Juggling Dynamite

From 2004 to 2008 the credit-fueled oil and real estate bubble billowed and burst in Dubai. In the midst of building the tallest and most expensive tower (of hubris) in the world, global oil prices crashed 70% and the emirate’s home prices fell 50% through 2008. In December 2009, the country received an emergency bail out package that extended it’s line of credit for a further 5 years to December 2014. The due date for that “emergency loan” is now approaching once more and the country remains more indebted today than ever before. According to the IMF, Dubai today owes about $142 billion or 102% of its GDP. About $60 billion of that debt is due for repayment over the next 3 years.

All of which coincides with expanding global debt trends since 2008: the world’s total debt now the highest ever in human history at 430% of global GDP. Our fiscal future is still going hard in the wrong direction to date. Of course we should not be surprised by any of this:  bail-outs have a familiar effect pretty much everywhere.  They stall necessary restructuring and bad debt write-offs buying a further period of bad fiscal habits and reckless management until the emergency funding expires and crisis resumes.

Dubai has been no exception. Over the past couple of years of QE-mania, the Dubai stock market was soaring in a dream where central banks were magic and debts would never have to be paid nor income statements reconciled ever again. But dreams of this nature always end in nightmare and over the past month, the Dubai stock market has fallen more than 27% (so far), prompting ongoing liquidation of highly levered participants all across the region.

All of which brings me back to this big picture reminder of where we are at with financial leverage and asset valuations in other global markets today. Margin use that peaked previously in March 2000 and July 2007, has been contracting again recently since February (red line below), even as the S&P 500 has pressed further into dream land the past month to fresh nominal highs (back to the March 2000 level in real terms).

We are wise to remember that although no one can know exactly when the trigger finally flips, decades of data attest that highly-levered, over-valued asset markets often do rise like a jet-fueled escalator; before plunging like an elevator on broken pulleys before participants can exit. All par for the speculative course.

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Over the past two years of QE-madness, central banks have fueled yet another era of epic complacency and reckless capital allocation based on the perverse thinking that when it comes to economic developments: good is good and bad is good– because bad news will mean continued monetary largesse. Hence a utopian world, where all economic outcomes make risk assets go higher.

But there is also a yin to this monetary yang which is naively or intentionally over-looked–we have now earned a time where good news will be bad and bad news will be bad for today’s over-valued asset markets. If growth miraculously does rebound as the Fed has repeatedly and erroneously forecast, then rates will go higher and stocks, over-valued bonds and already struggling debtors will necessarily weaken. And if growth doesn’t rebound and the economy stalls once more, a redux of more QE is likely to be seen as just desperate thrashing from central banks already long gutted of power by still zero-bound rates.   See: The asset-rich, income poor economy  for more.  To wit:

“The Fed’s latest forecast has the economy growing above 3% during the balance of this year and next, and the unemployment rate falling to about 5.5% by the end of 2015. If the Fed’s sanguine scenario finally comes to pass, interest rates are likely to move meaningfully higher across the yield curve. The money pouring into the financial markets may be redirected, in part, to the real economy. Stocks, leveraged loans and real estate are likely to re-price in a higher interest-rate environment. If rates move quickly or unexpectedly, the vaunted balance-sheet recovery could suffer a blow.

What if there is an unexpected shock that causes the economy to slow in the next year or two? The Fed would surely be called upon to bolster asset prices and stimulate the real economy. But would a return to $85 billion per month of bond-buying really be effective? We are skeptical that either Wall Street or Main Street would be comforted by quantitative-easing redux.”