|Local meets global in Ulaanbataar: ice sculptures of Chinggis Khaan in front of the popular Grand Khaan Irish Pub.|
It was more than 20 degrees below zero (centigrade) as we visited Ulaanbataar this week. If you want to understand Mongolian culture and politics you have to visit this coldest of the world’s capitals in the dead of winter. My wife joined me on this trip and provided some useful perspective since it was her first trip since summer 2005. What struck her immediately was the absence of traditional Mongolian clothing, which had been prevalent four years before, and the explosive growth of cars and traffic, which had not. Since 2005 Mongolia has undergone a mining boom as the price of its main export, copper, climbed from historical levels of about $2,000 per ton to a high of $8,685 in mid-2008.
The commodity price boom meant that Mongolia earned far more dollars for roughly the same physical volume of exports. This increased income reached a lot of the population through increased government spending and transfers and the real estate and construction booms. People could afford a lot more imported products including cars, clothing, appliances, and an increasing share of their food.
The boom has come to an end now because of the global slump. The copper price has dropped two-thirds in the past few months, and prices of other exports such as cashmere and coal have fallen as well. Within a short time Mongolia’s balance of payments swung from a surplus of 7% of GDP to a deficit of 7%. During the good times Mongolia had built up some reserves so that it was able to maintain its exchange rate and import levels for a few months after the commodity prices started to drop. But about half the reserves disappeared in a few months and it became clear that the exchange rate would have to devalue.
Devaluation is the classic adjustment mechanism for commodity exporters. Countries such as Australia, Chile, and South Africa saw devaluations of 30-50% as commodity prices dropped at the end of 2008. Russia and Mongolia resisted the trend for a while, but are now devaluing as well. Devaluation was one of the big topics of discussion among the population during my visit. The Tugrik has devalued from 1100/dollar to 1500/dollar in a short period. Everyone is unhappy because their salaries and savings no longer buy as much in terms of imports.
Painful as this is, the adjustment is necessary. First, it is unavoidable. I learned a good Mongolian phrase this week: “you can stretch your legs as far as the blanket goes.” Think of sleeping in a ger  in 20 below zero weather, and you get the idea. Well, Mongolia’s reserves are running low and it is impossible to support the currency any further than the reserves can stretch.
|Standing in the middle of recently-developed Ulaanbataar traffic.|
But a second, more important, point is that devaluation is a very powerful stimulus to the real economy in this kind of difficult circumstance. During the boom time the production of all kinds of Mongolian products dwindled – clothing, food items like milk and eggs – because it was cheaper to import them with the earnings from commodity exports. (This is an example of the “Dutch disease ” in which a boom in minerals reduces the incentives to produce other things.) The drop in commodity prices and the subsequent devaluation reverse the Dutch disease. Devaluation makes imported items much more expensive, and thus encourages the purchase and production of Mongolian goods. The devaluation also encourages exports. The global price of cashmere has dropped as part of the slump, but the devaluation means that what herders earn by exporting cashmere remains the same.
Mongolia has great potential outside of the mining sector. With 15 head of livestock for each person, it could export a lot more meat, cashmere, and cashmere products. Eco-tourism is just starting to take off. Winter is daunting, but summer is paradise . Global tourism will certainly be down this year, but Mongolia is a small economy in the part of the world that will do best this year. If it can increase its share of tourism even a small amount, that would be significant growth. Devaluation is a boon to all of these non-mining sectors. Mining will come back some day, but hopefully Mongolia will have used the slump to diversify its economy in a way that will pay dividends for years to come.