Thursday, November 26, 2009

Dubai Boom Turns Into Bust

Today when most Americans are busy eating turkeys, global markets was hit with news that Dubai, one of the seven emirates in the United Arab Emirates, now seems to be defaulting on its debt, rattling global markets.

Dubai has invested tens of billions of dollars in construction and other activities in a bid to lessen its dependence on oil exports. That may be an understandable ambition, yet as they are now learning, dependence on construction, finance and tourism financed by inflationary credit is not really any better.

They go through ups and downs just like the oil business, and in this case, the downturn in construction and finance (and to a lesser extent also tourism) came at around the same time as oil prices dropped, providing no meaningful diversification.

It is difficult to say with certainty at this point what the repercussions will be. The most likely scenario is that the damage will be largely limited to the Arab Middle East as most of Dubai's dealings are made according to the principles of Islamic finance (which non-Muslims have limited stakes in) and that the repercussions for the rest of the world will be limited. However, a small risk exists that the problems will spread through indirect mechanisms to the rest of the world.