Is North Korean leader Kim Jong Il ailing? His absence from this week’s 60th anniversary parade – a major milestone in the North Korean calendar – certainly suggests this. The word is that he seems to have suffered a stroke, although on Friday, South Korea’s Yonhap News Agency reported that Kim had regained the ability to brush his teeth.

Why does all this matter? The answer is that North Korea is something of an economic black hole in one of the most economically pivotal parts of the world – the intersection of rapidly-growing China, Japan (still the second-largest economy in the world), and South Korea (a major industrial powerhouse). Any serious trouble in the North could lead to its collapse, followed by Chinese or South Korean troop deployments; potential civil war in a country armed with nukes and bio- and chemical weapons; and massive flows of refugees. In other words, there is a major security threat here. In practice, though, I believe that in the event of Kim’s removal, a military-dominated collective leadership would take power and maintain the status quo, at least in the near term.

So, what are the investment implications of all this? One very obscure security which I have been tracking for some time now is North Korean tradable debt certificates, which were created in 1997 by a group of European bankers to cover the country’s defaulted debt. In 1998, they were trading at 60 cents on the dollar on expectations that North Korea would collapse and be absorbed by the South, which would then honour its compatriots’ debt. However, by 1999, the debt had fallen back to only 7¼ cents on the dollar, according to Exotix Ltd of London. The accompanying chart shows the vicissitudes of the debt price in relation to key events. As you can see, the debt has now fallen significantly from a peak of 32 cents on the dollar in January 2008. This mainly reflects North Korea’s persistent stalling of its ‘denuclearisation’.

North Korean Debt Certificates (Source: Exotix Ltd)

As I have mentioned previously in Business Monitor Online, my own guess is that the debt instruments will rally only if things get really terrible or really good in North Korea. The former scenario would increase the chance of a South Korean takeover of the North (followed by debt repayment), while the latter might persuade Pyongygang finally to cough up, especially if it wants access to new international loans.