Sunday, February 6, 2011

North Korean-Chinese Agreement on Raw Materials is a Troubling Development (update 1)

Bloomberg Reported on North Korean-Chinese Rare Earths Deal
Readers of the Seoul Gyopo Guide knew this prior to Bloomberg's report, which was published on February 8th.  Below, the Seoul Gyopo Guide's February 6th report and a quick analysis of the ramifications to the South Korean economy, and its potential effect on North-South Korean relations, is posted below.

It's No Secret:  China's Economy's Growth Has Benefited South Korea
It is a well-known fact that the economic development of China has been very rapid, as it has grown at basically 8-10% per year for almost the past 30 years.  The impact on the global economy has been enormous. The largest Korean companies, Samsung Electronics, Hyunda-Kia Motor Corporation, LG Electronics, Hyundai Heavy, SK Energy, POSCO, to name a few, have benefited \during this time.  The revenues earned \by the largest Korean companies have funded research and development efforts which have yielded global market share gains versus its global competitors, including the Japanese.  Globally, Korean companies are at least on par with their global competitors as measured by almost any measure.  The Seoul Gyopo Guide has pointed out that the relatively weak Korean Won has also played a very strong role in this.

China's Growth Has Kept Down Global Inflation.  For Now.
The reason that "inflation" on a global level has been subdued over the past 20 years has been largely due to the fact that China has absorbed much of the price pressures that would have otherwise occurred.  As demand has increased in other parts of the world, China supplied cheap items at an almost-endless rate, it would seem.  China has been able to do this because it is trying to transition 1.3 billion people out of its rural living into cities and a modernized economy.  Doing this has been no small feat.
However, the slow-moving train of global inflation seems to be picking up steam around the world.  Korea has also experienced this.  As those same 1.3 billion people have gradually become wealthier, they have become consumers on their own as well.  As the Chinese economic evolution continues, China will demand raw materials in order to continue it development.
The problem:  the supply of raw materials is in question and the demand continues unabated.  The result:  inflation for raw materials of almost every type.  China, once the great dampening force on global inflation, is becoming the great source of global inflation.

China's Delicate High-Wire Act
As a centrally planned economy, China has looked into the future, which means that its time horizon is more than 5 clicks on the internet.  Its demand for raw materials, and energy resources, has been undeterred by almost any economic shock over the past 2 decades.  Many in the financial markets would suggest that China has hoarded certain raw materials.  It is understandable to see why.  Take copper, for instance.  Copper is the one metal which is absolutely essential for construction.  Over the past 20 years, the price of copper has tripled, even with global output increasing by over 50% during that same time.
At a time that China is trying to grow its economy, it must also try to quell inflation.  Inflation has historically been the reason that governments are thrown into turmoil.  Many countries today are facing this as food shortages coupled with inflation have made the general populations...uneasy, to put it mildly.  The Chinese Central Bank is playing a very delicate balancing act indeed.
Out of Singapore, this article appeared, and it can, almost all by itself, explain why China won't allow a war between Koreas, and why this can fundamentally change the nature of the North-South Korea relationship.

If True, North Korea's Raw Materials Reserves Are Enormous
According to the CIA, North Korea's GDP in 2009 was about $40 Billion.  According to the AsiaNews site above,
South Korea estimates the total value of mineral deposits in North Korea at 6.3 trillion dollars.
"The agreement contains a specific list of mines to be developed...including gold, anthracite coal and rare earth mineral mines," Yonhap quoted a source familiar with North Korean affairs as saying.
Well, how much is $6.3 trillion dollars?  Let's say there are 25 million people in North Korea.  That is $252,000 per person.  This is not to say that North Korean citizens will instantly become $252,000 wealthier (yes, I have received this type of email).  It simply gives you an idea of how much money that is, and its effect on the relatively small North Korean economy.  This is actually a HUGE understatement of the potential effect because of the associated infrastructure that will need to be built in order to extract those raw materials. This has occured in the past, as reported in the Washington Post in 2008.
 
Most recently, China has threatened to cease the export of minerals called 'rare earth' metals.  The reason for this is that those rare earth metals, although used in very small quantities, are critical for technology manufacturing.  It is yet another reason that the $6.3Trillion estimate may be too low, i.e. it will not take into account the potential for much higher prices of rare earth metals.

If True, North Korea's Raw Materials Reserves Are a Game Changer
Development of raw materials extraction could not come soon enough for the North Korean economy.  How this develops will be interesting, and potentially can strongly affect the North-South Korean dialogue, as well as how Korea fits in the greater regional geopolitical structure.
Readers of the Seoul Gyopo Guide know that the writer believes that war on the Korean peninsula is unlikely at best.  The bottom line is that there are too many parties who have too much to lose if there is a widespread war on the Korean peninsula, and the Korean people are unlikely to wage war with one another (self-defense is another, more complicated matter, and that is why President Lee has taken harsh, well-deserved criticism, for his administration's handling of recent events).  Development of raw materials is critical to China, which further supports the Seoul Gyopo Guide's claims.  There are other issues to consider.  First, the Chinese are likely to strike exceptionally favorable terms from North Korea, given North Korea's economic woes.  It is not hard to imagine that any agreement is tied to further economic assistance from China to North Korea.  Second, the question will remain on where those revenues will go.  If the revenues are diverted for military development, then this would be a source of funds that could be very dangerous to the North-South Korean standoff.  Third, South Korea itself could be greatly disadvantaged compared to Chinese competitors.  Already, China poses a threat to certain important Korean industries.  A steady supply of raw materials at below-market prices would be a great advantage for China-based corporations.  Any one of the three issues may prove to be a flashpoint:  the combination of all three is particularly intriguing. 

Conclusions
South Korea, too frequently, is a mere spectator to large, transformational changes in the global economy.  Most of this is not due to anything that the South Korean government has done.  South Korea remains small geographically, without many raw materials resources of its own, and with a relatively small population.  These limitations make South Korea's rapid economic development even more amazing in many ways, especially in light of the fact that there has been continual, competent competition from foreign-based companies (ever hear of Toyota or Sony?).   Until now, South Korean economic and monetary policy have provided a shield for South Korean industries which has allowed these industries to become global leaders.  However, it is a story yet uncompleted because Korea is not China, and the fact that such a large economy has levers that can be used to disadvantage South Korea is troubling.  This will not happen overnight, and how raw materials are developed in North Korea is still yet to be determined. Nevertheless, the potential effects of North Korean-Chinese cooperation on the development of sorely-needed raw materials could be enormous.

Clearly, this post needs to be expanded greatly, and will be expanded in upcoming updates.
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