Saturday marked the first flight between Egypt and Iran since 1979. The election of Islamist President Mohamad Mursi in Egypt in June 2012 significantly thawed relations between the two countries. Diplomatic ties had been cut by Iran in 1979 when the deposed Shah took refuge in Egypt, but the heads of state from the two countries visited in February and the relationship is now largely mended (Reuters).

President Mursi was a leader in the pan-Islamist movement called the Muslim Brotherhood, which has approximately 600,000 members who pay a percentage of their incomes to the organization. It has members worldwide, and promotes Sharia law and the unification of Arab states. These goals are, incidentally, shared by the terrorist group Al Qaeda. The 2011 popular overthrow of President Mubarak in Egypt served as a strong indicator of the Muslim Brotherhood’s growing power. The US announced diplomatic relations with the group immediately following. Egypt was a strong US ally against the Soviets during the Cold War, and was a voice for stability in the Israeli-Palestinian conflict. The manifestation of the Arab Spring in Egypt, which deposed long-time US ally Hosni Mubarak, has not been kind to US foreign policy goals in the region.

Iran and Egypt are the third and sixth largest Muslim countries by GDP. Iran has a GDP of $522 billion and Egypt has a GDP of $231 billion (United Nations 2011). While the economy is half that of Iran, Egypt will attempt to expand its regional power status in the Arab states, Africa, and closely align with Iran and China.

For indicators of balancing against NATO and tilting away from the US, watch for Egypt joining the Shanghai Cooperation Organization (SCO) as an observer state, as has Iran. Watch for increased commercial relations with North Korea and Iran, and improved diplomatic ties with Pakistan. For indicators of nuclear club aspirations, watch for Egyptian efforts to improve types of nuclear power generation that yield fissile by-products for potential use in nuclear weapons. Also watch for increased Egyptian government links to organizations with likely ties to global terrorism. Egyptian political instability will continue until more authoritarian rule is imposed by either the Islamists or the pro-western faction. Expect further loss of value in Egypt-tied investments, including equities, commercial debt, and sovereign debt. Egyptian oil production is less than 1% of global supply, so there should be negligible effects on oil prices.

The United States Treasury Department claimed on March 22 that it was confident that China would back new United Nations’ financial sanctions against North Korea. The sanctions punish North Korea for the nuclear tests of February 12. An anonymous Chinese official — almost certainly speaking at the direction of his government – on March 22 revealed that China halted oil exports to North Korea.

Unfortunately, the pro forma Chinese punishment of North Korea for its most recent nuclear test will be intentionally lightweight. China had a similarly weak response to the first North Korean nuclear test on October 6, 2006, and it proved an insufficient disincentive to further nuclear and missile development. It increased backing to UN financial sanctions, and ceased oil exports to the country for a short period. As in 2006, China knows that Iran is likely to supply the energy shortfall to North Korea resulting from any loss from China’s embargo. Without a much stronger set of sanctions and enforcement mechanisms, a network of embargoed, rogue, and failed states have the outside option of trading with each other, and regaining overt Chinese and Russian support when international attention fades.

Anything more than a slap on North Korea’s wrist would chill Chinese relations with authoritarian regimes across the globe. For this reason, China can ill-afford any drastic action against North Korea. China is a long-time supporter of authoritarian governments worldwide, from Uzbekistan to Syria. This support is concretized in the Shanghai Cooperation Organization. China is the key diplomatic supporter of North Korea, and can dictate many North Korean policies based on China’s economic power and physical proximity. Other authoritarian states will watch the magnitude of Chinese reaction to North Korean behavior to calibrate the trust they can place in their own relations with China. These global relations between China and authoritarian regimes are crucial for China to obtain relatively inexpensive raw commodity imports that fuel its present top priority of economic growth. It is inconceivable that China would risk slowing its own economic growth because of a recent uptick in threats to the West from North Korea.

Short-term sanctions, however, will occur. China believes the young Kim Jong-Un, the new leader of North Korea, has overstepped his bounds with recent tests and threats towards the United States and South Korea. The increased Chinese support to sanctions and a decrease in North Korea’s access to oil markets serve China as both a message to Kim Jong-Un to follow a slightly quieter path, and a tool to stave off criticism of China at the United Nations were it not to support sanctions. Time is currently on the side of China and North Korea, leading to a trend of which China is well aware. China’s economy is growing much more rapidly than Western-allied economies, which strengthens China’s military and diplomatic position with respect to the West. North Korea continues tests of its nuclear and missile technology, with no effective response from the West. With the latest sanctions, China is telling North Korea not to rock the boat because the race is being won.

Watch for China’s long and short-term strategies to have an immediate effect on Kim Jong-Un by decreasing his public belligerence. Also watch for China to ease pressure on North Korea as soon as it either complies or public attention goes elsewhere. Without a Chinese-supported embargo on imports and exports to North Korea, plus enforcement by international naval vessels deployed to the East China Sea and Sea of Japan, the latest round of financial and oil restrictions will be ineffective; North Korea will continue to progress in developing and proliferating nuclear weapons and missile technology.

Today North Korea put their medium-range missiles on combat alert and repeated threats against US military bases including in South Korea, Guam, and Hawaii. The US Defense Department sent a strong signal by flying two nuclear-capable B-2 Stealth Bombers over South Korea in training exercises, and through comments to the press by the Defense Secretary that indicate a readiness for conflict should that be necessary. A Defense Department spokesman softened those comments by reiterated that the US seeks to deescalate tensions, and that the important goal is to stay ahead of North Korea in terms of its capability to marry a nuclear warhead with a missile delivery vehicle (CNN). However, a potentially greater threat from North Korea is an unconventional or terrorist delivery of nuclear or other weapons of mass destruction (WMD). Were a nuclear device to explode in a major port city, for example, it would likely cause up to one trillion dollars of damages, 500,000 deaths, and $40-70 billion in trade losses  (Bloomberg. Congressional Research Service).

It is unlikely that the North Koreans would follow-through on their most recent threats, and unlikely that were they to try, a missile strike would be effective. The North Koreans are having difficulty with the technical challenges of component miniaturization that would allow them to place a nuclear warhead on a missile. To stave off such an attack in the future, the US must nevertheless maintain robust intelligence, deterrent, and preemptive strike capabilities. North Korea could provide us with an unpleasant surprise. Saddam Hussein surprised the world in 1990 with the progress he had made towards achieving nuclear status, and there is much more technological improvement in rogue state nuclear capabilities twenty years later.

China and Russia are likely sharing, to a limited extent, nuclear technologies with Pakistan, Iran, and North Korea. These rogue states are likely sharing with each other as well. This sharing does not necessarily have to be state-sanctioned. A poorly-supervised agency within a rogue state would have the capability to proliferate nuclear or other WMD technologies without the knowledge of its government. Many individual scientists or government officials in these corrupt countries, if offered sufficient incentive, would likely be willing to share technological expertise or hardware necessary for the making of blueprints or reverse-engineering.

Staying ahead of North Korean improvements is a challenging task, and risky. As Defense Secretary Donald Rumsfeld famously said,  “There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know.” (Press Briefing, February 12, 2002)

The risk is not only that North Korea has a nuclear delivery capability about which we are unaware, but that they could be considering unconventional approaches to delivery. These approaches could include smuggling a nuclear weapon into the United States, Japan, or South Korea. Radiation detection used on all containerized cargo coming into the United States does not effectively detect nuclear materials encased in lead. X-ray scanning, which might detect such encased materials, is only used on 4% of the highest-risk cargo inbound to the United States. The Department of Homeland Security has found it impractical to implement a 2007 Congressional mandate to scan 100% of incoming containerized cargo  (Bloomberg). Implementation of scanning and detection technologies is currently insufficient to guard against nuclear terrorists or rogue states that use containerized cargo as a delivery vehicle.

North Korea could also simply drive nuclear materials and components across the Canadian or Mexican borders, or smuggle them on fast boats from a nearby Latin American country. Such components can be reassembled once in the United States.

Finally, North Korea is in a unique position to use biological weapons of mass destruction. Often referred to as a hermit kingdom, North Korea has the world’s strictest restrictions on immigration and emigration. This makes them relatively invulnerable to blowback from a biological WMD. The most dangerous biological weapons are highly contagious. Contagion through humans is the delivery vehicle. Thus a strong disincentive for use of biological weapons by non-secluded states is the danger that the contagion will spread to one’s own country. This applies to a much lesser degree for North Korea. Biological weapons have the advantage over nuclear weapons in that they cannot be detected by radiation detectors or x-ray scanners, can be produced by small teams of bio-chemists with relatively ordinary lab equipment, and would be easily smuggled in containerized cargo. North Korea certainly has the capability to construct such weapons, and Defense Secretary Rumsfeld’s “unknown unknowns” applies. Finally, unconventional delivery of WMD has the advantage over missile delivery for North Korea in that its origin is less traceable.

The United States came close to a preemptive strike against North Korean nuclear capabilities in the 1990s. While there are certainly risks of retaliation against regional US bases and allies, such a strike is still on the table as a policy option. It could have a salutary demonstration effect for other rogue states and proliferators, including Iran and Pakistan. The option of waiting, and continued technological development by a belligerant and immature North Korea, could make it impossible to take such actions in the future.

The Wall Street Journal reported today that a North Korean closure of the Kaesong Industrial Complex would be a signal of increased probability of hostilities with South Korea. North Korea hosts the industrial complex a few miles within its boundary, where approximately 50,000 North Koreans work for 123 South Korean companies. On an average workday, about 120 South Korean managers cross the border into the complex. South Korean companies operating in the complex pay $80 million in cash wages directly to the North Korean government, and conduct approximately $2 billion worth of North Korean trade. This is a significant amount considering North Korea’s largest trading partner, China, yields only $6 billion worth of trade. The complex is a source of inexpensive labor for South Korea, rare US dollars for North Korea, and a foundation for pan-Korean economic and political cooperation (Reuters, WSJ).

North Korean threats and provocations are primarily bluster and bluff meant to elicit talks and appeasement payouts from the west. North Korean closure of the Kaesong Industrial Complex would be no different.

More informative signals would be: 1) South Korean closure of the border crossing, or 2) North Korean capture of South Korean complex workers by abruptly closing the border. The first of the two scenarios would indicate that South Korea believes hostility is imminent. The hostility could include the second scenario, or more seriously but less likely, a North Korean attack on South Korea. The capture of South Korean complex workers would be the most serious Korean crisis since 2010, when North Korea sunk a South Korean naval vessel and shelled a South Korean island. It would likely lead to US and Chinese-mediated negotiations, a payout to North Korea, and a definitive end to North Korea’s access to trade through the Kaesong Industrial Complex. Not North Korean, but South Korean closure of the border, is the signal to watch.

Today Fitch Ratings upgraded the Philippines to investment-grade, which will substantially increase investment in the country. Expect particularly strong growth in electronics and textiles, which will buttress current export strengths in electronic assembly and garments.

Update 5/22/2013: The Philippines obtained the #3 position in foreign investment among South-East Asian countries so far in 2013 (WSJ).