The other black swan

Korea: Asia’s markets are not pricing for nuclear war after North Korea opened fire on the South. That’s not because the situation isn’t serious — the attack marks the North’s most aggressive act in years, and comes at a time of delicate political transition for the hermit state. But, investors may be relying on China, North Korea’s large neighbour, to keep the peace.

A North Korean collapse would be bad for China. A flood of immigrants over the Yalu river border would be one problem. Amnesty International estimates that 50,000 already cross the border every year. The prospect of a unified Korea on its doorstep may jar with Beijing too. China has defended what some analysts call its “buffer zone” before. Its involvement in the Korean War of the 1950s cost China some 400,000 lives, including Chairman Mao’s son.

For now, China seems happy to support a state of contained chaos. The People’s Republic accounted for 57 per cent of North Korea’s imports in 2008, according to the CIA Factbook, while the World Bank has estimated that China supplies 90 per cent of the state’s energy. The United States has also tended to support the status quo, worrying about Pyongyang going nuclear but pushing for peace.

Investors seem to believe that delicate balance will hold. Korea’s benchmark index rose slightly the day after the Yonpyeong shelling. The won weakened, but by less than the 4.7 percent fall when the South blamed its neighbour for sinking a warship in May.

The calm looks right: neither China nor the United States want war. Still, there is no room for complacency. Financial markets proved poor predictors of unthinkable events in 2008. North Korea’s regime remains a black box - and one with more capacity to damage the world than banks’ opaque valuation models.

That makes the Korean spat a warning, if not yet a crisis. In particular, it means the United States and China must work harder to resolve their differences over financial imbalances, starting with eschewing protectionist tariffs and committing to fairly valued currencies. Economic disagreements may not directly cause war, but they might prevent the world’s superpowers from coalescing when it really matters.