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A disaster for the global economy

Published: 15 Apr. 2013, 21:15

Wall Street hedge fund trader Nassim Nicholas Taleb became one of the world’s most influential writers and an expert on risk management with his pioneering work on uncertainty and randomness and “black swan theory.” Before Taleb’s theorization on the concept, black swans were often referred to as a rare and unlikely bird species, even presumed non-existent - until a Dutch explorer discovered them in Western Australia in 1697.

Black swans since then have been used as a metaphorical term to refer to perceived impossibilities until later proven otherwise. Before the release in 2007 of his groundbreaking book “The Black Swan” that explored hazardous dangers and risks in the financial market, Taleb warned of an imminent catastrophic disaster in Wall Street in the 2008 financial meltdown. He gained international fame when the subprime mortgage crisis panned out in almost exactly the same way he suggested it might.

Since then, Western societies have been on the lookout for potentially improbable black-swan events that could cause havoc or have major impacts on the world. Last year, pundits warned of a war between Iran and Israel that would certainly disrupt oil production and supply, dealing a heavy blow to the global economy. In recent months, the Korean Peninsula has emerged as a black-swan hotspot with the possibility of regional war.

Strictly speaking, the Middle East and Korean Peninsula conflicts do not fit into Taleb’s definition of a highly improbable black-swan event. The two regions have long been conflict zones with lingering dangers. Taleb cited the abrupt dissolution of the Soviet Union, the September 11 terrorist attack and the 2008 financial meltdown as typical examples of black-swan events. They had been unprecedented as well as unimaginable, thus bringing about enormous shocks. Yet when they happened, these incidents were strangely self-explainable even though they had not been imagined and foreseen by even the so-called experts.

In Taleb’s epistemological term, another Korean war would fall into more of a “gray swan” category than a rare, impactful and hard-to-predict black-swan event. A gray swan event can be anticipated to a certain degree, yet the probability of it occurring is largely ruled low due to its sizable potential impact. If a war does take place on the Korean Peninsula, the outcome and ramifications would be immeasurable. If it involves nuclear weapons, the result would obviously be apocalyptic.

Insecure times breed various theories, with some even arguing that there are forces plotting and fanning a regional war. Some historians say that the world was pulled out of the Great Depression period of 1930s, not because of U.S.-led New Deal economic programs, but thanks to World War II. The Korean War (1950-53) also served as a windfall for Japan. Japan could start to rebuild and rerun factories amid war rubble to manufacture military supplies to American forces engaged in the Korean War.

Japanese businessmen regarded the Korean War as a godsend. The Japanese police established reserve forces on the pretext of protecting public security. The 80,000-manned reserve forces later became Self-Defense Forces aimed at protecting the security of the mainland while its post-war constitution in principle forbids any formation of a conventional military force. Japan now argues for reinforcement of the Self-Defense Forces, citing North Korea’s nuclear threat. If another war breaks out on the peninsula, there may be those betting on another boon for the Japanese economy.

A war on the Korean Peninsula will most likely undermine the value of risk-sensitive banking and financial assets in the country because of the insecurity and fear factor. The stock markets in Northeast Asia will obviously lose investors and vitality. At the same time, the yen could rise again as the next safest asset to the U.S. dollar. It would then be a critical blow to the Shinzo Abe administration’s policy to devalue the yen to prop up the economy.

Japan rakes in billions of dollars in surplus from trading with South Korea. It posted a net of $36.1 billion last year. We can hardly assure the impact of a modern war on trade, but no one in the region will benefit if industrial production in South Korea is inexorably disturbed by the war.

Last year, South Korea registered a trade volume of $1 trillion. It’s the world’s eighth-largest trade powerhouse after the U.S., China, Germany, Japan, the Netherlands, France and the U.K., ahead of Spain and Italy. In particular, most Korean exports are material and parts that serve as the nuts and bolts of other countries’ products. If Korean factories suddenly stop, the industrial network among South Korea, China and Japan would be disrupted, inevitably disturbing the supply chain feeding the global economies.

The impact on the financial market would be more devastating. When prices of Korean equities and bonds fall, foreign investors lose big. Capital exit would be temporarily blocked due to the government’s control on foreign exchange and securities markets. The boon for the military industry alone won’t be able to compensate for all the losses and damages on the world economy. A mega-sized military clash on the peninsula in today’s intricately connected and interlinked world would only result in a gruesome catastrophe for the world economy.

*The author is business and industry editor of the Korea JoongAng Daily.

By Heo Kwi-sik