Dubai May Trigger Major Sovereign Default

Alex Messenger
Dubai’s announcement on Wednesday that it would be delaying by “at least” six months the maturity date of $59 billion in bonds issued by the city-state’s largest state-owned company, Dubai World, has sent global shares tumbling. The market reaction to Dubai’s massive debt default is partly explained by the exposure of European and Asian banks to DP World and its tourism subsidiary, Nakheel.

The real reason for the falls, however, is that Dubai’s apparent insolvency confirms that default by hyper-indebted government borrowers is now a real risk right across the globe, especially in the Middle East and Eastern Europe. Such a default would not only mean an immediate worsening of the already brutal post-crash conditions suffered by millions of workers in defaulting countries, but would usher in a second, and probably worse, phase in the global financial crisis.

A note published by Bank of America strategists warned of the possibility of a major sovereign default. “One cannot rule out—as a tail risk—a case where this would escalate into a major sovereign default problem, which would then resonate across global emerging markets in the same way that Argentina did in the early 2000s or Russia in the late 1990s,” the note said.

An editorial in today’s Financial Times noted that while markets were not expected to return to the panic of September 2008, because the financial sector had state backstops, “fearful investors have started to worry about how safe sovereign debt is,” citing Ireland and Greece as two examples.

The Dubai meltdown represents only a small sum in terms of total global indebtedness. Nevertheless it indicates that despite talk of global economic recovery, the world remains on a knife-edge. Attempts at reassurance by British prime minister Gordon Brown indicate that financial and government elites are already fearful. Brown this morning acknowledged the risk that Dubai posed to the global economy but, with careful understatement, told reporters “I think we will find this is not on the scale of the previous problems we have dealt with.”

Market falls on news of the Dubai crisis were sharpest in Japan, where a number of banks (including Mitsubishi UFJ and Semitoro Mitsui) are directly or indirectly exposed. Japanese shares plummeted 3.2 percent yesterday—the market’s largest one day decline in 8 months. A 2.9 percent fall in Australia the same day reflected the fact that a Dubai World subsidiary, stevedoring company DP World, carries one third of Australia’s sea cargo. In New York, the share index opened 2 percent down and only partially recovered those losses. Forty-four billion British pounds has been wiped off the London market, the largest single day loss since March. Shares in UK bank HSBC fell 7 percent. HSBC is reported to have lent Dubai $17 billion. Other UK banks with a Dubai exposure are Standard Chartered, Citigroup UK, Lloyds and Royal Bank of Scotland, an institution now majority-owned by the UK government, which has received more bailout money ($67 billion) than any other bank in the world.

Dubai World accounts for three quarters of the $80 billion borrowed by Dubai’s state-owned companies to fuel the emirate’s property boom. That boom—which came to an end when property values halved in a period of weeks from October 2008—was an expression of the global elite’s fantasy of endless wealth, with Dubai’s ruling family creating a desert playground for the global rich. Its most notable features were the world’s tallest building, a giant indoor ski slope and a series of vast man-made islands in the shape of palm trees and stars. Dubai World, which manages billions in construction projects, also used its foreign borrowings to diversify into global transport, especially ports and shipping. DP World is the largest port operator in the Middle East.

It is testimony to the anarchy and irrationality of the global financial system that although the scale of the Dubai crisis has been apparent for months, the government’s default announcement still caught global markets unawares. Banks had apparently assumed the existence of an implicit government guarantee of DP World’s debt, if not by the Dubai government, then by Dubai’s sister emirate, oil-rich Abu Dhabi. But there was no guarantee—Dubai World is a limited liability company owned by the Dubai government. The expectation that Abu Dhabi would rescue foreign investors was just idle hope.

Along with worldwide share market falls, the immediate effect of the Dubai default has been a surge in the insurance costs for national borrowings, especially by poorer countries. That cost is represented in the price of credit default swaps (CDS) on government bond issues. Greek CDS costs in particular have skyrocketed, raising fears that Greece, with public debt levels at a staggering 130 percent of GDP, will follow Dubai within weeks. CDS costs for Hungary have also soared since Wednesday, and there have been CDS price increases of about 11 percent for Malaysia, South Korea and Qatar.

These developments are by no means unforseen. Rather, the Dubai default is a lit match for ready-to-burn tinder, namely global sovereign debt levels. The key response of capitalist institutions to the global financial crisis has been to transform the toxic debts and unsustainable borrowings of private institutions into public debt via bail outs, guarantees and other stop-gap mechanisms. According to new estimates by Moody’s, the credit rating agency, the total stock of sovereign debt worldwide will have risen by nearly 50 percent between 2007 and 2010 to $15.3 trillion.

This ballooning of sovereign debt has been so fast and so immense that there is little chance of debtor governments, mired in unemployment and low growth, repaying either in the short or long term. As borrowing costs increase because of the perception of increased default risk (also called ‘long tail’ risk), the situation for indebted countries becomes worse. Global funds available for such borrowings are also drying up. While Greece, Hungary, Latvia, Estonia and Turkey are at the top of the global watchlist, default is also an eventual likelihood for the United States, which has public debts of $12 trillion. The key difference between the United States and smaller states, in this regard, is that the US is currently deemed by its bondholders, including the Chinese government, as ‘too big to fail’.

The Dubai default also pierces claims that allegedly well-managed and well-regulated national portions of the world economy can escape the effects and aftershocks of the financial crisis. Government and the corporate press have claimed that Australia, for example, is immune. But it is now likely that DP World’s Australian ports—a substantial piece of that country’s infrastructure, currently worth $1.5 billion—will have to be sold in the near future. Early reports indicate that there is unlikely to be strong interest and there may be no buyers. Few local companies have funds of that scale to invest in what is now, in the context of an uncertain future for global trade, a very risky asset.

Peace Prize Winner Obama to Send 45,000 More Troops to Afghanistan

Image by Getty Images via Daylife

WAR IS PEACE

The BBC is reporting that the Obama administration has told British officials that it will announce a "substantial increase" in U.S. forces for Afghanistan.

The report, attributed to British sources, follows today's announcement that 500 additional British troops would be sent to Afghanistan if certain conditions are met.

According to the BBC's Newsnight program, "the US could next week announce plans to send up to 45,000 extra servicemen and women."

White House press secretary Robert Gibbs dismissed the report, saying President Obama has made no final decision on troop numbers.

Earlier today, Prime Minister Gordon Brown pledged more troops on the condition that Afghan President Hamid Karzai reduce corruption and improve his government's performance, and if they have the necessary equipment, if other NATO allies also bolster their forces and if more Afghan soldiers are trained. About 9,000 U.K. personnel are in Afghanistan now.

On Tuesday, AFP reported:

In an unannounced move, President Barack Obama is dispatching an additional 13,000 US troops to Afghanistan beyond the 21,000 he announced publicly in March, The Washington Post reported Monday.

The additional forces are primarily support forces -- such as engineers, medical personnel, intelligence experts and military police -- the Post said, bringing the total buildup Obama has approved for the war-torn nation to 34,000.

"Obama authorized the whole thing. The only thing you saw announced in a press release was the 21,000," a defense official familiar with the troop-approval process told the daily.

The report, posted on the newspaper's website late Monday, came as Obama weighs a request from the top US and NATO commander in Afghanistan, General Stanley McChrystal, for more combat, training and support troops, with several options including one for 40,000 more forces.

G20 Summit - Casino Capitalism as Usual

Image by International Monetary Fund via Flickr

With only piecemeal reforms to the financial system made at the G20 summit in Pittsburgh, the key tenets of market fundamentalist economic policies still prevail. Not until the global economic system is democratised will the world’s poor be given priority over the wealthy few, argues Mark Engler.

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1st October 2009 - Published by Foreign Policy in Focus

Last week's Group of 20 (G20) meeting in Pittsburgh brought together leaders from the most significant players in the global economy and charged them with renovating the financial system at the heart of the economic crisis. Change was on the agenda, and the heads of state claimed to deliver. As the summit concluded, The New York Times hailed the meeting's final statement as a momentous shift, reporting that "Leaders of G20 Vow to Reshape Global Economy."

Unfortunately, the changes left off the table at the summit were far more significant than the modest reforms actually debated, and the few alterations that did make it into the final agreement are likely to be further watered down in implementation. Even the most common-sense reforms are being met with determined corporate opposition. Indeed, given the depths of the collapse one year ago and the volume of public outcry for change, the real surprise is how little transformation has yet taken place.

Late and Little

Many of the items on the Pittsburgh agenda were not bad in themselves. They were merely limited in scope and under siege by lobbyists. The G20 moved in the right direction by announcing that it would require banks and other financial institutions to have greater capital reserves. Mandating that a bank keep more in reserve for every dollar it lends out makes it less likely that the institution will be caught short and need a bailout. While such a change may sound arcane, it could mark a significant break from the past if done right and made part of broader regulations. After all, leveraging assets in order to obtain greater profits — whereby overextended firms made high-risk wagers with ever-greater amounts other people's money — went far in provoking the crisis.

While higher capital ratios and greater oversight would limit this kind of wanton speculation, the G20 statement is short on specifics about the actual requirements that financial institutions would be made to respect. And, sadly, the determined opposition of European bankers will likely keep changes to minimal levels. The difficulty with implementing even this most minor and reasonable of reforms shows how entrenched corporate power remains in post-crisis policymaking.

This bodes ill for the prospects of other heralded changes. On Wall Street's behalf, the Obama administration worked to curtail a French and German push for caps on executive pay — specifically controls on the outrageous bonuses given to top bankers whose institutions have lost billions. As a result, the G20 agreement forgoes any hard limits on compensation. It instead promotes guidelines that would somewhat delay when bankers receive their multi-million dollar payouts. Ostensibly designed to focus executives on long-term performance, this substitute measure is a far weaker alternative.

Why is the Obama administration going to bat for Wall Street firms at international meetings? It's hard to say, especially since this has not produced any apparent goodwill at home. Despite the White House's efforts on their behalf, the financial industry is fervently opposing the president's proposed Consumer Financial Protection Agency, which would protect Americans from predatory lending by credit card and mortgage companies. A representative of the U.S. Chamber of Commerce's Center for Capital Markets recently explained to McClatchy that the Chamber is "spending about $2 million on ads, educational efforts, and a grassroots campaign to kill the agency."

Such backlash against reform suggests that the global economy is still being run like a gambling hall. The betting limits at some tables may be modestly reduced and payouts to the highest of high-rollers slightly reined in, but we have not strayed far from Harrah's or the MGM Grand.

The Muscle Behind Market Fundamentalism

The G20 is only one component of the global economy's management. As it turns out, the activities of other bodies compromise the G20's declarations of reform. While agreements at the G20 are notoriously lacking in enforcement, financial institutions that can discipline and punish — such as the International Monetary Fund (IMF) and World Trade Organization (WTO) — appear notably unreformed and unrepentant.

After a previous meeting of the G20 in London last April, British Prime Minister Gordon Brown announced, "the old Washington consensus is over." However, key tenets of market fundamentalist economic policy that defined this consensus — including fiscal austerity and pro-corporate deregulation — still prevail.

At the April G20 meeting, world leaders vowed to provide as much as $1.1 trillion in new resources to the developing world to blunt the impact of economic downturn. However, much of this funding has yet to materialize, and only a fraction of it is slated to go to low-income countries (rather than middle-income states). Moreover, the bulk of these resources are to be channeled through the IMF, which has typically demanded that recipients of its loans accept harsh neoliberal polices as a condition of receiving money. While Fund officials claim to have changed with the times by relaxing "conditionality" and easing their previously stern attitudes toward countries that dare to buck the neoliberal Washington Consensus, many of their recent loans suggest that, in practice, their conversion has been quite limited.

A recent report from the Center for Economic Policy Research indicates that the IMF "has tied pro-cyclical, contractionary economic conditions on Eastern European countries to sorely needed loans." While struggling economies are desperately in need of government social spending and monetary stimulus, IMF agreements with Latvia, Hungary, and Ukraine demand slashed budgets and policy restrictions that look a lot like the "structural adjustment" of old. In advance of the April G20 summit, Gordon Brown had admitted, "Too often our responses to past crises have been inadequate or misdirected, promoting economic orthodoxies that we ourselves have not followed and that have condemned the world's poorest to a deepening crisis of poverty." Sadly, the IMF has yet to demonstrate that it is truly breaking from this established pattern.

The WTO is not helping things either, especially when it comes to reviving financial regulation that can protect the public good. As Lori Wallach, director of Public Citizen's Global Trade Watch Division, observed last week, "the G20 leaders have announced a very perplexing plan of action that calls for reregulation of the financial sector to try to avoid the next economic crisis while simultaneously calling for completion of the WTO Doha Round, which would require additional financial deregulation, including new WTO limits on accounting standards through a text the disgraced Arthur Andersen firm had a hand in formulating." New "free trade" rules may prohibit countries from shielding themselves from exotic derivates such as credit default swaps or from capping the size of mega-banks that threaten to take down the entire system when they fail.

Left Off The Table

That the G20 is not undertaking a more serious transformation of global financial structures might reflect the power of continued corporate lobbying. It does not, however, reflect a lack of good ideas. A broad array of financial experts and civil society organizations — ranging from the Stiglitz Commission tasked with making recommendations to the UN, to grassroots coalitions such as Put People First, the Citizens' Trade Campaign, and the labor network Global Unions — have advocated for sensible and needed reforms that could be easily enacted if the political will existed.

One example is the "Tobin Tax" — a small tax on international financial transfers first advocated in the 1970s by Nobel economist James Tobin as a way of cooling speculation on foreign currencies. ATTAC (the Association for the Taxation of financial Transactions for the Aid of Citizens), a leading organization for globalization activism in many parts of Europe, takes its name from this proposal and has pushed for it for over a decade. A version of the tax recently gained an even higher profile in Europe owing to the support of Adair Turner, the head of the British Financial Services Authority, which regulates UK banking. Oxfam argues that, beyond discouraging short-term gambling on currencies, a tax as small as 0.005% could raise between $33 billion and $50 billion per year. This pool of money could support sustainable development in places where the majority of people are still living on less than $2 per day.

Reform proposals also include debt cancellation for countries in the global South. Many poorer nations must spend substantial portions of their budgets on interest payments to the North rather than serve populations hit hard by the crisis. Often, their debts were unjust to begin with, accumulated by dictators who have since been thrown out of power. In most cases the countries' citizens have already sent back payments that dwarf the original loans. Rather than having to submit to the IMF to receive new loans, poorer countries should be allowed to keep their own resources as part of a just stimulus program.

Reflecting the widespread agreement that no corporation should be "too big to fail," citizen advocates have pushed for a much more aggressive application of antitrust and anti-monopoly laws. In this vein, the Stiglitz Commission recommended the creation of a "Global Competition Authority" to provide "adequate oversight of these large institutions" and to "limit their size and the extent of their interactions." These suggestions have a strong grounding in the public interest but are of course anathema to corporate chiefs. Accordingly, they have thus far remained off the table at the G20.

A Democratic Economy

A final demand is that real steps be taken to make the global economic system more democratic. Although leaders at the Pittsburgh summit lauded themselves for moving key discussions from the G8 to the larger G20 — which includes regional powers such as China, India, and Brazil — the international financial institutions with real muscle remain woefully undemocratic. The IMF is a perfect example. The United States, with a 17% voting share, retains the ability to veto all key decisions, because these require an 85% majority. In recent years the IMF has made high-profile announcements of changes to its voting structure. These changes, however, amount to token shifts of a few percentage points from still-dominant wealthy nations to countries such as China.

Ultimately, the goal of economic reforms must not merely be to revive a system that, until its bubbles burst, produced extraordinary wealth for a fortunate few. Rather, it must be to create living wage jobs and slash inequality. Yet that end is unlikely to be achieved if control of economic decision-making remains forever in the hands of the privileged. While the G20 has invited some new members into the club, decisions about the global economy are still made in elite and exclusive venues, where bailed-out executives still matter far more than the world's poor. In changing this, democracy will have to be a means as well as an end. For as long as the bankers rule, we will have little chance of breaking from a dispiriting state of affairs: casino capitalism as usual.

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Mark Engler, a writer based in New York City, is a senior analyst with Foreign Policy In Focus.

Gold rally met with ferocious resistance from bullion banks

Image via Wikipedia

Ed Steer notes:
I said yesterday that Wednesday's gold o.i. numbers would be "u-g-l-y". In actual fact, they were beyond u-g-l-y. Gold o.i. rose by one of the largest amounts that I've ever seen in the ten years that I've been involved in the precious metals market...26,051 contracts. Total open interest is now 410,754 contracts, and yesterday's volume was a very large 165,302 contracts. Silver was better, with o.i. rising 'only' 1,629 contracts to 108,300 contracts of total open interest... on volume of 33,296... which is a lot.

It should be obvious to anyone that this price rally in gold is being met with ferocious resistance from the bullion banks, who are going short against every long placed. Without a doubt, they piled on the short positions again on Thursday... and I won't be going too far out on a limb to say that we are very near to having the largest net short position in gold in the history of the Comex. That's about 265,000 Comex contracts, or 26.5 million ounces of gold... more than one third of 2009 gold production held short by a handful of bullion banks. And two U.S. bullion banks are short about 18 million ounces of that total. Where the hell is the CFTC???

And, as I mentioned yesterday, because all this price action began on Wednesday, none of what's been happening since the Tuesday cut-off, will be in today's Commitment of Traders report. And, to add insult to injury, today is also the release date for the Bank Participation Report for positions held also as of the Tuesday cut-off... so none of this action will be in there either. Coincidence??? Not bloody likely.

As you can imagine, Ted Butler and I spent a fair amount of time yesterday talking about this whopping increase in open interest. Neither one of us were happy campers. But we both agreed on how it was going to end. Either the bullion banks get totally overrun and we have the much vaunted "Commercial Signal Failure" or, at some point down the road, the bullion banks [who will then be short even more obscene amounts of gold and silver] will engineer a sell-off and we all get our heads handed to us... again. There's just no other way out. It's only a matter of timing as to which way this all ends.

The Comex Delivery Report showed that three gold and 145 silver contracts were delivered yesterday. And, for the first time in a while, there was activity at both the GLD and SLV ETFs. The GLD took in 470,959 ounces... 14.65 tonnes. Over at SLV, they finally added some silver... 1,967,020 ounces... after taking out over 5 million ounces during the prior five business days. There was no report from the U.S. Mint yesterday, and a smallish 36,482 ounces of silver were removed from the Comex-approved warehouses.

The usual New York gold commentator did not put in an appearance at all yesterday, so I [regrettably] have no story from him. However, as a consolation prize of sorts, here's an interview I did with Al Korelin of Korelin Economics yesterday. In it, I elaborate on the current major escalation in the gold price, and the link is here.

Moments after I filed my commentary in the wee hours of Thursday morning, I ran into the following gold story filed at marketwatch.com, which is now widely disseminated on the Internet, but here it is again... "Hong Kong is pulling all its physical gold holdings from depositories in London, transferring them to a high-security depository newly built at the city's airport, in a move that won praise from local traders Thursday." The link is here.

The next story is another one I found shortly after I filed my Thursday commentary. It's a story posted over at mineweb.com and is introduced as follows... "Reports suggest that China's main sovereign wealth fund and other state entities are under pressure to invest in strategic Western assets as the country tries to offload its dollars for firmer-based wealth including gold and oil." The headline reads "Chinese sovereign wealth fund dumping dollars for strategic investments like gold"... and the link is here.

Here's a gold story that appeared over at cnbs.com yesterday. I remember three years ago when the first stories about gold began appearing in the main-stream press... and how ecstatic I was at the time. Now they're commonplace. This one is special in two ways: first of all, it's talking about a four-digit gold price; and secondly, the lead-off paragraph mentions that investors are now taking physical possession of the metal, as they are becoming wary of other investment choices... and rightly so. I thank Donna from Florida for sending this along, and the headline reads "Gold Rush by Many Investors Could Push Price Up to $1,200"... and the link is here.

The next piece contains only one paragraph and one chart, which should take about a minute of your time. It appears that the U.S. Treasury has just announced another Treasury auction for next week... where $70 billion will be created out of thin air. Click on the chart to get the 'big picture'. I thank Craig McCarty for sending it along, and the link to the zerohedge.com 'story' headlined "$128 Billion in Total Treasuries On Deck, $70 Billion in Bonds"... is here.

And lastly is this story from The Times in London. Apparently the $1.1 trillion global rescue package agreed by G20 leaders in London in April, is in serious danger of coming apart at the seams... and Prime Minister Gordon Brown is trying to save whatever's left of his crumbling legacy... as this was his baby. The headline reads "Gordon Brown's $1 trillion global rescue package unravels". Once again I thank Craig McCarty for the story, and the link is here.

So... where do we go from here? Silver is now entering oversold territory, with gold close behind. Can we go higher from here? Absolutely! Can 'da boyz' engineer a sell-off from this point? Absolutely! It's my opinion that this bull run in gold could still have a lot of legs left to the upside, but I must admit that the record net short position in gold just screams of 'Danger Ahead.'

If we do go higher from here, it will follow one of two scenarios... either the bullion banks stand back and let this market run... or they continue to go short against the spec longs that have been entering the market in droves in the last several days. Which will it be? So far, it's been the latter option.

As I put this Friday commentary to bed, I note that not much happened in gold in Far East trading... and a small spike in silver during early morning trading in Sydney got hammered flat. But with London now open, I see that both metals have come under a bit of selling pressure from the U.S. bullion banks. But, as we've seen over the last few days, all the action [and volume] is in New York trading on the Comex... as it will be again today.

With the long weekend upon us, it will be interesting to see what sort of day the bullion banks have planned for us. I'm sure they don't want a gold price over $1,000 for everyone to talk about over the Labour Day long weekend. But as I told Al Korelin in my interview yesterday, every gold analyst out there [including yours truly] is making this up as we go along... so we'll just have to wait and see.