lifestyle leader

The NYT provides important context to the Swiss vote in favor of a constitutional amendment banning new minarets:

Of 150 mosques or prayer rooms in Switzerland, only 4 have minarets, and only 2 more minarets are planned. None conduct the call to prayer. There are about 400,000 Muslims in a population of some 7.5 million people. Close to 90 percent of Muslims in Switzerland are from Kosovo and Turkey, and most do not adhere to the codes of dress and conduct associated with conservative Muslim countries like Saudi Arabia, said Manon Schick, a spokeswoman for Amnesty International in Switzerland.

The Lede looks at the reaction around Europe.

When the judging the systemic implications of Dubai World's default, it is helpful to keep everything in context. FP Passport does just that.

A final thought on Dubai: don't discount the city-state's long-term prospects too much. Service-based economies with weak domestic demand (or in Dubai's case almost no indigenous population) are destined to be pro-cyclical. The vision to become a financial, services, transport and residential hub in a region with limited integrated infrastructure and service capacity, as well as tremendous development potential, seems a sound one. If the new silk road will be paved with microchips, euros and renminbi, Dubai could very well become the great marketplace connecting east and west.

It is a holiday week here in the US, so I have been only passively following the developments of the past few days. But as the global reaction to the Dubai Government's request for a six-month restructuring and standstill on Dubai World's, and its subsidiary Nakheel's, debt makes its way to the US markets this morning (the US was closed for the Thanksgiving holiday yesterday), I have been thinking about the implications of the decision over my morning espresso (or 5 to be exact).

Briefly, a few thoughts on the decision:

-Legalese aside, this is a default and the markets are treating it as such. S&P has said that under its default criteria, Dubai World's restructuring may be considered a sovereign default, that is the failure of the sovereign to provide timely financial support to a 'core government-related entity.' The Dubai Ministry of Finance's bogus assertion that they are simply asking creditors to 'wait until May' is ludicrous.

-You can view the risk of contagion from two angles. One perspective would have us shaking in our trading smocks, worried that much like South East Asia in the late nineties, the bursting of a property bubble backed by the sovereign in an opaque legal and financial environment would quickly spread to other, similarly fragile economies. Just look at the spike in borrowing costs over the past 48 hours for not just Dubai, but regional peers like Abu Dhabi, not to mention emerging markets more globally. Compounding this fear is the still fragile state of the international financial system. On the other hand, and this is the perspective I have come to hold over this morning's coffee, Dubai is a unique beast, and its fallout should be fairly small. It is a property-driven bust with no economic muscle to speak of besides construction and services. It was always destined to burst in spectacular fashion amidst the global financial crisis. Its development model fundamentally relied on cheap borrowing costs, conspicuous consumption and financial services. Unlike its regional peers, it holds no natural resource wealth or, to my knowledge, potential, which is why it staked its future on becoming a global financial center. The implicit guarantee that the Dubai government, or even Abu Dhabi, would back Dubai World's obligations was a miscalculation, and now creditors are left uninformed and, until Monday at least, out in the cold. Its regional peers hold massive forex reserves, recovering oil and gas revenue and sovereign wealth funds that back most of their government-owned entities (companies similar to Dubai World.) The prospect of a similar situation developing in Abu Dhabi is highly unlikely. This is why, once markets settle next week, the contagion should be minimal.

-But the prospect of contagion, and current panic over Dubai's position, highlights the critical importance of information to the functioning of financial markets. Dubai World's fragile position has been apparent for months, and as I mention above, the assumption was that it was fully backed by the government. But in an opaque political and financial environment, this assumption was really a matter of faith. It was never clear that the government would fully back Dubai World's debt: that's why, as Willem Buiter points out, private creditors demand and earn higher risk premiums on property developers than they do on sovereign debt. I think this will raise interesting questions about, and perhaps greater scrutiny of, sovereign enterprises and wealth funds worldwide. Limited liability extends to the owners of these firms (that is probably a gross generalization), even if the owner is the state itself. As Buiter says, creditors will have to manage this risk the way they always do: hope for the best. Greater transparency will allow investors to more accurately price this risk. Finally, the current anxiety is compounded by the lack of information coming out of the Ministry of Finance. This is partly a matter of poor timing, with some markets closed for holidays in the Middle East and US. The government of Dubai has essentially told investors to wait until Monday, which to globally interconnected financial markets can be a lifetime. Even in an opaque environment, a timely and transparent response can go a long way towards stabilizing market expectations and limiting the contagion.

This is the funniest thing I've seen all day.

(via Felix Salmon)

Dubai wastes no time in illustrating some of the sovereign debt problems highlighted below.

On Monday, Gillian Tett wrote an article in the FT speculating on whether the latest asset bubble is sovereign debt. Since the onset of the financial crisis, financial institutions have been flooding to (and indeed have been encouraged to) government bonds because they are 'safe' and 'low-risk' assets. That they are perceived to be safe and low-risk is also reflected in their prices. But as Gillian explains, this sense of safety may be misleading:

[C]ould this flight to the "safety" of government bonds in itself be creating subtle new dangers? Government debt, after all, has soared to levels not seen in peacetime for centuries, if ever, in many countries, not least the US and UK. Fiscal deficits are swelling across the western world. And the level of political commitment to curbing those deficits remains uncertain - not least because with yields currently so low there is less pressure on politicians to push through reform.... it is easy to imagine that some countries will end up eroding the value of their bonds by debasing their currencies in the coming years, printing money and stoking inflation.

Gillian's concerns reflect the main message of a book I am currently reading: This Time is Different, by Carmen Reinhart and Ken Rogoff. With a tag-line reading "Eight centuries of financial folly," the book uses a wealth of data to demonstrate just how frequently countries default on their domestic and external loans. The answer is: often.

One of the trends they identify is that banking crises are usually a precursor to sovereign debt crises. This is particularly true for emerging market economies, regardless of whether the banking crisis occurred in their country/region or the rich world, because of their reliance on funds from external sources. Since the rich world just went through a banking crisis (as part of the wider financial crisis), and levels of global trade have collapsed, this is something to watch out for.

But Gillian isn't talking about emerging markets: she's talking about large, wealthy countries like the US and the UK. Rich countries are very unlikely to default straight up. But there are other ways to partially-default on your loans, like inflation (as noted above). This works particularly well when both your domestic and external debt is denominated in your own currency (as it is in with the US).

The problem boils down to this: financial institutions just spent a lot of time & taxpayer money replacing now-worthless financial products like CDOs and commercial paper with government bonds. Now the value of those government bonds is at risk due to the huge sums of money governments spent bailing out those very same financial institutions. Unless governments (or more specifically, the wider public) are willing to make difficult spending choices to tackle national debt problems, we risk repeating this cycle a few years down the road.

And in case there's any doubt that governments have been loading up on debt, I will again point to the Economist's global debt calculator. Add to this the short-term costs of lost productivity from the financial crisis and the long-term costs of a massive demographic change in Western countries, and it's a sobering picture indeed.

Here is the fleet of the North Atlantic Treaty Organization which aims to maintain peace and order in the world. Very powerful and really impressive