SERIOUS MONEY:Recent events in Dubai serve as a wake-up call that excessive world debt has not vanished, writes CHARLIE FELL
THE BOOK of Revelation 9:3-11 reads: “Then from the smoke came locusts on the earth, and they were given power like the power of scorpions of the earth; they were told not to harm the grass of the earth or any green growth or any tree, but only those of mankind who have not the seal of God upon their foreheads; they were allowed to torture them for five months, but not to kill them, and their torture was like that of the sting of a scorpion, when it strikes a man. During those days men will seek death, but will not find it; they will long to die, but death will elude them.”
There are 36 biblical references to locusts, and although the Bible’s relevance may be lost to investors, it is of interest to note that in Arabic, “dubai” means “locust”.
Recent events in the cosmopolitan emirate and playboys’ paradise serve as a wake-up call to investors that the excessive build-up of debt worldwide that so plagued global capital markets in 2008 has not simply vanished.
The $60 billion (€39.8 billion) of debt at the centre of the debacle pales in comparison to the $1.7 trillion of losses and writedowns that have struck the world’s banking system, but the uniform negative reaction across capital markets reveals how interconnected and highly correlated the markets have become.
Dubai existed as a barren, desert state with limited natural resources until the discovery of oil in 1966. Revenue from oil exports helped transform the city-state into a booming service-based economy that has embraced several aspects of western culture and technology wholeheartedly. The Al Maktoum family, which has ruled the emirate since 1833, embarked on a programme of economic development before the formation of the United Arab Emirates (UAE) in 1971 that was designed to build on the city-state’s reputation as an entrepôt for international commerce.
Substantial sums had been borrowed from Kuwait in 1960 to fund the dredging of the Dubai creek in order to provide a substantial improvement in trading capacity.
Revenues from oil exports began to flow in 1969, which fuelled infrastructure projects and development of heavy industries as a base from which the emirate could attract foreign investment and start expanding into a wider variety of industries. Diversification continued through the 1980s with the construction of substantial hotel capacity alongside the development of Emirates Airlines as vehicles to exploit the state’s tourism potential.
The improvement in Dubai’s appeal as an attractive destination for foreign investment continued with the creation of the first free trade zone at Jebel Ali in 1985.
Aggressive development continued through the 1990s and beyond with a sizable increase in numbers of free-trade zones, and creation of the Dubai International Financial Centre.
Economic diversification was an important strategic consideration, given the emirate’s oil reserves were relatively small compared with Abu Dhabi’s. Indeed, oil production peaked in 1991, and has been declining since. The emirate’s reserves are forecast to be exhausted within little more than a decade.
Diversification efforts, however, achieved their desired goal, and oil revenues today account for just 6 per cent of GDP. However, it is clear the emirate’s self-styled reputation in recent years as the Eighth Wonder of the World was neither desirable nor sustainable.
The emirate’s aggressive development strategy was increasingly built on real estate and tourism in recent years. As property prices and rents increased, real estate projects became more ambitious and foolhardy. Office rentals almost doubled in 2006 and added a further 55 per cent in 2007, while residential prices exhibited similar trends.
The global financial crisis woke Dubai from its fantastical dream and prices have since more than halved, with further declines in store as a result of chronic oversupply.
The modern-day Tower of Babel subsided in the desert sand as the misguided expansion contributed to a build-up in debt amounting to between $80 billion and $100 billion, or 100 per cent to 125 per cent of GDP.
Dubai has about $9 billion in payments due by March of next year and $50 billion over the next year, so the announcement that Nakheel, the property arm of the state-owned Dubai World, was seeking a delay in outstanding payments until May 2010 sent a shudder of uncertainty through the markets.
The fact that Nakheel is struggling comes as no surprise, but given that the ruling family sought to assure investors only days previously, and that Abu Dhabi, which provided funds to its smaller neighbour earlier in the year, had not come to the rescue, investors began to fear the worst.
The Dubai debacle will ultimately be resolved and is not of itself sufficient to spark a correction in the world’s capital markets. Liquidity remains abundant and has allowed market prices to move far ahead of the improvement in fundamentals.
The initial response to the announcement last week is an early warning signal that the world economy remains overleveraged, while markets have become highly correlated so that even a relatively small event can produce outsized effects. Liquidity has simply postponed the inevitable adjustment.
