The Luxury Frontier

By MAUREEN ORTH


What happens when a country previously hindered by vastness and foreign rule awakens to wealth on its doorstep? With Louis Vuitton on one corner and one of the world's largest gold deposits down the road, the previously nomadic society of Mongolia is putting down some rich roots.

There he stands alone on his horse, a fierce giant shimmering out of nowhere rising 131 feet against the vast Mongolian sky. Eight hundred years after he declared the Great Mongolian State in 1206, Genghis Khan rides again, all 250 stainless-steel tons of him. As I bump along on one of the few paved roads 20 miles outside the capital, Ulan Bator, this kitschy monument to the new mineral-rich and independent Mongolia seems more like a huge middle finger raised to its powerful neighbors, China and Russia. July marks the 21st anniversary of Mongolia's robust democracy after more than 200 years of despised Chinese rule followed by 70 years as a satellite of the Soviets, during which time the proud history of Genghis Khan, who spawned the largest contiguous empire in world history, was banned from public view and utterance. Today, owing to deposits of 80 different minerals, including immense reserves of coal, copper, gold and uranium, as well as ongoing exploration of oil, this sparsely populated country, twice the size of Texas, is undergoing a dizzying transition. No other nation today so squarely faces the choice that Mongolia does. Will it become Nigeria or Chile? Venezuela or Australia?

"Mongolia really is the land of opportunity," says Howard Lambert, head of corporate banking for ING in Mongolia. "Everything can be done here. The financial infrastructure doesn't exist, so you can be a part of building it. Instead of sitting in an office in London turning a wheel, you can build the machine. Every day I see new buildings, developments going up—people buying sports cars in a country that doesn't have roads. The social divide is getting wider."

Nothing illustrates the topsy-turvy nature of Mongolia today more than the capital city's main Sukhbaatar Square, where a bronze statue of Lenin once presided. Now a gleaming Louis Vuitton store, opened in October 2009, offers clients champagne in a circular VIP room outfitted with a lavish ceremonial Mongolian saddle and antique caviar case. Outside the store, however, several hundred yards away, a group of dissident poor have pitched their round felt and wood yurts (gers in Mongolian) to protest the government's cozying up to foreigners and not doing enough for them. "We want jobs. The poor need to have a better quality of life," 52-year-old I. Baganuur tells me. "The government is implementing policies for themselves, not for its citizens."

Sharing the same luxury mall with Vuitton are Burberry, Zegna, Emporio Armani and Hugo Boss. Burberry is planning a second store in a Shangri-La hotel currently under construction. Ferragamo and Dunhill are also looking for space. At the same time, the capital, which boasts the most vibrant democracy in Central Asia, does not have street addresses and has just begun to introduce zip codes. "The irony for Mongolia," says American ambassador to Mongolia Jonathan S. Addleton, "is the more successful they are, the more challenging it becomes."

How could it be that luxury retailers have come to Mongolia? The country has only 2.8 million people, almost half of them living in a capital built for 500,000, including 700,000 destitute former nomads whose gers crowd the surrounding hills and who burn coal and even plastic bottles in the harsh winters, choking the city with extreme pollution. I wanted to understand how a luxury brand could turn a profit in this antiquated land where the livestock outnumbers the people 16 to 1.

My first interview with a Mongolian official is the tieless, 38-year-old vice minister of finance, C. Ganhuyag, whose office sports a putting machine with a strip of artificial turf. "I decided to install casual Fridays," Ganhuyag proffers. (In Mongolia, last names go first, often indicated only by an initial, and people are routinely referred to by first names.) After recounting his latest stay at Davos and directing me to his website, which promotes the new Mongolian "Wolf Economy," because wolves can survive in Mongolia's minus-40-degree winters (Ulan Bator has the lowest average temperature of any world capital), Ganhuyag explains how Mongolia is trying to cope with its two largest mining treasures.

First, in October 2009, a $4 billion deal with Ivanhoe Mines of Canada and Australia's Rio Tinto for Oyu Tolgoi, the world's largest undeveloped copper-and-gold deposit, was finally signed by the government. Currently under construction, the mine is estimated to contain a staggering 40 million tons of copper and 46 million ounces of gold and should start operating in 2012. Next, six competing companies are waiting to hear which of them will win an even bigger deal to develop what will perhaps become the world's largest coal mine, Tavan Tolgoi. Both of these behemoths are situated in the southern part of the Gobi Desert not far from the northern border of the voracious, commodity-hungry China. The area today contains mostly nothing except a few nomads, rare animals and priceless scenery. To manage the coal mine, a city of 60,000 is being planned.

"Mongolia has always been here," Ganhuyag says. "With all our riches, with all our hearts, we were trying to reach out to the West. The West noticed us too late, fortunately for us. If we were Czechoslovakia, they would have grabbed us in the first five years and everything would have been snatched. We suffered through 200 years of Chinese rule, 70 years of Soviet rule and 20 years of being ignored by the West. In retrospect, we had time to educate ourselves. We learned all the tricks of privatization."


It took six years to hammer out the gold and copper deal of which the Mongolian government owns 34 percent and will get a healthy 59 percent of pretax profit without having to advance any money. Along the way there have been some bumps, however. At one point Mongolia instituted a 68 percent windfall profits tax on mining, since revoked, which scared all the banks away. During the last election, in 2008, politicians promised the populace cash handouts that amount to about $17 a month to everyone, rich or poor, taken from the down payments made to the government for the gold and copper deal. Today that cash is moving into the deficit zone and the handouts have been widely criticized for taking funds away from desperately needed infrastructure projects, as well as creating a welfare dependency.

Even so, Ganhuyag says Mongolia's current GDP of $7 billion a year is set to grow at least 20 percent a year for the next decade. "We are going to double our economy every three to five years—even the IMF agrees on that. That's why luxury retailers get a good smell from us. It all depends on the global markets. If China is trying to equip every man with a car, then the demand for copper, coal, iron, gold, gas, uranium, which we also have, will be endless."

Louis Vuitton, which first created its trunks for African explorers, is indeed pleased with its entry into the Mongolian market and the demand does not even have to be endless. Rather, LV CEO Yves Carcelle thought it was a special sign when he learned that "How are you?" in Mongolian is asked, "How did you travel?" I tell Carcelle that Burberry says their Mongolian customer base is little more than a thousand people and they are happy. He agrees. "One to two thousand people is all you need. You can't judge by average income—average doesn't mean anything. The question is, do you have a few thousand people who can afford luxury? What you need is a stable political environment and the necessary environment to put your store where you are the place."
What I observe in Louis Vuitton is a clientele of women ages 30 to 40 already sporting LV bags and men shopping for gifts. LV's interest, of course, was sparked after going into Russia and China. "In 20 years China has become our biggest client," Carcelle says. "Apart from that, our expansion is quite well spread around the world. Because of media today, luxury and fashion have become the universal language." Mongolia follows global trends too. "People look at fashion and TV online here. We get Russian Vogue, and Cosmo Mongolia just came out," B. Delgermaa, a fashionable Mongolian woman, tells me. "You have to subscribe to American Vogue and it's very expensive."

It is traditional for Mongolians to display their wealth on themselves. "Nomads move around the country four times a year," Ts. Ariunaa, executive director of the Mongolian Arts Council, says. "All your wealth goes to jewelry and costume, your horse and saddle." Adds Delgermaa, "Culturally, Mongolians like to show off. Mongolians are very proud of themselves—there is only one me. They think they deserve exclusivity."

A rich nomad today is known for having a satellite dish and a solar panel for his ger and a motorbike for himself. But his primary relationship has always been with nature. According to Ariunaa, "First you sing about the land, your horse, your mother, and then you sing about your loves and relationships. Mongolians are better at communing with nature than with each other. You live on the steppes in a ger. You don't need to know what your neighbor is thinking." Nomads are also used to "singing outside, so you need to listen in a big space."

Thanks to its years under Soviet rule, Mongolia has a literacy rate of 98 percent, as well as 151 universities where 70 percent of the students are female. A less fortunate hangover from Soviet rule is the rate of alcoholism, especially among Mongolian men, up to 25 percent of whom are classified as alcohol-dependent. I traveled to an orphanage in Mongolia's second-largest city, Darkhan, about a three-hour drive from Ulan Bator, where some of the 40 or so orphans had ended up because of the alcohol problems of their parents. "You can buy a bottle of vodka for 75 cents, less than a cup of coffee," says Meloney C. Lindberg, country representative for Mongolia of the U.S. NGO the Asia Foundation. I was told that if you collapsed on the street in the capital from a heart attack, no one would help you because they would probably think you were drunk. "We never before used hard drink like vodka," B. Baabar, one of Mongolia's leading intellectuals, tells me. "Our alcohol came from milk like sake [from rice]."
Baabar is one of the best-loved figures in Mongolia. He gave up his job as a biochemist to become a historian, writer, publisher and activist. He led the project to translate the Encyclopedia Britannica into Mongolian and was jailed by the Russians, whom he clearly does not like. He believes that the Mongolian government today is still too reflexively Socialist and the central-planning Russian model of state paternalism too often prevails. "The people here who are running the system still think like Communists or Socialists," he says. "Every five years the Soviet Union gave Mongolia $5 billion. This supplied Mongolian industry, agriculture and military. On the other side, it made Mongolia fully dependent."

He is angry that the Mongolian government started giving cash handouts that he calls "economic infantilism," a product of those educated under the Soviets. "Members of Parliament must go through elections and make many promises to the people. If the people are fed like children from this guy who acts like the father and promises cash money, free education and everything free because the state is getting richer and richer—that is the bad side of this sudden wealth."
The inner sanctum of the cash cow that everyone hopes the Oyu Tolgoi copper-and-gold project becomes is the Ulan Bator office of Cameron McRae, the redheaded, 52-year-old Australian CEO and president in charge of the site construction. The "first step" investment of Ivanhoe and Rio Tinto is $7 billion, he says, and they are currently spending $7 million a day to dig the mine.

His computer contains numerous animated models of the construction site, where a tiny Eiffel Tower is used for scale, towered over by the vast project. "We are building at a scale never tackled in this country," McRae says. "We are facing a shortage of artisans and technologists and people with large-scale construction experience." At its peak, the construction site will require 17,000 people and when completed, the mine is expected to produce 50 to 55 million tons of ore annually.

The government has already received about a half billion dollars in fees and taxes and has not had to put up a penny. Yet because of a lack of technically trained Mongolians, two of the mine's major contractors are Chinese—the mine is located only 28 miles from the Chinese border and up to 80 trucks a day from China carry in necessary building supplies. "We made a commitment to the Mongolian government to train up to 5,000 Mongolians," McRae says. Once the mine is built, "a minimum" of 90 percent of the workers will be Mongolian.

The mine's remote South Gobi location requires considerable amounts of power and water, not to mention an airport. "We'll help bring power to Gobi and upgrade roads. We'll build a powerline to China and tap into the Chinese grid," McRae says. But the amount of water required, especially in a desert, is unprecedented. "We're exploring for water. We found a very large ancient aquifer in a gravelly area not related to anything else." I ask McRae where he thinks they will be in five years. "We'll be the second-largest copper mine in the world with a very inexperienced workforce with a big training program."
efore World War II, Mongolia served as a buffer state between Japan and the Soviet Union, and after, between the USSR and China. Beijing is just 340 miles from the southern Mongolian border and the Great Wall was constructed mainly to keep out the Mongols; 70,000 Russian troops were once stationed in Mongolia. Those old enmities are hard to overcome. For example, the Trans-Mongolian Railway conforms to the gauge of the Russian railroad, not the Chinese one, so each train to China from Mongolia must go through a tedious re-fitting process. Under the guise of "national security concerns" there is now a major debate going on in Mongolian business and political circles over how to export the coal from Tavan Tolgoi—by rail to Russia or by truck to China? It would require hundreds of miles of new rail to be constructed to ship out through Russia, or the coal could simply be trucked 150 miles to the Chinese border.

National security concerns is code for concern about the possible use of the railway for military intervention," says Graeme Hancock, who until recently was the senior mining specialist for the World Bank in Mongolia. "These Cold War concerns are still being played out all over Mongolia. They consider the Russians their Big Brothers, their friends, and for 70 years they've been told there's a big yellow evil to the south." He adds, "From our perspective, Mongolia places too much [emphasis] on national security interests and not enough on economic interests. Instead of basing decisions on what's good for the economy of Mongolia, decisions are based on geopolitical considerations." I actually came across the lingering reverence for Russia in, of all places, Mongolia's only five-star hotel resort, the lavishly appointed Terelj. I was startled to find the deposed statue of Lenin ousted from the main square of Ulan Bator in 1993 stuck behind the building in one of its gardens.
Changes in Mongolia are happening so fast that L. Sumati, the country's leading pollster, says it is impossible to group people into social classes—mobility is too rapid. At the same time the situation is made more complicated by the fact that almost all of the poor have accumulated in the ger areas of the capital city, many forced there after the horrendous winter of 2009–2010 caused nearly six million of their livestock to die. "An army of the poor is besieging UB. Any political party standing for election has a tough time negotiating with these people," Sumati says. "They are very volatile and just asking for survival. In some ways they are angry. They see a widening gap between the rich and the poor and they see no way out." I ask him why he can't classify who is wealthy. "We have a group of very rich people supported by their access to power," he says, referring to the crossover between business ownership and government. "The rich are not a class yet because there is still very high mobility both up and down." Although Mongolia has strict laws requiring top officials to publish their assets and a lively media that includes 22 daily papers in Ulan Bator plus 21 TV news channels, there is no freedom of information act and cross-ownership of media and business interests abound. I'm told editorial control is nearly always held by owners and there are ways to pay to get a story on the news.

Corruption here is endemic. The Asia Foundation pays Sumati to poll a thousand households quarterly to benchmark attitudes toward corruption and how many bribes they have paid in the previous three months—usually to doctors, teachers, administrators and police. The last poll showed that Mongolians consider corruption to be the government's third most serious problem after unemployment and poverty, and that while the number of bribes decreased from 16 percent of households in March 2010, to 13 percent in September 2010, the amounts of the bribes more than doubled. Of course, these surveys do not address the big guys and government officials who somehow may be secretly attached to these lucrative concessions, a lot of which are done on an all-cash basis, the preferred method of the Chinese. "The Chinese come in with a suitcase full of cash," says banker Lambert. "A Chinese guy buys a bottle of vodka and he will buy your mine for $7 million with no due diligence. Even though the Mongolians don't like the Chinese, they have a healthy respect for them."
The transition from Communism is still being felt. The alphabet is Cyrillic and there are many parts of the capital that look a lot like old Moscow. The era after the Soviet Union collapsed is still recalled painfully. Those who made out like bandits were similar to the apparatchik of Russia—people who had had contact with the West. One such person is national rich guy Kh. Battulga, one of the most controversial figures in political and business life today. He is a former national judo champion, a man who drives a Bentley and paid $10 million out of his own pocket to build the gargantuan statue of Genghis Khan on Mongolia's steppes. Battulga is a developer—he is turning the land around the statue into a resort—and also happens to be the minister of road, transportation, construction and urban development and a powerful leader of Parliament. He traveled the exterior as an athlete, started trading by selling electronic appliances from China, graduated to computers and now owns a large meat-processing plant that supplies the country. In 2004, "my own needs were met," he says, so he decided to run for Parliament.

Today, his grand vision is to build a $10 billion industrial complex the Mongolians call a "production city" named Sainshand, also in the middle of nowhere in the Gobi, 300 miles from the Russian border, 125 miles from China and about 200 miles northeast from the proposed Tavan Tolgoi coal mine. It would be connected by highway and rail to the capital and by rail only to Russia. Instead of selling unrefined ore and coal to the Chinese, who collect it in trucks, Sainshand would process the minerals and refine the oil. Mongolia could then sell its commodities at an increased profit of at least 30 percent, according to estimates, and create hundreds of thousands of new jobs. But first the city has to be created from scratch. Then the coal will have to travel 3,000 miles from the mine, including a connection to the Russian railroad, before reaching the port of Vladivostok. Battulga told me he got the Sainshand idea because a Buddhist thinker in the 19th century predicted that one day a great metropolis would grow there.

All over Ulan Bator I hear naysayers on Sainshand. The local gossip is that Battulga is in cahoots with the Russians. "The Russians quite naively believe if they monopolize the railroad around the minerals they'll have control of the mineral wealth," says J. Od, who with his brother is one of Mongolia's biggest businessmen and taxpayers, doing a lot of business with the Chinese. He dismisses it all as politics, declaring that's the way "the clowns" in government mix politics with business. "Sainshand," he continues, "is some so-called geopolitical policy of Russia. It cannot be implemented in Mongolia today—it's too late." Battulga counters: "For Mongolia it's not profitable to sell raw materials to China. It's not geopolitical, it's business. We want minerals sold to the world market."

The fragile coalition government that is up for reelection next year is literally besieged on all sides. To hedge against inflation and to share the wealth, Parliament has passed a law creating a Sustainability Fund with money set aside from mining industry revenue including the Tavan Tolgoi coal profits; sometime in the future, all citizens will also be issued 10 percent of the shares of an IPO the government will offer on the Hong Kong and London stock exchanges. (The government has also established a more general Development Bank.) They know they cannot count on the fluctuating prices of commodities to sustain their long-term growth. When I spoke to Z. Gombojav, minister for foreign affairs and trade, he chose to spin the country's many immediate needs as "vast opportunities and room for investment in infrastructure, including roads and railways, energy, urban construction, light industry and food production."

The reality on the ground is more challenging. For example, Mongolia has the best cashmere in the world, but domestic producers who refine the wool say they are in danger of being put out of business because the government does not collect the 30 percent export tax from the Chinese, enabling them to buy vast amounts of raw wool from the herders at higher prices while domestic producers are fully taxed. According to D. Erdene-Ochir, head of sales for Goyo Cashmere, the government is sacrificing them to the herders. "It's terrible politics to treat herders badly. So there are no taxes and the Chinese manipulate the market. They are supposed to pay the government, but the government doesn't collect. Mongolian companies have to pay income and VAT taxes. . . . If I want to be elected, I cheat the producers not the nomads." He also accuses the Chinese of mixing the cashmere with wool, silk and cotton. "They mix it and call it anything they want. We will be extinct very soon."

There is no doubt that Mongolia is white-hot in multinational-investment circles. One night I attended GE's welcome reception celebrating Mongolia as the 130th country where it does business. GE will begin by selling MRI machines to the country's underequipped and overburdened hospitals. Caterpillar already has a $100 million business going there. "Mongolia is like baking a cake," says business consultant Jackson Cox. "All the ingredients are on the table. You've got everything you need in Mongolia to build a modern, prosperous economy. The only thing that's missing is the political leadership to make the tough decisions. You have to envision the Mongolia you want 25 years from now and then take on the decisions to plan the education, infrastructure and health care to get there."

Nevertheless, most of the Mongolian hands I dealt with seemed to believe things would somehow work out in the end, even though environmentalists rightly fear precious grasslands and watersheds could be destroyed in a country that so far has only been 25 percent geologically explored. As Graeme Hancock says, "There is a very, very active civil society. Companies don't get away with making a mess very long."

The looming question is what Mongolia will do once its finite treasures have run out. "Twenty years from now, if all this mineral wealth—which is not renewable—is not turned into renewable wealth, which is knowledge, then we will have missed the point," says newspaper columnist D. Jargalsaikhan. "This underground wealth needs to stay aboveground to suit our will and aspirations."

"Money without policy does more harm than good," says J. Od, who believes "we are only at the tip of the iceberg" in knowing how rich Mongolia really is.



Source:Wall Street Journal