Dubai Sends Markets into Chaos

“Dubai sends markets into turmoil,” begins the Financial Times. Dubai is a financial center, built on sand.

Probably a good thing US markets were closed. In Europe, the Dubai affair caused the biggest drop in 7 months. European banks have lent $40 billion to Dubai.

Emerging markets lost 2.1% yesterday. Worldwide, the loss was 1.5%.

Even gold lost a little ground.

Jim Chanos, a famous short seller, thinks Dubai is merely the camel’s nose in the tent, so to speak. “ China is Dubai times 1,000...if not a million.”

“People are panicking: this whole process counters everything that the rulers have been saying and the way it has been communicated before the holidays is confusing,” said one hedge fund manager.

The ‘rulers’ are the fellows who run “Dubai World,” and incidentally Dubai itself. Whether they are fools, knaves or sly geniuses was what everyone wanted to know yesterday. Dubai officials announced that they had raised $5 billion on Tuesday.

Two hours later they said they weren’t paying interest on it or on any of the rest of the $80 billion in borrowings. What’s going on? Are they really broke? Or are they playing for some kind of advantage?

“ Dubai gambles with its financial reputation,” says one headline at the FT.

Then, on the facing page, the editors think they know how the gamble will turn out:

“A breath-taking blunder in Dubai... Dubai is looking more like Argentina than Singapore – but a lot less predictable,” says the FT editorial.

No one is sure what is going on. Most people take from this story what we knew all along:

Lending to shady characters in sunny places is not an easy way to make money. Especially when the shady characters own the country.

Trouble is, shady characters run near all the world’s countries. If an investor cannot trust the ruling family of Dubai, how can he trust the commies who run China? Or the hacks who run the United States of America?

To err is human. For a central banker, it is practically a professional requirement. Count on a major ‘error’ to trigger a sell-off in the world’s bond market.

But Dubai’s mistake did not infect all other sovereign debt. German bond yields went down, not up. Investors sought safety from Dubai debt in Deutschland debt.

And gold sold off. Which makes us wonder: when investors get another big fright – say, when the stock market crashes – will they run to US dollar bonds...just as they did a year ago?

Yesterday, the dollar fell to its lowest level against the yen in 14 years. And Japan is back in deflation.

But what is the real meaning of what is going on in Dubai? It’s the story of the collapse of the financial industry. Dubai has no oil...no natural resources...and no real industry. The rulers tried to turn it into a financial center. Entirely financed by debt. And now finance itself is falling apart.

“The camel put his nose in the tent,” says colleague Simone Wapler. “He saw that there was nothing there.”

What will he think when he gets a closer look at Britain’s finances? Britain, too, relies heavily on the financial industry. And Britain, too, is heavily dependent on debt. Its public finances are among the worst in the world. Japan’s public debt, to add another example, is already 200% of GDP. It’s expected to reach 300% in a few years.

And yet, Japan – like the US and Britain – just keeps borrowing.

How long can this go on?

When will Britain, the US, and Japan announce their own moratoria on debt service payments?

“A couple years ago, there would be only a handful of bidders on a job. Now, there are hundreds of them. The guys who used to be putting up shopping malls and housing developments are now trying to get work from the government.

“There’s a lot of work.

They’ve got projects starting up all over the place. Most of them are a ridiculous waste of money. Those Homeland Security projects, for example, are a big joke. They are always buying computer systems.

Half the time they don’t work. The other half of the time, they’re just useless. You can see that just by looking at the news tonight. A couple of people just walked through the security systems at the White House and sat down to a state dinner. If they had wanted to they could have easily killed the president. Any determined and resourceful terrorist could do it. Fortunately, there aren’t many of them.

“Homeland security is a joke. But they’re spending more than the whole defense budget of France.”

US personal income rose in October. But it was boosted by government benefits, says David Rosenberg. Take away the free money from the feds and income actually went down.

Income has been going down for a long time in the US. English colleague Brian Durrant wonders why there is no revolution:

“Consider a country. For the top 20% of the population real incomes have increased by 60% since 1970. But for the other four-fifths real income has fallen by more than 10%. Am I talking about Guatemala or Bolivia? These sort of inequalities have in the past provoked resentment sometimes articulated through revolutionary movements and social unrest.

But I am not talking about a tiny Latin American state; these figures apply to the US. How can this be? Middle class America is surely better off compared to 1970; if you look at higher car ownership, better housing, more white goods and gadgets. The answer is debt. No wonder the politicians are frightened of it contracting!”

We have been saying that the last 10 years was a ‘lost decade’ in terms of income, employment and stock market growth. For most people, their whole adult lives have been spent slipping backward. Since the Carter Administration, the typical American has lost income.

A whole generation made no financial progress.

But they didn’t revolt. Instead, they borrowed.

It gave them more gadgets, gizmos and floor space. It also gave them the impression that things were getting better. Now we’ve reached the end of that period of debt expansion.

Now debt is contracting. So are lifestyles.