Dubai debt crisis harbinger for a global bond crisis?

To say the debt moratorium declared by Dubai World last week rattled global markets is an understatement. The earth really moved but this is probably nothing compared to the later bond market earthquake that is going to follow these tremors.

Markets will keenly await further news of Dubai’s ‘carefully planned intervention’ to suspend payments on $60 billion owed by government-owned Dubai World just before the Eid holidays. But Dubai is not the only city or government in the world to be deep in debt.

Credit agency Moody’s estimates that the total sovereign debt across the world is up 50 per cent since the start of the financial crisis to a staggering $15.3 trillion. Dubai’s debts are just a drop in this ocean.

Global debt explosion

And on current forecasts this debt will grow another 50 per cent over the next five years. Can the bond markets actually support this explosion of government debt?

Surely this will at least come at the cost of higher interest rates in the future, and that would crash bond prices. Dubai spreads are now wider than for Iceland. But the world is not short of over-borrowed countries.

In Western Europe meet the PIGS: Portugal, Ireland, Greece and Spain. Hungary and Latvia are in poor shape. Then of course do not forget the surging debt levels in the major economies, Japan, the US and UK.

No major financial crisis in history has ever ended without a bond crisis, as the author of the Rothschild’s family history Professor Niall Ferguson reminds us. As a matter of fact Dubai has just appointed Rothschild’s to work alongside Deloitte on its restructuring of Dubai World.

Contagion risk

But the more immediate threat is market contagion. British Prime Minister Gordon Brown said yesterday that the Dubai crisis was confined in Dubai. But then this is the same man who mismanaged the British economy for over a decade to its current parlous state.

Of course there will be market contagion. It started yesterday in global financial markets. If Dubai sells property assets in London that impacts on the market there. If Dubai World sells its stake in Standard Chartered Bank that may impact the bank’s market capitalization.

Indeed, Rothschild’s is there to assess the group’s assets, which include the QEII cruise ship (pictured above) although apparently not port operator DP World. Yet the biggest impact of the Dubai debt crisis may still be in the bond markets.

Future debt

Ironically that meant an immediate flight to the safety of the bond market yesterday and a stronger dollar. But looking a little further out it needs very little imagination to see that government bonds from Dubai are now going to be treated somewhat differently than before Dubai dropped its bomb-shell on global markets last week.

A crisis in the bond market with governments forced to raise interest rates substantially to attract funds lies ahead if history is any guide to the progress of financial crises. That will not be good for the global economic recovery story.