Forty years ago,
it was a small town on the Persian Gulf, merely one of seven sheikdoms joined
in federation in 1971 to create the United
Arab Emirates. Basically, there was nothing
there but sand. Yes, oil had been discovered under that sand, and the
city/state was enjoying its first economic boomlet. From about 60,000 in
1968, population tripled by 1975, doubled in the next ten years, and nearly
doubled again by 1995.
Problem is,
especially compared with many of its Gulf neighbors, it didn’t have all
that much oil to begin with, and its reserves were falling fast. What it did
have was Sheikh Mohammed bin Rashid Al Maktoum, the most influential member
of the family that had ruled for more than a century and a half. And the
sheikh had a vision.
Sheikh Mohammed
believed that the Muslim world needed a New Baghdad, a center of commerce and
learning and culture that would shine like the hub of the old caliphate,
which had dominated the civilized world a thousand years earlier. He was
determined to erect a dazzling, ultra-modern new metropolis, starting from
scratch.
On the sands of Dubai.
The rest of the
story is pretty well known. The crown prince, and later ruler, of Dubai
had his way. His emirate became one of the richest and gaudiest places on the
planet. Population shot to almost 1½ million, about 90% of them
immigrants – from unskilled Bangladeshi laborers to software engineers
from the U.S.
– all lured by the promise of better-paying jobs than they could find
at home.
Even more
striking was the explosion of construction projects. Up went mansions, office
skyscrapers, artificial islands, stadiums, a speedy Metro, a busy
international airport, and the world’s only 7-star hotel, among other
things. And the capstone was, of course, the Burj Khalifa, formally opened on
January 4.
The Burj Khalifa
is the tallest manmade structure on earth. Not by a little, mind you; halfway
is not a word in Sheikh Mohammed’s vocabulary. Tallest by so much that
it boggles the mind. It’s 2,717 feet high. That’s more than half
a mile. For comparison purposes, take New York’s
late Twin Towers.
Stack them one atop the other. Now you’ve got the Burj Khalifa.
Begun in late
2004, the building was originally budgeted at US$869 million. Final tally as
we entered 2010 was something north of a billion and a half. That bought the
first luxury hotel to bear the Armani name, four swimming pools, a 158th-floor
mosque, 57 elevators, and an observation deck at 1,450 feet, along with
52,490 square meters of office space and 288,000 square meters divided among
900 apartments.
Its coming-out
party, with 10,000 fireworks and synchronized fountains shooting jets of
water 150 feet into the air, was a spectacular light show, worth watching if
you haven’t yet seen it, here http://www.youtube.com/watch?v=yRxxv6AZ_xg&feature=fvw .
Hard to believe that you’re looking at a bone-dry desert.
You may also be
looking at a gargantuan white elephant. Although every unit in the Burj
Khalifa has supposedly been sold, some unknown percentage of buyers (likely
very large) was speculators who opted in during the height of the world real
estate boom. Properties were flipped like it was Southern
California. At the market peak, modest flats were fetching more
than $2,700/sq. ft. No wonder Emaar Properties, developer of the project,
claims it has already recouped its capital outlay from these suck--, er,
investors.
Those prices have
now plummeted by up to 50%. Of the folks left holding the bag, how many of
the 25,000 slated to live in the building will actually do so? We don’t
know, and no one who does will talk vacancy rates. In terms of transparency, Dubai
makes the Bush administration look like an ad for Window World.
What we do know
is that at the moment the structure is the Big Empty. Western critics have
limbered up their keyboard fingers in order to pound out expressions of
disdain, everything from “The Final Monument to Excess” to
“Bling City Is Dead” to “The End of Capitalism.” The
first may be apt, as we’ll probably not see the likes of the Burj
Khalifa again, but the last? That’s something we want to look at more
closely. There is a lesson to be learned.
The truth of the
matter is that there were two key, and contradictory, elements to the Dubai
miracle, and when the world recession hit in 2007, one overrode the other and
the whole thing came tumbling down.
First: As noted,
Sheikh Mohammed didn’t have a river of oil money to rely on. So how did
he manage to build his gleaming city by the sea? On the surface, it was
simple. Turn Dubai
into one of the world’s premier places to do business. Make it
essentially tax free. Create investment incentives. Attract entrepreneurs
from all over. Enlarge and capitalize on the city’s status as a deep
water port. Replace traditional smuggling with legit import/export operations.
Become a world financial center.
In short, install
the best aspects of free-market capitalism, then send an Open for Business
letter to the world.
It worked.
Capital, resources, and personnel flooded in. By 2005, oil and gas were
responsible for only 6% of the emirate’s GDP. Property and construction
was the biggest contributor at 22.6%, followed by trade at 16%, entrepôt
(duty-free import/export business) at 15%, and financial services at 11%.
No one,
apparently, thought it ominous that nearly a quarter of GDP was generated by
the construction and trading of properties, nor paused to consider what would
happen when the music stopped and supply exceeded demand. Dubai was riding
high, a model for other resource-poor, developing nations, showing them how
to get rich.
Today, the hot
desert wind blows through half-buildings that will never be finished.
Immigrants, their work visas rescinded, are rounded up and sent home.
Mercedes Benzes and Jaguars have For Sale signs taped to their windows
or are just abandoned at the airport. Real estate prices tanked by 50% in
2009 and are projected to suffer another 30% haircut this year. The stock
market has plunged 70%. Unmaintained, the artificial islands designed as
millionaires’ playpens have begun to sink beneath the sea.
The glorious ride
is over. But just in case there was any doubt, the point was hammered home
last November, when Dubai World – one of the country’s leading
development conglomerates – told creditors it was declaring a six-month
moratorium on repayments it could no longer make.
That sent shock
waves through financial markets the world over. Everyone, it seems, had
invested in Dubai during the boom times. Now they’re staring at a very
unfavorable restructuring at best and flat-out default at worst.
Dubai’s
debt, or at least as much of it as its rulers will reveal, is about US$80
billion, or 140% of GDP. Bad enough, but it may well be significantly
understated. One local investment banker puts the real number in the $120-150
billion range; with no balance sheets to pore over, we can’t know.
Dubai will ask oil-rich fellow emirate Abu Dhabi for help, but there are no
guarantees help will be forthcoming. Abu Dhabi has always cast a disapproving
eye on Dubai’s helter skelter expansionism, and if it does step in, it
will probably demand a whole lot of collateral.
Critics of a
certain bent have pounced. History’s grandest experiment in unfettered
free-market capitalism ran aground, they cry. Therefore the system
doesn’t really work.
Which brings us
to the second element in the Dubai miracle. It was built on a mountain of
debt that couldn’t survive an economic downturn. And who supported that
debt? The government. All of those go-go corporations, like Dubai World, are
essentially government owned. Sheikh Mohammed wanted his New Baghdad, no
matter the cost.
Granted, private
enterprise businesses are imperfect. When in trouble, they will lie and cheat
like anyone else. But in the end, they have a bottom line that they have to
reveal at some point. Accounting tricks are eventually exposed. Capitalism,
like a computer, is strictly binary. A company with sound finances prospers;
a company that fails in the marketplace simply disappears.
Government-sponsored
entities have no such limitations. They’re actively encouraged to
overreach, to take risks that no sane CFO would approve. Because if they
bleed red ink, the government is there to step in and prop them up. All of
Dubai’s corporations were “too big to fail.” But fail they
did, and in the process pushed the government into insolvency as well.
The takeaway from
this story is simple. Dubai was no more free-market capitalist than Soviet
Russia. Or the U.S., for that matter. If the government is the guarantor of
last resort or just perceived as the ultimate reliable source of bailout
money, a business has no incentive to be well run. When government (with
taxpayer funding) takes a stake in even that most American of corporations,
GM, capitalism truly has collapsed. Not, however, because of its
shortcomings. Because government has not allowed it to function properly.
Though we lack a
symbolic last gasp like the Burj Khalifa, make no mistake about it:
we’re all fellow travelers with Dubai now. Washington would do well to
study what happened there and hopefully learn a thing or two. Because
we’re speeding toward the same crack-up.
The U.S. economy
is like an out-of-control sports car in search of a tree, and the government
is not “here to help you.” Take matters in your own hands and
prepare as best as you can for the crash that will come. To find out what to
expect in 2010 and how to bullet-proof your assets, read our FREE special
report “The Good, the Bad, and the Ugly.” More
here…
Doug Hornig
Senior
Editor, Casey Research
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