Peter T Treadway also serves as Chief Economist, CT RISKS, Hong Kong.


November 29, 2009

The  Global Liquidity Bubble Claims Another Victim

As this letter goes out the world is scrambling to find out which banks and which countries are most exposed to Dubai and Dubai World, which has now announced it wants to reschedule its $ 60 billion in debt. Conveniently, Dubai chose to make its announcement during the American Thanksgiving holiday and on the eve of Eid, a four day Moslem holiday which will excuse the emirate from answering questions over that period.

Nothing like a news blackout and a big default to send global markets into a tailspin. Still, it appears that overall investors can relax. There appears to be little likelihood that the Dubai default will set off a new round of similar defaults in other countries. Dubai as will be explained is sui generis.

The Magic Kingdom Hits a Bump

Dubai is the real Magic Kingdom that Walt Disney would have built if only he’d had the money. The Burj Dubai, the world’s tallest building, the Burj Al Arab, the world’s tallest hotel, Terminal 3 at the Dubai International Airport, the world’s largest airport terminal, the Palm Islands, an entire residential community for multimillionaires in the Persian Gulf, Ski Dubai, the world’s only indoor ski resort in the desert— it’s a Walt dream list. Endless rows of skyscrapers define Dubai, many with architecture so daring as to make ultramodern Singapore and Hong Kong look stodgy. Dubai is at the cutting edge of the human imagination. Financed of course by the excess liquidity from the global bubble machine and the malfunctioning international monetary system. And now its latest victim.

This author has made several trips to Dubai in the last few years. I have walked through the immense malls, listening to never-ending piped in Christmas music and observing women in black head to toe burkhas, shopping in Louis Vuitton. I have observed hordes of tired and dazed looking Indian and Pakistani laborers wandering aimlessly around the Dubai creek on their half day off on a Friday afternoon. I noted the abundance of middle aged Russian men in nightclubs, arm in arm with six foot, twentyish, blond Russian “models”. I listened as the voices from the mosques called the faithful to prayer. I felt like I was in India as most of the service and taxi personnel were from that region and spoke in English. (Mumbai should look as good as Dubai!)

I asked myself where all the money came from to build this fantasy land, where the buyers would come from for all the condos under construction and what Dubai really did for a living. It wasn’t oil, as Dubai has little of that. Were sun seeking Western tourists, Middle East oil money looking for a home, trade with India and Iran, the stock exchange with its handful of traceable stocks, Russian men with their hot Natashas, Halliburton with its corporate headquarters in Dubai, enough to support all of this? Dubai was different I was told. Bubbles happened somewhere else.

Well now we know some of the answers. The money was borrowed and not enough people showed up to buy a piece of the Magic Kingdom. Dubai can’t pay back its loans. Dubai as it turned out was no different from Las Vegas or Miami or London or the south of Spain.

Panic Is Unwarranted About Emerging Markets

Dubai is different.

Allow me some observations:

1. The Dubai default is sui generis. The majority of countries in the Persian Gulf have oil and gas and lots of dollars. They can afford their extravagances, none of which on a per capita basis are likely to come close to Dubai’s. Kuwait, Saudi Arabia, Iran, Qatar, Abu Dhabi, Iraq (technically not on the Persian Gulf) – that’s where so much of the world’s energy is buried. Bahrain (population 1.05 million) and Oman (population 2.6 million) have oil and gas but are underendowed energy-wise relative to their neighbors. But both have been run in far more conservative manner than Dubai.

2. Bank losses from the crisis beginning in 2007 reportedly exceed three trillion US dollars. Lehman Brothers alone accounted for $613 billion in liabilities. The Dubai debacle is minor by this standard even if it turns out the number is more like $100 billion rather than $60 billion. Dubai will not become Demon Brothers.

3. The lenders and Abu Dhabi will share in the pain of restructuring. Anybody with eyes could see the excesses that were happening in Dubai, fascinating as it was. The lenders whoever they are get no sympathy. Abu Dhabi unfortunately has oil and money and, as the “senior” emirate in the United Arab Emirates (UAE), will get stuck paying for the excesses of its profligate Dubai brother. The next few months will see hard negotiations between the foolish lenders and Abu Dhabi. Of course it might make a difference depending on whether the bulk of the lenders were local vs. international banks. A column in this weekend’s Financial Times referred to the “assumption – unwritten but widely believed –that Abu Dhabi would be on hand to pick up the pieces if the emirate’s (Dubai) bubble burst.” Hmn. That sounds familiar. Didn’t Fannie and Freddie have their own implied guarantees from Uncle Sam? Never Give a Sucker an Even Break was the title of a 1941 WC Fields movie. That’s the advice I’d give Abu Dhabi. Play tough. Uncle Sam can’t keep his wallet in his pants. He’s not a good role model.

4. Dubai should be viewed as a busted real estate deal. Busted real estate deals get restructured and life goes on. Dubai will still be an exciting place. Remember Canary Wharf. It went broke in the 1990s but like a phoenix it arose out of bankruptcy to become one of London and the world’s most successful real estate developments.

5. The UAE is an important ally of the United States and is the location of an American military base. Just ninety short miles across the Gulf and you are in Iran. It is in America’s interest to make sure this Dubai debt debacle has a reasonably happy ending. The seven emirates in the UAE used to be called the Trucial States and were a British Protectorate. (It’s unclear who the British were protecting the Trucial states from. Perhaps it was the British. Or one another as the emirates had occasional territorial wars among themselves.) America has a geopolitical interest here.

6. Statements made by some prominent analysts on Friday that this would set off a series of defaults in emerging markets don’t make sense. The so called emerging market countries, notably Brazil, India , China, Taiwan, all of Southeast Asia (except Vietnam), Chile and even Mexico, have been deleveraging since the crises of the nineties and most have a surfeit of dollars. The emerging market countries are not going to default on anything. Big sell offs in emerging market stocks as a result of the Dubai default and the so called flight from risk trade don’t make sense. Of course it’s yearend for portfolio managers. Those who bet correctly on the rebound in emerging market stocks in 2009 might be looking for an excuse to take profits. A buying opportunity for everyone else if they do. The January effect in action.

7. I continue to be optimistic about India even though India and Dubai have close economic and trade relationships. From all first accounts Indian banks and real estate developers were not exposed in a major way to Dubai and Dubai World. With their long involvement in Dubai and the Middle East, they may not have been more aware of the risks and did not go as ga ga over Dubai as apparently did certain London based lenders. The risk to India lies outside the banking sector. Hundreds of thousands of Indian (and Pakistani) laborers have worked in Dubai. Remittances back to India, especially to the southern Indian state of Kerala, have been significant. But Indian employment in Dubai has been declining for the last twelve months. The blow has already been partially delivered. I continue to believe that India, with the semi-reformist Congress Party firmly in control for the foreseeable future, is in a long term bull market. Again, sell offs in Indian stocks would be a buying opportunity. India may take a hit but it will get by it. Sell Infosys or Wipro because Dubai can’t pay its bills? Not rational. Indian bank stocks took a hit on Friday but in fact that may have been an overreaction.

8. If you are looking to avoid risk there are other places you might avoid first. Like Spain, Italy, Greece, Eastern Europe … The UK? Vietnam excepted, the emerging markets are not where the risk is. As this went to press, three major UK based banks reportedly had the largest exposure to Dubai World. News reports said these banks exposure was “manageable.” Still, if you want to worry…

Peter T Treadway also serves as Chief Economist, CT RISKS, Hong Kong.

Peter T Treadway, PhD
Historical AnalyticsLLC
pttreadway -at-
305 761-4718
852 940-91186

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