Nuclear

The Wolf who cried “Boy”

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North Korea’s threat to fire a nuclear missile at Guam should the US try anything to jeopardize the hermit kingdom’s nuclear programme is more the domain of an hysteric media for now. He is the wolf crying boy – “I will eat your sheep when I wish, what are you going to do about it?” Of course, no sane government can dismiss his threats. The 33-year old leader has assassinated subjects and relatives who he feared might pose a challenge to him. He taunts his enemies in full knowledge the collateral damage the West may suffer would likely be factor fold higher than he stands to lose. North Korea’s GDP is estimated to be around $12 billion annually. Tokyo’s GDP is estimated to be around $1.5 trillion, 125x larger. Seoul’s GDP is around $780 billion (65x North Korea) but is located in shelling distance. From a purely militaristic standpoint, North Korea doesn’t stand a chance. The US has spy satellites parked permanently over North Korea surveilling troop movements, missile test sites and US submarines will have constant watch over Pyongyang’s naval activity. Mutually Assured Destruction (MAD) is not a bargaining chip in this case. While it does raise the ‘risk’ factor, it is not enough to exclude war on the peninsula.

The problem is that all the while no action is taken, PyongYang’s arsenal grows more sophisticated. Kim has no plans to halt his development. In 1994 then President Bill Clinton came closest to taking action against its nuclear capability but in the end chose diplomacy. We are 23 years on and the capabilities are such that this game has increasingly limited life span. Trump made his thoughts clear in a 1995 interview. Try to talk him out and if all else fails take the military option

The more advanced his arsenal becomes, the more weight his demands carry. Kim is in his 30s. Assuming the West does nothing, there is another three decades of threats and bellicose to consider. Over time its weapons programme will be sufficiently credible to hit Washington DC. Just like Russian missiles in Cuba, America will not allow a condition which could threaten it to exist.

North Korea has 3 main nuclear missile launch sites (Musudan-Ri,  Punggye-Ri and Tongchang-Ri) among the fourteen nuclear facilities ranging from R&D, power generation,  mining and refined fissile material production. A surgical strike would be difficult to achieve without North Korea getting away a few missiles itself.

Why Guam? Of course one can view his threat in several ways. One, Guam is the current realistic technical capability of his nuclear weapons, two; Kim hasn’t said he’ll strike Washington DC which should be interpreted as evidence that he is not completely deranged and bragging about capabilities he does not yet have, three; he could theoretically bomb the US military installations in Okinawa which is closer than Guam and more likely to score a relative hit but he has been careful not to drag Japan into this contest (yet) and finally; his nuclear programme is his only bargaining chip. Were Kim to cease his atomic aspirations, he would literally be a sitting duck. He knows – as did his father and grandfather before him – the regime survives on the will of the Rest of the World to appease it. If he has no trump card, the RoW can ignore it.

On April 10th this year, China’s special envoy on the North Korean nuclear programme, Wu Dawei, visited Seoul with the idea of pushing a harder UN resolution in case of another nuclear test. In the short term China is hoping a short term halt to coal imports will bring Kim Jong-Un to heel they have not ruled out removing him entirely. It is the least preferred option but Trump’s moves will only mean China is being forced to up the ante. However China has been lamenting that it can’t force Kim to come to heel. Once again this is partly China testing the will of Trump versus his predecessor. Do not think for one second that China hasn’t been channeling Sun Tzu as to how it can pull off a geopolitical masterstroke by bringing Kim to heel and the US to back down. This is becoming harder to achieve, even more so with an unpredictable president.

Let us not forget the strategic benefits of North Korea to China. It provides a buffer to the US friendly South Korea and keeps furthering China’s status as a dominant force (economically and militarily) in the region. One of the last things China wants is the equivalent population of Australia (24 million) as refugees on its northern border. Best it remains contained inside a regime presiding over a tiny economy. Even less desirable is a US invasion/strike which puts a US protectorate on China’s doorstep.

Global markets are not reacting too erratically to this crisis. They are collectively taking the path of most common scenario vis-a-vis history to date. Minor risk on. Even Korean CDS spreads, at 14 year highs (61) remain well down on GFC and the death of Kim Jong-Il. However a president who wants to reassert US foreign policy after 8 years of willful abuse under his predecessor may be more than willing to take decisive action and put an end to the North Korean problem. He won’t risk it unless his generals can give a very high level of assurance the collateral damage will be minimal

While some media want to believe that Trump is itching for a war in North Korea or Iran to resurrect his sliding poll numbers, that is an obtuse way of thinking. North Korea is a growing threat. Pure and simple. If North Korea gets a capability to potentially hit the US mainland then that is untenable. Any country that threatens to attack another puts itself on a geopolitical chess board of its own making. This is dragging China into a game it would rather not play but inevitably Beijing realizes that it has to take control before Trump takes it from them leaving them in the worst of all worlds.

Cooler heads to prevail? Maybe but something suggests that North Korea is brewing beyond what markets are currently pricing.

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Storing the Fukushima nuclear waste

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Scattered throughout Fukushima prefecture are some 5.5mn black bags containing soil contaminated by the crippled reactors. This picture is on the outskirts of the exclusion zone. To put it in perspective this is what it looks like from the air. They now have huge black tarpaulins draping over them to keep it dry.

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Most of the ‘unusable land’ has been converted into waste dumps like this or solar parks. Cars with flashing blue lights waft slowly around the neighborhoods to prevent theft and looting from deserted homes.

Even driving into Sendai some 100km+ north the highways have radiation level information alongside speed limit signs. A reminder of that terrible event 6 years ago which was highly preventable had the money been spent on relatively low cost sensible placement of the back up generators (in the $10s of millions) on high ground. It was forgone because the plant was scheduled for closure 6 months after the quake. The idea was that the risks of a tsunami or quake were so negligible that penny-pinching was the right thing to do. Of course PM Kan refused to give the order to release the presssure inside the reactors against the advice of nuclear experts. The clean up is in the 100s of billions. Go figure.

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Fukushima City feels dead. It is a long way from the reactor but unsurprisingly infamous for one thing now. As I mentioned a few weeks ago I’m guessing the government will turn up investment projects to revitalize it.

For a good video on the reactor check ABC’s Mark Willacy on Foreign Correspondent

Follow the market on North Korea

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Follow the market. Financial markets are the ultimate arbiter of risk. What we have here is the 5yr Republic of Korea CDS which gives a rough guideline of how risk is being priced over time. Clearly unchartered waters at the time of GFC saw Korean risk leap to 700bps. The death of Dear Leader Kim Jong-Il saw around 240bps on the clock and Kim Jong-Un’s first nuclear weapons test saw a slight nudge over 100bps before sliding back to a standard 50bps range. Since Trump sent a carrier battle group and China issued an ultimatum (the ‘bottom line’) the rate has popped to 58.7 from 50-odd earlier in the week. It will be no surprise to see the fear factor rise in coming days but the odds are now on for China to take charge and work to install a pro-Beijing puppet which can be sold as a way to dismantle the nuclear threat and remain China’s protectorate. Kim Jong-Un may be offered a Rimowa of cash and an Idi Amin style exile in Saudi Arabia as a way to saving his hide because he has no alternatives and backing down in the face of the current situation will bring his power into question. China wants North Korea to survive for its political aims. For now markets are not panicking. Gold drifting higher and Korean won softening but it is hardly showing fear at this stage.

Japanese school kids take up nuclear attack drills for the first time since the Cold War

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For the first time since the Cold War, Japanese school kids are practicing evacuation drills in the event of a nuke attack by North Korea. When five of the top 10 selling books in Japan were related to nationalism several years ago be sure that the feeling of protecting sovereignty is by no means taken lightly. Five years ago, at my previous company I wrote a four part series on the coming military tensions that are expected to occur in Asia. This is further proof things are going to continue to escalate. The Japanese Defense White Paper 2016 articulates why Tokyo is lifting military spending and changing from mere defence to attack capabilities. They’ve recognized the game has changed.

An excerpt from this 2016 White Paper reads,

“We are seeing an increasingly severe security environment surrounding Japan, as well as shifts in the global balance of power including in the Asia-Paci c region. Since the beginning of this year, North Korea has repeatedly conducted military provocations, such as a nuclear test and ballistic missile launches. Such military actions by North Korea constitute a serious and imminent threat to security not only of Japan but also of the region and the international community. At the same time, Chinese and Russian military forces have intensifed their activities in sea areas and airspace surrounding Japan. In the East China Sea, Chinese government vessels have repeatedly intruded into Japanese territorial waters and have been engaged in activities that are seen as promoting the Chinese government’s own assertions regarding the Senkaku Islands. In the South China Sea, China has continued large-scale and rapid land reclamations, established outposts, and utilized them for military purposes. By unilaterally altering the status quo and attempting to turn it into a fait accompli, these actions heighten tension in the region…

…Against this backdrop, the Ministry of Defense (MOD) / the Self-Defense Forces (SDF) has a responsibility to assume any situations and take seamless responses in order to resolutely secure the lives, property, and freedom of the people as well as Japan’s territorial land, water, and airspace. The legislation for peace and security was passed in the Diet last year and entered into force this March. This legislation enables Japan to strengthen its ability to prevent wars from occurring, i.e. its deterrence, and implement seamless responses. To ensure that our deterrence functions adequately, it is essential that Japan continues to build a more effective Dynamic Joint Defense Force that is ready to respond to various situations appropriately.”

Note now that Japan has a first strike capability to ensure its safety. No longer does it have to be punched in the nose if it sees threats are imminent. As peaceful as Japan is today, sadly it bears deep scars not forgotten by its neighbors during the imperial years in the 1930s and 1940s.

Toshiba, NEC, Panasonic & Sharp lost a combined ¥1.9tn over the last 25 years

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I am putting together a piece on corporate governance in Japan and stumbled over some interesting charts. The one above shows the aggregate net income of Intel and 20 of Japan’s tech juggernauts over 25 years. Sadly, Intel on its own made 41% more net income (currency adjusted) than all of the Japanese 20 combined. Toshiba, NEC, Panasonic & Sharp lost a combined ¥1.9tn ($18bn) over the last 25 years.

I’ve been speaking to the Financial Services Agency (FSA) about how to improve corporate governance as they look to tweak the code.

Is it any surprise that companies tend to perform better when board members (insiders) have a higher proportion of their remuneration linked to stock performance? Shareholders have traditionally been well down the list of priorities of Japanese companies, much to the chagrin of foreign investors. Stock incentives, especially in larger corporations, are often a minuscule part of total compensation for leaders. So much so that there is little incentive to focus on chasing real returns through more aggressive strategy. Many leaders in Japan would prefer to see out their tenure as CEO without blemish or scandal to avoid the risk of failure and the shame it would inevitably bring.

In hindsight looking at Sharp’s (6753) desperate long term need for crisis management could we have honestly expected any substantial restructuring when the CEO had $33,000 in stock despite being at the company 36 years? Had Sharp’s board held more skin in the game they might have defended shareholders much better against Terry Gou’s constant renegotiations. Perhaps if Sharp had learnt from Carlos Ghosn style performance based compensation structures, they might have been able to defend their turf from Gou. As it stands now Sharp were mere whipping boys of Hon Hai.

When I looked at insider (executive) ownership of Japanese corporations over 10yrs mapped against total returns, surprise surprise, there was strong correlation.

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More to follow but there is actually a lot of longer term hope here. Japan licks the world in most areas of technology. If they managed to connect those dots to shareholder returns then this market would re-rate substantially. Looks as though a growing number of corporations are working more performance linked pay.

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I think that the authorities should encourage corporates to adopt English language financial materials. By doing so would invite more eyes from investors in markets where shareholder returns are prioritised. This would create an environment that would encourage Japanese corporates to unlock more value.

The JPX would accrue large upside. Not only would it gain more status as a proper global exchange, it would invite higher activity which would improve liquidity which is a virtuous circle for a financial exchange.  This is the number of Japanese corporates where CEO/Chairman engagement with foreign shareholders -a little over  10% of listed entities.

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So some interesting trends and maybe something to look forward to if Japan accelerates the pace of corporate governance application. They can start by hiring fewer lawyers, accountants and academics as independent directors too!

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Toshiba reveals yet again the depths of its lack of imagination and innovation

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If we needed any more proof of how starved Toshiba’s board is of innovative thinking (by the way Toshiba’s logo is “Leading Innovation”) the actions to cut wages, salaries, costs and travel highlight it in spades. Simply put, to exact more self inflicted pain across the entire group that is struggling to recover is corporate suicide. Toshiba should be picking its battles and investing in its portfolio of relative winners to climb out of the hole of its own making. Wages are not going to be the swing factor here. While it might help the P&L for a few months, the actions are likely to further demotivate an already demoralized labour force leading to further revenue declines. Instead of asking those at the coal face what process improvements and efficiencies have been overlooked that may save them a fortune they can’t think beyond cutting free biscuits in the tea room. Clients also notice when companies start to scrooge. No client sees value in forging relationships with companies that look increasingly likely to go out of business. Scans in America is considering canceling two nuke plants for this reason. When we tally the cost savings of cutting salaries, we can be guaranteed that Toshiba will meet its maker. Time to let it fall under the weight of its own incompetence and let sensible buyers of its business divisions rediscover latent asset value. For a company that has been in deep crisis for years, I don’t buy that they’ve realized they have a problem only recently. Toshiba has dropped another $1bn in market cap since yesterday. At that rate (limit down rules excluded) is technically worth nothing at that rate in a little over 7 more days.

Why America needs to upgrade its nukes even though they can blow the world up 20x over

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Once again I read a bunch of newspapers taking a dig at the incoming president’s plans to upgrade America’s nuke arsenal. Sure Merrikka can nook the world 20x over with its current stockpile. Even better it fits a narrative that he’s a red button trigger happy fool who will embark on nuclear war on Day 1 in office.

Let’s look at why upgrading nukes is a sad reality. Nukes from the 80s and 90s aren’t state of the art anymore. It’s a bit like stealth technology. The Americans pioneered stealth almost 30 years ago. Back then it enabled the USAF to go into enemy territory undetected and hit a target. However the Russians, being masters of detection worked out how to overcome stealth, with their S-400 surface-air-missile system (soon to be upgraded to the S-500) rendering it an obsolete technology. The US Forces have ended up taking around 10% of their original demand for stealth craft including the F-22A,  the increasingly inept F-35, B-2 and the F-117A. The Chinese worked out that while a F-22 would wipe the floor with Chinese fighters, the conformal fuel tanks and internal missile bays that kept the stealth signature limited combat radius meaning non-stealthy aerial tankers could be taken out meaning F-22s would fall into the drink. A non stealthy Boeing EA-18G was credited with shooting an F-22 down in aerial combat simulation – its electronic interference software made the F-22 think it was somewhere it wasn’t.

So back to upgrading nukes. Now that rogue nations have them, they aren’t the deterrent they once were. By upgrading the home arsenal with superior technology  enemies think twice and that is the real motive. It isn’t about simply lobbing a nuke from a silo and fly it across the world in a straight arc. The next gen  missiles are supposed to be able to evade anti-missile missiles with superior agility through state of the art kinetics to make sure it can hit its target.

Yes, it all sounds so futile to build up a new stockpile of missiles to finish a job which can already be done 20x over. The idea is to stay a step ahead in the arms race. The Romans realized the trebuchet was more effective than the gladius.  The samurai realized that rifles were more powerful than the katana. In WW1 armies realized machine guns were more powerful than rifles. In WW2 the Atom bomb was deemed more effective than deploying a whole army and so on. Defense today progresses in the same way.

It’s easy to run madman twitchy trigger finger scare stories that fit narratives but if they actually understood the motive of staying one step ahead  of perceived enemies they may actually seek to congratulate not censure Trump. I know it’s asking too much but perhaps we should look at how quickly Lockheed Martin has snapped into line after being told their rubbish, late, ineffective and massive cost overrun F-35 needs a rethink on price, performance and capability. He hasn’t taken office and defense contractors are complying like chastised schoolboys escaping a potential caning.