It was January 2008 when I first set foot in Dubai. It was a land full of grandiose, landmark projects. Few cities in the world could match the sheer number of high-rise buildings and skyscrapers being built in the emirate. FULL ARTICLE by Fernando Ulrich
Source link: http://blog.mises.org/11260/rise-and-fall-in-dubai-an-austrian-perspective/
Rise and Fall in Dubai: An Austrian Perspective
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Thank you for an always interesting Austrian view on the socio-economic situation in Dubai.
I have been following the situation in Dubai at its closest as I can and can fully abide by this story.
To add, Abu Dhabi (AD) $10bn loan to Dubai is currently available for 4 percent interest per annum.
In reply to your reference to Dubai’s debt servicing capacity, I would add that its cashflow is severely impaired. The exodus of expatriate workers and rules that imply that UAE nationals should be the last to leave an impaired entrepreneurial entity, will surely result in closing of facilities and retail outlets.
The Netherlands business council already indicated that some companies are focussing on future growth with existing clients in more stable countries. Some expectation are indicating a decade of stagnation before the 2007 price levels return.
Thanks again for a great read.
Regards,
It was May 2006 when I first set foot in Dubai… the analysis in this text is more or less correct, but I would like to add one additional point: some 20+ years ago Dubai was practically a village (or we can call it a town) with lots of nothing around (actually not nothing… actually it was just sand), today it is a big city with unbelievable infrastructure in place, and all those development was financed by capital (and built labor) from outside, after the bust all those buildings, roads, telecommunication lines etc. and all kind of other resources will stay in place in Dubai and one thing will happen, people will be able to get property for low prices and they will because it will be a good long-run investment.
As for the native people of Dubai this will be a gift because… well it is much better to have all those (useless) buildings and infrastructure around than useless sand they used to have before.
The fact that all those development was financed from outside means that Dubai is a winner anyway, the losers would be the people who financed that development.
The problem with all those development is that while the city looks like a modern American city it is actually not, it is still a “little town” inside, the market is way too primitive compared to US or European levels, the structure of social cooperation is primitive and that is why all those infrastructure is hardly needed and with no return at all. The investment is a short-run waste. But here we are with a bunch of real property, soon up for grab at low prices and new people will come to Dubai and they will start to build the social structure of a real big city, this time without the easy money credit distortion… sure it will take time, and the people who financed all that development will probably never see a dime of return on their investments but Dubai will stay there for many years with a completed and very useful infrastructure ready to serve those who are willing to put some real work into it and who are ready to take some risk.
So I am afraid, Dubai is not the best example to show how development driven by credit expansion is a bad thing… because the people who lose in this case are not the people of Dubai but most of the time foreigners from all over the globe (and most of them are invisible from the point of view of an average observer) .
The people of Dubai get extraordinary development for unrealistically low prices (exactly because of the relatively primitive market and social structure in place), they are practically the winners in a wealth redistribution scheme designed and executed by central banking. They may not get the “super city” we all experienced in the last few years, but they get incomparably more than the “naked” sand they had some 20+ years ago. It is up to the people who stay and who will come after the bust to build a real social structure of a big developed city, who will actually be able to utilize all that infrastructure and made a real return instead of a current mass of people who only live there but who renders productivity levels much lover than a productivity of a developed city can render in any given day.
I guess Hayek was right when he said that it is impossible to recreate or to build a “cosmos” a grown order, an “organism” out of nothing because there are no “memory”, no experiences needed for the network of social cooperation, rules and other needed fundamentals of human cooperation
People who come from other settings have no city skills (and experiences) at all or they connections, skills and experiences are useless in the new setting. They productivity is far less than needed to made any return on the capital at hand… and they are highly dependent on the opportunities created for them by some outside entity, they ability to make new opportunities for themselves and for the other members of the social structure are severely limited by the fact that they lack the social bonds, the experiences etc. needed to build a real market economy of the “required” “order”. The whole thing can’t sustain itself, and it will bust.
You may build the building but you can’t build the social structure which needs that high level of infrastructure and which actually can utilize those high levels of investments, you can’t have an economic return in that kind of scenario. It is always a roller-coaster ride financed by credit expansion (a great game made possible by someone else), and just as Mises said… it always come to an end, but for the native people of Dubai it is a win in any case, for many others, there is no doubt… it is a clear bust.
Rob, thanks for the compliment.
Andras, thanks for the comments.
Let me add that what you have written doesn’t really contradict anything I said.
Regarding that “the buildings being built is a good thing and will stay there”. Well, it is only a good thing if they really find demand for it. If you are a citizen of
Dubai (not a foreign resident) and you buy a property for investment for a very low price, how much will be your return in case you are never able to rent it or sell it?
The native people of Dubai are only 10% of the population. They enjoy a large financial support from the government. I too think most will fare well in this crisis, but there will be many losers, even among the native.
Perhaps the Sheikh of Dubai is among them, since he now owes Abu Dhabi (or UAE Central Bank) $20 billion and I have serious concerns he’s able to generate income from his current lines of businesses to service this debt and the upcoming in 2010 and 2011 owed to foreign investors.
If Abu Dhabi keeps bailing-out Dubai, then foreign investors will not be among the losers, it will probably be Abu Dhabi, financially, and Dubai, politically. I anticipate Dubai might lose a lot of its autonomy.
It is certainly better to have infrastructure in place than sand. But many buildings might not be occupied for years, who knows. Some might not be completed. In these cases, it is just a waste of resources which cannot be easily converted in something else. Even to demolish a building takes a lot of resources.
My point with the article is that credit expansion allows for a lot of waste of resources, that is, unviable businesses.
Regards,
Fernando Ulrich
I agree, all those resources are more or less wasted or at least a large part of it. Those resources would be put in a much better use somewhere else where there was real urgent need for them and if nothing else even if those resources would be put in productive use some day in the future the fact that we generally value present goods more than future goods is enough to make all that development a bad investment decision. But lets face it… the native people of Dubai ends up with something for (mostly) nothing and even if that something is not the deal they was hoping for in the first place it is still a hell of a good deal for them.
The deal however is not so good for the original owners of the wasted capital/resources, or the public at large (worldwide) who actually financed a big chunk of that development trough the resulted inflation of the central banking system all over the world which made this actually possible (which are actually responsible for the act of channeling such large amounts of capital to uneconomic use/waste).
One additional thing: if the tax policy in Dubai (no tax) stay in power in the coming years/decades I believe it would be sufficient incentive for many people from developed countries to invest some additional capital and time there and try to use all that infrastructure in a productive way. The mere fact that Western countries will have to face increased taxation in the coming years (and as a result more people will try to find opportunities oversea) are also a factor in the future of Dubai.
Regards,
Andras
Andras, you are right on your last paragraph. But I haven’t argued Dubai will be reduced to ashes. Of course not.
However, it does need a severe recession.
As you know recession is the first step. How long it will take to become a solid and sound economy again will depend on how the government addresses the issues.
This week it is on the news they are really trying to develop bankruptcy laws. Better late than never.
In short, there is a long road ahead.
Fernando
The Broken Window Fallacy still applies – even if the victims are unidentifiable somebodies somewhere around the globe.
Fernando, I agree more or less with everything you said, the fact is a matter is that there is a bust in Dubai, that there will be a recession in Dubai (probably already is), that there is an enormous capital waste there, etc.
I just attempted add an additional point to the story, mostly because the average Joe learns from the “expert” driven news media that Dubai is doomed, the usual “hidden between the lines” storyline is: “it was great while it lasted but now, well they will suffer…”
I just wanted to point out the fact that this isn’t the case, the doomed are the owners of the wasted capital who are – in the very specific case of Dubai – mostly people far away from Dubai.
We must pay attention that this is a very specific case because in most other cases this is not the fact of a matter. In reality while the credit expansion driven boom lasted, Dubai consumed other people’s capital, most other places consume their own capital. That alone is a significant difference.
That will teach you to peg your currency to that of the hyper-wise GB Super Fed team.
This whole thing was destroyed by the value of US assets falling. My guess is that they had reserves of US currency or dollar denominated assets instead of the superior oil or gold. The central bank probably holds dozens of billions in mortgage backed securities. Of course when the true value of these assets became obvious the whole banking system realized that their reserves were worthless.
Bogart, as Mises said: “there is no security in economics/market”… and don’t forget that there is also no such thing as a “true” or intrinsic value… and the PRICE of the US assets decreased, not VALUE as you said. Value is a subjective thing and has no cardinal number assigned just a place on the ordinal scale… We are talking about Austrian perspective here so lets stay out of the false pseudo-economist fantasy world of the central banks.
“Although credit expansion did indeed play a fundamental role, actual saved resources were also drawn into the UAE market, further fueling the malinvestments.”
Shouldn’t real savings stabilize the economy?
And one further question: The theory stated by Mr Ulrich, which is very well-thought and interesting, seems to be wholly endogenic, with Dubai’s financial system being the main source for the business cycle.
However, didn’t most investments in Dubai stem from foreign sources, like other Arabian nations, Europe and Asia? Isn’t it possible that the business cycle was imported from abroad?
This is what I find lacking in ABCT: What happens to imports, exports and foreign direct investments during a business cycle?
I hope that someone here or Mr Ulrich himself can answer my questions.
“Although credit expansion did indeed play a fundamental role, actual saved resources were also drawn into the UAE market, further fueling the malinvestments.”
I forget to comment on this before… but this is an incorrect view. The “mechanism” of credit expansion is not capital creation it is capital redistribution, so all capital invested in Dubai was actually saved capital (resources), one can’t build a city with imaginary capital, one must always exchange the created credit “money” for commodities, labor and land. So the waste is always real (real commodities/goods, real labor and real land).
Credit expansion drives the price of capital lover (low interest rates) so businesses and people tent to take higher risks because of the cheaper capital, but the capital they invest is always somebody’s real saving. Not all investments are malinvestments during credit expansion fueled boom, but a large chunk is. Also malinvestments are a reality even without credit expansion, just the scale is much smaller.
Credit expansion is a “device” of redistribution of investments not a device of creating new investments, it is always a device of channeling the flow of capital and consequently labor from serving more urgent needs to serving less urgent needs.
The real consequences are a permanent injury to businesses (and people) who attempts to serve the consumers and they don’t tend to employ capital if the risk is unreasonable so they stay behind more than usually because of the fact that other businesses (the unreasonable risk takers) are now very aggressive in employing the scarce resources (capital/labor etc.) This new market condition put a higher risk on their investments too, so they are left with the choice, ether go out of business (usually sell that is one of the reason of high rate of acquisitions during credit expansion times) or take the higher risk. Because of this the whole business world (even the more responsible ones) are forced to take higher risks and higher risks means a less accurate prediction of future needs, hence it means more malinvestments. The price structure of the market becomes distorted so economic calculation becomes a sham instead of a method of predicting future needs of consumers.
I hope I answered with this to Mr. Bogner, because as we see the real role of credit expansion it becomes clear what happens to import, export and direct foreign investments, they too tend to go from serving the needs of the consumers to serving an imaginary needs or less urgent needs, they tend to drive businesses from profit to loss right after it becomes clear to the markets (actually the millions of acting individuals) that the expected return is not what they had in mind a few days earlier. That is when the bust kick in. The bust is a moment when the market learns that the expected return (production) on the invested capital is less than the expected consumption. When we actually realize that the investments won’t support our expectations, then we try to walk away from those investments, we try to exchange them for more appropriate investments, but usually it is hard to find one, so we try to convert them to cash, gold etc. Of course the first few succeeds in this, others are not so successful because the information about the new expectations spreads quite fast trough the market so in a matter of days the demand of everything goes down (except for gold and some other commodities suited to “conserve” wealth) and the supply goes up (everybody try to sell). That is when you can’t sell and the economic exchange stand still (except for resources needed for subsistence which are not suitable for growth anyway).
The remedy is liquidation and a start over. Or we can try to prolong the fantasy world roller-coaster ride a little further by creating a “new” picture in the eyes of the acting individuals in the market, by telling them that they investments are “safe” because the government is here to help. Or we can have a little bit of both, the liquidation of those investments in a hand of people not so important to government power structures and the bail out of those who are important to the guys at the top of the “food chain”… and usually that is what happens.
In the meantime we end up in a recession or if the malinvestments are really really high a depression kicks in.
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