Mirage in the Desert


". . .Dubai was constructing the perfect metaphor of the 21st century economy"

Recently, the world has focused on the potential debt default of Dubai World, the main government-owned corporation in the emirate of Dubai. As palm-shaped islands sprouted and spires shot up into the clouds, few spectators realized that Dubai was constructing the perfect metaphor of the 21st century economy: a mirage built on debt.

Dubai was put on the global economic map by Sheikh Rashid al Maktoum, father of the current ruler. The Sheikh shunned outward flamboyance and focused his energy on improving the lot of his kingdom.

I first met the Sheikh in 1972, as Director of Middle East Operations for a London-based merchant bank. Back then, Dubai was nothing more than a desert settlement beside a beautiful, deep-blue port. But the Sheikh was a real frontiersman—with shrewd business acumen built over a lifetime of hard knocks. He sought to build a strong capitalist economy on top of the natural oil wealth.

He succeeded, and his heirs grew up in a period of growth never before seen there. Slowly, however, they shifted away toward a vision of Dubai as the dashing fantasyland of the Middle East—a dream to be financed by debt, based on the massive pool of cheap U.S. dollars, and secured by the continued rise in the price of real estate.

Unlike the U.S. administration, the Dubai government is drawing a line in the sand. Even though an 'implicit' guarantee was assumed by investors, the Dubai government has refused to bail out Dubai World.

The holders of Dubai's real estate assets and sovereign debt are the major Western financial institutions already weakened by their escapades at home.

This may prove to be the first of a new wave of defaults as the commercial mortgage markets begin to buckle. Worse still, any new series of major defaults could spread rapidly to and within the derivatives market. If that were to happen, a sudden cascade of settlement defaults could cause a devastating implosion of international financial markets—one that central banks may be powerless to contain.

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