The Dubai Aftershock - London's Vulnerability

If you get a major earthquake, you should expect aftershocks. The collapse of Lehman Brothers was an earthquake for the global financial system. What is happening in the Gulf now is an aftershock.

The Problem of Dubai World

The trigger for the latest crisis, which has seen major banking share price falls across the world, is not a crash as such but a rescheduling of debt. Dubai World has $59bn of debt (the bulk of Dubai's $80bn debt) and repayments to all lenders are being put on 'standstill' for six months.

If something is state-backed, especially when the state involved (Dubai) is understood by the market to be backed by a much wealthier energy-rich State (Abu Dhabi) within a sovereign confederation, it is supposed to be copper-bottomed.

Dubai World's delay to the repayment of some of its debt not only suggests that Dubai itself may be in trouble. It raises questions about the extent to which Abu Dhabi will come to the rescue not only of its sister state but of the many banking, property and construction interests who are in over their heads.

The Gulf Financial System

Markets are built on confidence. The financial system that had been propping up this deck of cards in the desert had assumed that the Gulf was playing to the same rules as Wall Street, the City of London and all the other financial centres that keep capitalism chugging along for good or ill.

But, whereas the rest of the capitalist world has a semblance of democratic and quasi-competent bureaucratic scrutiny that keeps everyone within certain 'rules', the Gulf is late to the game. Its policies are still driven by dynastic whim and an uncertain professionalism amongst technocrats and regulators.

Old Middle East hands have always been aware of uncertainty of outcome in the Gulf and have discounted matters accordingly. The Boards of some major construction companies and get-rich-quick professional and financial service advisers may not quite have understood the 'risk profile' as well.

Uncomfortable Risks

This crisis is not going to bring down capitalism by any means but it presents some very uncomfortable risks for London in particular. Hysteria about a second global crunch can be discounted but we should not be complacent.

David Cottle on the Wall Street Journal Blog puts things into some perspective today but he notes that:

"Dubai did as many larger, older countries have done and carried on borrowing and splurging through the economic downturn ... [the current crisis] does serve as a reminder that, no matter where you are, the money runs out in the end."

There are two issues here for London. The first is that money does run out in the end. This lesson must strike home in the week that the public found out that the Bank of England had secretly printed £61bn of cash (later repaid) to help two rocky Scots bank get out of the hole they had dug themselves.

Promoting Dubai

The second is that, in its national business model of heavily promoting the City of London to overseas capital centres in order to increase tax take, the British Government encouraged a lot of construction and service sector companies to ignore some fundamental risks in supporting Dubai's megalomania.

Banks and Government have probably been deluding themselves that everything might go to the wire but that Abu Dhabi would eventually cover all Dubai's financial liabilities, after extracting some political advantage, and that all accumulated local debts to British companies would then be paid.

These latter have not been quantified but they are very worrying. Most big companies have been able to make appropriate banking arrangements on an implicit sovereign promise to pay so the decision by Dubai to declare a unilateral holiday on debt repayments will have shaken some banks badly.

Knock-On Effects

This is represented by the falls in bank shares in London but there are many mid-sized law firms and other advisory firms and payment-on-payment suppliers to the larger companies who cannot last out much longer and for whom the expectation of payments and new business restarting soon was vital.

The knock-on effect to some over-stretched City of London professional and financial services firms and small export-led businesses could be considerable. We cannot be sure of this because there are no figures but the British commitment to the region has been substantial.

We had advised our contacts to be cautious about the Gulf after the 'credit crunch' but some desperate service firms felt they had nowhere else to go as business dried up in London. They certainly seemed to be backed up by the positive talk from Government and banks about prospects.

London's Vulnerabilities

This need not, by any means, turn out to be a complete disaster. Abu Dhabi is still likely to step in after exacting whatever leverage it requires but the assumption that all will be settled by dynastic whim has been replaced with a dangerous uncertainty that these people actually know what they are doing.

But what is the worst case for London? There are several risks here. The first is the obvious one that some British companies will crack, reducing the tax base and the reputation of the City of London.

A second is that the pressure on banks involved in the Gulf will require another round of financial assistance from the Bank of England which will not be so easy to keep secret and may not be so easily repaid if recovery falters.

Investor Assessments

What this means is that the Bank of England could start unnerving investors about how much it is prepared to print money and how much it is prepared to be open about its policies. King's decision on the secrecy of the £61bn appears to have been accepted but future secrecies may not be.

If the vast overhang of existing debt is to be managed, it can only mean massive spending cuts, increases in taxes ... or dealing with the problem by printing money. The investment community does not care about the first two but it does care deeply about inflation, let alone hyper-inflation.

If the democratic political process severely limits Government's ability to recoup its expenditure on (as the public may see it, possibly unfairly) ensuring bankers keep their jobs and their bonuses, the temptation to print money must eventually become overwhelming.

Inflation

As Cottle implies, the international investment community has, to date, given the benefit of the doubt to the Keynesian strategy of spending your way out of crisis into recovery, recouping the costs later on tax revenue and a return to sound financial management. But this is predicated on sustained recovery.

The Dubai case is definitely not comparable with developed Western economies but it must unnerve some investors on the very grounds that Cottle suggests - eventually the money runs out and (though he does not say this) you have to print it. Without adequate asset-backing, it becomes worthless.

The oil price fell on the news from Dubai but the British case may be complicated by the expectation that, while the crisis might hit global recovery somewhat, an eventual recovery is coming and it will increase food and oil prices.

If the UK is lagging because it is still clearing up the disproportionate mess in its own books then we may get a period when Government is forced to 'print money' while commodity prices are rising. This would bring back 'stagflation' - not seen in the UK since the 1970s.

Disproportionate UK Risk

The Dubai crisis also hits the UK disproportionately because of its past policy of supporting Dubai's pitch to be the natural 'time zone' financial centre without fully understanding that dynastic megalomania might have been undermining that ambition at another level. 

There is an even bigger picture here which goes back to the oddities of British foreign policy in the wake of Tony Blair's disastrous and somewhat private decision to be the US' out-rider in the region - a story painfully being unravelled in the current Iraq Inquiry.

Two policies have converged on Dubai. The first is the UK's determination to be an export led services provider to the world in order to maximise tax take from the City of London. This must be seen as central to its active encouragement of what may turn out to be over-investment in Dubai.

The second is the effect on its foreign policy of a determination to buttress the dynasts who maintain the stability necessary to build mega-projects that hire British construction companies and develop the infrastructure for a financial hub that gives business to expert services.

Unfortunately this has also meant that the UK has become the Gulf's voice in Washington regardless of its lack of democracy and adequate human rights cover and that it has developed a forward policy on Iran that places it as an enemy of a country that might have been a market.

Where We Are

The choice of the Gulf over Iran is not so much of a moral choice as liberal-progressives would like us to think. It has been a choice for a services export approach based on the City over the export of more general consumer manufactures and capital goods.

So the crisis in Dubai is significant at many levels. It shows us that the world economic crisis is not yet over, that dynasts are still only half-baked members of the Western system and that the UK's economic and foreign policy are dangerously entwined.

Like Cottle, we do not think this crisis is shattering. The spinners are determinedly, and probably rightly, referring to it as a 'sideshow' as far as the global financial system is concerned. But the UK is particularly exposed to this one and all the 'spinning' from London will not change that fact on the ground.

We do not think this crisis will shatter the British economy but it is another blow to it in its weakened state. It may further limit policymakers' room for manouevre. What we have to do now is ask how we ever got into this position in the first place?

The Al-Ghussein Case & The Rule of Law

Our work is confidential, behind-the-scenes, often working alongside legal counsel, although we are always clear where we have an interest, especially when we raise a matter on our blogs. We usually have an aversion to discussing or referring to our clients but today we are going to make an exception.

Some months ago, we were approached by the family of the late Jaweed Al-Ghussein, former Chairman of the Palestine National Fund and a moderate reformer well known and respected, some would say loved, by the British liberal establishment.

Jaweed's story shows just how vicious international affairs can be. I have to refer you here for the facts to the campaigning website Justice 4 Jaweed, created by Janis Hetherington, in which we have no involvement and which long predated our interest.

Justice 4 Jaweed was created in frustration at the length of time that had elapsed since a major human rights abuse was perpetrated on Jaweed without any sign of the 'mistake' (let alone the 'wrong') being recognised.

In essence, he was abducted twice for trumped-up reasons by the Palestinian authority with the co-operation and facilitation of the Abu Dhabi authorities. His assets were expropriated and he was bullied and denied adequate medical treatment for conditions from which he later died (July 2008).

The family assumed that these terrible deeds would be seen by the Abu Dhabi authorities just as a mistake (if only to 'save face'), that apologies would be forthcoming and that property would be restored. Years passed and informal promises alternated with intimidation and, above all, confusion.

The campaign began only after an initial commitment to show respect for the persons behind the 'mistake' merely demonstrated that such persons were no longer deserving of respect. They were either 'in denial' about what they had done or thought that they could get away with it with impunity.

In recent weeks, the situation has changed again. A strengthened team is now advising the family and it initially advised one last attempt at negotiation. Dialogue was encouraged in good faith and there was reason to believe that the matter might be taken off the chess board of international affairs.

This was not to be so and the team supporting the family of Al-Ghussein has become ever more determined that the abuses involved in this case should be exposed and should come to be regarded as a symbol of whether Abu Dhabi and the Palestinian Authority are fit partners for the liberal West.

There may be more news to come on As It Happens although Justice 4 Jaweed is still the public face of the campaign to expose what was done to Jaweed al-Ghussein.

On November 23rd, 2009, Stephen Desmond's independent film (again, nothing to do with us) on the life and work of Jaweed will be shown at the prestigious Frontline Club. This will be a marker event in its own right. But what we at TPPR know is this:

• A wrong based on the use of arbitrary power and back-door factional deals has been done not only to the deceased but to his family. They deserve both an apology and the restitution of their assets. Indeed, they deserve compensation.
• Those who perpetrated this crime and those who continue to attempt to cover it up are small and identifiable groups of interconnected persons who, in our opinion, are acting against the interests of the small nations for which they purport to speak.
• A growing body of research suggests that these groups truly live in a political twilight zone. This case may now be best served by, eventually, bringing into the open the surprisingly small but increasingly wealthy complex of security, political and commercial interests that they represent.

Neither the Palestinian Authority nor Abu Dhabi should be assumed to be the simple villains of the story. Both appear to have allowed powerful individuals to dictate the course of this case against what we believe to be their natural national interests. They are being poorly advised.

Abu Dhabi, in particular, aspires to be an equal partner with the West in the maintenance of global order through its dominant role in the United Arab Emirates. Its massive funds are now critical to the survival of Dubai and to the eventual outcome of the Peace Process.

But if it believes that Europeans in particular and many ordinary Americans will now turn a blind eye to serious failures in the rule of law, even if there is a pragmatic acceptance that democratic reform is many decades away, then the authorities in Abu Dhabi are equally seriously deluded.

They may think that sheer weight of money talks. Tony Blair, a putative EU President, has been exposed as an adviser to the small country's Sovereign Wealth Fund by the Daily Mirror and a major financial PR campaign for Invest AD starts this Autumn. according to the trade Press.

But there have already been serious allegations about the use of arbitrary power against independent business interests by this small rich emirate and Europeans are generally not minded to find such behaviour acceptable, any more than they found acceptable extraordinary rendition by the US.

Abu Dhabi may think that the Al-Ghussein case is 'old news' and that the story will just 'go away'. It will not. Strength of feeling in London should not be underestimated, especially as many of those critical of Abu Dhabi's conduct are known and established friends of the Arab World who feel shamed by this case.

As for the Palestinian Authority, it is hard to kick a nation when it is down but it is time for it to take responsibility for its past actions and to draw a distinction between acts that might be justified by the laws of insurgent war and crimes perpetrated and perpetuated by factional struggles against its own.

Both Abu Dhabi and the PA need to understand that this is a test case in the rule of law and of political maturity. Leading figures can no longer behave like jumped-up oligarchs relying on weight of funds to buy their way into the West.

There may be more to say about the Authority and its conduct later, but let us, at this stage, just say that those involved in blocking this matter, despite the advice of the wisest of their own colleagues, need to start thinking now about the consequences of their state of denial.

No one is walking away from this case. Not now, not ever.

[Declaration of Interest: TPPR has had an interest as adviser since the Spring of 2009 to the al-Ghussein family]

Dynastic Whim & Business Risk in the Gulf

When the credit crunch first hit British business, it seemed like a good idea to scuttle out of a depressed London and head for the black gold-fuelled shores of the Gulf. Like lemmings, panicked law firms and many others headed for the desert ... but is it really so risk-free in the long term?

A Contracting Gulf

The IMF has reported that the Gulf economies are now expected to contract in 2009, largely because of the slump in the oil price from its $147 peak in July 2008. The IMF has also noted the stresses in the banking sector, most notably in the UAE, as a result of the property collapse.

To be fair, contractors are now saying that Dubai developers are tentatively beginning to honour their contracts after months of delay. The colour is returning to the pale white cheeks of many a British businessman operating in the region. Yet, under the surface, all is still not fundamentally well.

There is, of course, no one single Gulf economy. Each Gulf state has its own economic profile. The massive reserves of both Saudi Arabia and of Abu Dhabi make these states very resilient, whereas Kuwait (outside the GCC), Dubai (a financially extended UAE component) and, possibly, Bahrain are not.

The issues are complex but a great deal depends on political stability. If local dynasties remain in charge then there is enough petrodollar cash floating around in the long run to ensure that the region will weather the storm and come out economically vibrant and strong.

Unfortunately, the strains of the credit crunch are raising the first signs of social unrest where it matters, in the middle classes who have most benefited from the recycling of petrodollars. We may be seeing the first signs of tension between popular aspiration and authoritarian leadership.

A Secure Saudi Arabia, A Flaky Dubai ...

In Saudi Arabia, much of this tension is alleviated by the fact that elite reformers have a voice within the regime. A split from the regime would only serve extremely conservative forces who have been troubled even by the weak reforms undertaken to date.

This tension will grow as it becomes clearer that the very conservative Prince Naif might become the next King at the expense of the equally conservative but more Westernised Prince Sultan. Reaction from the desert is more to be feared than a bourgeois revolution.

The smaller states are a very different kettle of fish. Their political problems with the middle classes fall into two broad categories. Discontent at economic mismanagement (Kuwait and Dubai) and the 'shame' of being arbitrary and feudal whilst claiming to be modern (Abu Dhabi).

Dubai is where most British business and professional service businesses have gone. It is Dubai that appears to be second only to Kuwait in being a potential basket case, dependant on the goodwill of its jealous and rich partner within the UAE, Abu Dhabi.

One clue to the seriousness of the situation is provided by the fact that the Director-General of Dubai’s Finance Department, Nasser Al-Shaikh, was removed from office late yesterday and replaced with Abdul-Rahman Saleh al-Saleh.

No reason was given for the removal from office but this will worry the business elite and the banking sector because Al-Shaikh was regarded as a young and realistic reformer amongst a bunch of feudal economic fantasists.

There may have been good reason for his removal but the suspicion must be that dynasts do not want modernisation if they then have to answer to technocrats. In another sign of trouble, shareholders have also staged an unprecedented walk-out at the AGM of Emaar, Dubai’s largest real estate company.

First Stage in a Regional Bourgeois Revolution?

It is hard to assess is how defiant the Gulf middle classes will become towards what will amount (in their eyes) to feudal incompetence if there is no recovery soon. Since there is still no real knowledge-based productive capacity, recovery can only mean another credit-fuelled boom based on the oil price.

This smells of the very first stage in a classic European-style ‘bourgeois revolution’ to the extent that Western diplomats may be secretly worried that the dynasts, at least in the UAE, appear not to be getting the message that reform, in the long term, is a matter of survival.

Here is the big problem - Abu Dhabi. Everyone in Europe is sucking up to Abu Dhabi because it is an open secret that its vast wealth is being played competitively yet almost randomly by competing dynasts seeking either personal status or dynastic political influence or both.

Observers are puzzled by the multiplicity of investment arms and their precise strategies. All that is clear is that Abu Dhabi has gone on a multi-billion dollar shopping spree – some $10bn has been invested overseas in the past six months and its purchases have been rather convenient for Western politicians.

The investments include entities as diverse as Daimler, Manchester City, the Chrysler Building and Barclays. The only credible interpretations are dynastic whim and fancy or of attempts to spend cash on shopping items with PR or political value.

If Abu Dhabi is trying to buy its way into influence, then this wasteful and opaque strategy may work. Desperate European elites want to offload bits of duff banks and manufacturing on Arabs keen to diversify family wealth and who want to buy strategic protection from Iran to the north.

Unfortunately for Abu Dhabi, these same European elites are about to feel some pressure themselves from below. Their new found friends are not exactly liberal. Whether labour rights in Dubai, women's or faith rights in Saudi Arabia or arbitrary justice in the UAE, these are rum pals for Western progressives.

The Meaning of the UAE Torture Case

[Please note that the link to the YouTube torture video may be disturbing]

The UAE ‘torture case’ recently exposed on YouTube is just one example of a pattern of feudal arbitrariness and incompetence. It is not the only one by any means. Domestic liberals and international activists are now turning their attention to this issue and towards other human rights issues.

There is some nasty historical baggage for most of the Gulf states (Qatar is probably most progressive in practice) unless they get to grips with putting in place a proper rights-based judicial framework and deal upfront with their own sorry history of torture, arbitrary asset seizure and even kidnapping.

The UAE wants something from the West - nuclear technology - and it is trying to play off an America highly sensitised to its own human rights abuses by warning that if it does not get what it wants, it will turn to some very greedy and amoral Europeans.

But hopes for a nuclear deal between the UAE and the US were severely complicated by the release of the torture video. Congressional resistance to the deal derives not only from human rights concerns but from fears related to the UAE’s role as entrepot for goods and services to Iran.

A deal would permit US civilian nuclear trade with the UAE and it was intended to be a reward for the UAE, an important Western ally. The UAE promised to forgo domestic enrichment or reprocessing – technologies that can lead to nuclear weapons capability - but the issue is this:

• if there is no rule of law in Abu Dhabi and everything depends on dynastic whim, promise-keeping about nuclear use also becomes a matter of whim and that way madness lies ...

What Is Needed ...

Meanwhile, the only example of democracy in the Gulf (outside Iran which is far more democratic than any other Western ally in the region) is Kuwait and it is looking decidedly dangerous from a dynasts’ perspective. The Saudis have not risked going beyond municipal elections and reforms to the Shura.

Kuwait is a political and economic basket case at the moment. This is a truly absurd state of affairs given its massive oil wealth. Its Parliament and Government have been in a state of near permanent confrontation for some time. Nor is this likely to change soon.

The Kuwaitis may have now elected four women members of the 50-member Parliament. This may be interpreted as a vote for wider change in the system by a discontented population but it is still not clear that dynastic arbitrariness and populist democracy can be squared.

What the dynasts really need is for the oil price to get back up to higher levels. Dynasts survive through patronage and subsidy. For all the talk of modernisation, the essence of Gulf politics remains eighteenth century in European terms.

Oil pushed through the $60 barrier this week for the first time since last year (though it drifted back a little later). The price had risen 85% since February (a five year low of $32).

OPEC has now increased output for the first time since prices peaked but a near-doubling since early 2009 is still less than half of what Gulf budgeting had expected a year ago. OPEC had set an initial target of $75 but it seems that the $50-$60 range is now regarded as acceptable.

What this tells us is that OPEC, in which the Gulf plays a significant role, is pleased, in a global recession, just to get what it can so that it can bail out some dreadful business models and hold the line against middle class rage.

Stability Through Baksheesh

The Gulf is in no better state than the UK politically. If New Labour was a machine for recycling the surpluses from an unsustainable credit boom for political advantage, undemocratic dynasts are little better than recyclers of the benefits of their historical luck in sitting on black gold and gas.

If New Labour has proved less than competent in managing the wealth created by an unsustainable boom, then the action of the Gulf dynasts raises similar questions about the political costs of their unsustainable business plans and over-ambition.

On balance, we think that the dynasts will survive. The West is restraining any Iranian attempts at destabilisation from below. A rising oil price and inter-regional stability transfers will soon allow the dynasts to sink their petty personal conflicts for the greater good of survival.

But public scrutiny of the dynasts is not going to go away. If they want Western technological benefits to satisfy their modernisation agenda and to provide jobs for the young, then they are going to have to get political traction for that within the West - and to get that, they are going to have to liberalise.

They will probably get away without democracy and perhaps with treating their migrant workers like social dog poo - and with treating the Shia like second-class citizens - but liberal Parliamentarians and Congressional leaders overseas will raise human rights issues and these will block strategic aspirations.

The dynasts are going to have to consider judicial, economic and property rights reforms that allow Westerners to feel safe in doing business and their domestic politicians not to look like hypocrites. The West wants to give the dynasts what they want and just needs their help in doing so.

If the small Gulf countries do not follow Qatar in drawing a line with the past, they are going to see more campaigning attacks, more unwelcome court cases and more videos on YouTube. They can try and hide behind opacity but the eventual cost might, one day, be sanctions against them and not Iran.

www.tppr.co.uk

www.pendrywhite.com

Recent Client Notes [Subscription Only]

13.05.09 - Update on West Asia
14.05.09 - Prospects for the European Economy
15.05.09 - Preparing for the Obama-Netanyahu Meeting
17.05.09 - The British Parliamentary Expenses Scandal

[Conflict of Interest Disclaimer: Please note that TPPR is confidentially involved in litigation support involving a human rights case in the region.]