The United Arab Emirate central bank (essentially the oil-richer than Dubai Abu Dhabi) stepped forward promising to provide the needed liquidity and back the debts. However, the markets viewed these developments as a matter of sovereign default with equities and commodities (including Gold) plunging as investors flew to short-term Treasuries and the Dollar.
The situation in Dubai is of little surprise to anyone taking a big picture view of the world’s economies. What we’ve essentially seen in the last two years is a massive transfer of private debt onto public balance sheets. This has been most pronounced in the US and UK, but even relatively sensible countries like Switzerland have engaged in the scheme.
Because of this we’re now in a transitional period in the US as we wait for the world to figure out that moving junk from the private sector to the public sector has simply increased the systemic insolvency to our include sovereign balance sheet.
In contrast, economies like Dubai don’t have this “waiting” period due to the fact that their debts always were public (the country is owned by the Royal family via its various holding companies). Because of this (and the fact that Dubai’s economy is largely driven by tourism and real estate: two industries that have been decimated by the credit crisis), it’s not at all surprising that Dubai is the first sovereign debt domino to topple.
Indeed, Dubai can be taken as a kind of metaphor for the developed world’s financial status. Long-time readers know that one of my central themes is the fact that the over the last 30 years the US economy has shifted from production to financial speculation. In Dubai, the situation was even more pronounced seeing as that country went from semi-developed to developed almost entirely on the back of financial speculation: at its peak, real estate and construction accounted for more than 22% of Dubai’s economy.
Financial speculation, whether it be in tech stocks in the US or high-end condos in Dubai, can create the illusion of wealth, but ultimately it is a ponzi scheme that requires a never ending line of bigger fools willing to pay higher prices for the underlying assets. And Dubai as a country was built on financial speculation: most of the construction and projects were built based on the hope that millions would flock to the Emirate to buy its luxury real estate, shop at the world’s largest malls, drink its expensively desalinated water (it is in the desert after all) and party at its luxury night clubs.
I spent time in the Emirate during its peak in 2007. At that time, the cracks were already beginning to show up in its capitalist illusion. Much of Dubai was a reverse ghost town with massive empty skyscrapers awaiting owners and businesses that would never arrive. And like any rushed, loosely regulated enterprise, the work wasn’t of the highest quality: a streetlamp caught fire while I was there.
Remember, this was a former desert town turned cosmopolitan metropolis within a 10-year time period. And it didn’t come from oil money (oil only accounted for 6% of the Dubai’s economy). Again, the entire economy was financial speculation: foreign investors and institutions setting up shop, drawn by the Emirate’s 0% corporate tax rate and the promise of 1.4 billion potential tourists within a six hour plane flight.
All of this came crashing down when the credit crisis began in earnest in 2008.
Since then, real estate prices have plunged more than 60%, entire projects have been brought to a halt and work visas revoked: 1,500 per day in fact. Expats fled the company, leaving 3,000 abandoned cars at the Dubai international airport’s parking lot (as of Feb. 2009).
The Emirate’s future-world development projects began crumbling… literally. The famous “world,” (a group of 45 man-made, private islands shaped like the globe) has begun melting back into the Persian Gulf. Other unfinished projects stayed that way… unfinished.
Indeed, Dubai as an economy was crashing. But you wouldn’t know it from the news: the Emirate passed a law making the publishing of any material that could damage it or its economy an offense punishable by $250,000 and jail-time.
However, those of us who read between the lines (any country that could have its economy “damaged” by a news article is in dire straits indeed) knew that something was up. And yet, it took a full six to eight months and a potential sovereign default for the world to catch on.
Which brings us to today: most of the policies enacted by the world’s central bankers have consisted of pretending that bad debts don’t exist. The biggest perpetrators of this are the US and the UK, but just about everyone has engaged in profligate monetary schemes in the last two years. This policy will work… until it doesn’t. The only problem is that when it doesn’t we’re going to see a second round of the financial crisis. However, this time it will be countries going bust, not just banks.
Put another way, the Dubai default is just the beginning. We’re likely to see more sovereign defaults in the coming years. The most likely candidates will those countries whose economies are based on financial speculation and easy credit — this includes the US.
Graham Summers – seekingalpha.com
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