Take a look at the paper or the blogs today, and you will see a myriad of headlines asking “What went wrong with Dubai?” How could this booming economy have succumbed to the grips of the recession just as the recovery started? But I ask, “Are you kidding me?” and “Why didn’t this happen sooner?”
For the past two years, the desert oasis has been building its own housing bubble out of borrowed money and speculation. Since then, the economy’s payment deferral has rocked markets the world over. The fear is Dubai is the Bear Sterns of indebted countries, foreshadowing the widespread disaster that is soon to come.
The city has maintained autonomy from the other six emirates comprising the United Arab Emirates due to its status as a free port. While the rest of the world sank deep into recession, Dubai gorged itself into debt, borrowing $59 billion to build private islands and lavish hotels. Last week, Dubai World (Dubai’s government-owned investment company) asked for a six-month extension to pay back its debts, with $3.5 billion due next month.
Dubai was never safe—the recession simply took its time arriving. If Dubai World expected it could ride out the recession on credit and keep on building, it was not prepared for markets remaining cool, or the fact that no buyers were prepared to take on these billion-dollar properties.
Creditors always assumed oil-rich Abu Dhabi would bail out its fellow emirate, but when Abu Dhabi made no move to back its neighbour, markets took a dive. On Thursday, after Dubai announced it needs an extension on its debt payments, stocks in London fell 5.5 per cent, with markets in France, England, Canada, China, and Hong Kong all following suit. The price of gold dropped, the Canadian dollar fell 1.35 cents, and when the markets opened in the U.S. on Friday, the Dow Jones fell over 150 points.
Dubai had credit woes as early as last year, but its leader, Sheikh Mohammed bin Rashid Al Maktoum, assured the world that all was well. Last month, when critics asked how Dubai planned to pay back a debt that might be larger than 100 per cent of its GDP, he told them to “shut up.” Last week, he demoted the head of Dubai World, Sultan Ahmed bin Sulayem, and Mohammed Alabbar, chief of Emaar Properties and developer of the Burj Dubai, replacing them with his sons.
Think back to the summer of 2008 when those people who had borrowed to pay for houses they couldn’t afford were facing a situation where those houses were now worth less than what they owed, and who were therefore defaulting on their loans. Instead of people, or even companies defaulting, we’re now talking countries and bad assets instead.
The fear is not that Dubai’s credit woes will start a banking crisis, but rather that they will seriously bring into question the viability of other deeply indebted nations, including the United States. Greece, Spain, Japan, Ireland, Lithuania, and Great Britain are all also at historically high deficits. Thus the international economy is placed in a precarious situation, where a banking crisis could start as soon as another nation defaults—a fear that is now considered realistic.
I doubt the chain will start just yet. Economically conservative Abu Dhabi will likely bail Dubai out after letting it, and the rest of the world, suffer for a bit. Dubai is a special case, linked to a wealthy emirate, but the rest of these indebted nations have no such allies. I’m just hoping that in a few years, we’ll look back and think this was all excessive pessimism. Lately though, economics has been cruel to us, and things have only gone from bad to worse.
