What does the Dubai crisis tell us?

As we come to the end of a Global ‘Nightmare’ signs continue to grow across the globe that the world economy is stirring back to life. The U.S. finally returned to growth in the third quarter, with its strongest showing in two years, India posted inspiring 7.9% growth and the results out of tiny Taiwan, one of the economies slammed the hardest by the global recession, were  impressive. Stock markets, aside from a downward blip here and there, have generally been buoyant.

The worst of the crisis is almost certainly behind us, but that doesn't mean the crisis is over. Lying ahead are a barrel of unresolved problems, policy challenges and, no doubt, further surprises. Unemployment remains a serious global issue; excess capacity left over from the boom years haunts the recovery; and the drastic stimulus programs utilized to fight the recession are creating a new menu of potential troubles.

That was made clear on Nov. 25 when the city-state of Dubai shocked the global investment community by asking creditors of its main corporate arm, ports-and-property conglomerate Dubai World, for a six-month payment standstill on its almost $60 billion of liabilities. The surprise hit stock markets in Asia and the U.S., while sending investors running for safe havens like the U.S. dollar. Experts have since engaged in a rabid round of speculation over what the Dubai debt crisis might mean for the world economy. Some see the problem as little more than a big real estate bust. "I don't see what the big deal is," Willem Buiter, economist at the London School of Economics and Political Science, wrote bluntly. Others see the Dubai crisis as the potential flashpoint for a new stage of the global crisis, a sign that heavily indebted sovereign states might begin having trouble financing their deficits, or that investors will reassess their exposure to risky emerging markets in some kind of financial ‘swine flu’

Stuff of horror movies, indeed, but so far, that worst-case scenario doesn't appear to be materialising. The central bank of the United Arab Emirates promised on Sunday to stand behind the country's banks with fresh cash, causing stock markets in Asia to rebound on Monday. Nevertheless, the Dubai fiasco is just the kind of dangerous unknown that can still arise out of the financial crisis, even while a general recovery is under way. Financial crises change the rules of the game, especially when it comes to determining how money flows, and where and to whom. Perceptions of risk among bankers and investors can change — but the ramifications of that change are often delayed, and not easy to predict.

Since the global financial crisis hit, the more sober Gulf economies have fared relatively well. Not only is the Middle East less integrated into global financial market than other regions, but oil prices have risen again since their initial decline last year. Unlike Dubai, the oil economies of the Middle East have been more sober during the boom years, putting their money in massive infrastructure projects, building cultural institutions, and keeping big piles of cash on hand for a rainy day. Dubai may want to do the same.

It seems to me that there is still quite a bumpy road ahead, who knows what will happen next. Giles Chance when talking of China and the credit crisis says ‘it’s like watching a duck swim, on the surface it seems fine, but underneath its quite chaotic’. That is an apt metaphor and could well describe the world economy. The rising economy is masking a lot of chaos. Please let that duck keep swimming!