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Monday Morning Quarterback: Will Dubai "Matter"?


UAE steps up to the plate.


Thanksgiving; a time for family, feasts and football. This year, it was also an opportunity to reflect on the financial stability of the world.

Dubai, the poster child of Middle East excess, shocked global financial markets late last week when they sought a moratorium on upwards of $60 billion debt on Dubai World, the state-owned corporate engine that financed the region's explosive growth.

The stunning admission caught many market watchers flat-footed and for good reason. Earlier this month, they assured investors all was well.

Sheikh Mohammed bin Rashid Al Maktoum, the ruler of Dubai and prime minister of the UAE, said on November 10th that Dubai had endured the worst of the economic downturn and the emirate was ready and able to pay its debts.

"The worst is over and Dubai is now well-placed," he said at the time, "The global economic crisis, despite its impact, will not deter Dubai's ambitions of implementing its development plans."

He spoke of the strength of Dubai's ties to Abu Dhabi and when pressed, told critics to "shut up," assuring them they "would be there for each other when needed."

True to form, The United Arab Emirates has pledged to stand behind foreign and domestic banks in the country-but stopped short of guaranteeing the debt of Dubai World-offering additional money while extolling the strength of the Gulf nation's financial sector, according to the Associated Press.

While unity is nothing new-The UAE has guaranteed bank deposits since October 2008 as real estate prices in the emirate declined 50% and multi-billion dollar projects have been scrapped or delayed-the new measures include a "special additional liquidity facility" with hopes of quelling fears and stemming potential contagion.

It would be easy to place blame on a select section of the world-we spoke about the potential for global "regions" back in January-but these actions have been universally consistent since the global meltdown began, new waves of crisis ushering in novel solutions with hopes of pushing risk further out on the time continuum.

Despite these approaches masking the symptoms rather than curing the underlying debt disease, they've effectively bought time with hopes that a legitimate economic recovery will take root. And yes, we've seen this movie before, pushing pain to a later date, over and over and over again.

Domino Theory

The timing of this latest chapter adds to the suspense of the storyline. Given the massive rally off the March lows, the psychological pendulum has viciously swung from the fear of losing to the fear of missing. The latest survey of advisory services by Investor's Intelligence finds 50.6% bulls vs. 17.6% bears, a skew last seen right before the market tanked in 2007.

The issue at hand isn't the magnitude of money-$60 billion aint't what it used to be-nor is it the locale of this latest spark in the dark. Folks are quick to forget that upwards of $500 trillion in derivatives still tie the world together and the cancer created by years of living beyond our means is entirely larger than the global economic patient.

On Friday, while most were digesting delicious meals, we scripted potential scenarios that could turn Dubai into the next Microstrategy (MSTR) or American Home Mortgage, the unlikely pinpricks of the and debt bubbles, respectively. The dominos laced with dynamite went something like this:

  • Dubai defaults or the perception thereof manifests.

  • European banks such as HSBC (HBC) and Royal Bank of Scotland Group (RBS) and Japanese institutions such as Sumitomo Mitsui Financial are the counter-parties on much of that risk.

  • The virus spreads through the fragile region; note debt insurance has spiked in Bahrain, Qatar, Turkey, Russian, Ireland and Greece.

  • The strain-coupled with fears of sovereign defaults- migrate to stateside financial institutions, as you would expect given the derivative machination in a finance-based global economy.

  • We see a "flight to quality" with a sustained rally in the US dollar, which would be the single biggest warning sign for global markets around the world.

  • Due to the correlation of strategies-everyone has the carry trade on in size, short the U.S dollar and long risk assets against it-an attempted "simultaneous exit" creates a bottleneck on the exit-ramp.

Given widespread anticipation of a melt-up into year-end as performance anxiety permeates, the mere hint of doubt could stir the animal spirits in the other direction. It's an "if-then" thing; if the tide turns, then it could get nasty.

As is often the case, the reaction to news will be more important than the news itself and I, for one, will be watching the U.S dollar as the single most important ingredient in this very saucy brew.

Will It Matter, Does It Now?

There is widespread assumption of systemic insurance backed by the full faith and credit of the United States of America. What was once the Greenspan Put has morphed into the Bernanke Helicopter-a similar theme with entirely more profound implications for generations to come.

A crisis in confidence may be the next manifestation of our cumulative imbalances but it remains to be seen if Dubai will serve as the trigger. With mountains of stateside corporate debt now "rolled" years into the future, the timing of the next trip is the singularly most important question.

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