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Currency reform may unsettle North Korean leadership

Old North Korean currency for sale in Beijing, China (file image)

By Marcus Noland
Peterson Institute for International Economics

North Korea's unexpected currency reforms destabilised its economy - but are they likely to unsettle the country's politics as well?

On 30 November 2009 North Korea launched a surprise confiscatory currency reform aimed at cracking down on burgeoning private markets and reviving socialism.

The move predictably set off chaos, and now it appears that the government is in retreat, acquiescing in the reopening of markets.

Now the question is what impact this episode may have for North Korea's looming leadership transition.

During the 1990s the state found it was no longer able to fulfil its obligations under the old centrally planned system. As a result, the North Korean economy was forced to adopt some free market principles.

Small-scale social units - households, work units, local government offices, and party organs - and even small-scale military units began acting entrepreneurially to survive.

The announcement set off panic buying as people rushed to dump soon-to-be-worthless currency

This free-market pressure from below received an enormous push during the famine period of the mid-1990s, when perhaps 600,000-1m people, or roughly 3-5% of the pre-crisis population, died.

The regime is extraordinarily insecure about the domestic political implications of economic change. At times it has acquiesced in ratifying the facts on the ground, while at other times has sought to reverse the process.

The trend over the past five years has been largely negative, and confiscatory currency reform could be interpreted as the latest in a series of moves designed to re-assert state control over the economy.

No warning

In principle, currency reforms are not a bad thing.

Governments often use them to signal after a period of high inflation that the bad days are in the past, and that they will pursue more responsible macro-economic policies in the future.

Typically, a government issues new currency with a number of decimal places or zeroes removed, often linking the nominal value of the new currency to a well-known currency such as the dollar or euro.

In recent years countries such as Turkey, Romania, and Ghana have implemented such reforms.

graph

The North Korean case is significantly different from the conventional examples in that the move was sprung on the populace without warning, and most critically, enormous limits were placed on the ability to convert cash holdings.

In effect this wiped out considerable household savings and the working capital of many private entrepreneurs.

Citizens were instructed that they had one week to convert a limited amount of their old currency to the new currency at a rate of 100:1 (that is, one new won would be worth 100 old won).

But the limit would not buy much more than a 50kg sack of rice at prevailing retail prices.

The announcement set off panic buying as people rushed to dump soon-to-be-worthless currency, buying foreign exchange or any physical good that could preserve value.

As the value of the North Korean won collapsed on the black market, the government issued further edicts banning the use of foreign currency, establishing official prices for goods, and limiting the hours of markets and products that could be legally traded.

Scapegoat

However as social opposition to these moves began to manifest itself, the government was forced to backtrack, offering compensatory wage increases, sometimes paying workers at the old wage rates in the new currency, amounting to a 100-fold increase in money income.

Street vendors in North Korea

The result has been a literal disintegration of the market, as traders, intimidated by the changing rules of the game, withheld supply, reportedly forcing some citizens to resort to barter.

Reports - difficult, if not impossible, to confirm - have emerged of civil disobedience, protests, and even physical attacks on government officials trying to enforce the tightened restrictions.

In the latest twist, the government appears to be in retreat - easing restrictions on markets and, according to some reports, scapegoating Pak Nam-gi, the Korean Workers Party Director of Finance, for the failed policy.

The politics of the episode clearly leave many questions unanswered.

Despite the fact that the reform was the year's single biggest economic event, it went unmentioned in the traditional joint New Year's Day editorial of several official publications.

Some reports emerging from the diaspora network of North Korean refugees indicated that the policy was being undertaken in the name of Kim Jong-eun, the North Korean leader's third son and purported successor, and was meant to signal his emergence as a major political figure.

Now it is an open question whether the fiasco has damaged his succession prospects in what is beginning to look increasingly like a nuclear-capable failing state.

Marcus Noland is Deputy Director and Senior Fellow Peterson Institute for International Economics and Senior Fellow East-West Center



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