promoting the realization of the relevant goals. All sides should increase contact, enhance mutual trust, improve relations, defuse tensions, and address each side’s concerns in a comprehensive and balanced way within the framework of the Six-Party Talks; earnestly carry out the various goals established in the 19 September Joint Statement; advance the process of denuclearizing the Korean Peninsula; and jointly maintain peace and stability on the Korean Peninsula. China is ready to make unremitting efforts with the international community to achieve these goals.”

Comment: The significance is that the Chinese spokesman precisely and in detail contradicted the North Korean NDC statement. This indicates that strain in relations has escalated to tension. China is likely to either send a high level trouble-shooter to Pyongyang or summon a North Korean senior official to Beijing for an explanation.

China’s Global Times wrote on 25 January that if North Korea engages in further nuclear tests, China will not hesitate to reduce its assistance to North Korea. China is North Korea’s primary source of petroleum products, its major trading partner and its major source of investment and food aid. The paper described North Korea as ungrateful for China’s efforts on its behalf.

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David R. Kotok, Chairman and Chief Investment Officer, Cumberland Advisors