The Dubai shock: What to learn from our previous bubbles


With one real estate megaproject after another, including an man-made resort island shaped like a coconut tree and the world’s tallest skyscraper, Dubai has been aiming to turn the tiny emirate into the financial center of the Middle East.

On Nov. 25, the state-run Dubai World conglomerate asked its creditors for a standstill on billions of dollars of debt. Concern quickly spread that the move would send shock waves through the global economy like the collapse of Lehman Brothers did in September 2008.

But thanks to aid from neighbor Abu Dhabi and support from oil producing countries in the Gulf Cooperation Council, the shock appears to be contained — for now.

What caused the implosion of the bubble economies in Japan, the United States and Dubai, and how can the world ensure similar mistakes are not repeated in the future?

First of all, all three bubbles emerged from real estate activity. In addition to real demand, speculative real estate deals flourished in anticipation of rising prices — an assumption that red-hot economies would keep on expanding.

Following the rise of Asia, it may have been natural to expect similar growth to occur in the Middle East. But the lesson to be learned from Dubai is that when a stock economy is growing faster than its flow economy, that’s a recipe for a bubble.

A second factor to explore is the balance between one’s finances and the real economy.

When Japan’s bubble was forming in the late 1980s, its real economy ranked second in the world behind the U.S. After it imploded, Japan needed a “lost decade” to recover from the hangover.

Tiny Dubai, on the other hand, has a small population that relies mainly on tourism and has a negligible level of oil reserves. Although it was apparently seeking to become a financial center, the scar left by the collapse of its real estate bubble will be relatively deep due to its size. Financial services are supposed to serve as a lubricant for economic activity, but Dubai has exposed the risks inherent in indulging in “hot money” capitalism.

The third thing to be noted is how the time zone differences separating Japan and Dubai from the U.S. and Europe call for financial and commodities markets to bridge those gaps. In addition to finding places to locally invest the region’s massive oil revenue, there are expectations for expanding Islamic banking as well.

This system of banking is supposed to be directly linked to real economic activity and thus carry little risk of contributing to bubbles. It is ironic that the world’s latest economic bubble has emerged in an Islamic emirate.

The fourth point to consider is that funds needed for real estate development in Japan and Dubai were raised mainly through indirect financing. Unlike the U.S. housing bubble, debt securitization was fairly limited in those cases. While alarm spread among European financial institutions that lent to Dubai-area firms, it is unlikely the shock will trigger a broader international crisis impacting companies and individual investors through the repackaging and selling of that debt.

Since it is known who lent to whom, it is possible for creditors to reschedule the debt payments just like they did during Latin America’s debt crises. Thus, the Dubai case underlines the differences between direct and indirect financing — and the consequences.

The fifth lesson to be learned is the importance of information disclosure, particularly in relation to state-affiliated businesses.

As part of its bid to fulfill its campaign promise of cutting wasteful government spending, the Democratic Party of Japan opened the process of screening ministry spending requests to the public. Information disclosure is key to the Dubai case as well.

The world’s economies are being hit by both economic slumps and inflation — a situation revealed by rising commodity prices. Japan’s bubble resulted from poor judgment in timing the termination of a credit easing policy launched earlier in the decade to blunt the impact of a strong yen.

Today, rising gold prices are indicating that there’s too much liquidity. The time has come to heed the lessons of the three past bubbles and prepare an exit strategy from ultra-easy monetary policies.

Teruhiko Mano is chairman of the Mano Economic Intelligence Forum.