The banks thst lent about $40 billion to the state-owned corporation Dubai World must have figured, “Okay Dubai doesn’t have oil, but it’s part of a larger oil country (United Arab Emirates), and it’s in an oil region, and so they’re good for the money.”
Apparently, no one thought that an enterprise based on ridiculously over-priced real estate — remember the palm shaped island, the world’s tallest building, the indoor ski resort? a playground for the Arab oil-rich — would ever hit trouble. But trouble came this week, with Dubai World suspending payments to creditors, including a number of high profile foreign banks, for at least six months.
Yesterday, Abu Dhabi, another part of the UAE which does have oil, agreed to help with repayments on a selective basis. Dubai World will restructure, but the news temporarily shook global markets which had somehow convinced themselves that having survived 2009 everything was now fine.
With much less fanfare, the largest bank in another oil-rich country, Kazakhstan, Bank Turalem has been taken over by regulators. According to the New York Times, it too had huge Western investment ($10 billion) which it sank in real estate dealings in Ukraine and Russia, and other places where it had little business or experience in. Now those loans have gone bad, too.
There were warning signs — Bank Turalem was not very transparent in its dealings, it lacked investment history, the bank’s former chairman Mukhtar Ablyazov is an opponent of the country’s president, Nursultan Nazarbayev, and Kazahkstan is a notoriously corrupt country — but those factors don’t seem to have mattered to the foreign banks, like Credit Suisse, that invested there. They pursued loans in a country they thought was too oil-rich for anything to fail. One investment banker was quoted as saying, “Kazakhstan was very sexy at the time, and foreign banks were just shoveling in money, so much so that that banks here had more money than they knew what to do with.”
There is one unexpected thing working in Dubai/Dubai World’s favor: like Iceland and Latvia which experienced terrible financial crashes this year, it is surrounded by larger and more stable neighbors with a vested interest in seeing it not fail entirely. It will survive.
There is a lot of noise that Dubai is the first of a second round of failures, and it may be, but that shouldn’t come as a surprise in this recession. Adjustable rate foreclosures were followed by unemployment foreclosures in the US, smaller bank failures have followed the bigger near-failures. It cannot come as a shock that the pilot fish of the oil countries should follow the trend of the shrunken oil market — oil may be between $70-80 a barrel but demand is still down. The second-hand leverage that proximity gave to those near oil has evaporated.
It is normal for oil countries to do what Dubai did: spend the cash as fast as possible — faster than it actually comes in — either in a desperate attempt to develop the country as fast as possible (if it is a good government) or to steal it the same way through corruption though bribes, payoffs and so on (if it isn’t). All countries create national budgets based on projected income, but the country that relies on the global oil market is on an unpredictable ride.
Dubai, with oil by proximity, thought it would bet on developing itself as an ambitious resort destination — an alternative to oil. Even at the best of times in a better setting, this would be dangerously dependent, but it wasn’t stupid or dishonest. It means that Dubai’s leaders bought into the oil market hype that oil would only go up, up, up to $200 barrel.
Oil budgets often fail. Just ask Venezuela or any of the dozens of other countries who have depended on “the devil’s excrement” to save them from their own poverty. It isn’t that Dubai’s planners did anything wrong, they just were unlucky. The terrible difficulty facing so many of these countries is to figure out what besides oil is their comparative advantage in the global marketplace, so they can move ahead and create a real complex economy. Even where the Dutch disease doesn’t hurt the economy with a too-strong currency, these countries can’t compete with China for manufacturing or India for well-paying services or Brazil for diverse resources; they don’t have the same complexity of human, social, financial or historical capital as the West or Japan.
As Voltaire wrote in Candide, we must cultivate our gardens. The struggle for Dubai and so many countries is to try to live up to the impossibly high living standard set by the West without an edge except oil or its geography.
