The world of international finance has been shaken by the default in Dubai. Shares have taken a tumble all over the world. Commentators have suggested that this could be the cause of the recession moving into a double dip, of a further downturn in the world economy.

What has happened? Dubai World has asked for a 6 months moratorium on its debts. That means it can’t keep up the payments. It’s in big trouble. The bankers reckon the company owes $60bn all around the world. Dubai World is not just a private company. It’s an arm of the government, run by the ruling sheikh. The vast sums it borrowed carried an implicit state guarantee. As we now know, this guarantee was worthless. Dubai World issued bonds, which are supposed to be much safer than shares. Its paper was seen as safe as Dubai government bonds.

Dubai is a comic opera country. One of the United Arab Emirates, it has a population of 1.2 million, most of whom are from abroad. Dubai started life as a sleepy fishing port. With less oil revenue than most of the other Emirates, Dubai World launched an immense construction boom aimed at turning the town and surrounding desert into a place for the super-rich to hang out. They built the tallest tower in the world. As plush apartments went up all over Dubai, so did the rents and Dubai World became very happy and very, very rich. But the party is over. They have recently had to abandon a half-built project to build islands in the shape of a map of the world in the Gulf, all holding luxury accommodation.

Why should we worry about the fate of a company in the Gulf? Because capitalism is a global system and it knits all our fates together. When it was doing well, Dubai World bought that iconic firm of British imperialism, P & O. They bought the Adelphi building in the Strand, Grand Buildings in Trafalgar Square and a share in the London Eye. They bought the QE2. They own 51% of Southampton container terminal and are currently developing the London Gateway Port.

But still Dubai World kept borrowing. The Bank for International Settlements estimates that the United Arab Emirates as a whole owe $123bn to the rest of the world. It looks like we can kiss goodbye to a lot of this money. Guess what? $50bn of the cash is due to UK banks. HSBC is owed $17bn, Standard Chartered $7.7bn, Barclays $3.5bn, RBS $2.3bn and Lloyds TSB $1.5bn. So it goes on.

White expatriates in Dubai have been living the life of Reilly till recently, with ‘all you can eat’ brunches in five star hotels on Friday (This is actually code for ‘all the champagne you can guzzle’) and Ferraris as standard issue. That the building boom was a bubble about to burst was plain for all to see, but everybody enjoyed the party to the full as long as it lasted.

The Burj Dubai, the tallest man-made structure in the world. Photo by Imre Solt. Life for the workers who actually threw up the skyscrapers was a little different. Lured from impoverished neighbouring Arab countries or the Indian subcontinent by tales of wages they could keep their families on with ease, their passports were confiscated upon arrival and they became indentured labourers, in effect slaves in Dubai.

But Dubai is part of the world economy and, when recession came, it hit Dubai hard. They could no longer fill all the luxury apartments they were building, rentals collapsed by 50% and they stopped building flats. The construction boom came to a sharp halt a year ago and the foreign building workers were packed off home. There are still 40,000 dwellings in the process of being built over the next two years. They will not find buyers, so the depression will not go away soon.

The trouble was Dubai was really nothing more than a gigantic building site. The default of Dubai World is really the national bankruptcy of Dubai. This is the second country after Iceland to be forced into bankruptcy as a result of the crisis of capitalism. The results of national bankruptcy were a catastrophe for the people of Iceland.

Sovereign default is the latest thing capitalist commentators have become seriously vexed about. You can bet on anything under capitalism. You can buy a bit of paper called a Credit Default Swap (CDS) and bet on the chances of a country defaulting. All countries are perceived as becoming riskier as the government deficit balloons. For instance UK public debt was 46% of GDP in 2006 and is assumed to reach 89.3% next year, nearly doubling in consequence of the crisis. As a result $24bn is being bet against the possibility of UK government securities defaulting compared with just $12bn in 2006.

Why might a nation be unable to pay its bills? Because government debt has swollen on account of the economic crisis. Crisis means government receipts such as taxes fall, while the state has to pay out more in benefits. In many cases the fiscal crisis of the state has been made worse by the need to bail out the banks. The government then borrows from other countries to cover the shortfall, and starts to slide down the slippery slope.

Now the latest twist in the tale means UK banks look likely to take yet another body blow, this time from Dubai. No doubt they will be lining up in the not-too distant future demanding that the government bails them out one more time, increasing government debt still further. The global interdependence imposed by capitalism may mean all countries share increased prosperity in a boom, but in a recession it spreads misery all over the world from the remotest, apparently accidental, incidents.

It’s possible the establishment may be able to organise a rescue for Dubai. It is expected that oil-rich brother Emirate Abu Dhabi may move to bail out the prodigal Dubai, after some grumbling. And the losses may ‘only’ be $60bn, compared with $600bn in the case of Lehman Brothers last year. But the finances of Dubai World are far from transparent. There could be some nasty surprises lurking in the detail.

Events have already proved quite dramatic, shaking the confidence of the financial establishment all over the world. This will not be the last we hear of the dangers of national bankruptcy. As Gillian Tett asks in the Financial Times (22.11.09) “Will sovereign debt be the new subprime?” She points out that banks are being exhorted to hold government bonds as an asset on the grounds that they are safe. There is bound to be pressure on governments to print money and, through inflation, erode the value of the bonds. The Dubai World default shows that government securities are not always safe and their promises cannot always be relied on. The banks could be packing their vaults with more toxic waste.

How can a country try to get out of the peril of falling helplessly into debt to other countries, triggering national default? One way is by devaluing its currency, letting it fall against other national currencies so that exports are cheaper and imports dearer. But countries in the Euro-zone do not have this emergency exit. They can’t devalue because they share a common currency. Interest rates and monetary policy are the same in all nations across the region, set by the European Central Bank, so they can’t print money to get out of trouble either.

"Creditors need to take part of the responsibility for their decision to lend to the companies...They think Dubai World is part of the government, which is not correct. Dubail World was established as an independent company; it is true that the government is the owner, but given that the company has various activities and is exposed to various types of risks, the decision, since its establishment, has been that the company is not guaranteed by the {Dubai} government." Addulrahman al-Saleh, director generalof Dubai's department of finance (trying to keep a straight face) - quoted in the Guardian 1/12/09

Actually some countries in Euro-land are feeling the heat more than others. The weaker economies in the South of Europe, often spoken of disparagingly as the ‘Club Med,’ are really struggling with the effects of the crisis. The Greek government is running a government deficit of 12.7% of GDP (more than four times the permitted European maximum), which means the government’s debt will hit 135% of national income. Greece has a deficit with foreigners of 14.5% of GDP and foreign debts amounting to 150% of national income.

At present the Greek government has to pay 178 basis points (nearly 2%) more in interest than the Germans to speculators to hold on to their 10 year bonds. Clearly the speculators demand higher rates because they fear the Greek government may default. As Lars Christian of Danske Bank comments, “There is enormous denial…They can’t devalue; they can’t print money.” George Papendreou, the incoming prime minister, is in despair at how dire the finances are. “Our country is in intensive care,” he warns. “This is the worst crisis since the restoration of democracy” (in 1974). A Greek default would be much more serious than that of Dubai. It would throw the whole of Europe into turmoil.

The crisis is putting immense pressure on all the countries of the Euro-zone and upon the existence of the Euro itself. It stalks one country after another, probing for weakness and laying the weakest low. The example of Dubai could have global consequences. It could in its turn knock over a lot more dominos in the world economy. Capitalism is inherently unstable. As long as it exists, it threatens all our livelihoods.

December 1, 2009