The Limits of Incentive-Based Diplomacy.

Once again, Kim Jong-il is testing the resolve of the international community. The latest North Korean nuclear provocation - an underground detonation yesterday - is the biggest trial of the Obama administration's foreign policy and of China's newfound global status to date.

The stakes are high not only because Pyongyang's provocations undermine security in northeast Asia, but also because a critical issue facing the US is nuclear proliferation to Iran. Should North Korea acquire the status of a nuclear-weapons state, any effort to prevent the nuclearization of Iran would lose validity. Additionally the prospect of a nuclear Iran could unravel U.S. Middle East policy, threatening the survival of Israel as well as the security of Egypt, Saudi Arabia and the Persian Gulf oil-exporting states. For China, the stakes in North Korea are no less important. It has banked its credibility on restraining Pyongyang through the diplomatic process of the six-party talks on Kim’s nuclear program.

The Kim family dynasty's determination to secure its survival through the acquisition of nuclear weapons not only threatens South Korea, but also may provoke Japan (the only country that suffered an atomic bombing) to weaponize its advanced nuclear technology. Yet Kim has success doing what he has been doing in the past – winning foreign aid to stave off his people's hunger and provoking diplomatic apoplexy to feed his megalomania.

A unscrupulous dictator, Kim bankrolls his state by counterfeiting U.S. currency and the export of narcotics. He has no fuel for his factories and no foodstuff to feed his people yet finds the time to kidnap teenagers from the beaches of Japan. He goes through the motions of building nuclear reactors, then wins subsidized oil shipments from the outside world in return for suspending construction. With thousands of land-based missiles pointed at South Korea and 1.2 million soldiers under arms, Kim has long had the West over a barrel.

The response to the removal of North Korea from the U.S. list of countries supporting terrorism has been for Kim to renew his campaign of nuclear blackmail. He has no fear of the UN Security Council, whose resolutions he has defied on multiple occasions in the past five years.

With yesterday’s events broadcast through the global airways, North Korea created critical mass. No doubt a nuclear arms race in northeast Asia would undermine the U.S.-Japan security treaty and inflame a fear of Japanese militarism in the rest of Asia, especially in China, where bitter memories of Japan's aggression simmer just below the surface. It’s pretty safe to say that a scramble to acquire a nuclear stockpile in any region of the world is not what the international community is hoping for.

The only way to restrain Kim from his course is the joint and explicit cooperation of the rest of the participants in the six-party talks, led by China and the United States and supported by Russia, Japan and South Korea. China's swift condemnation of this week's nuclear test by North Korea signals that its patience is at an end.

In the coming days, we will see whether the international community can rise to the challenge. The limits of incentive-based diplomacy have been reached. The world must now tolerate imposing painful sanctions on Pyongyang. The price of inaction is too high. The risk of a war that would once again devastate the Korean Peninsula has deterred any military option. So it would seem that only close co-ordination between China and the United States to devise sanctions (such as a total energy embargo on a state that has no domestic source of oil) might constrain the continued operation of the North Korean regime without firing a shot. However it could also provoke a suicidal attack on South Korea or Japan from a power-crazed and desperate neighbour.

Kim threatens the world with the push of a button out of weakness, not strength. The world may ultimately be forced into an uncomfortable and uncharacteristic game of brinkmanship, because clearly it seems the international community is running out of options.

Global Banking - Regulator Envy.

Amid a global economic meltdown - Canada - with its highly regulated banking system has become the envy of the world. In a survey by the World Economic Forum in October, with the financial crisis and bank failures that have shaken world markets - Canada was voted to have to world's soundest banking system followed by Sweden, Luxembourg and Australia.

Britain, which once ranked in the top five, has slipped to 44th place behind El Salvador and Peru, after a 50 billion pound ($86.5 billion) pledge this week by the government to bolster bank balance sheets. The United States, where some of Wall Street's biggest financial names have collapsed in the fall, rated only 40, just behind Germany at 39, and smaller states such as Barbados, Estonia and even Namibia, in southern Africa.

The World Economic Forum's Global Competitiveness Report based its findings on opinions of executives, and handed banks a score between 1.0 (insolvent and possibly requiring a government bailout) and 7.0 (healthy, with sound balance sheets). Canadian banks received 6.8, just ahead of Sweden (6.7), Luxembourg (6.7), Australia (6.7) and Denmark (6.7). UK banks collectively scored 6.0, narrowly behind the United States, Germany and Botswana, all with 6.1. France, in 19th place, scored 6.5 for soundness, while Switzerland's banking system scored the same in 16th place, as did Singapore (13th).

The Globe and Mail's Report on Business created a neat little chart that summarizes how some banks around the world are doing:

Canada
Ranked tops in the world by the World Economic Forum for soundness of banks. Canada’s big five lenders all reported healthy profits in their most recent quarter, generally beating analysts’ expectations. Tightly regulated, with cash-spewing retail banks that can offset losses in other areas of the business.

United States
There are 252 problem banks being tracked by the government’s bank insurance program. In 2008, 25 banks failed, including household names like Washington Mutual. The government has rolled out numerous programs and spent at least $1-trillion (U.S.) in a bid to prop up the financial system, but there are no sure signs that the bailouts are working. The Federal Deposit Insurance Co. is now on track to seize 100 failed banks in 2009.

Brazil
The big economies in South America have had little trouble with bank failures resulting from stumbles on risky assets such as subprime mortgages. Still, they won’t be immune to rising defaults from slowing economies, which will be a test of how far financial regulation and bank management have come in recent years.

Iceland
The banking system of this tiny island nation -- which boasts a population half the size of Winnipeg -- represents probably the most spectacular rise and fall of the global financial meltdown. In 2003, Iceland’s three main banks had just a few billion dollars of assets, but by 2006 this hit $140-billion (U.S.). Today, all three have failed and been nationalized in a bailout that’s cost about $330,000 per citizen, leading to the collapse of the country’s currency and economy.

Sweden
Sweden faced a banking crisis in the 1990s, and was forced to remake its financial sector. This time around, while one bank has failed because of toxic assets, the country has mostly dodged the problems and Sweden’s banking sector was ranked second only to Canada’s for stability by the World Economic Forum. Exposure at some big banks to Eastern Europe could lead to loan losses.

Britain
The British government has been forced to bail out big lenders such as Lloyds Banking Group, Northern Rock Plc and Royal Bank of Scotland, which have been crippled by forays into risky mortgage products before the property market in the UK and in the U.S. fell apart.

Switzerland
The country’s reputation as the home of the quiet, prudent banker is in shambles after gambles by Swiss giants UBS AG and Credit Suisse led to massive losses totalling more than $65-billion (U.S.). The government is now looking to write new rules to keep the financial sector out of trouble.

Austria
Austria has historically been the bridge between Western Europe and Eastern Europe. In recent years some of its largest lenders focused on expansion in such countries as Czech Republic, Romania and the Ukraine. Lending to the Central and Eastern European region amounts to almost 70 per cent of Austria’s gross domestic product, according to Moody’s. That was great when those countries were booming, but Eastern Europe is hurting badly and now many loans are likely to go bad.

Spain
Spain’s banking system has held up better than most with banks reporting gains in profit in large part because of strict regulatation when it comes to high risk assets, a legacy of a banking crisis in the 1970s. As a result, big Spanish banks like Banco Santander focus mostly on low-risk retail banking. Still, there are signs it may not last. The country’s swooning property market could lead to loan defaults, and the government and some bank executives warn that the domestic banking sector may have to be restructured should the global financial crisis deepen.

Namibia
Namibia has the highest-ranked banking system in Africa for stability, well ahead of Spain, the U.S. and Britain. According to the International Monetary Fund, the country’s banks entered the financial crisis very profitable and well capitalized. And while the country is being buffeted by the global troubles, the resource-based economy is still expected to grow 1 per cent this year, according to Namibia’s central bank.

Russia
The Russian government has already invested about $11-billion to try to aid banks, and is looking at another $55-billion stimulus package to restart the economy and support the country’s ailing banking system. Lenders are suffering from a fast downturn in the oil-powered economy of Russia.

China
China’s big banks have avoided troubles with subprime and other toxic assets, and may benefit as the government unveils a big stimulus package designed to keep the country’s economy growing quickly. If that doesn’t work, though, expect the banks to face bigger loan losses.

Japan
Japan’s response to the banking bust of the 1990s was a ‘What not to do’ lesson. The country put off dealing with bad loans and propped up bad banks for too long. Just as the country finally started to take big steps to fix the problem, this financial crisis cropped up. So far, Japanese banks have avoided the worst of it, signalling perhaps they’ve learned from experience.

Australia
Ranked fourth by the World Economic Forum for soundness of banks, Australia’s system shares many attributes with Canada’s. It’s centralized, with a few big players that are making money. The big problem for Australia is an economic one: its banks may not be big enough to take up the slack as global lenders cut back on lending, leaving the country’s borrowers in the lurch.

Maybe government regulation is the way to go - don't you think?