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Dubai and other specters overhanging the world economy
Commentary: Real problems may be about to emerge in Europe
By David Marsh, MarketWatch
Last Update: 11:54 PM ET Nov 29, 2009
LONDON (MarketWatch) -- Who will pay off today's national debt tomorrow and beyond? And how much financial solidarity will stronger nations show their weaker neighbors?
These questions have been hanging wraith-like over financial markets for more than a year -- ever since the world took the collective decision to repulse the economic crisis through a massive increase in government borrowing.
A new, disturbing trend has now massively affected confidence in the solvency of governments. The shock waves have rolled in, not from the West -- where public deficits have risen most -- but from the exotic regions of the Middle East.
In many headline-hitting cases, sovereign wealth funds and other investors from these territories have acted as sources of support and succor for hard-pressed governments and corporations from the old industrial nations. Now, the Midas touch has gone into reverse. The oil-rich lands of financial plenty have spawned the first serious state victim of the credit-crisis era.
The moratorium for heavily indebted state investment group Dubai World and its real-estate subsidiary Nakheel has sent a tremor through financial markets. Bemusement and head-shaking over the decision are unlikely to die down.
For some observers, Dubai's rulers stand guilty of gross incompetence. Monumental underestimation of market sensitivities has been laid bare. Others see the move as the culmination of a Byzantine power struggle within the United Arab Emirates between the innovative financial spirits of free-wheeling nouveau-pauvre Dubai and the prosperous, ultra-conservative sister sheikdom of Abu Dhabi.
Whatever the reason, the payments standstill underlines the fault lines in the world economy. Worldwide, governments and central banks are running uphill against a mountain of debt.
In many ways, it's a race against time. Sooner or later investors will demand higher interest rates on government securities, either from the industrialized economies or the emerging nations, reflecting fears of inflation or insolvency or both. If capital market conditions tighten when economic recovery is still not secure, then a downward spiral is well-nigh inevitable.
Additionally, central bankers and financial regulators need to accelerate their efforts at reforming and internationalizing supervisory and regulatory structures. The triple specter of Dubai, default and doom has underlined the risk that new asset bubbles will burst before we have gotten over the effects of the last one. If a second banking crisis erupts before new processes to make capital markets safer have been put into place, then we will see a repeat of 2007-08 -- with far less financial and fiscal ammunition to fight back.
For capital market consequences of this race against time, just look at Germany.
Given escalating public-sector debt, the Bundesbank and the Berlin Government are increasingly united by desire to make the most of Germany's high credit standing to secure finance at the best possible conditions. They comprehensively reject any idea of showing solidarity with the other members of European monetary union by devices such as common European bond issuance.
Instead, we will see increasing intra-Euro competition for the best credit terms. Germany has no wish to unfurl its fiscal umbrella over deficit countries such as Greece, Ireland or Spain.
In the Gulf emirates, by contrast, it is more likely that the debt of upstart parvenu Dubai will eventually be taken over, on certain painful conditions, by the straight-laced sister state of Abu Dhabi. Don't forget, the UAE is a political union. The Emir of Dubai, Sheikh Mohammed, is also UAE Prime Minister.
Chancellor Angela Merkel's writ does not, however, run in Athens or Madrid or Lisbon. The whole point about EMU is that its constituent states, while pooling their money, have remained politically sovereign in many ways.
The world is looking in awe across the desert sands at the disaster in Dubai. But the real problems for the future may be about to break in the ancient cultural heartlands of the Old Continent.
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