There’s an old saying that people with too much money on their hands soon find themselves with the opposite problem, and Dubai has just handed the world a prime example.
Global financial markets were rocked late last week by the startling news that the Persian Gulf emirate’s sovereign wealth fund (SWF), Dubai World, is effectively insolvent and has arbitrarily declared a six-month moratorium on debt payments it’s unable to make.
Global currencies from Colombia to Singapore took a tumble, and stock markets worldwide had a panic attack, fretting that some of the world’s other 30 or so SWFs might soon also be in dire straits. Many SWFs have extensive debts outstanding with the world’s largest banks.
For all the worldwide efforts to bail out the global banking system, it has only returned to stability, not good health. Having endured the spectacular collapse of the U.S. housing market, the system is now girding for a string of defaults in commercial real estate. Additional failures among SWFs, unforeseen until last week, would not cause a second global credit freeze. But they would further delay a complete recovery of the banks and a sputtering world economy.
What’s the origin of this latest shock to world finance?
As global trade and commodity prices – particularly oil – spiralled upward earlier this decade, a Niagara of money poured into the coffers of export powerhouses like China, Korea and Singapore. And into the state treasuries of commodity producers including Saudi Arabia, Kuwait, Russia and Dubai.
Those states created so-called sovereign wealth funds to hold all that money. By mid-decade, the SWFs’ rapidly growing assets were expected to reach as much as $12 trillion (U.S.) by 2015, just shy of the size of the U.S. economy. With oil heading for a $147.50 per barrel peak, that estimate didn’t seem far-fetched.
The opportunity to tap these new and massive pools of cash was seized upon by capital-hungry real estate developers, private equity shops and hedge funds worldwide.
And in some quarters, the SWFs were seen as a threat to national security. That worry came to a head, ironically enough, in the ultimately failed attempt in 2006 by Dubai Ports World to acquire some of America’s biggest East Coast seaports. DP World is the principal arm of the now crippled Dubai World. The deal was thwarted by objections in the U.S. Senate.
"Should we be outsourcing our own security?" U.S. Democratic Senator Charles Schumer said of the spectre of state-controlled Arab investors in charge of inspecting cargo coming into New York and New Jersey ports.
Stephen Harper got into the act. While sanguine about the loss of Alcan, Dofasco, Inco and other iconic firms to foreign private-sector buyers, Harper vowed to block takeovers by government-controlled SWFs on national security grounds.
That paranoia was immediately reminiscent of the much-feared Japanese accumulation of Western assets in the 1980s. Japan was then the world’s top creditor nation and seemed poised to take over America’s industrial crown jewels. Japanese purchases of Columbia Pictures and the Rockefeller Center were seen as a mere appetizer.
You know the rest.
Japan’s overheated economy was peaking as it began its short-lived U.S. foray, which was soon followed by the implosion of the Japanese property and stock-market bubbles. For good measure, the Rockefeller Center and Hollywood purchases were dumb. They were made at the top of the market – a beginner investor’s folly – and lost a tonne of money for their Japanese buyers. The Japanese economy was to endure 10 years of stagnation in the 1990s – Japan’s so-called "lost decade" – and the Land of the Rising Sun has not fully recovered to this day.
Despite that object lesson, no thought was given to a similar fate for the more recent SWF bubble. After peaking at about $3 trillion in 2007, total SWF assets had plummeted in value by May of this year to a mere $1.8 trillion.
The obvious culprits are the global recession and resulting 11 per cent drop in global trade that sharply reduced Western cash inflows to goods exporter China and oil producer Dubai.
Less obvious is that the wet-behind-the-ears SWFs made lousy investments, as the Japanese had done in their moment of exuberance.
Abu Dhabi’s Investment Authority snapped up $7.5 billion worth of stock in Citigroup Inc. at prices in the mid-$30s. The stock in that U.S.-government controlled basket case now trades in the $4 range.
The Beijing-controlled China Investment Corp. was taken to the cleaners when the principals of Blackstone Group LP, America’s biggest private equity firm, decided to cash in through an initial stock offering. The Chinese paid $3 billion for a slab of Blackstone equity, or about $38 a share. That stock now changes hands at about $14 a share. Dubai World’s piece de resistance of poor investing judgment was the billions of dollars in loans it made to property giant Nakheel, developer of the much-photographed, palm-tree-shaped resort a few hundred metres off the Dubai coast. That landmark is a sort of Sydney Opera House run amok that always struck me as an overblown symbol of national coming-of-age rather than a viable financial proposition.
Not everyone has been crying in their beer since the Thursday shocker, despite the extensive collateral damage Dubai World has wreaked on global capital markets. The managers of the much older sovereign wealth funds of Alberta, Alaska and Norway, mocked for their conservative investment practices when the newbie SWFs were spending with reckless abandon, have been vindicated.
And in contrast to the prolonged Japanese decline, China, Korea, Kuwait and almost all of the other SWF-owning states will be on the mend relatively soon as the global economy recovers, enabling them to backstop losses on their SWFs.
Just as the fear of Japan was misplaced, so too the SWFs of communist and Arab nations. The concern should have focused on the SWF’s ineptitude.
The crack-up of Dubai’s once stupendously endowed SWF is also a powerful reminder that it’s wrong to associate investing smarts with those in possession of large sums of money. The world’s biggest banks not long ago were awash in more money they could intelligently handle. And tens of millions of workers are unemployed today as a result of the ill-advised bets they made. The everyday analogy is the lottery winner uncertain of what to do with his windfall who finds himself broke within a year. But at least his folly is not the cause of widespread misery for others.
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