Rumbles in the Desert

By Megan McArdle

While you were all stuffing yourself with turkey and gorging on sweet potato souffle, Dubai World, the Dubai government's investment arm, asked investors for some extra time to make its debt payments.  In normal times, this would be a big problem for Dubai.  But these are not normal times, and the world is suffering from the mother of all debt hangovers.  A big sovereign default--for this is essentially what this is--raises questions about who might be next.

Paul Krugman sums up the possibilities:

First, there's the view that this is the beginning of many sovereign defaults, and that we're now seeing the end of the ability of governments to use deficit spending to fight the slump. That's the view being suggested, if I understand correctly, by the Roubini people and in a softer version by Gillian Tett.

Alternatively, you can see this as basically just another commercial real estate bust. Either you view Dubai World as nothing special, despite sovereign ownership, as Willem Buiter does; or you think of the emirate as a whole as, in effect, a highly leveraged CRE investor facing the same problems as many others in the same situation.

Finally, you can see Dubai as sui generis. And really, there has been nothing else quite like it.

At the moment, I'm leaning to a combination of two and three. For what it's worth (not much), US bond prices are up right now, suggesting that the Dubai thing hasn't raised expectations of default.

I agree with Professor Krugman--it's hard to see this presaging a sovereign debt default by, say, the United States.  On the other hand, emerging markets are subjects to runs on their currencies, and debt, and I'm not so sanguine that we won't see effects there.  We might get a split in sovereign debt prices, with developing world debt being shunned by investors who have suddenly remembered what a risk premium is, while US debt and that of other developed countries becomes more valuable.  A positive movement in US bond prices agrees with that theory.

Which is not to say that this won't hurt us.  The global economy is not really robust enough to stand up to repeated blows.  Presumably that's why stock indices are off on worries about what follows.

This article available online at:

http://www.theatlantic.com/business/archive/2009/11/rumbles-in-the-desert/30910/