You are here: Economy » The bust in Dubai and exogenous shocks
By now you have heard that Dubai World, the investment company, has asked its creditors for a six-month delay in repaying its debt (see articles in links). This is what is commonly referred to as default. Now many are wondering if Dubai the country is on the verge of default and asking who is most exposed. Markets are selling off in a major way. While this situation has been building for sometime, the announcement was an unexpected shock – an exogenous event – which has some talking about Creditanstalt and 1931.
Dubai is not an oil-rich country. It certainly has the greatest population amongst the United Arab Emirates, but oil and natural gas provide only 6% of income to the country. The country’s oil is expected to be depleted in as little as 20 years. Dubai is now much more dependent on its services like sporting events, trade and entrepôt services, and financial services and especially on property. So, when the Dubai property bubble went spectacularly bust in the credit crisis, Abu Dhabi, a UAE emirate with considerably more oil revenue, stepped into the breech in February.
Now, mind you Abu Dhabi’s sovereign wealth fund was rumoured to have lost a 12-figure sum in the financial meltdown in part because sovereign wealth funds from the Mideast recklessly poured capital into the American and European banking sector. Still, its support for Dubai calmed investors.
Even before the Abu Dhabi bailout, I thought the Dubai property boom and bust was a marvel to watch. In January, I commented:
I am fascinated by Dubai. They don’t have oil and they massively overbuilt. I would very much like to keep tabs on this economy because its position in the Middle East makes it a symbol for much of the interconnected financial bubble-like world we have just exited.
I think of the events in Dubai as having a bit of the butterfly effect to it – with everything selling off because of this one isolated incident. That was my thinking when I wrote the paragraph above 10 months ago, but I had since lost this particular storyline out of sight. If there was to be any global butterfly-effect contagion, I have been looking more to the Baltics and their property bubble (see this October post for an example).
But now that Dubai is back in the news, I have looked back in my archives to see what (if any) links I have had on the situation in the country. The last two were in April about developers defaulting and in May about an S&P debt downgrade. Since then – as the global equity markets have turned up – nothing.
What does this tell me? First and foremost, it hints at the fragility of this recovery and the real risk exogenous shocks pose. We are barely recovering now and a lot of debt and unemployment put us at stall speed, making the risk posed by events of this nature that much greater.
More importantly, however, the Dubai World events underline the unpredictability of exogenous shocks. All of these potential crisis situations — dollar carry trade unwind, debt crisis in the Baltics, oil price spike, an unexpected surge in interest rates, war in the Middle East — are still there lurking in the background. We don’t see coverage in the press on them everyday, but they are still there
I have been optimistic about the near-term prospects for the global economy in large part due to the myriad pro-cyclical effects of recovery. Longer-term, however, there are some serious obstacles to a sustainable recovery. This is not a garden-variety recession and recovery. It is a recession within a longer-term depression. And while we are in a technical recovery, I believe much of the fundamental problems which triggered this downturn are still there, lurking. The debt troubles at Dubai World bring this point home.
About Edward Harrison
Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.
Like us on Facebook
Follow Edward on Twitter
- The new normal that never was
- Negative interest rates are just a tax on reserves that lowers net interest margins
- The German current account surplus requires deficits elsewhere
- Is the Fed panicked about the downshift in the US economy?
- The Eurozone has been infected by the US slowdown
- Britain, Brexit, and sovereignty
- Why China cares about Japan’s negative rates
- My thoughts on the US Q4 2015 GDP numbers
- Is there a US Goldilocks scenario possible for 2016?
- The Saudis as the driving surplus oil producer
- The Fed rate hike and the potential for US recession
- When market contagion occurs, this is how it will happen
- Asset allocation in a period of wealth mean reversion
- The mess in Portugal is negative for debt sustainability
- Jensen: How long bonds could actually outperform equities
- Profit mean reversion and recession
- Credit Writedowns is ending paid subscriptions for now
- If we don’t understand both sides of China’s balance sheet, we understand neither
- Do markets determine the value of the RMB?
- China’s stock markets and revisiting 2011 predictions