How The Surging Philippine Peso Reflects On Global Inflationism

``But the administration does not want to stop inflation. It does not want to endanger its popularity with the voters by collecting, through taxation, all it wants to spend. It prefers to mislead the people by resorting to the seemingly non-onerous method of increasing the supply of money and credit. Yet, whatever system of financing may be adopted, whether taxation, borrowing, or inflation, the full incidence of the government's expenditures must fall upon the public. With inflation as well as with taxation, it is the citizens who must foot the total bill. The distinguishing mark of inflation, when considered as a method of filling the vaults of the Treasury, is that it distributes the burden in a most unfair way, overcharging those who are least able to bear it.”-Ludwig von Mises The Truth About Inflation

The Dubai Bugaboo

The recommendations of most of the local institutional analysts quoted in the media at the start of this abbreviated week had mostly been bearish. And if anyone did heed on their calls they would have regrettably stampeded out of the market for the wrong reasons. That’s because these analysts have interpreted the initial shock waves from the Dubai Crisis as having a lasting impact. Their fundamental premise: Dubai’s adverse effect on the OFW market.

I find it peculiar to read highly paid analysts to babble on false causalities based on spurious evidence. I guess they are paid not to be “right” or “profitable” instead they are there to say what people would like to hear, or to confirm on other people’s biases. Well one doesn’t need to be an “expert” (CFA) to employ “available bias”- or the fallacy of attaching recent events to market actions.

As discussed in Why Dubai’s Debt Crisis Isn’t Likely THE Next Lehman, the Dubai Debt Crisis seems to validate our outlook, which we deduced as more influenced by politics than by plain vanilla economics.

“A political struggle going on” says this New York Times article, “Analysts say Abu Dhabi has long been unhappy with Dubai’s independent, free-spending ways — and its strong trade links with Iran, which sits just across the Persian Gulf but is considered an enemy by most Sunni Arab states.” (bold highlight mine)

This from Oxford Analytica as quoted by Research Recap, ``OxAn suggests payoffs for Abu Dhabi’s bailout might be on a political level rather than commercial via, for example, a stake in Emirates Airlines: -Abu Dhabi could demand a strengthening of federal authorities, while Dubai would need to relinquish certain sovereign rights, such as the control of customs, which so far remain at the level of individual emirates. -Hints at increased centralisation are already discernible, with Abu Dhabi and federal institutions playing a more visible role in national development policy and Sheikh Mohammed increasingly appearing in his role as prime minister of the United Arab Emirates (UAE) rather than as ruler of Dubai. -In particular, centralised control of customs — in exchange for financial help — would give Abu Dhabi a firmer grip on the implementation of sanctions policies against Iran, which has been repeatedly demanded by Washington in the past. Such a move would also serve its own tough stance with regard to the regional ambitions of Iran. Interestingly, despite the blow Dubai has taken as a financial center, OxAn thinks that more regulation of capital markets, and a unification of the stock markets in Dubai and Abu Dhabi, could strengthen the position of the UAE as a niche player in international capital markets.” (bold emphasis mine)

Moreover, in addition to last week’s argument, Dubai accounts for only 26% of the UAE’s GDP (2006) with Dubai’s share of gas revenues at only 2% (wikipedia.org).

Besides, even if we tally up the remittance data, the entire Middle East accounts for only 15% of the global share (see figure 2)

Figure 2: POEA: OFW Remittances By Origin

In addition, in contrast to conventional expectations, the UAE registered the largest growth in OFW deployment in terms of new hires and rehires, in spite of the crisis year of 2008 (60.6%). UAE is followed by Qatar 49.9% and Canada 40.5% according to the POEA.

This means that to lump the Dubai Debt woes to UAE or to other Middle East countries would be terribly shortsighted and account for sloppy analysis.

Philippine Peso A Manifestation Of Global Inflationism

Besides since mainstream associates the price direction of the Philippine Peso with that of remittances, this week’s fantastic 2.55% jump of the Peso to Php 46 vis-à-vis US dollar implies that the Dubai Credit Crisis has been a discounted factor.

If indeed the Peso has a strong correlation with that of remittances then the Peso should fall and not firm up. However, we don’t subscribe to the mainstream view that the Philippine Peso is entirely about remittances [as discussed in Claims Of The Peso’s Dutch Disease Is A Symptom Of Political Hysteria or in What Media Didn’t Tell About the Peso].

Figure 3: Phisix-Peso Correlation

In spite of the 2008 crisis, the growth in OFW remittances accelerated by 13.7% (Inquirer.net), yet the Peso fell by a staggering 19% from around 40.5 to 50 (see figure 2 left scale, line chart)…so much for specious mainstream reasoning.

In contrast the Philippine Peso has mainly manifested the state of global liquidity flows during both the crisis and post crisis period. And this can clearly be seen in the Phisix-Peso chart.

The correlation between the Philippine Peso and the Phisix (black candlestick) may not be precise but the general trend is quite observable.

During the bear market of the Phisix from October 2007 to October 2008 (red descending line), the Peso likewise fell (red ascending line). Notice that the inflection point of the Peso (left blue arrow pointed up) lagged the Phisix (left blue arrow pointed down) by about 3 months.

We see the same motion during the last turning point.

As the Phisix bottomed in October of 2008, the Peso belatedly bottomed about a month after. From then, both the Phisix and the Peso has strengthened. The recent breakout of the Peso even came amidst repeated interventions by the Bangko Sentral ng Pilipinas (BSP) or the Philippine central bank to subdue the Peso’s rise aimed at promoting the mercantilist perspective of protecting exports and enhancing the purchasing power of the OFW.

Of course it is pretty naïve and myopic for our officials or mainstream “Keynesian” experts to oversimplistically associate weak currency with stronger exports or with expanded purchasing power for the OFWs. That’s because theory and experience tells us that this is NOT true.

Whatever the gains from inflating the system to weaken a currency will always be temporary, that’s because inflationism results to a lower standard of living, capital outflows and a lower purchasing power of the currency will offset any short term gains [as discussed in The Evils Of Devaluation].

Besides, inflationism only distorts a nation’s production structure that would benefit a few at the expense of the rest of society (see Joe Studwell exegesis below)

The Peso fell from Php 2 during the 60s to Php 55 in 2005 and still lags in terms of goods and service exports relative to its neighbors. Instead of goods exports, we became a major exporter of manpower, of course with the attendant social costs.

Why the Philippines failed to become an export giant? Primarily, because of the anti-market policies that protected the interests of the political and economic elite.

Joe Studwell in Asian Godfathers explains (all bold emphasis mine): ``The reaction of local business to the multinational exporters, welcomed back so soon after foreign enterprises that grew up in the colonial era had been kicked or bought out, is telling. Small firms found innumerable opportunities supplying parts and components and services to multinational investors. But their ability to move up the value chain was inhibited by a lack of scale that left them without resources for research and development. Tycoons, on the other hand, had scale and access to capital, but were rarely interested in working in the export sector. The reason is simple. Exporting is a globally competitive business. Where the godfathers outperformed was in trading on the inefficiencies of south-east Asia’s domestic economies, whether in the form of politicians’ willingness to disburse monopolistic concessions on the basis of personal relations or through the profits to be made when governments tried to micromanage industrial development. For tycoons, the benefit of EOI (Export Oriented Industrialization) was significant but indirect: the growth produced underwrote the continued relationship between political and economic elites and eased pressure for deregulation of domestic economies. Public work projects without tenders, and privatizations decided behind closed doors, where politically much more feasible when exports were driving the growth in the south-east Asian economy.”

In short, another evil promoted by inflationism is the economic fascism brought upon by complicit crony-state capitalism.

So while we can usher in a new popular president, unless the anti-market structures are dismantled, we ain’t gonna see much of an improvement on the political economic spectrum. Populist policies are likely to harm than aid the plight of Filipinos.

Instead of an organic growth, the Philippine economy will be dependent on the tidal flows that accrue to its neighbors and the impact of policies to imbue more debt.

Asian Outperformance and Path Dependency

It would also be fundamentally incorrect to suggest that the Asia can’t benefit from a policy based bubble cycle despite the slack from developed economies.

That would translate to “anchoring” or the reading past performances or interpreting past models as tomorrow’s dynamics.

Figure 4: Danske Bank: Asia Decoupling Is Back

Fundamentally Asia has led the world out of recession see figure 4. China and the rest of Asia have massively outperformed the developed country economies. As we wrote in Following The Money Trail: Inflation A Key Theme For 2010, ¾ of the economic losses of US, Europe and Japan in 2008 to the tune of $580 billion have been offset by China’s $450 billion growth. And we are seeing this outpeformance in Industrial production and domestic retail sales.

That’s basically because of low systemic leverage, high savings rate, unimpaired banking system, current account surpluses, a trend towards deepening regionalization and integration with the world economy.

Moreover, because of these inherent advantages, aside from fundamentally pegged currencies (by varying degrees) on the US dollar, monetary policies of the US are being transmitted to Asia.

As David Malpass rightly argues against zero interest rates in an article at the Wall Street Journal,

(all bold underscore mine),

``The irony of the zero-rate policy, coupled with Washington's preference for a weak dollar, is a glut of American capital in Asia (as corporations and investors shun the weakening U.S. currency) and a shortage at home. For gold and oil, the low-rate policy works, weakening the dollar so commodity prices go up and providing traders with ample funds to buy into the expanding bubble. Those markets are almost daring the Fed to try to break out of its zero-rate box….

``According to International Monetary Fund data, U.S. GDP has fallen to 24% of world GDP from 32% in 2001. And as U.S. capital escapes the weak dollar and high tax rates, the U.S. share of world equity market capitalization has fallen to 30% from 45%. This leaves the U.S. alone with Japan at the bottom of the monetary heap, with rate expectations so low they repel investment.”

Hence, US policies combined with local policies have generated significant traction. This we believe is the trigger for the policy induced Asian-emerging markets business cycle or boom-bust cycle.

Proof?

In the Philippines, the following are headlines from our Bangko Sentral ng Pilipinas: Automobile Loans Up by 5.1 Percent From Last Quarter, Credit Card Receivables Up By 4.6 Percent From Year Ago, Residential Real Estate Loans Stand at P162.5 Billion in Q3 (down 1.4% over the quarter but up 13.1% from last year), Other Consumer Loans Stood at P36.7 Billion in Q3 (down 2.6% from last quarter but up 12.8% from a year ago) and November Inflation at 2.8 Percent.

In short, systemic leverage has gradually been picking up in response to these policies.

True, markets may not move linearly but policies to reflate the system has clearly shown divergent impact on individual economies and in the marketplace. This implies that trying to read economic dynamics as one size fits all is virtually flawed.

What ailed the US in the Bear Stearns-Lehman episode in 2008 isn’t likely to be repeated soon. That’s because policy makers are likely to engage in path dependency as guiding principle for their decisions.

Path Dependence according to wikipedia.org is a ``set of decisions one faces for any given circumstance is limited by the decisions one has made in the past, even though past circumstances may no longer be relevant”. Bank Of Japan’s decision to implement a new QE program is a testament of this- due to the alleged fear of systemic deflation, the applied solution stems from the apparent triumphalism from the recent money printing nostrum utilized by their peers.

In other words, policy approach has all been directed to combat another Stearns Lehman episode at a future unseen cost. That’s why tunneling on a deflation scenario won’t be advisable.

This also means we should understand the political incentives guiding the actions of the political and bureaucratic leaders to address financial and economic issues than simply analyzing economics exclusive of political goals. For instance, as discussed in 5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects, we identified why the US banking system has been in a US government guided therapy known as the ``bank as trader” model.

Conclusion

To recap, the Dubai debt crisis as an issue to be bearish would be a mistake. There are larger factors that affect the markets or even the Philippine Peso such as the cocktail mix of the US government monetary policies, local policies and intrinsic idiosyncratic traits for each economy.

Moreover, in contrast to conventional wisdom, remittances essentially have not been the prime factor that drives the direction of the Peso’s pricing levels. Instead the Peso has reflected on the policy induced decline in the US dollar, which is a manifestation of global liquidity. That’s the reason the Peso and the Phisix has had a strong correlation.

Although the Peso has been mostly a lagging indicator relative to the Phisix, the recent breakout of the Peso should augur well for the Phisix.

Finally, path dependency will likely guide the actions of policymakers. That’s why we view a Bear Sterns-Lehman episode of 2008, which caused a seizure in the US banking system, as lesser risks in contrast to a spike in inflation. In other words, governments are likely to engage in sustained inflationism.

The effect of inflationism will ultimately be unraveled but like all business cycles, this takes time and massive “clustering” misallocation of resources. Eventually, in spite of government actions, the marketplace will manifest on such strains.

For the meantime, inflationism appears to be in a sweetspot.

The Peso and the Phisix is likely to resume its ascent in 2010, with the latter likely to breach its old highs and may even attempt to reach the 5,000 level.

Dubai's Bubble Cycle 2: The Real Estate Crash

Here's a chart from Business Insider's Clusterstock illustrating the recent real estate crash of Dubai.

From Business Insider: ``Far too much easy money flowed into Dubai during previous years, fueling a massive construction boom financed with debt. For awhile this debt looked sustainable to those involved because it was ostensibly backed by valuable property.

``Yet when the global financial crisis hit, property prices fell in many parts of the world. Dubai property prices were hit especially hard.

``Dubai property rates per square foot fell 45% from Q3 2008 to Q3 2009 according to Colliers International.

``Thus just as many American's went underwater on their mortgages due to the American property crisis, owing more to the bank than their house was worth, the same thing basically happened to the Nakheel property business of the Dubai state-owned conglomerate Dubai World.

``Combined with near-term cash flow constraints, this finally forced Dubai World to admit to its creditors that it would not be able to meet all of its debt obligations.

Dubai's Bubble Cycle

Dubai's imploding bubble is another lesson that needs to be taken heed.

Inflationism can be initially seductive and temporarily gratifying, but comes at an excruciating price as a result of non-economically feasible projects or misallocation of resources.

The chart from Bespoke Invest is a harrowing depiction of the unraveling Dubai Bubble cycle as reflected on its stock market benchmark.


Bespoke explains, ``Since 2004, Dubai's stock market has taken investors on a wild roller-coaster ride. Unfortunately, investors are at the bottom of the ride and not the top at the moment. From the start of 2004 to November 9th, 2005, the DFM General rose a whopping 748% as oil prices shot up along with the global economy. After the DFM General peaked on 11/9/05, however, it declined 57% over the next year and a half. The index staged a 72% snap-back rally from 4/3/07 to 1/15/08, but then it jumped on the global meltdown bandwagon and has declined 71% since then. Currently, the DFM General is down 78% from its peak on November 9th, 2005, but it is still up 83% since the start of 2004."

To quote Professor Ludwig von Mises, ``Continued inflation inevitably leads to catastrophe."

Market Myths and Fallacies On The Dubai Debt Crisis

``Economic history is a never-ending series of episodes based on falsehood and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited" -George Soros

For an abbreviated trading week, the US Federal Reserve bought $11 billion worth agency debt, mortgage backed debt securities and US treasury. Tyler Durden of Zero Hedge notes that the balance sheet of the Federal Reserve has “hit a new all time record of $2.2 Trillion in assets”.

Following their failed prediction for a market collapse late October, the “desperately seeking normal camp” are back with their old antics of forecasting a deflationary doomsday or the “end of the bear market rally”, following the latest market volatility prompted for by the events at Dubai.

Dubai through its state owned Dubai World asked “creditors for a “standstill” agreement as it negotiates to extend debt maturities” (Bloomberg) last November 25^th, which apparently rattled Europe first, whose shockwaves reached Asia, and belatedly to the US-since the latter was on a Thanksgiving holiday when the Dubai debt crisis surfaced.

We then read headlines of “Era Of Green Shoots Over” or “Hyperinflation in Reverse” or “Mark End of Risk Trade” or emotive comments like ``The stock markets and the bond markets are in violent disagreement, and at some point, it is going to be resolved by a sell-off in the equity markets” (New York Times) to even a simpleton “expert” swagger at a Bloomberg interview claiming that “when a crisis emerges everyone runs to the US dollar”.

Figure 1: stockcharts.com: Dubai Temblor

As one would observe in Figure 1, upon the revelation of the Dubai debt crisis on the 25^th, the US dollar fell steeply to a 17 month low rather than functioned as safehaven, as fictitiously alleged by the expert.

It was the next day, Friday, when the violent US Dollar rally occurred, which inversely took down commodities as gold. Babbling from the perspective of Friday’s action as a generalized trend is blatantly misleading.

However, the rally appeared like a knee jerk response. The USD gave back most of its gains but still ended the session 1% higher. This huge reversal was equally reflected on the commodity markets.

Yet despite the sharp intraday fall of gold, the former commodity money bounced mightily until the end of the session. Over the week gold registered a 2.3% gain, just a few percentage points (about 1.5%) off its fresh record high $1195, established Thursday, incidentally when the lid of the Dubai crisis was uncovered.

It takes a lot of chutzpah to make logically false claims on air.

I would like to further point out that the rally in bond markets have been an ongoing event since late October as shown by the record move of the 2 year Treasury bill (see window $USTU). This means the rally has fundamentally little to do with the Dubai crisis, and could likely reflect on position squaring for sprucing up year end balance sheet goals of financial institutions and or importantly, a manifestation of the distortions from government interventions.

To interpret for a “violent disagreement” that would be resolved by a selloff in the stock markets accounts for as nothing more than a preconceived bias which fallaciously underestimates the political imperatives by the US government (or even global governments) to support asset markets with the ultimate aim to uphold the survivability of the US banking and financial sector.

Proof? A Bloomberg report as quoted by the Credit Bubble Bulletin: ``French Prime Minister Francois Fillon said Dubai’s request to reschedule debt repayments shows the global financial crisis “is not over” and that stimulus efforts must be maintained to avoid “breaking the weak recovery.’” (emphasis mine)

Figure 2: New York Times: Tsunami Of Debt

If there is any asset market that would likely experience a bust as a result of the reversal of bubble conditions, it would primarily be the US treasury market.

According to the New York Times, ``With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.”

$1.9 trillion of debt required for refinancing + $1.5 trillion in additional deficits + $ .2 trillion in interest payments=$3.6 trillion of financing required for 2010! Since US and global savers (particularly Asia) are unlikely to finance this humungous amount, [other parts of the world will require debt financing too (!!)], the available alternative options appear to be narrowing-the Federal Reserve would have to act as the financer of last resort through the Bernanke’s printing press or declare a default. Of course, Bernanke could always pray for a “Dues ex machina” miracle.

So embracing a bond bubble “out of deflationary fears” would be like a Turkey accustomed to a plethora of feeds but is unknowingly headed for the Thanksgivng day kitchen.

We might like to add that Europe’s stocks as represented by $STOX 50 appears to have been diverging with US stocks, even prior to the Dubai episode. While US stocks are off the new highs, European stocks have been flaccid since mid November. The Dubai debt crisis has only exacerbated the sentiment rather than ‘caused’ it.

And another important perspective missed by the mainstream is that China’s Shanghai bellwether, which lost 6.4% this week (as seen in the $SSEC window), has likewise been languishing even prior to the Dubai episode.

Bottom line: Volatile market action during the week has been aggravated by the Dubai debt crisis instead of a Dubai prompted meltdown. Hence, to interpret this week’s volatility as a start of cross cascading market selloffs would likely account for as another gaffe in a disgraceful menagerie of errors.

Eventually since markets operate on cycles driven by government policies, there will be another crash due to mounting unsustainable imbalances. But as a cliché goes, even a broken clock is right twice a day, which means wrong conclusions from false premises will be peddled until markets will confirm their outlook for “timing” reasons.

Why Dubai’s Debt Crisis Isn’t Likely THE Next Lehman

``In the first place, government must cease inflating as soon as possible. It is true that this will, inevitably, bring the inflationary boom abruptly to an end, and commence the inevitable recession or depression. But the longer the government waits for this, the worse the necessary readjustments will have to be. The sooner the depression-readjustment is gotten over with, the better.” Murray N. Rothbard Economic Depressions: Their Cause and Cure

The unraveling of the Dubai debt crisis during the US Thanksgivng holiday may have contributed to the sharp gyrations in the marketplace. The dearth of information speedily led to emotions based speculations. Since there was a paucity of information from the details surrounding the Dubai Debt Crisis, perhaps some investors made decisions or projections anchored on a leash or a chain effect where countries sensitive to leveraged balance sheets will likewise suffer from debt woes.

And perhaps that’s the reason why some selloffs had been broad based (except in parts of Latin America) and not limited to the banking system or to some crisis affected countries.

We even read some even citing the Dubai Crisis as evolving to “Icelandic proportions”.

Figure 3: Bespoke Invest/Bloomberg: Dubai CDS

It’s a folly to trade based on emotions but as we wrote in Dubai Blues As Seen In CDS, It's All About Perception!, we have to look at the bigger picture than react intuitively like our ancestors during the hunter gatherer era in the face of wild predators. Technology has given us the privilege of accessing global information at the touch of our fingertips.

So we basically agree with Bespoke Invest that the recent market carnage seems as a vastly exaggerated reaction, as per Bespoke, ``As shown in the Bloomberg snapshot of Dubai's historical sovereign debt credit default swap price, the recent spike up to 600 bps or so isn't even near the level of 1,000 bps seen earlier this year. Had Dubai's default risk spike earlier this year been an isolated event like it is this time around, it would have made news back then. At the time, however, default risk was spiking for the majority of developed nations as well, so Dubai was the least of our problems. Now that global markets have stabilized and exited crisis mode, an isolated event in Dubai where default risk doesn't even spike to its 2009 highs has caused a global market selloff." (bold highlights mine)

In a rush to drum up a contagion effect, some have even mistakenly, in my view, placed the entire United Arab Emirates at risk!

The United Arab Emirates is a federation of seven emirates, particularly Abu Dhabi, Dubai, Sharjah, Ajman, Umm al-Quwain, Ras al-Khaimah and Fujairah.

Dubai is only the second largest emirate, while the Abu Dhabi serves as the seat of the national government. Abu Dhabi according to Wikipedia.org, ``is also the country's center of political, industrial, and cultural activities.”

Dubai’s meteoric rise via profligate projects produced many of the world’s landmark projects (boondoggles), such as the only seven star hotel, the Burj Al Arab, the world’s tallest skyscraper, Burj Dubai (uncompleted), biggest indoor ski slope, Ski Dubai, largest shopping mall (in terms of total area and not gross leasable space), the Dubai Mall, the world’s biggest theme park, the Dubailand and the Palm Islands, the Palm Jumeirah, has virtually challenged Abu Dhabi’s role.

Figure 4: McKinsey Quarterly: The New Power Brokers

To consider that Abu Dhabi has still the world’s largest sovereign wealth fund estimated at $470-740 billion as shown in Figure 4, despite suffering an estimated $125 billion of losses last year due to the contagion effect from the US mortgage crisis (Bloomberg).

Meanwhile the debt burden accrued by Dubai World, Dubai’s investment arm, is estimated by UBS AG to be in the range of $80-90 billion, which includes its property arm unit, the Nakheel PJSC, which has some $3.52 billion of Islamic bonds due Dec. 14. (Bloomberg)

This means that Abu Dhabi could easily extend a bailout if it so desires, without necessarily roiling the markets. But it didn’t. Although we understand that some Abu Dhabi banks already have loan exposures estimated at $5 billion to Dubai prior to the Dubai Crisis (Reuters).

The point is, this may not necessarily be confined to an economic “debt problem” spectrum but to one with a political face. Perhaps Abu Dhabi desires to impose some sort of discipline or temper Dubai’s spendthrift ways or politically revert Dubai to her role as supporting cast.

So a contagion risk is not necessarily in place.

Second, it would be another mistake to argue that the Dubai Debt Crisis is outside the jurisdiction of the major central banks.

The fact that the biggest underwriter of loans to Dubai World is the Royal Bank of Scotland Group, which according to Bloomberg, ``RBS, the largest U.K. government-controlled bank, arranged $2.3 billion, or 17 percent, of Dubai World loans since January 2007, JPMorgan said in a report today, citing Dealogic data. HSBC, Europe’s biggest bank, has the “largest absolute exposure” in the U.A.E. with $17 billion of loans in 2008, JPMorgan said, citing the Emirates Banks Association”, means that major central banks have direct and indirect influence on Dubai’s credit predicament.

As Bob Eisenbeis of Cumberland Advisors rightly explains, ``US financial institutions are not exposed to Dubai to the significant extent that European institutions are. Furthermore, discount-window and other borrowing facilities are already in place, should liquidity be needed.” (bold emphasis mine)

This means that existing currency swap arrangements can also be used, aside from extending the Quantitative Easing programs to cover problematic assets or loans held by HSBC or RBS or other banks exposed to Dubai.

Moreover, even if we incorporate all estimated Western banking system’s loan books of UAE they appear to be manageable.

Figure 5: Danske Bank: Western Banks Exposure to UAE as of 2008

To quote Danske Bank, ``Although some UK banks have exposure to UAE (Dubai is only one of seven emirates) it is not material in our view…As can be seen the exposure to the region is fairly limited. Furthermore, it should be stressed that so far we are only talking about one (big) company. Still, it is a factor to watch out for in case the problems are more widespread than they appear. Remember, back in 2007 virtually everybody agreed that subprime mortgage loans were a manageable and limited problem. So some caution is warranted.”

Indeed.

Bottom line: The Dubai Debt Crisis doesn’t necessarily imply a contagion risk. That’s because the crisis appears to have a national political twist, since Abu Dhabi alone could have reticently mounted a rescue considering its immense forex holdings in its SWF-the largest in the world.

Besides, global central banks have the means to deploy their “inflationary” tools to “rescue” anew national banks exposed to potential bad loans in Dubai. European and Abu Dhabi banks have the most risk exposure to Dubai.

And this is exactly why inflation is a future risk because of mainstream central banker’s fundamental fear of a deflation triggered global banking meltdown. Hence, we should expect some Dubai related globally coordinated policy actions in the coming days or weeks.

Furthermore, the western banking system has relatively minute exposure to the UAE which isn’t likely to further dent on their beleaguered balance sheets.

What needs to be seen is if other nations suffering from similar debt pressures may surface and do a Dubai.

Otherwise, the Dubai tempest will likely signify as a short term bump or a bear raid amidst an inflationary recess.