Insight: North Korean economy surrenders to foreign currency invasion

CHANGBAI, China/SEOUL Mon Jun 3, 2013 2:32am BST

1 of 14. North Korean leader Kim Il-sung is seen on this 5000 North Korea won banknote in this photo illustration taken in Shanghai May 23, 2013.

Credit: Reuters/Carlos Barria

CHANGBAI, China/SEOUL (Reuters) - Chinese currency and U.S. dollars are being used more widely than ever in North Korea instead of the country's own money, a stark illustration of the extent to which the leadership under Kim Jong-un has lost control over the economy.

The use of dollars and Chinese yuan, or renminbi, has accelerated since a disastrous revaluation of the North Korean won in 2009 wiped out the savings of millions of people, said experts on the country, defectors and Chinese border traders.

On the black market the won has shed more than 99 percent of its value against the dollar since the revaluation, according to exchange rates tracked by Daily NK, a Seoul-based news and information website about North Korea.

North Korea is one of the most closed countries in the world, so it is difficult to determine what impact this could ultimately have on Kim's regime.

But experts said the growing use of foreign currency is making it increasingly difficult for Pyongyang to implement economic policy, resulting in the creation of a private economy outside the reach of the state that only draconian measures could rein in.

For now Pyongyang appeared to be capitulating, rather than trying to stamp out foreign currency use, they said.

Estimates of how much hard currency is in circulation vary, but an analyst at the Samsung Economic Research Institute in Seoul put it at $2 billion in an April study, out of an economy worth $21.5 billion, according to some assessments. Pyongyang doesn't publish economic data.

The use of dollars and yuan is now so pervasive there is little Pyongyang can do about it, said Marcus Noland, a North Korea expert at the Peterson Institute for International Economics in Washington.

The government would increasingly have to force people to provide goods and services to the state and get paid in won, added Noland, who closely studies the North Korean economy.

"It's been a tug of war for 20 years where the state would like to get control of the economy, to quash the market and to get everyone to use the North Korean won, but it just doesn't have the capacity to do any of those things," he said.

"It just makes it harder and harder for them to govern. Nobody wants what they're selling."

SECRET VIDEO

In the Chinese town of Changbai in Jilin province, just across the border from the hardscrabble North Korean city of Hyesan, one Chinese trader said North Korean officials he dealt with wanted yuan more than anything else, even food.

The yuan they earned from doing business quickly gets circulated into Hyesan, a city of roughly 190,000 people whose industry-based economy has slumped since the 1990s.

"The only thing they want is foreign currency," said the trader, who sells products including medicine and tea in Changbai. He declined to be identified because he did not want to jeopardize his business or endanger his North Korean partners.

In April, Daily NK posted video it said was shot secretly in February at an open-air market in Hyesan. The shaky footage showed vendors openly quoting prices in yuan for products like gloves and jackets, and one accepting payment in yuan.

Pyongyang has waged periodic campaigns to try to stop the use of foreign currency but with no success.

North Korea made circulating foreign currency a crime punishable by death in September 2012, the Paris-based International Federation for Human Rights said in a report last month.

Another group, Human Rights Watch, recently interviewed more than 90 defectors who had fled North Korea in the past two years about punishment they had received for economic crimes. None said they were penalized for using or holding hard currency.

Nevertheless, ordinary North Koreans are very careful.

"I have heard multiple stories of people hiding foreign money under the floorboards in the house, or burying it up the hill in the woods out back," said one person in northeastern China who has lived in Pyongyang and regularly interacts with North Koreans.

"Nobody puts it in the bank because nobody trusts the government."

THE WORTHLESS WON

Faith in the North Korean won crumbled when Kim's father, Kim Jong-il, ordered the sudden revaluation of the currency in November 2009.

The government chopped two zeroes off banknotes and limited the amount of old money that could be exchanged for new cash. The move, seen as an attack on private market activity at the time, spurred a rush to hold hard currency.

It also quickened inflation and according to South Korea's spy agency, sparked rare civil unrest in one of the world's most entrenched authoritarian states after North Koreans realized the won was not a safe store of value.

The government is widely believed to have executed the economic official who oversaw the revaluation.

Dollars have circulated in North Korea for decades, partly because of the cash siphoned off from official foreign trade.

The rise in the use of yuan is a more recent phenomenon and reflects a surge in trade and smuggling between North Korea and China along their 1,400 km (875 mile) land border, where a lot of the currency changes hands. Official trade with China is worth $6 billion annually.

Black market rates illustrate how far the won has fallen since the revaluation. It has plunged from 30 to one U.S. dollar to about 8,500, according to exchange rates tracked by Daily NK. The current official exchange rate is about 130 won per dollar.

Daily NK has sources in North Korea who report every fortnight on rates in Hyesan, the city of Sinuiju opposite the Chinese border city of Dandong and also the capital Pyongyang.

In border areas some 90 percent of transactions occur in hard currency, said Christopher Green, Daily NK's manager of international affairs. Elsewhere, foreign cash accounts for 50 to 80 percent transactions in private markets, he estimated.

INFORMAL ECONOMY EXCEEDS FORMAL - EXPERT

North Koreans increasingly did not refer to prices in won, Dong Yong-Sueng, senior fellow at the Samsung Economic Research Institute in Seoul, wrote in the April study on the use of foreign currency in the country.

Prices were marked in U.S. dollars for beer, university preparation courses and apartments, Dong wrote.

South Korea's central bank estimated foreign currency in circulation at $1 billion in 2000. Dong reckoned $2 billion in foreign cash was now sloshing around the economy. Around half was in U.S. dollars, 40 percent in yuan and 10 percent in euros, he told Reuters.

Dollars seeped into the market because trading firms exploited government quotas for exports and imports, making profits when prices diverged from those set by the state, Dong said.

It was not possible to estimate the amount of North Korean won in circulation, Dong added.

He said the North Korean informal economy was now bigger than the formal, state-led economy.

"Without foreign exchange, the economy would stop functioning," Dong said.

U.S. officials have previously accused North Korea of making extremely high-quality counterfeit $100 notes. This money is believed to have been used to raise real cash for the regime abroad rather than get cycled into the economy.

"JUCHE" IN NAME ONLY

Despite purporting to follow an ideology of "juche", or self-reliance, Pyongyang did not have the will to stop the circulation of hard currency even if it had the means to do so, said Yang Moon-soo, an expert on the North's economy at the University of North Korean Studies in Seoul.

Ordinary North Koreans wanted yuan while the elite preferred dollars, said Yang, who has carried out a study on the use of both currencies based on interviews with North Korean defectors.

One official at a European embassy in Pyongyang, who has been visiting North Korea for more than a decade, said the most noticeable change had been the increased use of yuan. Most shops carried prices in dollars, yuan or euros, said the official.

"People ... pay in yuan at the market for rice and other daily necessities," said Ji Seong-ho, a defector living in South Korea who stays in touch with friends in the North.

An estimated 70 percent of defectors in South Korea also send cash back to family in North Korea, according to the Organization for One Korea, a South Korean support and research institute on North Korean defectors.

A Reuters report last year showed how this money was getting to North Korea via underground agents in China, mostly Chinese of Korean descent. They use ties on both sides of the border to funnel around $10 million into the North each year, usually in yuan given the defectors send money to banks in China where it is collected by agents.

Use of the South Korean won is unheard of in North Korea. Even in the recently closed Kaesong industrial zone between the two Koreas, which employed 53,000 workers from the North, wages were made to a North Korean management committee in U.S. dollars, not the South's legal tender.

There are small signs some in the North Korean government may be coming to grips with the hard currency reality.

In the Rason special economic zone in the far northeast of the country on the border with China, the government-run Golden Triangle Exchange Bank changes yuan into North Korean won.

The rate - according to people who visited the bank recently - was 1,200 won per yuan, or 7,350 won per dollar. That's a long way from the official rate of 130 won for one dollar.

(Additional reporting by Narae Kim, Daum Kim and David Chance in SEOUL. Editing by Dean Yates)