Is Dubai's Default a Black Swan Event?

The term “Black Swan” is used far too often in today’s discussions about the financial markets and it pertains to unforeseen events that cause havoc on the economy or the markets themselves. Last year was called a “Black Swan” event even though the warning signs were there for at least a year, some say since 2006. In today’s discussion the news coming out of Dubai is being hailed as another Black Swan event as they are talking about delaying payment on some of their debt on December 14.

The events in Dubai are the furthest thing from a Black Swan event as we have all known about this problem for the better part of 6 months or more. The country is in poor financial shape and is, basically, insolvent without a bailout from its neighbor Abu Dhabi. The rulers of the two nations are related. I would be willing to bet that the bailout will come in some fashion, but only after an example is made of the smaller nation, but is this a Black Swan event? What is a more relevant question is will a technical default on Dubai’s debt be a trigger for something bigger?

I do not believe that the Dubai situation is a Black Swan event as it was a known situation for some time and those who lent the country money knew they were way over leveraged and lent that money at their own risk. Whether or not this default, if it actually happens, will lead to other events, a domino effect if you will, remains to be seen. Since the sub-prime situation led to a domino effect in the mortgage market, it is safe to assume there will be some fallout from a sovereign default somewhere along the way. Considering Mexico was downgraded to BBB and Vietnam raised interest rates and devalued its Dong by 5%, there are definitely tremblings in the FX markets that cannot be ignored.

The effects of these issues are unknown to me at this time because I do not know how China will respond, although I have my speculations, nor do I know what exposure US or European banks have to the Middle East at this stage of the game. I am willing to bet their exposure, especially JP Morgan (JPM), BoA (BAC) and Citi (C), is much higher than we all think since interest rates in that area of the world are much higher than the “norm” in the US and Western Europe. However, the real Black Swan events that I think are being ignored are the ones in Eastern Europe where currency devaluation and real sovereign default is actually happening and has been happening for some time now. Not that you ever hear about that from the media, but read about it sometimes in European blogs or news outlets - and it is disturbing.

Basically, I believe the greenback will have the stay of execution I have been expecting for some time now and it should rally nicely on this possible default news. In reality, a Dubai default means very little to the US other than a sovereign nation defaulting, but it will trigger a flight to quality. This means if the dollar equity trade is intact, the market could be in real trouble. Further pressure for the greenback is coming from Japan who said it was concerned over the Yen’s strength Wednesday night in a Bloomberg story. This is an issue I wrote about a day ago as well, but essentially the Yen is up about 8% against the USD, which is an issue for the Japanese since they export more goods than they import. A strong Yen is not good for them as it means their products will be more expensive in the US and China; expect to see Japan intervene in the FX markets to strengthen the USD/JPY pair.

This puts the US at odds with its trading partners because while we talk like we want a strong currency, we do not. A weak currency means we make our products cheaper overseas, narrow our trade deficit and essentially boost our GDP in a very phony way. As an aside, it also makes corporate profits look fantastic if they generate any overseas business. A weak dollar means they can sell the same amount, or less in fact, and when those earnings are turned over to US dollars it looks like sales increased when they did not: Houdini earnings! We will have to see whose will is stronger, the will of investors who are about to flee to the USD for protection, which will surely drive up the USD, or Helicopter Ben and our Congress, hell bent on devaluing our currency to pay for their crazy social engineering. This will make it look like they are leading us to recovery when they are really leading us to a Zimbabwean fate.

Comments

[j-dub]

Like it or not, I am going to answer this question in a over simplified manner. I do not believe this is a black swan event. Oh no. Lehman and Bear was, this isn't.
What you had was a world wide gorge on easy money and government guarentees. The problem is that all governments, no matter how powerful, can not stand up to free markets. They can only cover up so many cracks with glue until the entire dam comes apart. That is the economy.

Picture our markets now.
Picture a pyrex glass sphere balanced on the pointed edge of a 6 foot samarai sword. Even though the men standing around the sword are telling you how stable this all appears, you have your own eyes and your own wits and can judge for yourself. Pretty easy to see it'll only take a light breeze to bring the whole thing crashing down.

Dubai a Black swan?
Oh no-just a light breeze. But that's really all that's needed.
One more thing - it doesn't matter how many more glass spheres are put atop 6 foot samarai swords. I don't see the wind letting up any time soon................

2009 Nov 27 04:13 AM

[swissfrank]

Even if one hadn't been tuned in to the market gossip about these dodgy bonds, common sense might have suggested that the Dubai infrastructure boom was indeed built on foundations of ... sand.

The author makes the vital point that a flight to safety, with consequent USD strengthening, carries substantial risks for Tim and Ben. A cheap dollar drives risk investment and helps reflate impaired assets which lie on the banks' balance sheets.

2009 Nov 27 04:54 AM

[rick12345]

Thank you for your divinity, but the fact of the matter is that insiders were looking for any excuse to drive markets lower. Why? So they can buy stocks at a cheaper price before selling them in a week or two at profit.
Dubai has gone from 19% growth to 4% in just two years. It therefore becomes increasingly obvious that the government is losing precious income as a result of foreign investors holding off projects that were planned before the economic crisis. Nonetheless, The United Arab Emirates still sources most of its GDP derived income ($270 billion) from the sale of natural resources such as oil and gas (approx $208 billion).
I suspect this region will eventually return to some form of normality as the economic crises eases, however the country is not about to go broke and bring the world down with it like some bears wish.

2009 Nov 27 05:55 AM

[damienhaas]

The author is trying to be smart. Next up Greece may be defaulting. Italy close to it. So are all these black Swan events? It look like a lot white swans.

2009 Nov 27 06:14 AM

[Davewmart]

So far, the 'crazy social engineering has amounted to hot air for the poor as they are thrown out of their homes and onto the streets, and are at the mercy of a 'medical system' which for the uninsured would be considered a disgrace in most parts of the Third World, whilst the actual, real money has gone to deadbeat scamming bankers who are paid hundreds of billions in bonuses after their gambles have crashed and their businesses are bankrupt but for taxpayer support.
The worthless bums here are the conected elite in the financial system and their poodles, the politicians.
Talk of a few crumbs falling off the table for normal people should not distract attention from this breathtaking robbery.

2009 Nov 27 06:50 AM

[a fat panda]

This isn't a black swan. It is just another domino. Black swans are suppose to be rare. The word is now used so much that people are naming their kids after it.

2009 Nov 27 07:52 AM

[apppro]

This is a just another example of how our collective short term trader/traitor mentality has infected the entire world now. Read the news: <<Fears of a potential sovereign default by Dubai roiled financial markets Thursday, sinking stocks across Asia and Europe and pushing up government bond prices, after Dubai said late Wednesday it would restructure Dubai World and announced a six-month standstill on repayments of the conglomerate's debt. See full story on the impact on financial markets.>>

POTENTIAL - RESTRUCTURE - STANDSTILL not default.

When we shipped all our bad paper over seas we also shipped our bad short term mentality and trading.

SO WHAT if a few rediculous malls in Dubai close up or a few of those ridiculous houses built on phony islands remain empty? That entire area was a waste of Arab oil dollars and should not be allowed to affect everyone else.

2009 Nov 27 07:57 AM

[Will.i.am]

This is the beginning (hopefully) of a bright light beginning to shine on Sovereign Finance and liability linkage. The real question is how many more DW's are out there?

People, corporations of all sizes, and now governments (who don't have unlimited printing power) are realizing this depression is about collapsing cash flows and the struggle to right-size.

Dollar unwind? Flight to safey? Bond haicuts? Contagion?

2009 Nov 27 08:20 AM

[User 507762]

Dear Sir,

Dubai and Abu Dhabi are not separate countries. They are like two states in one country.

2009 Nov 27 08:21 AM

[apppro]

And as 2nd issue:

To heck with them! Did any of those Arab countries help pay for the reconstuction of Iraq or Brunai when we got rid of Sadam for them!

2009 Nov 27 08:21 AM

[left_line]

Trying to spin the situation as an Act of G-d or a Black Swan is just the predators way of making the prey feel better about being eaten alive. The term has now become an instrument of propaganda.

Act of G-d, Black Swan, who cares. People who knew about it made money, people who didn't lost money.

2009 Nov 27 08:25 AM

[Timon Singh]

I think that Dubai's construction bubble was going to burst at some time. Sure, it saw construction slow down during the worst parts of the recession, but it weathered them and even finished the Burj Dubai on schedule (ok, a few months behind).

Unlike Abu Dhabi, they don't have oil reserves to fall back on, but I think heavy foreign investment will see the region recover. I wouldn't rule Dubai out just yet.

www.menainfra.com/news.../

2009 Nov 27 08:27 AM

[TheFounder]

The black swan term is devaluating and people use it now for every surprise. A black swan is not the same as a surprise, even a rare one. It is more like something never seen before and with a dramatic effect.

Dubai is not a black swan. Even Lehman was not, given its 30:1 levereged balance sheet.

2009 Nov 27 08:35 AM

[Ransome]

Most likely the banks have off-loaded the debt and protection on unsuspecting investors. Won't they be surprised. It is more like Russian Roulette. It is why casino capitalism and opaque risk sharing are destabilizing. The Black Swans are yet to come, which is the real source of panic when it hits the market..

2009 Nov 27 08:37 AM

[User 514962]

My 5 cents: this is not a black... The collapse of an entire banking industry (AIG, Bear, Lehman, et al. is). Great companies soar, great companies fail, that's the name of the game. Dubai was, in my view, was simply flawed, too much money spent in trying to reinvent itself into something they weren't.

Simply a foundation built on sand!

2009 Nov 27 08:41 AM

[Adamantane]

Seems to me that any Middle Eastern event that engenders a sharp drop in the price of oil -- which we are seeing -- probably will be mitigated by guarantees and funds transfers within the Middle East, in the self interest of those places whose income-stream is tied to oil and oil revenues.

My guess is that by Monday morning if not sometime today there will be an infusion of support for the Dubai state entities from other UAE states and perhaps elsewhere in the region. There may be a lot of shouting among the oil princes but that will be a family affair, not a global one. Not the first time in the world's history that someone's bailed out a profligate brother-in-law.

Adamantane

2009 Nov 27 08:42 AM

[Leslie78]

The concern about emerging markets actually should benefit the U.S. markets, because we've been losing investors to foreign markets. And keep in mind that the big boys have been looking for every reason under the sun to get longs to panic and dump their stocks, so they can buy shares on the cheap. Like every other negative news story of late, Dubai is overblown. The supposed worry is about a $33 billion bond, which is chump change Abu Dhabi, which is Dubai's Middle Eastern version of our China.

According to today's Wall Street Journal (Nov. 27, 2009):

"DUBAI—Pressure mounted on oil-rich Abu Dhabi to step in with financial support for Dubai after fears of a debt default by one of its state-owned conglomerates hit stock markets in Asia and Europe.

The U.A.E. is a federation of seven sheikdoms including Abu Dhabi and Dubai. Abu Dhabi is the senior partner in the grouping and controls 90% of its vast oil reserves, considered to by the world's fifth largest.

"Abu Dhabi's support for Dubai might be less generous than the markets have assumed so far. Perhaps Abu Dhabi has forced Dubai to tackle the problem of excessive corporate debt 'in-house' first before extending more financial support," Swiss lender UBS AG said in a research note.

Persons close to the Abu Dhabi government told Zawya Dow Jones Friday that the United Arab Emirates as a whole won't allow Dubai to be crushed by the problems of its troubled business conglomerate Dubai World.

The dollar and the yen roared higher Friday as the fallout from the Dubai debacle continued to resonate through global financial markets. Proving that gold doesn't always benefit during bouts of risk aversion, gold fell 4% along with a decline in crude oil."

Meanwhile, equities markets across Asia fell sharply Friday. Japan's Nikkei 225 Average fell 3.2% to 9081.52, its lowest close since July. In Hong Kong the Hang Seng Index plunged 4.8% or 1075 points to 21134.50, led down by banking stocks. HSBC Holdings shares in Hong Kong fell 7.6% and Standard Chartered shares closed down 8.6% on news the banks were directly exposed to Dubai's debt problems.

European shares, which dropped sharply Thursday, rebounded from early session lows Friday ahead of the U.S. stock market open, suggesting that the selloff on Dubai World's debt worries was overdone."

2009 Nov 27 08:47 AM

[p church]

If 60 Minutes, who did a show on all the vacant Dubai real estate last year, was in the know-- then who wasn't?

2009 Nov 27 08:48 AM

[air tango]

Rid of Saddam? or George W. Oil
Bussines??


On Nov 27 08:21 AM apppro wrote:

> And as 2nd issue:
>
> To heck with them! Did any of those Arab countries help pay for the
> reconstuction of Iraq or Brunai when we got rid of Sadam for them!

2009 Nov 27 08:50 AM

[jbde]

apppro said: "That entire area was a waste of Arab oil dollars"

No - OUR DOLLARS.

The flow of wealth taken from the average person has been used unwisely. Not FOR the average person, but for the elite.

What we need is reality - $40 oil - no war premiums, no rapid up and down trading - good ol' boring oil prices without speculators.

When 7 FED members [and counting], plus Tim say there is no asset bubble - THERE IS AS ASSET BUBBLE. How big it is will be measured as to how low prices get as everyone scrambles for the door and the overhead abundance of sellers depresses prices for years.

Yes years. Deflation is here and the 're-inflation' trade of low interest rates is not working. Sure you may 'recover' price as risk is chased, but just try to sell a lot of something - like foreclosed and now deteriorating homes. Looks good on paper - but not in the real world.

2009 Nov 27 08:57 AM