November, 2009 Archives


Dubai World’s Default – Is It a Systemic Threat?

by Riaan Nel in News

The government of Dubai announced on Wednesday, November 25, 2009 that the Emirate’s Sovereign Wealth Fund, Dubai World, will halt interest payments on its debt for 6 months.  This announcement sent shock waves through the global financial system.  On Thanksgiving Day European and Asian markets reacted negatively to the news, followed by US markets on Friday.  However, European markets were mostly positive on Friday, but Asian markets remained in negative territory. 


What are the risks of Dubai World’s effective default on its debt?  I think the crisis will remain contained.  Let us place Dubai World in context.  Dubai World is an investment company that manages a portfolio of businesses and investments on behalf of the government of Dubai.  Dubai is part of a seven-state federation, the United Arab Emirates (UAE).  The states are termed “emirates”, and they are Abu Dhabi, Dubai, Sharjah, Ajman, Imm al-Quwain, Ras al-Khaima and Fujairah.  Abu Dhabi is the capital of the federation, and also the second largest city, Dubai being the largest.  Abu Dhabi, though, is the richest of the emirates with a GDP of $187 billion.  Dubai’s GDP is $75 billion.  All eyes are now on Abu Dhabi to see if it will step in and assist Dubai, or if the UAE federal government will assist. 


The UAE has the world’s sixth largest oil reserves.  It is the world’s thirty-sixth largest economy at market exchange rates; however, it is the fourteenth largest in purchasing power per capita.  The UAE is also a surplus country with a 2009 Current Account Balance of $36 billion (compared to the USA’s Current Account Deficit of $569 billion).  The UAE’s national debt is estimated to be a $142 billion, and the federation’s GDP is $270 billion. 


As mentioned above, the emirate of Dubai has a GDP of $75 billion; however, the emirate’s debt outstanding is $80 billion.  This debt burden is disconcerting.  For the federation as a whole the national debt-to-GDP ratio is 53%; for Dubai specifically the debt-to-GDP ratio is 107% (think of this as a person’s debt-to-income ratio).  For comparative purposes the US debt-to-GDP was 70% in 2008, and it is projected to be 90% in 2009.  Of Dubai’s $80 billion in outstanding debt, $59 billion is owed by the government’s investment company, Dubai World. 


Given the above statistics it is my belief that Dubai World’s default does not pose a systemic threat to the global financial crisis.  The only Western Bank with substantial exposure relative to its overall loan book is Standard Chartered, but it apparently has a robust capital position to absorb the losses.  I agree with Simon Nixon of the Wall Street Journal that Abu Dhabi won’t just walk away from Dubai.  The UAE’s reputation and credibility has already been dealt a nasty blow, it is not in Abu Dhabi’s interest to let Dubai go it alone.  For this reason contagion risk is small.  As Nixon notes, maybe this is a wake-up call for the frothy equity markets around the world which are pricing in a robust recovery. 


The lesson from Dubai is that a robust global economic recovery is not reality.  The recovery is going to be slow and stuttering.  Dubai World is one of those stuttering, but it is not going to derail the recovery.



Is Our National Debt a “Phantom Menace”?

by Riaan Nel in News

In Paul Krugman’s latest column in the New York times he argues that the administration should not be intimidated by the scare stories about a potential bond market crisis as a result of America’s unsustainable budget deficits.  Krugman is also a proponent of a second stimulus bill to address the current 10% plus unemployment rate. 

Krugman  states, ” Ever since the Great Recession began economic analysts at some (not all) major Wall Street firms have warned that efforts to fight the slump will produce even worse economic evils. In particular, they say, never mind the current ability of the U.S. government to borrow long term at remarkably low interest rates — any day now, budget deficits will lead to a collapse in investor confidence, and rates will soar.”   He continues, “Well, spikes in long-term interest rates have happened in the past, most famously in 1994. But in 1994 the U.S. economy was adding 300,000 jobs a month, and the Fed was steadily raising short-term rates. It’s hard to see why anything similar should happen now, with the economy still bleeding jobs and the Fed showing no desire to raise rates anytime soon.

A better model, I’d argue, is Japan in the 1990s, which ran persistent large budget deficits, but also had a persistently depressed economy — and saw long-term interest rates fall almost steadily. There’s a good chance that officials are being terrorized by a phantom menace — a threat that exists only in their minds.”

I agree with Krugman that the danger eminating from our current mind-blowing deficit is exagerated.  I do not foresee any drastic interest rate spikes in the next year or so.  I believe a government should run a deficit during recessions.  Deficits during recessions are critical for stabilizing profits.  If not for the current government deficit spending the recession would have been much worse, with a drasticly elevated unemployment rate.  I am also a proponent of a second stimulus bill, which will add to the deficit.  (Yes, I have reversed some of my thinking in this regard.  See Minsky’s book “Stabilizing an Unstable Economy”).

Although I support a second stimulus, I do not support spending programs similar to those of  the first stimulus bill.  There were far too many wasteful liberal spending programs which were not all that effective.  I would prefer a stimulus with measures more directly functional for spurring job creation in the private sector – for instance a tax holiday for the payroll tax.  Furthermore, although I agree with Krugman about the exagerated inflation and high interest rate dangers associated with our deficits in the short-term, I do believe that in the long run we will suffer, and suffer severely, if we cannot create a tax and spending regime that produces a surplus during prosperous times. 

Without the expectation of a surplus in the future, the bond market will lose confidence in the US governement, and interest rates will soar.


Forecast 2010

by Riaan Nel in Global Economy, News


1.       Introduction


We are now two years into the worst credit crisis in generations, which resulted in the deepest and longest recession since the Second World War.  It is my belief that the world is tentatively exiting the recession.  It is also my belief that the current market rally reflects the strengthening economic backdrop and investors’ increasing appetite for risk.  However, one should be very cautious in predicting a continuation of the current stock market rally.  We should also guard against being overly optimistic.  There are still many challenges facing the global economy. 


In this forecast I will deal with the following questions. Is the recession really over?  Is the market rally sustainable?  I will address the specter of inflation, and the dollar’s valuation.  Importantly, I will try to provide guidance regarding investment opportunities in a slow-growth environment. 


2.       Current Economic Environment


It is apparent that earnings growth is on the rise, and          that economic conditions have improved compared to the last quarter of 2008 and the first quarter of 2009.  We are experiencing declines in unemployment claims as well as increases in residential building permits, increases in productivity measures, and increasing manufacturing data.  Moreover, the Case-Shiller Home Price Index has been rising through the summer, and there is an upturn in the Conference Board’s Leading Economic Index series.  There are indications that US corporate earnings will be better than expected in the fourth quarter. 


During the third quarter virtually every developed nation has seen an uptrend in key measures of growth – manufacturing output, exports, housing activity, and business confidence.  We seem to witness a global synchronized recovery.  It seems like the emerging markets are a driving force in the recovery.  The Institute of International Finance emerging economies to the tune of $672 billion in 2010 from $349 billion in 2009.  At the end of September the MSCI Emerging Markets Index posted a total return of 65%!  It is important to point out that nations outside of the US and developed Europe account for close to 50% of world GDP. 


In answering the question if the recession is over I would venture to say “most likely”.  There are still many challenges facing the global economy.  Global credit markets remain impaired.  It is my contention  the economic crisis over the last two years was caused by an unprecedented increase in the supply of credit.  The wealth destruction that occurred over the last two years will diminish the availability of credit for a long time.  Leverage fueled much of global growth leading up to the credit crisis in 2007.  One can thus conclude if there will be less credit available in the future, growth will be inhibited.  One of the main forecasts I am making is that we are facing a long-term slow-growth environment. 

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