Yuanization, Lessons from Argentina, and Dreams of Self Sufficiency

The New York Times recently carried an article titled “Pyongyang losing grip on economy” that concisely summarized the ongoing currency crisis in North Korea. (a longer version of the article was also carried by the Guardian

Utilizing testimonies from traders in China, research from the Samsung Economic Research Institute, information collected by DailyNK, and expertise of Christopher Green and Marcus Noland, the piece highlighted key features of North Korea’s informal sector that must be kept in mind when analyzing the purchase and distribution of food in the country’s market.

The article claims that the state has lost control over the economy since the 2009 revaluation of the North Korean Won (KPW) because of the widespread loss of confidence in the currency and the proliferation of renminbi as the accepted tender for purchasing goods. “Yuanization” of the North Korean economy has been discussed on our blog before and DailyNK has been closely monitoring the dollar exchange value in the black market since the revaluation – although the official exchange rate remains at 130 KPW per dollar, the black market exchange rate is at 8500 KPW per dollar, having fallen from 30 KPW to the dollar since the 2009 revaluation.

While the article admits that nature of North Korea’s closed economy makes it difficult to assess how this will affect the regime, it raised concern that this phenomenon will make it more difficult for Pyongyang to implement economic reforms because it is losing control over the informal sector which is larger than the state-directed formal economy. Estimates of foreign currency in circulation range from $2 billion, calculated by Dong Yong-sueng at the Samsung Economic Research Institute, to $21.5 billion. Dong Yong-seung further estimated that about 50% of the foreign currency is held in US dollars, 40% in renminbi, and 10% in euros.  

There are definite benefits to using foreign currency in transactions as the wide use of renminbi in the informal sector appears to correlate with market stability – we have noted in the past that Hyesan exhibits less price volatility in the rice market than other cities in North Korea and the NY Times article highlighted the city as an example of a place where the renminbi is in high circulation.

It seems the pervasive use of foreign currency has made it indispensable for the circulation of goods in the North Korean market – accounting for 50 to 80% of the transactions in private markets, according to Christopher Green – and in a tacit acceptance of this fact, the North Korean state, despite making the circulation of foreign currency a crime punishable by death in September 2012, has apparently not been punishing people for using or holding hard currency.

On the other hand, according to a March 2010 report by Stephan Haggard and Marcus Noland, “economic crimes,” defined as

diversion of state output to private use, including food grown on cooperatives, and the illegal use, profiteering from, or even sale of state assets, …spreading “depraved culture,” [presumably South Korean materials, and] some border crossing,

has been disproportionately used against “politically suspect groups, particularly those involved in market-oriented economic activities.” In part, Haggard and Noland note, this appears to be motivated by the desire to extort money, raising concerns for predatory corruption. This further damages the credentials of the state, pushing more people into the informal sector and into holding foreign currency for both subsistence and bribery. A vicious cycle is undoubtedly breaking out in the North Korean economy.

So what can the North Korean state do to restore confidence in the KPW so that it has more control over reforming the system? Obviously the pervasive corruption must be stopped, but in terms of reestablishing the KPW as a credible store of value, the state could make its currency legally convertible to foreign currencies. It might be an unavoidable reality given the massive circulation of currency in the economy; furthermore, normalizing the use of foreign currency might increase the efficiency of the informal sector, which the majority of the population depends on for subsistence and could help build export capacity of the state to better service imports.

The danger lies in establishing a hard peg to overcome the lack of confidence due to historic inflation and/or fiscal mismanagement – because such an arrangement, by placing convertibility as a contract, will necessarily raise exit costs when the exchange rate needs to be adjusted.

This was the dilemma facing Argentina in 2001 when it attempted to establish its peso as a credible international currency by pegging it to the dollar at 1:1. It was devised as an extreme response to the loss of credibility following hyperinflation and government mishandling of public finances – it did provide nominal stability at the cost of indigenous financial dollarization, but failed to foster actual fiscal or monetary discipline – liquidity was simply injected by allowing the banks to hold government bonds in place of some of their liquidity requirement, exposing the banks to state insolvency. And when the strained government finally attempted to sever convertibility and “pesify” the deposits of domestic banks, the resulting bank run ruined the economy.  

Argentina had failed to foster its peso as a means of payment – in a grander picture, North Korea is a facing a similar problem. The value of the KPW is depreciating because people are increasingly refusing to use it as a means of payment. If Pyongyang hypothetically engaged in a hard peg with another currency to re-establish credibility, the KPW would be unlikely to meet the convertibility for a long time unless it was pegged at below market exchange rates. But a sudden devaluation would make imports more expensive when the country is lacking significant export capacity.

The better alternative might be to engage in a dirty float/peg, devaluing slowly, quarter by quarter, based on the relative values of the RMB, dollar and the euro. This would allow cross-border purchasers to be able to better predict the value of the KPW in the near future, decreasing price volatility and enhancing commerce between China and North Korea.   

The above case is admittedly a fanciful hypothetical; nonetheless, the issue of of currency exchangeability is directly tied to food policy –

In a fascinating interview conducted by Sino-NK, agriculturist and agronomist Tom Morrison suggested that self-sufficient food production was possible for North Korea.

He dismissed the argument that North Korea’s terrain was not suited for self-sufficient agricultural output

lots of other countries achieve national food self-sufficiency with less [arable land]. China and Burma also have 15 percent arable land and they are self-sufficient.  Australia is a big food exporter with 6 percent arable land. Indonesia has achieved food security with 11 percent arable… the DPRK also fares quite well at 0.11 hectares per capita (ha/caput), the same as Italy, and well above China at 0.08 ha/caput, and Japan at 0.03 ha/caput

He observed that natural disaster-related crop losses could be largely mitigated if the country would engage in proper soil and catchment management to prevent inundation of rice paddies and soil erosion.

In resolving these problems, he cited the country’s ongoing currency crisis as a major obstacle

Farm managers and cooperative farms are generally not poor. They have the won (local currency) to purchase everything they need. But they don’t have the dollars, euros, or more practically the Chinese yuan. Even if they did, only a few have the knowledge on how and where to spend them.

This bolsters the earlier argument we made that establishing convertibility might have real benefits in boosting the productivity of the nation by normalizing the usage of both foreign and domestic currencies, here, in purchasing farming inputs.

The failure to acquire proper inputs has yielded the following problems:

  • lack of mechanization
  • diesel fuel deficit – leading to farmers diluting the fuel source with contaminants that speed the breakdown of machinery
  • inadequate fertilizer usage
  • imbalance in the agri-environment

Summing up, Morrison highlighted four key areas of concern:

  • soil fertility and crop yields are still low;
  • there is vulnerability to natural disasters caused by soil and environmental degradation (note that it is not the natural disasters themselves, but the DPRK’s vulnerability to them);
  • there is a perennial shortage of critical inputs like fertilizer, agro-chemicals, seeds, up-to-date farm machinery, and clean fuel;
  • the overall problem is structural. If the state is going to be responsible for everything, it must act responsibly.

The article hints that the first step towards a solution must be initiated by the leadership in Pyongyang – a coherent strategy must be implemented to facilitate the mechanization of agriculture and the supply of inputs. This might mean to engage in another painful currency reform to set the asymmetry in the exchange rate straight, and commerce liberalized, so that fundamentals can be rectified through market mechanisms.

The North Korean state will be good to remember that the currency reform is a means to an end, not an end in of itself – it must complement reforms with equally paradigm shifting changes in laws regarding market behavior while restraining the extractive nature of the local bureaucrats. The question is, does King Jong-un have the political capital to achieve all this?

On another note, the blog was cited recently in an article by Geoffrey Cain regarding the viability of reforms in North Korea.


About Yong Kwon

I develop trade advocacy strategies for a DC-based consulting firm. Studied economic history at the London School of Economics, and can be found on twitter at @ykwon88
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6 Responses to Yuanization, Lessons from Argentina, and Dreams of Self Sufficiency

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