What You Need to Know about Dubai Debt Drama
Economics / Global Debt Crisis Dec 02, 2009 - 11:18 AM GMTBy: Q1_Publishing
“U.S financial institutions could take direct hits,” warned a CNN headline after last week’s market rattling announcement from Dubai.
Like an eerie reminder of last November, when the only reasonable expectation you could have as the markets closed was that you would wake up to something unexpected, the markets opened up with a renewed sense of fear.
For investors who are willing to look past the day-to-day drama and look at the bigger picture, the Dubai debt issue is just another step on the current path. Because once you take a step back and look at what’s really going on, and the implications of a Dubai World meltdown, and how it’s all likely play out, you can see where this scare ends up. And from there you can see the big opportunity resulting from it all.
Ever-growing List of Too Big to Fail
Dubai World has real estate investments all over the world. As the investment arm of the Dubai government, it owns and operates shipping ports, dry docks, hotels, and built the man-made palm shaped island which epitomizes the debt-fueled opulence.
To fund the lavish and aggressive growth, Dubai World was a big borrower. Over the years it has accumulated $59 billion in debt (that used to be a lot, in an era before Fannie, Freddie, GM and most of the major banks were handed trillions of dollars).
Despite its relative size, Dubai World is too big to fail. Here’s why.
Dubai World owns a lot of commercial properties in the United States. One of its crown jewel properties, the Las Vegas CityCenter, an $8.5 billion joint venture with MGM Mirage (NYSE:MGM), just opened today.
The CityCenter is the biggest venture yet in a city whose skyline is filled with big ideas and big risks. And, quite frankly, it couldn’t come on line at a worse time. Las Vegas resorts are still struggling from low occupancy and even lower gaming revenues.
Basically, there are no buyers who would even be able to scrounge up $4 billion – less than half the construction cost - to buy out the CityCenter. And given the state of the economy, few would even try.
That’s exactly problem.
Sticking with What “Works”
The CityCenter is a massive commercial real estate property and a forced liquidation of it could send the commercial property market plummeting to reality. That’s something no bank or government wants right now.
You see, the U.S. commercial property market is massive. The Fed estimates the total value of it at $6.5 trillion. About $3.3 trillion of that is backed by commercial loans and commercial property securities.
If you recall our coverage of the impact of a commercial real estate meltdown, commercial real estate debt has been a favorite of regional banks, pension funds, and insurers. They’re deep into commercial real estate debt and they will be the ones taking the hit if commercial real estate price collapsed. This would accelerate bank failures, unveil the pension Ponzi schemes, and would quickly short-circuit any recovery.
So a large commercial property foreclosure, debt writedown, and/or forced sale of a property like the CityCenter would have a snowball effect. The writedown would lead to more and more writedowns of other commercial property and cascade into another market crushing scare.
We’ve already witnessed what a few hundred billion dollars worth of writedowns do to banks’ balance sheets. Any decline in the commercial property market will just kick off a few hundred billion dollars more in writedowns.
Basically, the collapse of Dubai World would lead to something the Fed is going to do anything it can to prevent. And since it already believes the “unprecedented liquidity” it pumped into the market last fall worked, it’s surely going to keep on doing what it does best – print money over any problem.
The Inevitable Fallout and Opportunity
That’s where we come back to the most dominant theme in the markets for the next few years – inflation.
Yes, there are natural deflationary forces, but the Fed has proven it will stave off any deflation at all cost. And the Fed has already tipped its hand to its exit strategy from the current economic malaise.
The Fed, in conjunction with the U.S. government, is trying going to inflate its way out of the current mess at any cost.
The massive money printing will ensure prices stay high and go higher. Meanwhile, the debts stay the same size. They’re basically bailing out debtors at the price of savers.
Since they failed to rip the band aid off last fall, this is the only way they know how to do it. It’s no secret they want inflation. But the key thing is with announcements like Dubai World’s and the dozens of others which will come along every few months until the world’s debts are inflated away, the Fed and central banks around the world are going to keep the printing presses running on high.
That’s why it’s no surprise gold is at another new all-time high, real assets are headed higher before the “inflationary bailout” is over, and the coming inflation will be the dominant investing theme for years to come.
Good investing,
Andrew Mickey
Chief Investment Strategist, Q1 Publishing
Disclosure: Author currently holds a long position in Silvercorp Metals (SVM), physical silver, and no position in any of the other companies mentioned.
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