What’s the difference between the United States and Dubai? The US is a playground for the wealthy just like Dubai, but at least America hasn’t declared bankruptcy ”“ yet.
Yesterday Dubai World, which is the investment arm of the Dubai emirate, asked its creditors to accept a six month freeze on interest due on its debt. That’s an admission Dubai is out of cash to make payments on its debt, and that it is de facto defaulting on this debt. It just isn’t using that word because it doesn’t want to trigger lots of nasty court claims from its creditors grabbing on to any collateral they can.
Dubai may not be able to avoid sovereign bankruptcy because not all of its creditors may agree on a debt payment moratorium. It only takes one aggressive lender to file a court claim and begin a mad rush to attach Dubai World’s assets, including its world-famous man-made Palm Islands. Still, that lender has a high likelihood of winding up with sand; most of the hotels and condominiums expected to be built on these islands are half-complete and already in a moratorium of their own because there is no money to finish them.
Therein lies problem number one. Dubai massively over-built office towers, hotels, apartments, condominiums, and retail complexes, all of them for the world’s nouveau riche who were expected to flock to this desert shopping paradise. Dubai offered the world exclusive shopping privileges at stores like Cartier, Bulgari, Bentley autos, and Versace because that is all it had to offer. Dubai ran out of oil a while ago, and beyond that it has sand and a dreadful desert climate that forces people to live their lives at night if they wish to leave their apartment.
Dubai gambled that it could turn itself into the Beverly Hills of the Persian Gulf now that it has no oil. It lost its gamble. The people who could afford a $10,000 purse have taken a big beating in the financial crisis and recession, and they are embracing a more moderate and discreet spending lifestyle. Dubai not only has half-finished buildings, it has many completed buildings uninhabited, like Miami and Las Vegas and other overbuilt desert mirages.
The second problem is how Dubai went about building its modern Garden of Earthly Delights. It did it with the poorest people in the world, Muslims from India, Pakistan and The Philippines desperate for work and lured by false promises of fantastic pay. The trade in workers used to build Dubai was as scandalous as the sex trade, with poor people expecting good money and a chance to prosper, only to find their employer had trapped them in a tenement one hour from Dubai out in the desert, with wage deductions so large that the worker will never have an opportunity to work back the ”œloan” the employer claimed to incur to bring the worker out to Dubai in the first place. At its peak two years ago, Dubai was estimated to have a population of millions, of which 18% were true Emirati citizens, the rest being unable to live in Dubai or afford any of the luxury goods in the stores they built. The city had taken on a bizarre Southeast Asian feel because of its immigrant population, to the point that tourists complained the only food you could buy in Dubai was curry.
The third problem might be called Dubai’s moral hazard. There are seven emirates that comprise the United Arab Emirates located in the former Trucial States along the southern coast of the Persian gulf. Not all of these have oil, and only the capital city ”“ Abu Dhabi, which is an hour northwest of Dubai by car ”“ has any significant reserves. Abu Dhabi, Sharjah and the other Emirates look like traditional Arab towns of the area, and have none of the high-rise glitz of Dubai or its money losing novelties like a ski resort. They have all looked at Dubai’s adventure in skyscraper over-abundance as at best a lesson in poor taste, and at worst a profligacy of sinful proportions.
Despite this, the emir of Abu Dhabi has always bailed out his fellow-emir in Dubai, with billions of dollars of loans and guaranties. Dubai has incurred about $80 billion in debt to build its fantasy along the desert shore, of which $59 billion was taken down by Dubai World. Around two-thirds of all this debt was bought by local interests, and the rest by foreigners. The foreigners always thought ”“ and were told this in Dubai ”“ that Abu Dhabi would make sure this debt was repaid, because it always had. Until today, when Abu Dhabi has said ”œenough is enough.”
This is a momentous decision that has shocked and disturbed the global investing community. Is Abu Dhabi teaching Dubai a lesson? Does Abu Dhabi have its own cash problems? Has Peak Oil reached the emirates faster than anyone outside appreciates? Whatever the reasons, in refusing to back Dubai for a penny more, Abu Dhabi has taken its own calculated gamble that reneging on United Arab Emirates debt by one of its members will not hurt the others in the long term. In the short term, Abu Dhabi must have known that the collapse in UAE debt ratings, plus a sharp increase in prices for credit default swaps used to protect against a UAE bankruptcy, would be inevitable.
Stock markets, bond markets, credit default swap markets, currency exchanges, and even gold and oil have all taken a beating in the past two days as investors realize the world doesn’t work the way they thought. There still are unexpected default risks out there even in unlikely places, and the deflation rippling through property markets worldwide has not abated. Those who lent to Dubai ”“ including some of the biggest banks in the world, who are already severely stressed by bad debts ”“ are going to lose billions of dollars even if Dubai merely postpones interest payments for six months as requested. Many investors now expect much worse than that, though.
So here we have a country that used to have oil which has now run out of the same. It has turned to massive amounts of debt to sustain not only its existing lifestyle, but to build a fantasy land of McMansions, luxury malls, trophy office buildings and theme parks for the wealthy. It has nothing anyone wants to buy and consequently stocks the shelves of its stores with goods from other countries it buys on debt. It has done all this using impoverished labor that works under a modern form of indentured servitude, in which the typical worker incurs excessive debts of their own that can never truly be paid off by their earnings. It creates an enormous income disparity between its privileged few and the huddled masses kept out of sight.
Sound familiar? When do you think global investors will start connecting these dots and ask: exactly what is backing the debt of the United States that has flooded the markets in the past nine years under Bush and Obama? At least Dubai had a presumed rich uncle in Abu Dhabi that would come to the rescue, even though now everyone realizes that was a very costly mistaken assumption. In the case of the US, the United States was the rich uncle everybody else looked to in order to solve global problems. Now that rich uncle has gone crazy in its own orgy of gambling, whoring, and over-indebtedness.
Except there is no one ”“ absolutely no one ”“ who can come to the United States’ rescue. And if you want to believe that the US would never, ever ask for a little extra time to pay back its debt, or ask for it to be restructured in some way, or debase its currency with inflation in order to throw its debt burden on to those who have financed it, that is your affair. Just remember there are millions of individuals, funds, corporations, and governments around the world who have bought US Treasuries. It only takes a few to wonder long and hard enough about just how safe and secure these Treasuries are to cause a stampede out of them, at which point the US is exposed like Dubai as a naked supplicant in the global market, begging for alms and a little forgiveness for past sins.