Wednesday, December 09, 2009

Dubai’s Weakness Does Not Bode Well for a Strong Global Recovery

Below is an excerpt from "Dubai's Shot to the Moon," by Vitaliy Katsenelson.
“Dubai’s construction wonders were made possible by high oil prices and, more importantly, unlimited (at the time) global liquidity – subprime global lending on steroids.
Today Dubai, a city/state that could do no wrong just a few years ago, is defaulting on the debt it issued to finance its building boom. However, what is happening in Dubai is just the most recent, most vivid example of what took place all over the world until the economic crisis. Economically impossible endeavors with negative returns on capital were everywhere, and Dubai is just the latest to go bust.
Though everyone is talking about Dubai’s potential default, the scope of the problem is greater. Think about how much energy (oil, coal, natural gas), materials (steel, concrete), and industrial products (cranes, tractors) – in other words, stuff – it took to build these economically impossible wonders. China, the most populous country in the world, also masked its share of economically impossible projects through the guise of “stimulus” and at times outright censorship. China is the birthplace of the largest shopping mall in the world which is empty, and a city built on spec for a million people that remains mostly vacant. These two just scratch the surface. The rest of the world, including the US, (after all, we built a lot of now-empty houses and condos) is swarming with economically impossible projects. How many houses (or in the case of Dubai, mansions), factories, hotels, skyscrapers, shopping malls, and railroads will not be built because there are too many already built? And if this is not convincing enough, funding economically impossible projects will be difficult for awhile, as lack of liquidity and insurmountable losses suddenly turn bankers into … bankers. They find religion (at least for a little while) and start giving loans to folks who are expected to actually pay them back.
Dubai is the exemplar of economically impossible activities that have taken place everywhere, and why one can’t be optimistic that demand for stuff will return to levels even remotely close to what they were in the days when everything was economically possible and financeable.”
Only by standing against the prevailing winds – selectively, but resolutely – can an investor prosper over time. Such a strategy may underperform during markets that are rising based upon the momentum of the herd vs. fundamental valuations.

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