Peter Cooper's  Instablog

Looking back over the past couple of months you have to wonder how much Dubai has damaged its reputation as a growing global financial centre. The headlines suggesting that the city is drowning in debt are not positive, and the reality that has emerged is not that great either.

Before the debt crisis the reputation of the Dubai International Financial Centre was definitely rising fast. A report commissioned by the DIFC from KPMG, and published today but presumably with field work from before the Dubai debt crisis, showed Dubai seventh ahead of Frankfurt in a competitiveness league table of financial centres:

1. Singapore
2. London (UK)
3. New York (USA)
4. Hong Kong
5. Zurich (Switzerland)
6. Tokyo (Japan)
7. Dubai International Financial Centre (UAE)
8. Frankfurt (Germany)
9. Luxembourg
10. Dubai (UAE)
11. Paris (France)
12. Dublin (Ireland)
13. Doha (Qatar)
14. Manama (Bahrain)
15. Riyadh (Saudi Arabia)

A press release from the DIFC said it was ranked this highly ‘on the strength of its world-class legal and regulatory standards; independent regulator and judiciary system; and strong value offering for financial businesses. DIFC’s infrastructure and business environment, custom-designed for the financial industry, also helped Dubai receive an overall competitiveness score higher than global centres like Paris and Dublin.

‘The report assesses the competitiveness of financial centres using an evaluation model that measures both ‘capability’ factors or immediate benefits provided by a financial centre, and ‘performance’ factors, which reflect historical or long-term results. The focus on ‘competitiveness’ puts the spotlight on the potential of a centre to excel in the future and not just on its current status.

‘The final rankings were based on a composite score derived from three pillars – Industry Opinion, Industry Performance, and Capability Measurement – that determines overall competitiveness.

‘The Industry Opinion pillar is based on the Global Financial Centres Index 6 published by the City of London, while the Industry Performance pillar is based on the Financial Development Index 2009 published by the World Economic Forum.

‘The Capability Measurement pillar is based on an assessment model developed to measure the growth potential of a financial centre in the future based on a three factors including business environment, cost of doing business and cost of living.’

However, any observer from the financial sector is bound to ask whether the ‘Industry Opinion pillar’ is not likely to have changed significantly in the wake of the Dubai debt crisis of the past two months. Certainly the risk perception of lending to Dubai must have been transformed.

But the global financial community are pragmatic folk. Dubai did not actually default on its Islamic bond this month. There is a rescheduling of $22 billion in debt owed by Dubai World subsidiaries Nakheel and Limitless now in progress. That is probably the biggest debt problem facing Dubai but there will be others.

So whether the Dubai debt crisis does significant long-term damage to its global financial reputation is likely a matter of how it proceeds from here. Greater transparency and openness and a willingness to discuss past mistakes is a step forward, so too is the merger of the two Dubai stock market trading floors announced today.

Most dramatically the gold price hit $1,226 an ounce as the dollar hit rock bottom, and has since given back $100, prompting renewed pessimism about the future of gold from the same voices that warned about gold at $300 as a ‘barbarous relic’. Oil has also dropped below $70 and could fall much further as the dollar rally continues.

The best way to view the dollar rally is as a contrarian. The dollar rally is the contrary action to the long rally in stock and commodity prices from the March lows of this year. All good rallies eventually come to an end but for every action there is an opposite reaction.

So the dollar bottom is actually calling a major top. The dilemma for analysts has shifted from being split over the dollar outlook to pondering the extent of its recovery, and what might happen after that.

Well taking up the contrarian theme a lot will depend on how far stocks and commodities retrace their record recent rally. Will this be an orderly 20 per cent correction? Or a step down to new market lows as Bob Prechter has just said again?

My own analysis has been stated recently on this website as a part of my review for the outlook in 2010. Basically my case is that we have a monstrous bubble in global stock markets, and that argues for a bigger than average correction.

Logically that ought to make a pretty sensational rally for the US dollar. The notion of $1.35 to the euro, or the $1.30 pound is perfectly possible, a prediction that would have brought calls for the straitjacket back in the summer.

However, before people living in dollar zones go rushing off to buy an extra turkey for Christmas, remember that this will only come with significant damage to asset prices, and to the highly tentative economic recovery. A strong dollar is bad for exports and lowers export earnings exchanged for dollars.

Turkeys do not generally vote for Christmas because it signals their own demise. But then the dollar rally will also contain the stuff of its own destruction.

For the bond rally that accompanies the rising dollar will also be a top to what is arguably the biggest and most dangerous bubble in the world today, US treasuries. If that bubble ever blows then the financial system will be in deep peril again.

That is why the real contrarians like my friends at the Daily Reckoning and Dr. Marc Faber and Bob Prechter warn of an ultimate nemesis in which the US dollar crashes and burns and precious metals soar in value as the only true money in a world of paper currencies.

This final scene in the global financial crisis could be played out over a few months but far more likely a few years as the central bankers grapple with a deteriorating situation. So if you think dollar strength is a sign of economic recovery, think again and do not forget to buy some gold and silver.

S&P told the Financial Times the Dubai decision ‘may be considered a default under our default criteria, and represents the failure of the Dubai government (not rated) to provide timely financial support to a core government-related entity.’

Bond markets responded with credit spreads immediately widening. But Gulf stock markets are closed for the Eid religious holiday, and this will give the government time to clarify its intensions. Markets will likely tumble when they reopen.

The $59 billion debt mountain belongs to Dubai World whose assets range from the Jebel Ali Free Zone to the quoted ports operator DP World and Nakheel the developer of three palm-shaped islands. Two palm islands lie abandoned as well as a map of the world formed from smaller reclaimed islands.

At the same time as the debt repayment suspension, the government appointed Deloitte’s Aidan Birkett as Chief Restructuring Officer to ‘oversee the restructuring process and ensure the continuity of Dubai World’s operations’. His report will be eagerly awaited by creditors who are very unhappy about the debt suspension.

Only a few weeks ago creditors were assured that the $3.5 billion Nakheel Islamic bond due in December would be repaid. Some speculators had bought the bond earlier this year at a massive discount in expectation of a huge profit that will not now transpire.

A statement said Mr Birkett ‘will start to assess and evaluate the extent of the restructuring required. As a first step, Dubai World intends to ask all providers of financing to Dubai World to “stand still” and extend maturities until at least May 30, 2010′.

But Dubai is not alone in its debt problems. Banks have been falling over themselves to lend money to emerging markets in recent years, and since the financial crisis there has even been a view that emerging markets carry less risk than developed countries.

The carry trade of borrowing in US dollars and investing in emerging markets for high returns is a liquidity bubble and an accident just waiting to happen. Perhaps the situation in Dubai should be regarded as a wake-up call.

Investor perception of stock market risk has just hit a five-year low in the United States. Any contrarian investor would have to conclude that such monstrous complacency could only come before a market crash, as indeed it did last autumn.

Shocks in emerging markets like Dubai are the flutter of butterfly wings that produce a hurricane elsewhere, and $59 billion is a bit more than a butterfly. Investors should exit all stock markets and buy bonds or precious metals or short emerging markets. Gold hit $1,195 as this article was written.