Tuesday, December 1, 2009

North Korea Redenominates Currency

. Tuesday, December 1, 2009

International news agencies and informants inside of North Korea are reporting that North Korea issued an order yesterday morning to redenominate the won, North Korea's currency. The Central Bank of the Democratic People's Republic of Korea (DPRK) has slashed two zeroes off of its currency and has placed limits on how much of the old currency can be converted into new bank notes.

Choi Soo-young, an expert on the North Korean economy at the government-financed Korea Institute for National Unification in Seoul, said: “The primary aim is to control inflation. But the North also wants to stop the [black and unofficial] market[s] from prospering too fast.”
North Korea's black market in both currency conversion and goods have flourished over the last decade years as the government turned a blind eye to their presence. But, the government has begun shutting down unofficial food and goods markets across the country as it tries to reassert its control over the economy. The DPRK also reinstituted its rationing policy in 2005. Under this rationing policy, the government runs stores where North Koreans go to purchase their necessities at low, state-subsidized prices. One reason the government has sought to reassert its power over the domestic food and goods markets,
is that the mix of state and private activity has fueled inflation, partly by drawing goods that would otherwise be sold at low, state-subsidized prices into more lucrative private markets.
The action is being aimed at negating profits that have been made in the black market over this period and decrease the growing gap between rich and poor in the country, hence the limit on how much of the old currency can be converted. By capping the amount that can be converted, the government essentially wipes out all of the wealth above that cap. One way to get around this cap would be to exchange the old currency into foreign exchange, but this option is very difficult since your typical North Korean doesn't have access to forex markets that can be used to convert the currency. Those that were able to convert the old currency into foreign exchange prior to the announcement lucked out.

My guess is that this action will fuel a new black market in old currency, with prices being posted at these unofficial markets in both new and old won, although the old won being accepted only at a large premium. Over time, the excess old currency would make its way through the system and end up being converted into new currency by those who have yet to reach their ceiling. One possible way this can happen is by merchants in these unofficial markets identifying those that haven't reached their ceiling and paying them off to convert the currency for them. This may fuel a side market in currency converters and if the market works like it sounds like it would in my head, it would end up being a boon for really low income North Koreans.

One of the long-term effects of this redenomination will be an increase in demand for foreign exchange from North Koreans. The people recognize that their currency's value has declined rather drastically over time and have now experienced what their government does when it chooses to redenominate. Dr. Layna Mosley and I are currently working on a paper (should be ready sometime in the spring) on the reasons why and at what point in time developing countries choose to redenominate their currencies. One of the initial findings is that countries that redenominate once have a much higher rate of redenominating again. Based on this evidence, my second guess is that this redenomination will fuel a new black market in foreign exchange and people will try to hold as much of their income and savings in yen, yuan or dollars in order to insulate themselves from any future redenomination. An interesting extension of this argument is that these unofficial markets may essentially dollarize or "yenanize" as a result of citizens holding more foreign exchange. This may take a long time though, since, as noted above, North Korea isn't the most free society in the world and getting access to foreign exchange in order to feed demand will take time.

Noting that the rise of the black market in North Korea is a reason for the redenomination is important, but it's not the main reason for the redenomination. Choi Soo-Young, in her quote above, hits the nail right on the head. Persistent inflation is the primary reason for the redenomination. An important finding of the paper that Dr. Mosley and I are preparing is that inflation, specifically persistent hyperinflation, is the primary indicator that explains why and when countries choose to redenominate. The rise of the black market is one contributing factor to rising inflation in this case, but it is inflation itself that has historically provided the impetus for redenomination across the developing world, and it is no different in this case.


Jacob said...

I'm sorry, but this is nothing more than government induced and unjustified theft of the wealth of the nation. Or an inflation tax of epic proportions that leaves the entire nation destitute and at the beck and call of the national banks. Why are these thefts being allowed, and is Obama responding? Are we even in a position to judge, or do we have to just sit there and watch people kill themselves because we cannot mess with China? Or worse, would we appear as the pot calling the kettle black?

North Korea Redenominates Currency




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