Saturday, November 28, 2009

A Very Short Comment on Dubai

Kevin Drum worries about the situation in Dubai.  Calculated Risk has been following it closely.  The NYT summarized thusly:
Of the many economies that gorged on debt in the boom years, Dubai stood out. In the space of a few years the emirate’s investment arm, Dubai World, racked up $59 billion in debt, borrowing to build lavish developments like a giant island shaped like a palm tree to entice celebrities like Brad Pitt, and to invest in glittery properties like the MGM Grand Casino in Las Vegas.
Now that the boom has gone bust, both in Dubai and in the United States, Dubai is stuck with a glut of real estate that no one wants to buy or rent. Creditors and markets had always assumed that when push came to shove, its oil-rich neighbor Abu Dhabi would bail out Dubai. But that assumption was called into question this week, and the resulting fear that Dubai might not be able to pay its bills sent a wave of uncertainty rippling through markets just as investors thought the worst of the global financial instability was over.
I don't propose to investigate this in any detail, but I wanted to quickly suggest a likely framework for thinking about this.  Whenever any genuine and important new trend appears, it's human nature for people to get overexcited about the possibilities, borrow too much money, bid prices up too high, and then crash.  Think South Sea Bubble (prospect of trade with South America) in the 18th century,  the Railroad boom in the 19th century, and the Dot-com bubble recently.

So it should surprise no-one that the new-but-ongoing era of high oil prices, which promises to make the Middle East a very wealthy and important region over coming decades (absent more war and revolution), should occasion a bubble or two. The fact that things got a little ahead of themselves does not mean the underlying trend is not important - just as trade with South America, railroads, and the Internet, all did prove extremely important trends over many decades.


Brian Hayes said...

It seems Fat Cats might be rare.

Emerging states encounter tremendous challenges over a narrow spread. Swings and defaults are damaging and increasingly volatile while demand on resources and revenue steadily increases. Visionary and deep projects are critical while risk remains. Many less brave might also stumble.

Gregor Macdonald's Powering the Dubai Overshoot cites permanent strain as Dubai [and the region] deal with electrification and desalination, only two of several costly challenges.

Stoneleigh said...

We aren't in a new era of high oil prices IMO. I think oil is peaking along with stocks, gold and other commodities, and at the same time the USD is bottoming. The long rally that produced talk of green shoots is essentially over and the next phase of the downturn is beginning. Dubai is not the trigger, it is merely the rationalisation for a trend change that was coming anyway.

The end of the rally should see a significant reversal in energy prices, temporarily obscuring the approaching oil scarcity. Price signals are useless as indicators of scarcity due to boom and bust dynamics that drive prices in counterintuitive directions. The bust that is coming will drop investment and sow the seeds of a supply collapse even steeper than than suggested by Hubbert's curve or the net energy cliff.

For the time being, finance is in the driver's seat. 2010 is shaping up to be a financial disaster of epic proportions. 2009 was the year when Wall street ate Main Street for breakfast, but Main Street hasn't realized it yet. Once the next phase of the credit contraction begins (ie imminently), Main street will wake up to that fact.

Stuart Staniford said...

Stoneleigh - last time we debated this, I predicted the government would bail out the insolvent institutions to the tune of a few tens of percent of GDP, and life would go on, albeit with a severe recession. You thought if the government attempted to do so, all hell would break loose in the bond market, and the end of western civilization would follow shortly.

So far, I think my views are looking better than yours! The US government can still borrow cheaply. Maybe 2010 will indeed bring complete disaster, but my prediction is that instead, deleveraging will be gradual, no major countries will be insolvent, the US economy will be go more or less sideways for a while - could be a modest recovery or a mild second-dip in the recession, but eventually - like in a year or three - increasing developing country demand will trigger another oil price shock, and either a second or third recession.