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The mirage in Dubai

Dubai was a property dream literally built on sand and borrowed money, where the rich could enjoy the sun and watch their assets soar in value. But like so much of recent capitalism, it has proved more mirage than substance.

Dubai World, the emirate’s main holding company, has asked for a six-month debt holiday from international bond holders because this oil-free state simply doesn’t have the cash. Result? Turmoil on world stock markets has returned with a vengeance as investors consider whether Dubai’s virtual default is the beginning of another round of the global financial crisis.

This is a story about a “boom” based on debt. Sounds familiar? It ought to because it’s a microcosm of how the consumer boom in the advanced capitalist countries was financed.

In a bid to emulate its oil-rich neighbours, Dubai borrowed heavily to build up a non-oil economy based on property, trade and tourism. The total debt is estimated at $80 billion, although no one knows for sure.

Hotels soared into the sky, luxury homes were built on man-made lagoon islands and no expense was spared to build a ski slope. The environmental cost of making snow in Dubai is mind boggling.

Dubai doubled in size and house prices almost quadrupled in 2002-07, since when property prices have halved. Trade and tourism has suffered because of the recession and plans for turning Dubai into a regional financial centre have come to grief in the midst of the global credit crunch.

Today the cranes stand idle as construction projects have ground to a halt. Skyscrapers are empty and apparently the airport parking lot is full of cars abandoned by expatriates who have lost their shirts in the property crash.

Graham Turner, of consultancy GFC Economics, said:

It gives you a picture of the fact that credit problem persists, despite everything that's been done. Despite having oil, it's still the case that many of these countries had explosive credit growth. It's very clear that in 2010, we've got plenty more problems in store.

That’s putting it mildly Graham! The near-collapse of the financial system in 2008 was only avoided by reducing interest rates to almost zero, printing vast quantities of electronic money and building up record levels of government deficits. Far from “restoring growth”, these measures have failed to prevent unemployment from soaring, especially in the United States. Many banks, notably in Germany, are still in some difficulties and the non-performing debt still overhanging the financial system is incalculable.

The amount of new money sloshing around the system has also fuelled a stock market boom, where share prices have soared by 50%. Andrew Clare, professor of asset management at Cass Business School, said:

I just don't understand the basis for the market rally: equity prices had gone too far. Investors are underpricing all the risks that are out there, and this is just one of them. Some of those risks are going to come home to roost, and this is just the first.

And next year they're going to have the shock of realising that interest rates can go up as well as down; and you've also got places like the UK, where taxes are going to have to go up and public spending will have to be cut – and the US, too, has some difficult decisions to make.

Behind Dubai come countries like Ireland, Ukraine and Greece with sovereign debt they may not be able to repay. The United Kingdom won’t be far behind either. Dubai’s is not the only economy built on sand, speculation and other people’s money.

Paul Feldman
Communications editor
27 November 2009

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