North Korea's stable exchange rates confound economists

It's a question that nags at North Korea economy watchers: How has the country been able to maintain stable exchange rates — and avert hyper-inflation — despite intense sanctions, political tensions and a swelling trade imbalance?

In a nutshell, North Korea buys a whole lot more than it sells to China and, because of the sanctions, is doing hardly any business with anyone else. Since no one in their right mind would accept the internationally worthless North Korean currency for any significant trade deal, North Korea must be burning up its foreign reserves. And when a country does that, prices generally start to rise — often dangerously so. All of which should be reflected in its exchange rates.

So what gives?

Understanding what's going on with the North Korean economy is essential for negotiators trying to gauge how seriously leader Kim Jong Un is about giving up his nuclear weapons and whether sanctions are actually what got him to the negotiation table, as many in the U.S. government have suggested. Exchange rate stability would normally suggest otherwise. But does it?

"The fact that the rate is stable means that the overall economy of the country is stable and it is growing," Ri Ki Song, an economist with the Economic Institute of the North's Academy of Social Sciences, said in a recent interview in Pyongyang with The Associated Press. "Our economy is not an economy that relies on exports. ... Due to the sanctions, we are not making a lot of trade or financial dealings with other countries, so there will be not so many changes in the exchange rates."

The North Korean currency, called the won, has two exchange rates. One is set by the government at an artificially high level and is used mainly in shops or hotels that deal only in foreign currency. The other, more closely watched, is tied to market forces and is a better reflection of actual economic conditions. It has stayed mostly within a narrow band of around 8,000 to the U.S. dollar since about 2012-2013.

As Ri suggested, there are signs the North Korean economy has been doing well under Kim. But there is clearly a lot more going on.

First off, North Korea's economy has never been self-reliant. It has depended heavily on exporting goods such as coal, textiles and seafood.

"There's a reason these goods are sanctioned," said Benjamin Katzeff Silberstein, co-editor of North Korean Economy Watch. He added that Kim has been trying to boost domestic production to reduce the country's reliance on imports and lift consumption of domestically made goods, which wouldn't be necessary if North Korea was economically self-reliant.

Silberstein and fellow economy watcher Peter Ward, in a paper published Thursday by the respected 38 North website, argued the North has several tools to promote stability, such as limiting traders to a specific exchange rate bandwidth or reducing loans in the local currency to keep its circulation low. They also suggested there simply might not be enough dollars in circulation for the market price to be impacted by the sentiments of ordinary people. Or, perhaps, the government is keeping it artificially stable "by sheer force — for political reasons — to present an image of resilience through sanctions."

Bill Brown, a former CIA officer and adjunct professor at Georgetown School of Foreign Service, said Ri's claims about overall economic stability aren't without merit.

"But the right question, then, is at what cost," he said in an email to the AP.

Brown, now an independent consultant, believes the North is doing what China has been doing for the past 40 years — selling off its assets. Because the state owns all capital, he said, in the short term it can fund itself and protect the exchange rate by selling or privatizing a good part of its property. It could also be raising money by allowing officials to charge for ordinary activities or skimping on salaries while looking the other way as they accept bribes to make up the difference. The problem, of course, is none of that is sustainable.

"Stable money is essential to building a new market economy, enhancing private sector-led productivity and growth and allowing citizens to save and invest their own money," Brown said. "I suspect Kim knows good, or at least not bad, relations with (President Donald) Trump and America are essential for confidence in the won and is behaving accordingly. So, for now, no ICBM or nuclear weapon tests, and lots of happy talk."

North Korean leaders are well aware of the dangers of a volatile currency.

Widespread panic ensued in 2009 when the government decided to exchange the old currency for a new one — at a rate of 100 to 1, erasing personal savings in one fell swoop. Kim Jong Un's father, Kim Jong Il, reportedly had the finance minister executed for the fiasco.

Because of such concerns, even ordinary people have good reason to want to keep their savings in dollars or Chinese yuan. And while confidence in the local currency has recovered in recent years, it still can't be converted into other currencies outside of North Korea and remains ill-suited for big transactions.

As Silberstein and Ward point out, its biggest denomination is the 5,000 bill — worth about 60 cents.

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Talmadge is the AP's Pyongyang bureau chief. Follow him on Twitter and Instagram: @EricTalmadge