By William Brown
The short answer is yes, but probably not the way Kim Jong-un was thinking. An increase in the domestic use of U.S. dollars, brought on by lack of trust in the North Korean won, at last seems to be stabilizing Pyongyang’s monetary system and may be creating an environment conducive to normal private economic activities. The government is playing a positive role by not stopping the use of foreign currencies and, presumably in order to control inflation, seems to allowing something of a capitalist style banking system that allows private savings with significantly positive interest rates, anathema to doctrinaire socialists. The trouble for Kim Jong-un is the large state sector can’t take advantage of these developments without major reforms so the gap between private and state activities may be growing to dangerous levels. Solutions exist but they could further diminish the power of the central government, probably not part of Kim’s “strong country” formulation.
Most discussions of North Korea’s economy include a question mark, or at least they should. Pyongyang releases virtually no economic data. To answer any good question we must resort to a combination of anecdotal information, North Korean propaganda, or data from foreign partners’ transactions with North Korea. Each of these sources comes with limitations.
We might then stir these data points together with what economic theory and experience tells us should be happening. This mix is true of our discussion here concerning how Kim is doing with his goal of building a usable nuclear weapon while, concurrently, creating a prosperous economy. We come to some tantalizing, though necessarily tentative, results on the economic side of this puzzle.
What does some of the available data tell us? The figure below includes monthly data on the market exchange rate for the U.S. dollar and the price of one kilogram of rice in North Korean won in the city of Hyesan, on the northern border with China. The data are painstakingly collected and reported by a South Korean NGO, DailyNK, with roots in North Korea, on its website.
The results, as one can easily see, are rather astounding. After decades of hyperinflation, and regular currency crises as real money began to supersede the Communist fixed price ration system, in late 2012 the price of rice stabilized and has even fallen since. A kilogram cost about 6,600 won when byongjin was announced and about 5,500 today, a drop of about 20 percent. Even taking seasonal considerations into account, since the price drops after harvest, there has been a slight decline. Granular reporting on prices of other commodities is not available, but since ancient times the price of rice has been one of the main markers for the Korean economy. It is doubtful other prices have moved much higher and anecdotal reporting indicates pretty good price stability of other marketable goods.
Even more surprising, given all the UN and U.S. sanctions, and the elimination earlier this year of the Kaesong Industrial Zone and its steady stream of U.S. dollar earnings, it took 8,490 won to buy a U.S. dollar in March 2013 and, slightly less, 8,285, today. So, the won has increased in value by 2 or 3 percent. Given a generally rising U.S. dollar around the world, holding won cash would have been a better deal than holding most any other foreign currency. Even better, a North Korean bank account is reported to yield 5.6 percent interest a year, at least for some depositors, making a won bank account a better deal than a U.S. or South Korean account.
So what is going on? Kim Jong-un came to power following his father’s death on December 17, 2011, and soon promised to fix the economy, saying no one would have to further “tighten his belt”. A little more than a year later, in March 2013, Kim added to his promise saying the country would proceed in parallel with the development of the economy and nuclear weapons, his so called “byungjin” development line. The U.S., among many foreign powers, have denounced that policy saying that Kim can’t have both prosperity and nuclear weapons, and has imposed layer upon layer of sanctions to prevent that from happening. One might have expected these moves to have caused North Koreans to flee to the safety of commodities and the U.S. dollar, trading in their won at ever cheaper rates, but this does not seem to have happened.
Since we don’t know what is providing this stability let’s look at several possibilities from a theoretical standpoint. It’s useful here to remember Milton Friedman’s simple way of explaining inflation, as “too much money chasing too few goods”.
All of these may be playing a role but the most likely explanation is less favorable to Kim’s prospects and more favorable to the North Korean public. And this is dollarization, a phenomenon in which foreign money enters an economy, replacing won as a “store of value”, a key characteristic of money. One might think this means more money in circulation and would thus be inflationary, but in a dollarizing economy the new foreign money may act more like a new good, something useful to hold on to. So for a time, North Koreans anxious to create some financial security would spend as much won as possible to buy dollars, or Chinese yuan, even illegally. But as policies have evolved, especially after the 2009 debacle, demand for dollars would first soar, lowering the relative value of won and creating hyperinflation. But hard cash doesn’t earn interest and as the won began to stabilize, along with the new potential to put it in a bank and earn reasonable interest, private savings even of won may have begun to rise, taking the heat off of inflation. Once reaching a “tipping point” it might have become apparent to savers that their won was not falling further and that it stood as a useful alternative to ever more expensive dollars. In other countries where production for private consumption is a large share of the economy, this rise in savings would have stalled economic growth, but in North Korea, where private savings had not been allowed, and where the state controls most production, the impact on aggregate demand would have been smaller.
Analysis of Latin American countries in the 1980s, when dollarization was rampant, showed a similar tendency. Inflation subsided but economic growth slowed as well, as private savings rose and spending declined. So his might be happening in North Korea, more savings and less growth.
If dollarization is a cause of price stability, what does it portend for Kim Jong-un’s “byungjin” policy? As in Latin America, it suggests big problems for government-sector finance, as private finance takes over and Pyongyang can no longer print money—U.S. dollars—to meet its bills. Higher real interest rates, moreover, play havoc with state enterprises in need of capital. Either Pyongyang slashes the already low real incomes of its huge bureaucracy and military—say by sharply raising ration prices, or like, China, it starts a long process of selling off state property and trade licenses to pay its bills. Either way, the economic part of byungjin might work, but better for private citizens than for Kim’s government.
William Brown is an Adjunct Professor at the Georgetown University School of Foreign Service and a Non-Resident Fellow at the Korea Economic Institute of America. The views expressed here are the author’s alone.
Main photo from BRJ INC’s photostream on flickr Creative Commons. Internal photo by William Brown.