Capitalism and serfdom: Capitalism on the wild frontier

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The market, like nature, is red in tooth and claw. It has no concept of ethics, morality or justice. Its agents are predatory and are concerned mainly with their own survival. They have no thought for the good of the system. That doesn't mean the market is bad or that it doesn't work. It means that present prescriptions for emerging economies do not reflect these realities. Nothing highlights more starkly the inappropriateness of the blind application of free market thinking to emerging markets more than the role of hedge funds. By Simon Brady.

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So Russia was going to discriminate against foreign holders of its rouble-denominated treasury debt. Under the terms of the country's debt rescheduling, foreign holders of GKOs were to receive only a fraction of the amount paid to Russian holders. Credit Suisse First Boston's Russia Update note of August 19 fulminated against this double-cross and, for a while, managed to stall the restructuring process. A few days later, when it seemed that the Russians weren't even listening to the firm that had best access to the oligarchs when the going was good, another CSFB spokesman raged: "Russia's elite is plundering the capital of the country," as though this long-evident truth had only just become clear.

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Euromoney
September 1998

CSFB protests that although foreign investors were "legitimately exposed to Russia's ability to smoothly complete the transition to a market economy" they only invested because they were assured that they would be treated on equal terms with locals. Of course this was not the basis of their investment decision. Investors in GKOs were betting that the IMF would prop up the rouble thereby protecting their huge yields; they were betting on a G7 bailout. They already knew that a criminal oligarchy was intent on asset-stripping the nation, ironically using the modern financial market infrastructure that was supposed to make this kind of thing more not less difficult.

The Russians seem to have relented but the fact remains that in Russia we have a perfect example of what happens when bankers -- the IMF and World Bank included -- are prepared privately to admit the truth but publicly treat a complex, emerging country as though it were an errant version of Italy or Belgium. As in Asia and Latin America, investors have been no better: only after they've lost their shirts have they acknowledged publicly what they knew all along. Few outside the Russian press complained that the privatization programme was a cynical stock-for-votes trade that subverted the whole point of the sell-off -- a far more blatant and damaging example of pillage than the debt rescheduling. And let's not forget that the real losers in Russia are not just foreign investors but ordinary Russians who face a winter of hunger and hyperinflation without even the security of their meagre savings.

A new prescription

Russia's default raises many questions. One of the most fundamental is how we should regard emerging markets. Should we treat them as embryonic versions of US-style capitalist democracies? If so it makes sense to prescribe a western menu of stock exchanges, derivatives markets, access to international capital, liberalized capital accounts, World Bank/IMF funds and strategies. Or should we admit what was always clear in Russia and what seems to be true of parts of Asia and Latin America -- that many of these countries do not have the economic physiology to digest this high-energy diet? 

They are not just infant versions of adult western economies. They are organized along different lines and we cannot simply prescribe cures for their ills from our own recent experience of financial markets. So, shouldn't we -- perhaps through the IMF -- confront them earlier with their faults? Indonesia was a crony state for 20 years before most mutual fund holders took notice. Indeed, it wasn't so long ago that Japan -- for whom many of these arguments also hold -- was paraded as an economic miracle with much to teach Europe and the US.

"Don't these people realize that we're the ones with the money? They need us."

Most important, governments and agencies have to admit that the imposition of techniques and ideas useful in mature post-industrial economies is often inappropriate outside them. In emerging markets, privatization is a destructive and pointless process unless it introduces ownership to the people and direct foreign investment and technology transfer to the companies privatized. Joint-stock companies are premature in a country without adequate bankruptcy and property laws. Shareholder value is an alien concept to companies organized in family-held conglomerates. Sovereign and municipal access to unfettered international borrowing will cause a crisis if a country has no effective tax system. 

Foreign portfolio investment is a dangerous substitute for direct investment and if, as was the case in Asia, local savings ratios are high enough to fund investment, it will be squandered on unproductive assets. Uncontrolled foreign currency borrowing is a recipe for disaster if the banks' traditional role has been to fund related businesses regardless of profitability. Most unpalatable to free marketeers, strong government control of capital flows can work. Just look at Chile.

To get a clearer idea of what emerging economies such as Russia require -- or don't require -- Euromoney looked at four of the ex-Soviet republics just before the crisis erupted. These are pre-emerging markets. They lack much if not all of the basic infrastructure -- physical and psychological -- of a modern capitalist nation. The financial institutions of the developed world are going to have to pay much more attention to the real needs of countries like these if they are to avoid causing further calamities.

A first-hand view

We started in Azerbaijan. On the tarmac at Baku international airport is what looks like the skeleton of a terminal building half built or half demolished? No-one seems to know. While we argue -- why would you need sacks of sand and concrete to demolish a building? Ah, but why would a newly-erected frame be crooked and falling to pieces? -- someone appears with a fax. It is a printout from Bloomberg. Russia's RTS index is 11% down on the day and 40 hedge fund managers suddenly feel like a beer. A garbage sack of cold cans appears.

Just out of the airport nine huge Mitsubishi land cruisers thunder past, a black Ford Caprice at each end of the convoy. Overtaking the 1970s Amsterdam city buses that seem to be Baku's public transport system they ignore every traffic signal.

This is where the IMF's theories become experiments with the lives of real people. It is also the world of the hedge fund, of the frontier market investor. There are 40 on the trip. Some run big name funds. Some are one-man bands. A lot run funds of funds. They spend their whole time interviewing the other one-man bands. All are looking for the quickest turn: "Kyrgyz T-bills, 30% compounded, got to be a bargain"; "Azeri privatization vouchers? Okay as long as you get a local to hold them -- then you don't have to buy the options"; "What do you think -- Shymkent Refinery or Hurricane Hydrocarbons?"

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Baku  an oil town that needs direct investment, not a corporate bond market

These investors don't work in London, Tokyo or Boston. One woman runs a fund of funds based in Ketchum, Idaho. She knows millionaire Edgar Bronfman -- recently in the news negotiating the Swiss Nazi gold settlement -- and sometimes looks after his children. Originally Australian, she speaks fluent German, Italian, Spanish and Japanese and has been an interpreter and a psychologist. The psychology has been the most useful. "When you're interviewing a fund manager you need to know where he is in his life: is he getting divorced, is he depressed, does he learn from his mistakes." She has been chatting to some of the investors on the plane and is not too impressed. They don't seem to have a method or strategy and they haven't learnt anything from the recent market falls. "They can't pick the bottom, they have no antidote to the volatility and anyway, they are all so antsy. Maybe I'll just stick a discretionary zero disclosure fund into this stuff."

The others are ex-grain traders for Louis Dreyfuss and Marc Rich, veterans of government-connected privatization consultancies, former derivatives traders -- even one ex-Euromoney writer.

Their vocabulary is eclectic, pseudo-scientific. They tip their hats to Modigliani -- they're always looking for non-correlated assets. They talk about punctuated equilibria in economic systems (long periods of stability broken by bursts of profound change), a borrowing from evolution theorist Stephen Jay Gould. They're addicted to technical and chartist jargon. Most of all though they spout the dogma of Friedman and von Hayek. They believe that they are the vanguard of a capitalist revolution, that they are bringing civilization to places so backward they've never heard of stock options. They believe their dollars are the seeds of this civilization, the elixir that will liberate the serfs.

Understanding Baku

Azerbaijan is the first of the chain of Turkic 'stans that join Europe to China and beyond. To western eyes these are unfamiliar places. Alexander the Great pushed his empire as far as Turkmenistan but it often seems little has changed since then.

The new emperors are foreign too. One of the US oil companies is in town. Every few hundred metres soldiers sit by their guns bored, smoking. Oil pipes snake up the side of the highway criss-crossing each other in a tangle of corroded metal. Precariously balanced on lumps of concrete or rusting wheel hubs they run through the reed beds and marshes alongside the main drag into town, pools of oil stagnant all around. The pipes lead to the shores of the Caspian. There a field of battered derricks sucks the dregs from the played out shallow field on the beach. Offshore, new rigs flare as the western giants move into deeper water. Black slicks stain the blue waters. It's pretty obvious how the Azeri economy works and what it needs.

Parts of Baku look half-built from plans photocopied too many times to read. Inside the tiny streets of the old city, a few ancient caravanserai survive, one at least now a restaurant similar to the up-market versions you'll find in Damascus and Aleppo. The owner could not be with us that evening. He lives in Monaco. Outside the centre, wide, tree-lined boulevards remind us that not all aspects of the Soviet era were a disaster.

One of the few modern buildings houses the new Minaret Group. Funded by Czech voucher millionaire (and exile) Viktor Kozeny, Minaret aims to be the premier local financial institution in the Caucasus. Money is no object. Charles Towers-Clark has been hired from Global Securities to head the group at a reputed salary of $500,000 a year. He doesn't have time to talk to Euromoney. An accountant at influential Washington privatization consultancy Coranna on $80,000 a year has been poached, had his salary tripled and been made one of the company's most senior executives. The building is state-of-the-art. Kozeny spends a lot of his time in Bermuda and isn't talking to anybody.

So, what is there to buy? As a series of local officials emphasized, what the Azeris need is foreign direct investment. They need substantial long-term funds and technical assistance. They need dormitories for migrant oil workers. This means they need links with developed-world oil companies, they need joint-ventures. What they didn't say publicly, but what they are happy to admit in private, is that they don't yet need a stock exchange. They don't need a corporate bond market. They may not need to privatize their oil company and if they do they would probably be better off selling stakes in it to those oil companies rather than to institutional investors. Right now shareholder value is not an appropriate concept in Azerbaijan, and in any case, it is difficult to see how foreign portfolio investment would drive it. One thing was absolutely clear. Azerbaijan does not need a flood of short-term hedge fund money.

The Azeris need foreign direct investment, not inflows of hot hedge-fund money

This is not what the funds want to hear. They want quick returns. They want a way to get into property. Foreigners can't easily buy it but the oil boom is pushing prices up fast. They want to buy privatization vouchers but don't like the fact that the vouchers are simply tickets to an auction and don't relate to any specific company. They've also heard that a local broker spent three days in jail for selling vouchers to foreigners who didn't have the requisite options (which are not strictly options but they do give foreigners the right to buy vouchers, hence the name). This is outrageous, particularly as several of them have been trying to work out how to avoid buying the options themselves. They want to buy into strategic sectors but the government doesn't want to sell. Key parts of the privatization programme have been delayed. As for the T-bill market, well the government isn't issuing enough paper and is the least indebted in the region. Outstandings are perhaps manat30 billion ($8 million) and yields don't look sexy.

The one piece of good news is relayed by the cynical representative of a foreign institution: "Luckily Azeris' power is not in their own hands. For this reason I do not see any political risk here." He means, though doesn't explicitly say, that a small country like Azerbaijan is simply a pawn of the oil majors and its larger neighbours.

The IMF is here. Azerbaijan is in their good books. "Azerbaijan is one of the better regimes in terms of sticking to Fund programmes. We are very impressed with the government's commitment to reform," says the representative. "GDP growth was 5.7% in 1997 and has been 9% so far this year. Inflation is down from an average of 3.7% to 1.4%." He implies these improvements spring from IMF involvement. The evidence is flimsy. Oil money -- of $1.1 billion in foreign direct investment in 1997, $750 million was oil-related , could just as easily be the cause.

The investors face the Azeris. The juxta-position, like that of the central bank's glistening new black and gold skyscraper with downtown Baku, highlights the chasm between the real economy and the western financial marketplace. They're bored. They start discussing Latvia and Lithuania. Port privatizations look hot. The ports can charge Russia what they like to export even when the price of oil falls. It looks like a good hedge against falling oil prices.

Azerbaijan is not a difficult place to understand. In the real economy, oil is the only thing in town and will be for many years. The most important issue facing the country is development of the Caspian fields and the routing of strategic regional pipelines. Maybe Dutch disease will come later, maybe it won't. In the meantime on the street, Turkish retailers have moved in. Marlboro and Coke are battling for brand supremacy and in a straight logo count Marlboro is winning. There is corruption, though in the words of an EBRD official: "Here it is not perceived as corruption, here they call it respect. Anyway it takes two to tango and they are being bribed by the western world. So it is difficult to say who is more corrupt." At the airport a Lukoil Gulfstream looks the safest route out. It's new and it wasn't made here. We drink, waiting for President Aliyiev's Tupolev-154 to take us to the Kyrgyz Republic. There's cumulus high above the airport, the plane must be ex-Aeroflot and Azerbaijan Air is strapped for cash. It's going to be a bumpy ride.

Bishkek beckons

As we start our descent for the capital Bishkek, the stewardess takes a bottle forward. It's for the pilot. We watch him swig from a vodka bottle as we land. Should we stop him? We decide not. After all, abstinence could have fatal consequences if he's used to a couple of sharpeners on landing. We persuade ourselves it might have been water.

The airport is empty. A few old Tupolevs sit on the tarmac next to two bloated Antonovs with their sinister, drooping wings, engines covered. A small private jet with Arabic script on the body shines brightly in the evening sunshine. Far across the plain the mountains guard the city. Even when the city roasts in 40-degree heat the snow never melts. There is no-one except soldiers around -- though they look more alert and professional than the ones who milled aimlessly in Baku. The big clue to the country's economic standing sits in a far corner of the airfield: a dozen or more ancient bi-planes -- the Kyrgyz airforce?

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Kyrgystan's capital Bishkek: infrastructure and agricultural know-how needed

The huge concrete terminal building is deserted and we don't need it anyway. On the tarmac a huge black Soviet limousine sits next to the coach that will take us to Bishkek. A soldier takes our passports. We will get them back when we leave. We bypass customs, if there are any, driving straight from the taxi-way onto the main road.

This is a poor, rural place. The road in is long, straight and lined with huge willows. As elsewhere their bases get a whitewash. Old, gabled farmhouses jostle in leafy hamlets. To the left the fields stretch forever. To the right the mountains rise like ghosts from the plain.

The hotel confirms it. Baku, Tashkent and Almaty all have luxurious five-star accommodation. In Bishkek things are a little more basic -- and none the worse for that. We visit the local micro-brewery. Long trestle tables are quickly loaded with home-brewed beer, sausages, chicken, fried fish and chips.

Making a killing

Talk turns to privatization vouchers. Bizarrely, given its size and wealth, Kyrgystan has made many of the funds a lot of money. Local brokers hoard the vouchers and sell to a foreign broker who doubles the price and sells on to the hedge funds, keeping plenty back. The funds tell their friends about this new and exotic opportunity. The price shoots up -- one fund here quintupled its investment. When it's time to take profits, the hedge funds sell out to the mainstream emerging-markets funds that follow them around. The foreign broker also sells more from his stockpile.

In this merry-go-round it's hard to see where Kyrgystan itself fits in. Most of the population sell their vouchers to local brokers at the bottom. A few of those make a killing selling to their foreign counterparts. The big money is made by the funds and their supplier. Those left holding the paper often find it hard to get out. The vouchers turn out to be more difficult to use than they thought. The underlying assets are less attractive than they seemed. The market crashes. In Kyrgystan nothing has changed.

As ever Russia is a conversational mainstay. "We've bought Gazprom through a structure that Deutsche Bank has put together. There are other structures out there but the Russians are getting annoyed -- they might close them down. We bought the Deutsche version because we all know the Russian government is never going to alienate Deutsche Bank. Their structure will survive when the others are shot down. In two years the ring fence is gone and it won't matter anyway."

Again, the investors' approach to the market seems at odds with the reality. "Buy Rosneft subs [subordinated debt] -- owning the subs is risky but they are a special case because they have relationships with the majors. Or buy options on Surgut and use the cash left over to hedge." In a country where the law barely recognizes bankruptcy and shareholder rights, arbitraging senior versus subordinated debt seems absurd, inappropriately sophisticated. In a cash market that turns over $10 million to $15 million a day, individual stock options make roulette look scientific.

Suddenly there is commotion. A large foreigner is sitting with three Kyrgis. He is very drunk. He asks one of the investors where they fly out from. He claims they are a "security risk" and he wants to alert the authorities. There is only one airport in Bishkek so the answer questions his intelligence. The investors start heckling: they bring money into the country, they bring the salvation of the markets, you should be grateful they've come at all. Things get out of hand. The drunk makes for our hosts and their bodyguards step in. His bodyguards step in. There is a stand-off. Apparently much of the shooting in Moscow now involves bored bodyguards waiting for their charges. I wonder if our guys are armed.

A slight, moustachioed local addresses us. "We are [he names a local bank]. We own this market. I'lI make sure you guys never work in Kyrgystan again." Frantic diplomacy by our hosts and things settle down a little.

"Who was the drunk ?" "Oh, he's one of the guys who look after financial institutions for the EBRD in this region. He was just concluding a deal with that bank when it all kicked off. The bank thinks we've wrecked the deal."

The bank in question is already on the EBRD's small and medium-sized lending programme, so that sounds unlikely. The EBRD won't lend directly to local enterprises so it picks local banks -- four soon to be six in Kyrgystan -- and lends them the money. They on-lend to local companies and are responsible for collecting principal and interest. The system seems to work, though the potential for corruption is obvious. The EBRD man is escorted away mumbling: "Who were those guys? What did I say?"

There is a seminar in the hotel next morning. TV cameras record the arrival of so many distinguished potential investors. Maybe these are the strategic partners Kyrgyztelecom needs to modernize its network. Maybe these are the big western companies with the technical know-how and long-term investment capital to help them in the transition from Soviet domination.

The questions dispel any such hopes. They are obsessed with correlations. Is the Kyrgyz T-bill market correlated with Russia's GKO market? Do Russian interest rate moves affect the Kyrgyz Stock Market? The Kyrgis are confused. Interest rate moves don't affect the stock market. The hedge funds titter -- these guys don't even understand investing 101.

But it's the investors who don't understand. Only $1.5 million-worth of Kyrgyz bonds and bills are issued a week. It's the hedge funds that create the -- usually temporary -- correlations by pouring cash into these tiny markets as proxies for Russia. Anyway, some of the investors' strategies seem pretty unsophisticated too. "We buy options on stock and then put the cash into gekkoes [GKOs]. When the gekkoes fall below 30%, then you see people piling into the stock market, so we win both ways. Tom Madeira at ING was a great guy -- we bought all the options he wanted to sell."

Later the local companies present to the investors. Ibraimov, vice-president at Kyrgyz-telecom, is still looking for partners to take strategic stakes. The funds ask about lines per 1,000 inhabitants, the difference between trunk call and local tariffs, international versus CIS rates and salivate at the growth prospects. They'll buy. This fundamental mistake -- extrapolating developed world usage of technology onto Russia, China and elsewhere -- will cost them, and others like them, a lot of money. In the medium term, subsistence farmers in the hinterlands of these vast countries will not be buying TVs, PCs or telephones.

Culture clash

They like Bakai too. This is the Coke plant in Bishkek. It's the most successful company in the country. As well as selling all its sugar to Coca-Cola, it is the country's only alcohol producer and has a guaranteed monopoly. It has 4,000 individual Kyrgis as shareholders but 80% of the company is foreign-owned -- UK and US funds and Turkish Broker Global Securities.

Bakai buys sugar from Cuba at $305 a tonne and sells it to Coke at $450. So far so good, but even with interpreters it's hard to get a picture of the company. "Why are inventories so high?" "They're not." "That's what it says here." "Oh, here we call fixed assets fixed capital." "So the rise in sugar inventory is a rise in fixed capital?" "No, it is seasonal." We never do clear up the inventory issue.

One investor at least owns the stock. New York-based he is tanned and extrovert. He is married to an ex-Olympic swimming champion turned television commentator. He makes Ronald Reagan sound Marxist. The share was recommended by his broker and Coke's ability to sell in emerging markets remains unsurpassed.

The company wants to do a share issue. The representative says it proudly, expecting the assembled investors to be impressed. After all, that's what proper joint-stock companies do, isn't it? "Don't do that, don't dilute me you bastard," mutters the investor loudly. "Why do you want to do a share issue?"

Bakai wants the capital to build a polypropylene packaging factory -- they use plastic bags -- and to build a premium beer brewery. Oh, and they want to form their own bank. This will help in financing and also playing the stock market. The investor can see a chaebol forming in front of him. His enthusiasm for the Bakai is evaporating as fast as it first formed.

"He's lost his focus, lost his focus." He puts down the documentation and takes off his jacket. There is no aircon, nor water and it is midday. "It's a sell," he says -- loud enough to be heard.

One last question. "How does your pricing compare with other competing products?" Bakai vodka is better than the imports and cheaper too. No brand pricing here. "Oh my god, this company is in trouble."

The one mainstream emerging-markets investor in the group has also been asking around. He too has problems. His reflect reality. "It all sounded great -- stock market reform, good privatization opportunities, more assets on the block -- until I learnt how big the market is." How big? "Turnover can reach $1,000 a day. If you include the over-the-counter market between local brokers [of whom there are dozens] it sometimes reaches $10,000 a day."

Nomura Research Institute and Merrill Lynch are in Bishkek next week and apparently it's IMF head Michel Camdessus' favourite 'stan. But this is another country that needs long-term strategic capital and technology transfer. It doesn't need short-term liquidity support from the IMF contingent upon a raft of unsuitable economic policies. It doesn't yet need modern, developed capital markets. And it doesn't need the hedge funds' hot money.

A long way from Washington

It was clear Tashkent would be different. We were warned not to take material critical of the country off the airplane. Where before we had bypassed customs and been treated as dignitaries, here, in a brand new and empty airport, we were kept waiting for three hours while our passports were stamped. The investors began to show their true colours. "Don't these people realize that we're the ones with the money?" shouts one. "These guys don't know what they're doing. If they treat us like this how are they ever going to get anyone to invest. These guys need us and they're screwing us around."

Since they believe that US-style capitalism is the only way to run a country, they are bemused by an ex-Soviet republic unwilling to accept their assumptions without question. Since imitation of everything American is so widespread they do not understand a country that does not want to copy them. The Marlboro versus Coke struggle is less evident on the streets.

The IMF too is bemused. Uzbekistan is the bad boy of the region. It has a dual exchange rate system. It is privatizing at a snail's pace. It's stock market is ready -- rows of brand new 486 PCs sit waiting to run -- but empty. "We are a stock market of the future," explains the chairman. And the government, outrageously, seems to question the agencies' qualifications for telling it what to do.

From where they sit, it's a reasonable question. Do the IMF's Washington-based economists -- criticized by many of their US peers as other-worldly and just plain wrong -- know enough about the workings of such a distant and alien place to say what it needs? Water is more important in Uzbekistan than oil. The country's most fertile region, the Fergana valley, would not exist without Kyrgyz water. So, in summer Bishkek makes do with less power -- it swaps the water that drives its hydroelectric turbines for Uzbek crude. 

Hedge funds believe their dollars are the elixir that will liberate the serfs

Afghanistan needs the water too and the threat of invasion is never completely absent. The Taliban are over the border, some way south of Samarkand -- a city that has been razed before, notably by Genghis Khan. Unsurprisingly, the government is more worried about this, the Aral Sea in the north -- half its former size and shrinking -- cotton production, its uranium, gold, copper, lead and antimony mines than it is about free capital movement and stock- market turnover.

We meet the government in the astonishingly luxurious Tashkent Intercontinental. The restaurant at the top, with its 360-degree panoramic view of the city, is called the Pleasure Dome. This version was decreed not by Coleridge's Kubla Khan, but by Islam Karimov, the only Soviet-era regional potentate still ruling his republic. He has an interest not only in the hotel but in much of what passes for business in the country.

From the top we can see mostly trees, the wide avenues the police closed to let us through and a number of well maintained mosques. Directly below is a small funfair of the type the Soviets built in many cities for the free entertainment of the people. Next to this one is a télécabine across a lake. In the distance an ultra-modern tennis complex is testament to Karimov's love of the game. And overhead, the National Bank of Uzbekistan's gleaming new skyscraper is the only other tall building around.

Apparently we are fortunate to have microphones. Our local fixer explains that they are only available from the ministry of communications. "They have the only mikes in the country, so it's kind of hard to get off the ground if you want to start a pop group." The hedge funds begin to wonder what kind of people we are going to see.

The chairman of the privatization committee is a pleasant surprise. Young and fluent in English he takes us through the World Bank-sponsored privatization programme. The gov-ernment looks at privatization on a case-by- case basis and also runs a post-privatization support programme. A voucher scheme was rejected. Because the value of vouchers given to individuals is relatively small, instead of being encouraged to act as owners and shareholders, the people sell the vouchers in exchange for "bread and vodka". Vouchers are then concentrated in the hands of "a limited number of people -- mafia you might say". This means that people do not become actively involved in the capital markets. So far it's difficult to argue with the analysis, though to the listeners' disappointment there doesn't seem much scope for a quick killing.

A sensible strategy

Instead the government has chosen a fund-based strategy. "The people initiate the creation of investment funds and these funds buy the shares of privatized companies on the stock exchange. The funds can borrow interest-free from the government to invest. The advantages are that the people are initiated into the markets and are motivated to invest actively rather than to receive a passive gift."

Large-scale businesses are exempted from the general programme. This is partly for strategic and partly for social reasons. Whole oblasts -- administrative districts -- rely upon large state employers and privatization would throw thousands out of work. Again, in these large industries -- primarily cotton and mining -- Uzbekistan needs large-scale direct investment and technology transfer, not simply joint-stock companies and portfolio investors. Foreign banks and investors might not like it, but the Uzbeks' slow, piecemeal approach seems no worse than the shock therapies tried elsewhere. In 10 years we may be able to judge.

Worst of all from the hedge funds' point of view, there is a way to get rich quick in Uzbekistan. Jitendra Patel first came to the country with a suitcase of cigarettes and alcohol. On his business card there are two addresses, one in Tashkent, the other on London's Whitechapel Road -- a downmarket street in the east end of the city filled with sweat shops and family-run trading companies. He now owns cotton-gins [processing plants], real estate and is moving into mining via a shares- for-soms swap. He is reputedly worth millions of dollars. He does not look 30.

Arbitraging subordinated debt seems absurd in the absence of firm bankruptcy laws

He grew rich by being willing to invest in local businesses directly and on a sole basis. "If you go to the government and are willing to offer them money for a business, then they will sell. But if you want to go in as joint venture, meaning that they have to spend money, then they will pick and choose partners very very carefully." But again it has to be direct investment where investors take an active role in managing the companies they buy and through which companies' markets are expanded or their infrastructure is upgraded. The hedge funds can only look on in envy at Patel's returns.

The worst insult is left till last. The head of a new mining concern reminds the funds of Kazakhstan's experience. "They privatized everything and had the most problems in mining and minerals. The licences went out to locals with no technical expertise or cash so then they wait for a majority investor to buy them out. Here the government does things more sensibly. It sells to those with expertise. The problem with Kazakhstan is that it has too much democracy and too free a press."

With this profanity ringing in their ears the investors decamp to the Dutch Club, a nightspot whose music would not disgrace a top London venue and whose reputation keeps more devout local taxi drivers from taking visitors to its door. Most of its occupants are looking for foreign direct investment too.

"Civilization" at last

Last stop Kazakhstan. You know you're a long way from Washington when one of the most popular programmes on TV is Tu Tu Main Main, India's top comedy show. But for the funds, finally, we are in civilization. This huge country has a stock market, a corporate bond market, government paper is outstanding in the Euromarkets, there are big state concerns ready for the block and a new retirement fund has been set up to replace the state-funded pension scheme that should, by itself, guarantee an asset price bubble large enough to take quick profits from.

One of the investors is particularly bullish on the bubble. He has worked with Paul Tudor Jones and Lewis "The new Soros" Bacon. His family firm competed with Armand Hammer for Cold War commodity contracts from Prodintorg in the 1980s and has high-level contacts in Kazakhstan.

A writer and political economist he isn't shy about his motives for becoming a hedge fund manager: he wants to get rich. Like emerging markets maven Marc Faber, he believes that Kazakhstan will benefit from a re-orientation of world trade from east-west to north-south. He believes that the commodity price cycle will turn and that central Asia will be the biggest beneficiary.

More important in the short term though he has calculated that the funds available for investment in Kazakhstan are around three times the likely free float of shares post-privatization. Kazakhstan looks like the ultimate liquidity play. But he is also excited by opportunities such as Shymkent Refinery.

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Hot money has targeted Almaty in Kazakhstan. Investors are waiting for the bubble

Shymkent is an ex-Soviet refinery. It seems well equipped -- though few of the investors nodding knowingly at the mention of cat crackers knew what they were -- and well situated. It needs money and is looking for investors. However, for reasons that are not entirely clear, one of the men who runs it has spent a brief time uncharged in a Kazakh jail and had not been given back his passport when Euromoney left. In addition, the exact ownership of the company is something of a mystery. While Shymkent claims that the owners are no great secret, all we could find out was that government officials, a leading local bank and others are rumoured to have large stakes they might sell. In this regard Kazakhstan doesn't seem much different to Russia or any other pre-emerging market.

High above the city, past the heavily guarded compounds in which foreign officials and the local nouveaux riches live in palatial neo-classical homes, just underneath a huge mud dam which apparently has collapsed before with enormous loss of life, we eat in a traditional yurt tent. At least it would be traditional if it were not built on a steel gantry. Surreally, four trombonists serenade us with the theme to the Pink Panther. Kazakh hospitality is legendary in the region so our host must eat the sheep's head -- or at least the best bits, the cheek and eye. He has to be carried back to the hotel.

For a brief moment we find evidence of beneficial market forces. In Almaty the best vodka comes in beautiful bottles engraved with an eagle that changes size as the vodka is drunk. So do the Kazakhs understand the power of modern marketing techniques and have sophisticated manufacturing facilities? Unfortunately we cannot conclude this from the glassware. While the vodka is local, the bottles are made in France.

Lessons in reality

Everywhere we have been, government officials want the same thing: investors with extensive financial resources, technical know-how, marketing expertise and long-term commitment to the region. They neither need nor especially want portfolio investment, particularly the kind of short-term money supplied by hedge funds unless it represents an opportunity for personal enrichment. Intuitively they understand what has become clear from Asia: excess portfolio investment causes damaging speculative bubbles. It does not, as apologists claim, necessarily act as the seed for longer-term investment capital.

Nor does it necessarily cure inefficiencies by exploiting them. Most of the money investors make at this stage of market development is made by exploiting structural inefficiencies -- tax, regulatory or moral hazard -- which do not eliminate themselves like simple price anomalies.

Capitalism yes, global capital no

Capitalism -- even when diluted -- has proved itself better at providing prosperity for citizens of countries that have embraced it than any other organizing principle complex societies have yet found.

However, capitalism does not require the premature introduction of post-industrial financial techniques and management to economies not ready for them. As even George Soros now acknowledges (in two recent articles in The Atlantic Review) modern, inherently unstable financial markets controlled by a shrinking number of large financial institutions can produce dangerous and damaging social and economic dislocation. In developing markets these dislocations can be too much to take.

The introduction of capital controls in Malaysia and the equity market intervention by the Hong Kong Monetary Authority are only the first ominous signs of a backlash. Unless we change our approach to emerging markets -- and by extension mismanaged economies in the developed world, more intervention and less capitalism will become the rule rather than the exception.