``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.
