North Korea

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The four horsemen are lining up. First came pestilence, in the form of swine flu; now war, emblazoned with the colours of despotic North Korea, has arrived. Relentlessly optimistic markets continue to take such visions of apocalypse in their stride. Since Pyongyang’s detonation of a nuclear device on Monday, South Korea’s benchmark Kospi has shed barely 3 per cent, while the won has lost a mere 1.6 per cent against the dollar. The FTSE World index has risen.

Fair enough. South Korea’s traditional discount to other markets already factors in its belligerent neighbour and, typically, cross-border shocks have minimal impact. As Morgan Stanley notes, the South Korean stock market usually barely flinches following big events in the north. The first nuclear test, in October 2006, sent the Kospi down 2.4 per cent but it recovered within the week. Rumours of sick leaders cause occasional market ripples, but investors often buy on the news. When Kim Il-sung died in June 1994, the Kospi gained.

Still, if Pyongyang’s latest show of force is an internal propaganda show designed to address an increasingly unstable domestic situation, that conjures up more extreme scenarios – such as unification. That really would trounce the South’s economy and markets. After the Berlin Wall came down, West Germany spent 4-5 per cent of gross domestic product a year on the East and unemployment surged. East Germany had just one-quarter as many people as the West, and per capita GDP was 30 per cent of their richer neighbours. North Korea, by contrast, has almost half as many people as the South, with per capita GDP just 6 per cent of levels across the demilitarised zone. On some estimates, reunification could cost Seoul $2,000bn-3,000bn, up to three times South Korea’s annual output. Investors’ current composure implies a belief this possibility is still remote – and South Koreans will surely hope, for now, they are right.

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