North Korea's Currency Conundrum: Unraveling the Enigma of Exchange Rate Fluctuations

In recent months, the foreign exchange rates in North Korea have experienced a surge that defies conventional logic. The Korean People's won (KPW), the country's domestic currency, has reached unprecedented heights, trading at 16,100 to the US dollar in Pyongyang – a staggering 92% increase over the past year and a nearly 90% rise in just six months. The Chinese renminbi (RMB) rate has also seen a significant increase, though less dramatic, rising by 35% in the same period. This puzzling phenomenon has left experts and observers alike grappling to understand the underlying factors driving these seemingly irrational exchange rate movements.

Unraveling the Enigma: Factors Shaping North Korea's Currency Dynamics

Reopening of Trade and the Pandemic's Impact

The reopening of trade after the COVID-19 pandemic is one factor contributing to the exchange rate fluctuations. However, the current trade levels do not fully account for the sharp rise in exchange rates. North Korea's trade with China, its largest trading partner, has only recently begun to recover, reaching 82% of pre-pandemic levels in 2023.

The "20×10 Policy" and Industrial Modernization

Another factor at play is Kim Jong Un's "20×10 Policy," which aims to build modern factories in 20 rural cities and counties each year for the next ten years. This ambitious industrial modernization plan requires substantial imports of industrial goods, potentially driving up the demand for foreign currency.

Increased Trade with Russia and Arms Exports

Increased trade with Russia could also be contributing to the exchange rate dynamics, although the extent to which North Korea's arms exports are paid in cash versus in-kind with other goods remains unclear.

The Role of Psychology and Market Expectations

The most significant factors, however, appear to be human psychology and market expectations. Expectations play a crucial role in setting exchange rates, as people's anticipation of the domestic currency's value can drive their behavior. In this case, the market's expectations of a broader reopening of trade have likely fueled much of the KPW's depreciation, as the anticipation of increased trade has led to a greater demand for foreign currency to pay for imports.

The Government's Counterproductive Efforts

Ironically, the government's policies aimed at stabilizing the exchange rate closer to the official level seem to be having the opposite effect. The authorities have issued directives instructing everyone to work towards stabilizing exchange rates, blaming "unfounded rumors" and unrealistic expectations for the rise in rates. However, the government's official exchange rate of 8,900 KPW to the dollar is widely considered unrealistic, set at about 50% of the "real" black market rate of 16,100 KPW. This discrepancy inevitably encourages continued trading at the much higher black market rate, given the opportunities for arbitrage.

The State's Crackdown and Its Unintended Consequences

In response, the state has ramped up its crackdown on illegal money changers, ordering the confiscation of goods and cash from anyone caught trading foreign currency at rates above the official level. These measures, however, only heighten market anxiety, prompting more people to hoard foreign currency, which in turn pushes the rate higher as expectations grow that the crackdown will make dollars even more scarce.

The Limits of State Control and the Path Ahead

The recent history of exchange rate fluctuations suggests that the state's repressive measures might be adding fuel to the fire. Exchange rates dropped sharply during COVID-19 border closures, and the North Korean won against both the dollar and renminbi as trade with China picked up in early 2023. However, the state's ability to control monetary policy is limited, as its reserves of foreign currency are small and tightly controlled, and a strict monetary policy could lead to reduced consumer spending and even deflation.Over time, exchange rates are likely to stabilize as the market's expectations of sharply increased trade fail to materialize, and demand for foreign currency among firms and individuals decreases. However, if the state's aggressive crackdown on illegal currency exchange continues, hoarding could persist regardless of actual economic conditions. The North Korean government faces a complex challenge in navigating this currency conundrum, with limited tools at its disposal to effectively manage the exchange rate dynamics.