North Korean economics 101: How much is a dollar worth?

A portrait of the late Kim Il Sung is seen on the 5,000 bill of the North Korean won, Monday, Feb. 6, 2017. While foreign brand-name goods are often paid for in the U.S. dollars, Euros or Chinese yuan, and priced accordingly at the official exchange rate, most people buy their daily necessities in North Korea's own currency, the won, which has an unofficial and more market-friendly exchange rate. (AP Photo/Wong Maye-E)

To get a feel for how North Korea's economy works, go buy a roll of toilet paper

PYONGYANG, North Korea — To get a feel for how North Korea's economy works, go buy a roll of toilet paper. Or start up a mobile phone network.

As capitalist-style markets have grown more important in North Korea, so has a market-friendly exchange rate for the much-coveted U.S. dollars, euros and Chinese yuan that lubricate the North's economy. But the official and unofficial rates are totally out of whack. And as one big investor recently found out, the difference can mean hundreds of millions of dollars in lost profits.

Dueling exchange rates are a common issue for developing countries that have an official premium rate set by the government, often for political purposes that don't reflect economic realities and are therefore often ignored in the marketplace.

The discrepancy can severely hamper foreign investment, undermine confidence in the local currency and contribute to corruption and economic instability.

But nowhere in the world is the gap bigger than North Korea, according to Steve Hanke, a professor of applied economics at the Johns Hopkins University who specializes in hyperinflation,

"The North Korean won's black market premium is the highest in the world: a fantastic 6,440 percent," he said. For comparison's sake, the black market premium for the Syrian pound is "only" 144.3 percent of the official rate, he said.

What does such a system look like on the ground?

If you pick up that roll of toilet paper in a shop catering to foreigners, tourists or the relatively affluent elite in the capital, it would probably have a price tag in the 200-400 won range, or $2-4. The prices in won are calculated according to the official exchange rate. In reality, you can't actually pay in won, at least not at that rate.

Typical Pyongyang residents, meanwhile, are more likely to do their shopping at a place like the Kwangbok Department Store, which does take won and therefore uses an entirely different pricing system. Here, a roll of toilet paper costs 1,400 won. An exchange booth right next to the checkout counter posts the day's rates — not the official 108-or-so won to the dollar, but a whopping 8,000-plus.

"The official rate is a political rate," Hanke said. "It is, therefore, totally arbitrary and no one really knows how it is determined. The black-market rate is a free-market rate. The supply and demand for dollars and won on the black market calls the tune and sets the rate."

Most North Koreans don't have foreign currency to begin with and don't shop in upscale stores, so the system is fairly invisible most of the time.

On a larger scale, it has major ramifications.

One of North Korea's biggest recent success stories has been the rapid spread of mobile phones, now in the millions, thanks to capital and expertise invested by the Egyptian conglomerate Orascom. The venture, Orascom Telecom Media and Technology, was hugely profitable, but rather predictably hit a big wall when it tried to get its earnings out of North Korea.

In late 2015, it announced a huge loss after North Korea insisted it use the unofficial rate to convert its profits into dollars, turning what would have been $450 million into a mere $8 million.

CEO Naguib Sawiris resigned on Jan. 1 this year.

Sawiris refused to comment to the AP until after the company releases its next financial report. But the company, which has staff working out of a hotel in Pyongyang, is apparently still waiting to get even its $8 million out of North Korea.

The importance of the unofficial exchange rate has grown tremendously since the 1990s, when the collapse of the Soviet bloc and natural disasters that devastated harvests took North Korea's economy to the verge of collapse. Citizens who previously relied on the government for their needs had to learn how to fend for themselves.

The result was the rise of an unofficial, but by now well-established, capitalist-style market, where prices are competitive and determined by supply and demand. Transactions are primarily made in cash. Outside experts estimate that half or even more of all economic activity in the North is done in this gray zone.

The transformation has not been without its shocks.

In 2009, leader Kim Jong Un's father, Kim Jong Il, ordered a revaluation of the won, effectively cutting two zeros off the value of each bill. That appears to have been an attempt to reassert control over nouveaux riches who had profited too much from the gray market and were seen as a potential political threat.

That put the country through a severe bout of hyperinflation from late 2009 to early 2011. Monthly inflation peaked at 496 percent in March 2010, according to Hanke's calculations, and the value of the won on the black market collapsed.

To the surprise of many, the won appears to have rebounded and stayed within a fairly stable range, both officially and at the unofficial rate, since Kim Jong Un assumed power in late 2011.

"This is a major quandary, and an apparent success story of the Kim regime," said William Brown, an adjunct professor at Georgetown University and non-resident fellow at the Korea Economic Institute of America. "I think for the time being people are getting used to monetary stability and that is allowing a big increase in market activity and growth."

He warned, however, that the stability could be fragile.

"Some kind of shock would instantly cause people to trade in their won for dollars and the exchange rate and won prices would soar," he said.

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