Even as Russia’s war on Ukraine rages, the Hamas-Israeli conflict risks plunging the Middle East into a wider conflagration, and the U.S./China great power competition intensifies, recent developments on the Korean Peninsula demand renewed focus. In a dramatic policy shift, on January 15, 2024, North Korea’s leader, Kim Jong Un (KJU), renounced the country’s decades-old policy of reunification with South Korea through peaceful means. Alongside telltale signs of a more aggressive nuclear posture, we think that the DPRK may be a far more prominent risk than markets have currently priced in. Our expectation is that North Korea will escalate nuclear threats in its bid to extract concessions, including recognition as a nuclear weapons state, from its regional adversaries and the U.S.
Reading the Signals
In KJU’s mid-January speech to the Supreme People’s Assembly, he made several unprecedented statements that reframed the North-South relationship in the language of war. First, he decried policies pursued by successive South Korean governments purportedly aimed at “unification by absorption” and “unification under liberal democracy.” Second, he declared South Korea “the primary foe and invariable principal enemy.” Third, KJU called for legal steps “to, legitimately and correctly, define the territorial sphere where the sovereignty of DPRK… is exercised,” including measures that “block all channels of communication along the border. As an exclamation point, he called South Korea a “foreign country,” and ordered officials to close all state agencies that were dedicated to unification, including the dismantling of a monument in the capital that promoted inter-Korean unity. “The reality is,” KJU declared solemnly, “that the North-South relationship is no longer a relationship of kinship or homogeneity, but a relationship of two hostile countries, a complete relationship of two belligerents in the midst of war."1
Beyond just reframing the North-South relationship in the language of war, KJU announced the removal of all restrictions underpinning the previous reunification process and urged preparation “for a great event to suppress the whole territory of South Korea.” He further warned that if North Korea is provoked into a conflict, it would be “an all-out struggle” that would involve the use of nuclear weapons against its enemies.
2022: A Year of Change
While assessing the risk of a potential nuclear strike is, of course, fraught with implications—and outside our realm of expertise—we can at least observe that the rhetoric and actions coming out of Pyongyang is qualitatively different from the past. This was especially apparent in 2022, when there was a significant ramp up in weapons testing.
Changing Nuclear Doctrine
In January 2022, KJU ordered a re-examination of the “issue of re-starting all temporary suspended activities.” In April, KJU reiterated that beyond the “primary mission” of preventing war, North Korea’s nuclear weapons had a “secondary mission” to protect his country’s “fundamental interests” if they were threatened. In a September speech to the Supreme People’s Assembly, KJU lowered the threshold for the use of nuclear weapons by announcing conditions under which it would launch a pre-emptive strike. This new “first strike” doctrine notably includes the use of nuclear weapons when: (1) the country’s leadership faces an “imminent nuclear or non-nuclear attack by hostile forces;” or (2) if Pyongyang determines that “it has no other way to prevent the expansion of a conventional war into one that would threaten the regime’s survival.” Moreover, in the same speech, KJU cemented North Korea’s nuclear status by enshrining the “first strike” doctrine into law, made clear that the country “will never give up” its nuclear weapons, and declared that its nuclear program is “irreversible” and “non-negotiable.”
Escalating Nuclear Program
Pyongyang’s nuclear weapons program clearly entered a heightened phase in 2022. North Korea reportedly launched ballistic missiles, a train-mounted ballistic missile, a new surface-to-air defense missile system, long-range strategic cruise missile, and multiple hypersonic missiles.2 In fact, as the chart below shows, North Korea fired more missiles in 2022 than at any time under the reigns of his two predecessors.
North Korea's Escalating Testing Program
Number of Missile Launches by Type
FT, CSIS Missile Defense Project. Figures are for full flight tests only, as of November 22, 2022. *“Unknown” unidentified weapons technology. **“Unknown Missile” unidentified missile technology (e.g., short range, long range, cruise, etc.).
U.S. - North Korea Relations
KJU’s shift followed the 2019 U.S. - North Korea summit in Hanoi, which failed to produce an agreement on arms control and normalization of relations with the U.S. KJU had staked his domestic credibility on the success of the Hanoi summit, and as diplomatic engagement fizzled out, KJU likely became convinced that engagement with the U.S. was no longer possible. In the wake of this disappointment, KJU reportedly ordered a review of the country’s national strategy, including changes to its nuclear posture. His conviction was further reinforced when President Biden took office. In 2021, President Biden referred to North Korea as the U.S.’ greatest foreign policy threat in his first press conference and later declared an end to leader-to-leader summits without preconditions.3
U.S. Approach: Extended Deterrence
Pyongyang’s nuclear program entered a heightened phase just as its relations with Washington and Seoul completely broken down. Even so, the U.S. and its regional allies have tried to strengthen deterrence against a potential NK attack on South Korea.
Washington has already warned Pyongyang that “any nuclear attack against the U.S. and its allies and partners is unacceptable and [would] result in the end of the regime.” In addition, Seoul has threatened to punish North Korea “multiple times as hard” in the event of a military provocation. Their resolve culminated in the Washington Declaration struck at a bilateral summit in April of 2023, which formally committed the U.S. to “make every effort to consult” with South Korean leadership on the potential use of a nuclear deterrent to protect South Korea and authorized the deployment of strategic assets to the country, including U.S. strategic bombers and nuclear submarines.4
Several months after the Washington Declaration, the Trilateral Summit composed of the U.S., Japan, and South Korea, convened at Camp David to expand the consultation process. Specifically, the countries agreed to a multi-year defense, anti-submarine exercises, and to share real-time defense information. With that stated, both Japan and South Korea have continued to bolster their individual defense capabilities in light of concerns that another U.S. leader may not share the same level of commitment to their defense.
Despite the agreements in place and measures taken, hope is running low that deterrence will work. Odds of a new round of sanctions to force North Korea’s compliance with its nuclear commitments are next to zero given Pyongyang’s ever-growing relationship with Russia, and China’s interest in preserving North Korea as a strategic asset in the region. Both Moscow and Beijing appear intent on frustrating every U.S. effort to isolate Pyongyang.
Over the Next 12 Months
We believe that tensions on the Korean Peninsula will ratchet higher. Below are several possible scenarios along with their potential market impact.
1. Base Case (80%) – Nuclear and diplomatic coercion.
Under this scenario, KJU will continue advancing the country’s conventional and nuclear missile capabilities. He will use the enhanced warfighting capability to further undermine the security status quo on the Korean Peninsula, thus sowing doubts about the U.S.’s commitment to South Korea’s defense and eroding confidence in the “extended deterrence” that Washington offered Seoul last year.
If unopposed by China and Russia, KJU will likely employ nuclear threats, possibly including limited military attacks against the South, to coerce diplomatic recognition of North Korea’s status as a nuclear power, or even the lifting of UN sanctions. His military provocations, however, will be targeted to minimize the risk of regime-changing retaliation by the U.S. and South Korea. The balance of power in the region will likely remain intact under this scenario.
Market impact in this scenario would likely be limited to the regional asset class complex, including Korean FX and equities and other risk proxies in the region. Ripple effects to the U.S. and other developed markets would be felt in the front-yield curves from safe- haven buying and perhaps the acceleration of rate cuts.
2. Worst Case (15%) - War with South Korea.
Under this scenario, North Korea will attempt a takeover of South Korea using military force, including the potential use of nuclear weapons. Per the ramp-up in missile launches, a full-scale scale attack against the South presupposes North Korea feels confident in its conventional war fighting capability to achieve a decisive victory over the South. It also assumes that North Korea has built up credible nuclear weapons capability to deter South Korea’s allies from intervening in the war. A nightmare scenario would be if North Korea’s attack against South Korea coincides with China’s invasion of Taiwan, threatening a permanent revision of the regional status quo.
Under this scenario, the global market impact would be dramatic, with steep a selloff in risky assets led by plunging values in the South Korean bond, corporate, and equity markets. Potential lack of global central bank coordination could further exacerbate the selloff of risky assets. Taiwan assets, especially the currency, may also drop in value as fears of Chinese military invasion climb. U.S. Treasuries, the USD, and Swiss Franc will likely rally as safe-haven destination for investment flows. The Japanese yen may see less demand as a flight-to-safety asset.
3. Benign Case (5%) - Return to Status Quo Ante.
This scenario assumes that KJU will reverse recent changes to the country’s nuclear doctrine and backtrack the renouncement of a peaceful reunification with South Korea. Under this scenario, KJU abandons nuclear coercion as a diplomatic and military tool and decides to resume denuclearization talks either bilaterally or multilaterally. KJU may even consider engaging unilaterally with the U.S. pledging to freeze the nuclear program in exchange for economic benefits, including lifting of sanctions. The regional balance of power would shift in the U.S. favor under this scenario.
Conclusion
North Korea’s accelerating buildup of nuclear and missile capabilities, its adoption of the nuclear “first strike” doctrine, and the ensuing removal of all constraints under the prior peaceful reunification policy may have changed KJU’s strategic calculus towards South Korea once and for all. As Prof. Andrei Lankov from Kookmin University in Seoul stated, “The best, or perhaps even the only, way to explain the direction of Kim’s nuclear weapons development is that the North Koreans are seriously preparing for a second round of the Korean war and conquest of the South. It is a threat that will start to become more and more apparent over the next 10 or 15 years.” In this sense, KJU’s policy towards South Korea is not unlike Xi’s policy towards Taiwan. In other words, neither country has decided to go to war, but preparations for it are nonetheless underway.
1 On July 27, 1953, the Korean Armistice Agreement was signed, ending the fighting. However, no peace treaty was ever signed between North and South Korea.
2 NK's ballistic missile tests are in violation of the UN’s bans. However, the country has managed to avoid fresh international sanctions as China and Russia have blocked efforts to toughen UN sanctions on the country.
3 President Biden has since stated that he is willing to meet with the North Korean leader in “good faith.”
4 White House Press Conference. "Remarks by President Biden and President Yoon Suk Yeol of the Republic of Korea in Joint Press Conference." April 26, 2023.