Finance Collapse

"Dubai sends markets into turmoil," says the FT. Dubai finance is built on sand...

PROBABLY a good thing US markets were closed for Thanksgiving when this news came out, writes Bill Bonner in his Daily Reckoning.

In Europe, the Dubai affair caused the biggest drop in 7 months. European banks have lent $40 billion to Dubai.

Jim Chanos, a famous short seller, thinks Dubai is merely the camel's nose in the tent, so to speak. "China is Dubai times 1,000...if not a million."

"People are panicking: this whole process counters everything that the rulers have been saying and the way it has been communicated before the holidays is confusing," said one hedge fund manager.

The 'rulers' are the fellows who run "Dubai World"...and incidentally Dubai itself. Whether they are fools, knaves or sly geniuses was what everyone wanted to know. Dubai officials announced that they had raised $5 billion on Tuesday. Two hours later they said they weren't paying interest on it or on any of the rest of the $80 billion in borrowings.

What's going on? Are they really broke? Or are they playing for some kind of advantage?

"Dubai gambles with its financial reputation," says one headline at the FT.

Then, on the facing page, the editors think they know how the gamble will turn out:

"A breath-taking blunder in Dubai...Dubai is looking more like Argentina than Singapore – but a lot less predictable," says the FT editorial.

No on is sure what is going on. Most people take from this story what we knew all along: lending to shady characters in sunny places is not an easy way to make money. Especially when the shady characters own the country.

Trouble is, shady characters run near all the world's countries. If an investor cannot trust the ruling family of Dubai, how can he trust the commies who run China? Or the hacks who run the United States of America?

To err is human. For a central banker, it is practically a professional requirement. Count on a major 'error' to trigger a sell-off in the world's bond market.

But Dubai's mistake did not infect all other sovereign debt. German bond yields went down, not up. Investors sought safety from Dubai debt in Deutschland debt.

But what is the real meaning of what is going on in Dubai? It's the story of the collapse of the financial industry. Dubai has no oil...no natural resources...and no real industry. The rulers tried to turn it into a financial center. Entirely financed by debt. And now finance itself is falling apart.

"The camel put his nose in the tent," says colleague Simone Wapler. "He saw that there was nothing there."

What will he think when he gets a closer look at Britain's finances? Britain, too, relies heavily on the financial industry. And Britain, too, is heavily dependent on debt. Its public finances are among the worst in the world. Japan's public debt, to add another example, is already 200% of GDP. It's expected to reach 300% in a few years. And yet, Japan – like the US and Britain – just keeps borrowing. How long can this go on? When will Britain, the US, and Japan announce their own moratoria on debt service payments?

This bubbly bounce must not have much time left. And it is surrounded by 10,000 pins. Our crash flag is still flying. But that was not a crash. Just a bad day. And today's news tells us that other Gulf States are rallying around Dubai, ready to extend a helping hand and lend a buck or two. Oil is rallying on the news.

Does that mean this bubbly trend is stronger than we thought? Is this a bubble made of Kevlar? Will it resist other pins?

We wouldn't count on it. When China pops, we'll see US stocks down a lot more than 154 points. In fact, we expect to see the Dow in 5,000-ish territory when this bounce is over. And when that happens, emerging markets will probably be hit even harder.

Dubai was a "wake up call," for investors in emerging markets, says The New York Times today.

But the pin that pricks recovery hopes won't necessarily be imported. There are plenty of sharp objects in the homeland too. Traditionally, people Buy Gold when they think the monetary authorities are up to something. And throughout the world, investors are getting edgy...they're wondering how it is possible to add so much cash and credit to the economy without sending prices to the moon.

We'll tell you how it's possible: there's a depression. In a depression, the flow of cash and credit coagulates. Even if you increase the cash in bank vaults, it doesn't circulate into the real economy. Banks don't lend. People don't borrow. Consumers don't consume.

It just sits there...waiting for the end of the depression...like a teenager waiting for Friday...