March 2, 1997 [home]

Listening to Uighurs (Weegurs)

Uighurs (pronounced Weegurs) are a Chinese ethnic group from the province of Xinjiang in far western China. This group is ethnically Caucasian and its roots certainly go back more than two thousand years to the origins of the Silk Road itself. With such a trading heritage it is not surprising that the Uighurs are now engaged in one of the most ancient forms of international commerce. They are involved in currency speculation. They don't sit in front of a display of monitors, wear suspenders, or lunch with George Soros. They are part of the black market in Beijing and they are betting against the Yuan, China's currency.

The yuan is only partially convertible. It is not freely traded on international currency exchanges. Forward contracts are very limited. No interest rate swaps. No fancy derivatives. Just good old-fashioned communist government controls. It is what we say it is. Presently the government says that the yuan is worth 8.2 yuan to the dollar. However, the Uighurs say differently. Their price is nine to ten yuan to the dollar, a depreciation of more than 10%. The Uighurs are predicting that Asian economic woes are coming to China.

So what. Why should the world financial community care about a small ethnic minority from god knows where running around Beijing preying on peoples' fears about the future. I mean they don't even work for a financial center bank, belong to a country club or drive a beemer. What could they know about the economic situation in China? Unlike Korea, Indonesia, and Thailand, China has a $40 Billion trade surplus and $141 Billion in foreign reserves, second only to Japan. Those other countries had trade deficits. Even if the yuan was convertible, no currency trader could get near it.

Except for the problem with the banks. "With an estimated $200 Billion in accumulated nonperforming loans - five times the equity capital of all Chinese banks - China's banking system is essentially insolvent. At least 50% of China's state owned companies are in the red, constituting a far larger chunk of the economy than failing companies present in any other Asian country." (WSJ 11/04/97). Since according to the World Bank Chinese Bank's "accounting, risk management, and credit systems analysis are woefully inadequate; and the quality if their loan portfolio is unknown" The $200 Billion figure from Standard and Poor's may be just a starting point.

What the Uighurs are trying to tell us in the absence of reliable information about China is that their financial system has major problems. They are telling us that there is a crisis in confidence on the local level. For anyone investing in any market especially in an emerging market, it is exceptionally important to pay attention to local perceptions of the strength of the local financial system. The confidence the local people and businesses maintain in the local financial system is an important indicator in whether currency collapses and the depth or length of an economic crisis.

For example, in Thailand the Wall Street Journal quotes a hedge-fund executive in Singapore who recalls that "The locals lost confidence in their own currency, whether they got tipped off that the central bank was going to end the peg, or they just saw the handwriting on the wall . . . it was the same in Sweden, in Italy, in Mexico." In Southeast Asia, as in previous currency crises, including Mexico in 1994, it was local companies scrambling to cover dollar-denominated loans, and ordinary portfolio investors such as mutual funds, doing the bulk of the selling, not speculators.

In a way, the Uighurs are like the first few drops of a thunder storm. They represent a change in how the society or market perceives the strength of their financial system. In countries where the government is trying to direct or control the economy, the forces of the market constitute a definite threat. Even in China, still a socialist country, the growing market forces are taken seriously. Unfortunately, the Chinese like other countries in Asia are still relying on the state develop answers rather than trusting in market forces.

The Chinese method devised to prop up their banks is typical. Rather than raise money for a recapitalization of the healthiest banks, the government will require other banks and perhaps state enterprises to buy the bonds and then the proceeds of the sale will be given to the four largest weak banks. The weak banks, of course, became that way because they were required to make loans to bankrupt state enterprises. So rather than trust the market to get rid of badly managed banks and state enterprises, all banks and perhaps some state enterprises will be forced to provide capital to shore up those same badly managed banks and state enterprises. It really is as silly as it sounds except that the same methods are being used in other parts of Asia.

Government policy in Japan encouraged their banks to lend to Asia countries. It was unfortunately very successful. According to Moodys, Japanese banks have amassed an Asian loan portfolio of $182 billion. The next largest lender, Belgium (of all places) Banks, have Asian loan portfolios of $15 billion. Japan's solution to the problem is no better than the policy that created it. The Japanese finance ministry has $230 billion bank bailout fund. This huge amount of taxpayer money will be distributed to banks regardless of strength and without any promises to revise management practices. In essence, they are funding bad management. Korea's policy of forcing banks to loan to Chaebols regardless of risk has ended in disaster. Indonesia's delay in reforming its crony monopoly system has lengthened its monetary and economic crises. In contrast, Taiwan's policy of encouraging many small businesses and Singapore's consistent good government have protected them from the worst aspect of the crises.

If governments try to substitute their judgement for the judgement of the markets, they will ultimately fail. So we must consider the Uighurs and the markets they represent. Confidence in the economic system has a great deal to do with confidence in the political and legal systems. Without that confidence, the economic fluctuations in emerging markets are bound to be dramatic. It is no accident that there is a correlation between the corruption of the political system and the economic volatility. According to the "Corruption Perception Index" published by Transparency International and Gottingen University (http://www.gwdg.de/~uwvw//icr.htm) the most stable economies including Singapore (8.66) have scores over 7.5 on a scale of 10 (US is 7.6, the top Denmark is 9.94). While China has 2.88, Thailand a 3.06, Indonesia a 2.72 and Russia 2.27. On this scale even South Korea suffers with a 4.29 lower than Malaysia with a 5.01.

According to Alan Greenspan "Episodes of vicious cycles cannot be easily forecast as our recent experience with Asia has demonstrated." Nothing breeds success like success. When an economy is growing at five to ten percent per annum it is easy to credit government policies for the success and ignore the long term effects of government interference. To avoid making such mistakes, we should carefully seek out Uighurs in each country and listen to them in the economic, social and political context in which they live. By listening to Uighurs we can best discern the level of confidence in the market. Perhaps this confidence is the best indicator of all.

Return to Top