The domestic monetary system was reformed in a way that, as most observers speculated, aimed at reducing the amount of money in circulation. A few weeks later news emerged that the use of foreign currencies was banned.

This is a dramatic move with far-reaching consequences. Money matters for personal survival and for society, so when a country initiates a currency reform of this kind, it has significant repercussions.

To understand what lay behind these measures and what their effect might be, it is helpful to remember what money is actually good for. People living in market economies, no matter how regulated or liberal these are, usually take it for granted that money serves as a means to store value, as a medium of payment and exchange, or as an accounting unit. States use monetary policy more or less wisely to pursue goals related to these monetary functions. Money translates most of our many and complex preferences created by taste, custom, shortage, future expectations and the like into a common language. Goods and services become objectively comparable via the monetary measure. All this is essential for rational decision-making on many levels, be it individual or state.

Socialism is a child of the ideal’s ugly sister, reality. Unlike communism, socialism is not a money-less economy. The political power of the working class has already been established, but in society and the economy many remnants of the old capitalist system still persist. Money is one of these. This stands in sharp conflict with the political and ideological idea behind socialism. The result is a somewhat schizophrenic view of the role of money. On the one hand, it is disdained and restricted as the source of all kinds of evil.  On the other it is needed for the orderly conduct of economic affairs in naturally imperfect socialist societies and hence is issued and circulated by the state.

The results could be observed in socialist Europe until around 1990. Prices were set by the state but they were not realistic. They neither reflected scarcity, nor the balance between demand and supply. Money was allowed to send signals, but the signals were distorted. The result led to wrong responses by consumers, producers, and the state. In addition to a weak incentive structure, through predominantly ideological motivation, this was, in short, the reason behind socialisms chronic economic inefficiency.

The unresolved problem is that in any society the flow of goods and services must be regulated somehow. If the task is too complex for the administration but money’s functions are too restricted, coping strategies emerge. These include barter trade, the use of foreign (hard) currencies, or the use of political capital. The experience of the Eastern Bloc is rich and telling on the range of related effects.

North Korea was and remains a socialist economy, but for decades, its leaders were able to almost demonetise it. As money sent no signals at all, it could not send the wrong ones. The administration, being naturally imperfectly informed about the present and the future, took over the allocative functions of money. As was to be expected, this resulted in severe difficulties.

These difficulties differed in a number of key respects from those experienced in countries like East Germany. There, one consequence of the distorted monetary system was a deep sense of frustration and often embarrassment. This severely threatened the legitimacy of the political system. The governments in East Berlin, Warsaw, Prague or Budapest had over the years lost the hearts of their citizens. Repression and convenience prevented a sudden collapse, but as soon as the people saw a chance, which came with Gorbatchev, they used it. The socialist system in Eastern Europe broke down within weeks, but it had waited to do so for years.

Unlike its Eastern European counterparts, North Korea had for many decades not excessively violated its ideological and political principles in terms of running the economy. People in North Korea too, like everybody, want to be ‘better off’. But until a decade ago, money simply was not thought of by most North Koreans as a way to achieve this. A better apartment, better food, better education for one’s kids, a higher status, more influence – all this was not connected to money, but to gaining political capital. Thus the state had enormous power over its citizens. They could only realise their individual ambitions by following the rules, by doing what it took by joining and rising within the Party, the military, the government. There was no alternative.

This changed dramatically in the late 1990s, when state distribution of the available food could not prevent a major famine. The amount of food available for distribution was just too low. People developed coping mechanisms, and the country recovered, but the leaders in Pyongyang knew that a repetition of such a situation was very risky. Some looked to China, and it seems those who thought that the Chinese model was the way to increase output were able to influence decision-making.

North Korea entered a phase of economic reform that first and foremost led to a monetisation of the economy. In this respect North Korea became a more normal economy. The timing of the reforms was bad, since it coincided with 9-11. As far as we know, so was the commitment to them. The new measures did not produce all the results expected; on the contrary. Suddenly, and powerfully, money turned North Koreans into the same people we see anywhere else. They discovered that any desire could be satisfied via money, and that there were many ways to get hold of it. The political path was now merely one of them, and no longer even the most effective. For the first time, many North Koreans saw an alternative, and they used it. This weakened the influence of the state.

Even worse, growing income disparity created an income gap that was visible, on a daily basis, to almost everybody. Few people in the 1980s had known how the upper 10,000 lived. But now they saw the guy next door who was anything but a good communist – and who had suddenly become affluent. They discovered that the value of a person not only depended on his characteristics or selfless deeds or conformity with the system. Value was now measured in money, brutally transparently. Money was good for those who had it – and bad for those who did not. Society started breaking apart; egalitarianism seemed to be a thing of the past. The same frustration that had brought socialism down in Europe began to grow in North Korea, dangerously, on a daily basis.

Leaders in Pyongyang had three options: Do nothing and await collapse, follow China and embrace the market fully, or try to pull the emergency brake and return to the status quo ante, the money-less society of the 1970s and 1980s. They have eventually opted for the latter.

The operation of markets was restricted, the activities of foreigners constrained, and the state planning system strengthened. The nuclear gamble was used to make up for the lost revenue as a result of declining productivity. But people responded only hesitantly. They had gotten too much used to the new opportunities that the beginnings of the market economy had brought.

In late November 2009, the state finally took a drastic and risky measure. It expropriated all holders of more than a basic amount of money, effectively closed the markets, and attempted to reintroduce the distribution of everything by rationing. Anecdotal reports indicate that this shift has not worked and, at least in some places, has created a dangerous vacuum. People appear to have protested, a reaction rarely reported from North Korea.

Some North Koreans discovered that if the domestic currency was now devalued and heavily regulated, they could still do business in hard currency. The state reacted again and banned the use of any but domestic money to close this loophole.

What are the consequences of all these developments? Provided that the state can use its power to maintain order and discipline, it will have won in the short run. Corruption, income diversification, the spread of a materialistic lifestyle and the hollowing out of the puritan socialist system will have been staunched – for the moment. But it is one thing to never have had candy, or another to be allowed to taste it once or twice and then being barred from having it again. Frustration will pile up, silently, but steadily. Unless the state manages to change the economic situation of its people quickly and substantially, so that a majority feels that it is better off now than under the market system (even if that system not only produced winners, but also losers), unless it resolves the food issue, the situation is unlikely to stabilise.

Why is that so? The economic reforms at the end of the 1990s were initiated precisely because North Korea’s socialist system had reached its limits. The introduction of market incentives was meant to increase productivity. Returning to old systems means returning to the old problems.

This is where China and the USA enter. China has a strong interest in preventing North Korea from collapsing and becoming part of a US-friendly unified Korea. A substantial aid is to be expected; most likely in the form of investment (teaching to catch fish instead of giving fish). North Korea would not be North Korea if it did not have a backup option, someone to balance the Chinese whom Pyongyang does not trust. All hopes here are on the USA. Although it remains very unlikely that North Korea would ever completely trade away the only powerful argument it has for being taken seriously, there are many stages between being a nuclear state and denuclearisation that might lead to settlement with Washington.

If a settlement with Washington can be reached, and North Korea becomes a partner to do business with, investment will flow in from Japan, South Korea and the USA. That will be used to get a better deal from China and Russia. In the end, there will be a competition of bidders, a situation that Pyongyang isn’t alone in liking best. The country could finally benefit from its favourable geographic location, its rich natural resources, its educated workforce and a political system that carefully allocates resources strategically, like the other successful developmental regimes in East Asia. At least, this appears to be the strategy.

Will it work? It depends on how and whether the outside plays along. It depends on whether the domestic political system remains stable and finds a workable solution to the succession issue. And it depends on how deep the effects of the market experiment have sunk into the minds of North Koreans. There is still a minimal chance for a successful outcome. But realistically, North Korea faces very tough conditions, so pessimism is advisable. In the long run, however, a return to market oriented reforms and a re-monetisation would seem inevitable.

Rudiger Frank is professor of East Asian Economy and Society at the University of Vienna and deputy head of the Department of East Asian Studies. He spent a semester in 1990/91 studying at Kim Il Sung University and is deputy chief editor of the European Journal of East Asian Studies and a co-editor of The Korea Yearbook.