What to Say about Iran?

I'd feel remiss if I didn't mention anything about the events in Iran since last Friday but I am not sure I have much to say or even know how to begin to wrap my head around everything. There are so many moving parts to this story that I don't know where to place them all at this point. Some things that interest me/bother me (in no discernible order)-

* The election itself. What does one make of it? I think this first issue on my list is the most difficult. Juan Cole in post on his blog on Saturday lists the reasons he thinks the election was stolen. Compelling but not necessarily a silver bullet. Other analysts/commentators have over the course of the past few days listed reasons why the election was probably legitimate- most infamously now Ken Ballen and Patrick Doherty's op-ed in the Post. (Some of the air was let out of the polling balloon by both the ABC polling unit and an organization called FiveThirtyEight.) Finally, the Post yesterday published an amalgamation of both sides of the argument in a front page article, perhaps in an attempt to take some heat off of the criticism of the Ballen/Doherty op-ed. As for this part of the moving story, I tend to think along with the Post, we'll never know what really happened on Friday unless someone decides to spill the beans publicly in a hope for redemption.

*The Protests. Lots of folks are noting that the protests, particularly in Tehran, are the biggest to rock the country since the Iranian election. What surprises me most about them is not how large they are or the fact that people keep coming to the street day after day, but that EVERYONE beyond the community of folks on Twitter and Facebook are surprised by them. I am still in a bit of shock that conventional media outlets have only gotten around to paying any attention to the social network response in the past 24 hours. Only today did the New York Times actually publish an article than resembled what's been reported non-stop on You Tube, FB, and Twitter since Friday. NBC caught on a bit more quickly but that was only after Monday's massive (!) protest and the deaths of 7 demonstrators. I am floored that even the experts I talked to on Monday thought this was a northern Tehran phenomenon only. This as You Tube was filled with videos of riot police in Shiraz and Isfahan.

Why were people surprised by the strength of feeling going into this vote? Did they assume that Iran's apathetic youth would remain apathetic? Did no one get the sense watching the rallies in support of Mousavi in the last week and a half before the election that perhaps this time it would be a little different? Reading posts on Facebook suggested that Iranians were much more engaged in the pre-election run up, watching the debates, arguing about the outcome. Why then, were folks surprised by the level of anger when Ahmedinejad and Khamenei quickly pulled the trigger on the results? It's not as if we're talking about a populace with no history of political uprisings, for god's sake. Ultimately, the protests may not change the election results but they have changed a few things. 1)Internal dynamics within Iran. I'd be surprised if the regime can ever put this genie back in the box entirely. I'd be afraid of the kind of repression it would take to make the populace passive again. 2) The way that everyone, both in the media and within governments, looks at social networking. I can't begin to understand its force (even as someone who uses it) but it will be one to be reckoned with for a long time to come. I hope we in the US finally begin to appreciate that.

*The Iranian Government Itself. Where can they possibly go from here? The little diversionary tactic of having the guardian council review some of the ballots has clearly failed and the response seems that the only way forward is to go more draconian. The You Tube images of students being hunted down in Isfahan (if they are credible) and gunshots in the night in Tehran are deeply disturbing. Clearly whomever is running the show these days is no student of history. The Shah tried to use the Savak to keep things under wrap, clearly an unsuccessful strategy. A friend of mine posted an interesting video to her FB profile of policemen standing alongside protesters. A consensus is forming that most of the violence being perpetrated against citizens is not being undertaken by conventional forces but by groups like the Basij. If this is true, it could indicate that the government could very quickly loose control of the security services outside of the militias. Yikes. The government's other tactic of shutting down media outlets is failing miserably. Let's face it- there are plenty of ways to get around government filters and those plugged in Iranians have been using them all, and using them pretty well. I can't tell you how many requests I've seen to spread anti-filter software around. How does the government get control back of the situation? I would posit that they don't unless the air goes out of the balloon for some reason. But the more violence and the more intractable Khamenei seems, the more likely this continues in my mind. A lot of people see Khamenei as the lynch pin, including this NY Times article. I'd argue that things are probably broken, perhaps not irreparably, but broken all the same for him as well.

*The US Response Almost as appalling confusing as the election itself is the varying expectations of how the US should respond. On the one hand, you have conservatives arguing that the system was broken before the election so we should just accept the fact that yes, the election may have been illegitimate (are they ever legitimate? goes this line), but Ahmedinejad is the winner and he's the one we'll deal with. You almost get the sense that there is some glee in this camp since Ahmedinejad is such an unlikeable character he's easy to kick around. Tied to this argument although a bit separate from it is the insinuation (as evidenced by the tone of the Ballen/Doherty op-ed) that there is something inherently untrustworthy about Iranians themselves so it should be no surprise that they re-elected a feckless, evil leader. Meyrav Wurmser in the NYT blog "Room for Debate" and Fouad Ajami on CNN break this way. Wurmser is particular wacky, ending her piece with the line "What is left is a military strike to stop the bomb program and rattle the regime." (Christ, remind me to defect to Canada if she ever enters government!) On the other extreme, you have the Journal's op-ed page today which accuses President Obama of abdicating his responsibility towards democracy in Iran. (Here's the first and here's the second)

Fortunately, the President himself seems pretty deaf to all of this nonsense. He knows that he will have to deal with whomever comes out of this nasty fray and he can't kick Ahmedinejad around beforehand (although he will certainly be able to do so post facto, I imagine) but at the same time he can't risk isolating a new movement in Iranian politics if that is in fact what is emerging. I think he's planning it pretty cool at the moment. Express your concern but stay uninvolved. Look what our history of interference has wrought in the past anyway.

Regardless, the events in Iran are frightening and fascinating all at once. It's almost like watching a woman in the midst of a terrifying childbirth. You're absolutely not sure that modern technology will save mother and baby but you can't help rooting for the daring will to survive and change.

As for the rest of the region, what happens in Iran is critical to every one's self interest. No one should expect that even if, by some as yet unseen miracle, a new election happens the policies of the state will radically change. But something is about to change. If I were a neighbor, I'd be holding my breath right now. But wait a second, I already am.

Some wholly unconnected bits of news

Here are a few things I found interesting in BME this morning-

Gas prices locked and loaded for a big bang

Nearly two thirds of Gulf companies not hiring

A third of Dubai's homes may be empty by end of next year

Recovery? What interesting times we live in...

Moderation in the Making?

Not being a political scientist and lacking in any hard data regarding public opinion, I have been struck with the results of the elections in Lebanon and the current presidential race in Iran. The Lebanon race is a bit harder to read in terms of popular sentiment, but one could argue that at least a plurality of voters who turned out are looking for a change away from Hizballah's "in your face" tactics. What exactly they are rejecting is unclear. The Washington Post argued yesterday that the majority of Saad Hariri's supporters are expecting a direct confrontation with Hizballah in order to overturn the group's veto right in the Lebanese parliament. Somehow, however, I doubt that all voters who favored Hariri's March 14 coalition want that knowing that such a confrontation risks an open rift with Hizballah, who still remains a powerful force in the country. So perhaps the election best represents a general shift towards the middle and away from the confrontational tactics that Hizballah best embodied, especially since the conflict with Israel in 2006.

Even more interesting is the campaign in Iran as it approaches election day on Friday. Again, take a look at this article in the Post on the pre-election atmosphere in Tehran. Some of the tactics being used by Mr. Mousavi's supporters seem almost directly in line with the energy and enthusiasm that President Obama was able to capture by harnessing social networking here in the US. At the end of the day, Mr. Ahmadinejad may in fact be re-elected but one cannot discount the strength of the support Mr. Mousavi has been able to garner and the creativity of his campaign, especially for Iran. The pictures that accompany the article in the Post are equally interesting since they represent a side of Iran not many people see, or have seen since Mr. Ahmadinejad's election. Mr. Mousavi appears to be tapping into a desire for change or at least moderation in Iran that his opponent continues to roundly reject. The Times has a nice synopsis of each of the candidate's positions on major issues that highlights this moderation in action.

US administration officials over the weekend called Lebanon the bellwether of the region. Certainly, Iran is not just a bellwether but a driver of events. With this in mind, what is really going on with the Arab/Persian electorate? Why the sudden lurch towards the political center? A few commentators over the weekend wondered if President Obama's speech might have influenced the outcome in Lebanon. Possibly, but could this also then account for the sudden frenzied support for Mr. Mousavi as well? Even more interesting is that the turns in the electorate in both countries seem to have taken most observers unawares. The Lebanon election was deemed to be a "surprising" outcome and as the Post article linked above notes even Mr. Mousavi has been surprised by the level of support he has received. Could it be that the region was simply waiting for an US administration that held out an olive branch? If Mr. Mousavi does get elected, the events of the past week in Lebanon and Iran might be the most damning condemnation of the Bush administration's policies in the Middle East yet.

What Obama Got Wrong

I'll start off by saying that I really loved the President's speech in Cairo today. Admittedly, I am an American who already has a tremendous respect for the work that President Obama has been doing to try and re-orient the country back towards a pragmatic, centrist position. But I think he hit the right notes almost across the board in quoting the Qu'ran, using a small flavor of Arabic, and more honestly addressing the Israeli-Palestinian problem than any other president since the first George Bush. He even referred to Palestine, a tremendously big deal for those who pay attention to such things.

What I didn't like were the policy recommendations towards the end of the speech when it comes to economic development. And here, I honestly chalk that up to the almost complete lack of nuanced understanding of the region from an economic perspective that is so pervasive among the "intelligentsia" and policy formulators in this country. I can almost hear local Washington think tanks or State Department spouting off the truisms that come with "analysis" of Middle East economies- not enough investment in education, need for entrepreneurship, etc, etc. Sadly, this is the one area where President Obama's vision for the Middle East diverged not one iota from the Bush administration's. I know having worked on the blighted from the beginning Broader Middle East project of 2004.

The fact of the matter is that illiteracy has largely been eradicated in the region, according to UNESCO, with the exceptions of a few countries (it continues to be an issue in Morocco and Yemen). Females in the region are being educated to an equal if not greater extent than their male counterparts and more often than not continue on to higher education in greater numbers. The reason the statistics still look a bit screwy is that you have a "lost generation" of females in particular who missed out on the mass wave of educational investment in the late 1970s/early 1980s. Women over 35 are likely the ones to remain illiterate. Well and good if you want to reach those segments of the population, but that requires a whole different set of policy responses than simply expanding primary education.

As for entrepreneurs, yes, it is a problem perhaps that you don't have more Bill Gates in the region. MEED a few years ago ran a cover story on this same issue. But the REAL problem here is not a lack of ideas as much as a lack of capital. The fact of the matter is that with the exception of the Gulf, perhaps ironically, bank lending remains largely tied up in claims on the government. Across the region, but especially prevalent in North Africa, most banks don't lend. And that is largely because of 1) the financing requirements of the state and 2) (and more importantly here) the fear of the banks that they will not be repaid. The Gulf, beginning in Saudi Arabia in 2003, got around this issue with a really basic, self-evident premise- the government instituted direct deposit. With paychecks going directly to one's checking account the banks could ensure that repayment on loans happened before anything else. How simple is that? With direct depositing, lending to the private sector flourished between 2003-2008. (I am not sure where lending stands this year yet.) And, as a result, private sector growth in much of the Gulf far outstripped government and oil growth. Not exactly rocket science.

So, my suggestion to the President would be to drop the summits and the focus on illiteracy and get down to business. Some of the best "exchanges" the region had with the US under the Bush administration was negotiating FTAs with the US. Give the region an incentive to change instead of meetings to attend.

You know it's bad when...

...you look to Iraq for assistance in economic growth. (Wall Street Journal article today on Syria.)

On an unrelated topic- another interesting article in the Journal today. This one on the disconnect between physical and financial markets in oil. As readers of this blog know, it's one of my favorite rants.

Is Corruption always Bad?

Don't you love it when people start a blog post/speech/op-ed/paper with a leading question? You can almost always guess what their answer will be. My answer, perhaps to the dismay of other more conventional thinkers on the Middle East, is no, of course it's not always bad.

Generally, I detest the topic of corruption since it always gets wrapped around the shallow axis of naughty behavior (without much thought into why), but often it's hard to avoid, especially the past few days. Corruption seems to be the topic du jour in Iraq, for example, after Prime Minister Maliki canned his trade minister two days ago. Business Middle East is reporting that Baghdad plans to arrest up to 1,000 government officials on corruption charges and a committee (presumably appointed by Maliki?) will take over government purchases of grains and foodstuffs from the trade ministry. It was the purchases of food supplies that led to the minister's downfall after his family was accused of making millions of dollars in kickbacks from the purchases.

US policymakers, at least in previous administrations, loved to salivate over corruption in the Middle East, largely I think because of its ridiculous proportions. Think of former Saudi Ambassador to the US Prince Bandar's relationship with BAE. The now deceased King Fahd's vacation to Marbella, Spain, when he was pretty much a vegetable. Sultan Qaboos' perfume line (corruption or legitimate business?); the now deceased Moroccan King Hassan V's pantheon, I mean mosque, to his own piety in Casablanca, the building of which was quite Eva Peronish since he taxed all citizens to pay for his heated marble floors. Corruption exists, with or without oil, with or without monarchy.

From one economic point of view, corruption is always bad because it causes inefficiencies in the system. Money meant for one purpose is diverted to another purpose, largely for personal gains. Therefore losses occur. It takes twice, three times more money, for example, to get a project done if there wasn't corruption, all things being equal, because of the bribes and/or kick backs that need to be factored in when project planning. Of course, corruption is never just viewed from an economic perspective and more often than not in the US, it is viewed from a moral point of view. It's wrong to take things that aren't yours or so the argument goes. The US is especially good at this when formulating foreign policy and now has itself tied up in knots over Iraqi corruption (as if this should even be on our radar screens at this point with all the other problems plaguing the country.)

But here, I'd like to counter with Ted Stevens. Yes, that's right, the esteemed and almost convicted former senior senator from Alaska. Stevens was always pretty much shameless in arranging deals and promoting earmarks for Alaskan projects. From his perspective, there was no way that remote, politically unimportant Alaska would ever get funds for development if not for Stevens' hook and crook style. And he was probably right. You might argue that maybe county xx in Alaska should never have been developed to the extent it was, but that's kind of beyond the point. Steven's argument was essentially that even in our institutionally strong, fairly transparent democracy a little bit of corruption is needed to ensure that everyone gets a fair share of the pie. Few of us outside Alaska thought the argument had merit, but to the people of Alaska, Stevens was a hero.

I've always felt that, in line with how Stevens felt about Alaska, there was and is something to be said for the importance that corruption plays in wealth redistribution in institutionally-poor countries. It certainly isn't perfect and god knows that the wealthy or politically connected may benefit first and foremost from corrupt systems. But, at the end of the day, they are not the only ones who do. Take, for example, corruption in Saudi Arabia. Sure, the Al Saud benefit greatly from their opaque control over government and the oil resources. It's pretty well accepted that most of the princes receive generous stipends from the state by sole virtue of their family connection. Some of them may get a bit greedier and set up side deals for themselves, ala Bandar's alleged relationship with BAE. But the Al Saud don't actually keep all the money for themselves. Under them are large patronage networks that depend on the royal family for income or some measure of financial support. If not for these patronage networks, these people would go without. Same goes with the border guards who demand extra payment, etc. Corruption usually kicks in because the institutions that are meant to support societies are not strong enough to do so. Whether you call it filial loyalty, patronage, or survival of the fittest, corruption exists largely as a wealth transfer mechanism, providing the assets of the state to those who would otherwise not have access to them.

With this in mind, I would argue that the answer is not always mass arrests or the integrity commissions that the Maliki government has established (probably largely as a sop to the US) but in fact institution building to ensure that wealth transfer happens within government channels. Even then, though, strong institutions don't always ensure that the people who need the money get it. Just ask Ted Stevens.

Sour Grapes

AFP reported on 20 May that UAE has decided to pull out of the planned GCC monetary union. Although UAE officials did not explicitly cite a reason for their withdrawal, observers strongly suspect the government made the decision after the GCC secretariat decided that Riyadh would host the monetary council that governs a unified currency. Not that a monetary union would have ever been achievable in the next year, but pulling out because you were not selected to host the council seems childish at best.

If the GCC as a whole is to achieve any kind of economic stature on the global stage, setting aside petty differences would seem to be goal number one.

Bashar's weird timing

Leave it to Syria to decide to undertake a more expansive approach to financial sector liberalization in the middle of the worst economic downturn in sixty years. In March, the Syrian government launched the Damascus Securities Exchange, and according to an article in today's Journal, they are preparing to grant new private banking licenses to foreign investors. The hope (on the government's part, that is)is that Syria will attract enough foreign investment to begin to offset its declining oil output.

Don't get me wrong- Syria has been working slowly towards this in recent years. It's been quietly allowing Arab foreign investors (usually from the Gulf) to open JVs with local partners in an array of financial services. It's also welcomed investment in oil and gas exploration and real estate. But presumably the little dog and pony show the government put on recently for the Journal is designed to attract a wider audience beyond the usual cast of characters- namely Kuwait, Iran, sometimes Russia, and UAE. I guess Damascus didn't get the memo, though, that foreign investment, like trade, has slipped sharply as most companies hunker down to outlast the crisis. In fact, I've seen more reports recently of companies selling off assets rather than buying new ones. Even China, once the hands down global leader in attracting FDI, saw a 23 percent drop in FDI in the month of April, compared with April 2008 numbers. And 2008 was a drop off from 2007.

Even with all of this in mind, Syria's best hope for further FDI remains with its neighbors. Taking UAE out of the equation, since they are largely a region onto themselves in their ability to attract FDI, few countries were able to attract non-Arab investment during the booms years. Saudi Arabia managed to attract interest in its financial service sector and in downstream oil industries, like petrochems, from US and European firms. Egypt saw some early interest for Europeans and Asians in its privatization program but even that was quickly superseded by Arab FDI. At the end of the day, the FDI boom which swept across the Middle East and North Africa between 2003-2008 was largely driven by a handful of companies coming out of an even smaller number of countries. Much of the FDI was sourced in either UAE or Kuwait. The nice thing about Arab FDI is that it doesn't give a whit about political stability or authoritarian governments. If there is money to be made, they'll go- whether or not going means dealing with governments as far afield as Sudan and North Korea, or, in this case, Syria.

But the rub for the Syrians now is that their biggest patrons in recent years are the two countries who have endured the biggest fallout from the crisis. Which may be why they are raising the flag of interest more broadly now. The thing is, though, that there are few people with cash left these days and even they are a little less willing to hold their nose than they used to be. Look at some of China's recent decisions in Africa.

So if Bashar is thinking he can get his cake and eat it too, he is in for a rude awakening. Best to go back to plan A, I think, and wait for oil prices to rise again. After that, I am sure Dubai's emir would love a visit.

What Lessons Are We Sending?

Yesterday I came across a surprisingly upbeat article on Lebanon in the Wall Street Journal. I say surprising since I have not been actively following Lebanon recently. The article recaps an interview with the country's central bank governor who is now forecasting a possible 6 percent growth rate in 2009 based largely on an anticipated strong growth in consumption in the second half of the year after the parliamentary elections next month. Continuing in this happy vein, Moodys upgraded the country's sovereign credit rating last month (around the same time it was issuing a warning for a downgrade in Kuwait), and according to a report in the Daily Star, the Lebanese benchmark outperformed the MSCI Arab market index, making it the best performing index in the Arab world second only to Qatar.

With all of this optimism, I had to stop myself and think- this is Lebanon, people. Political instability is only a stone throw (or an election) away. Debt to GDP ratios still exceed 150 percent and finance continues to be the one thriving industry in a country that has witnessed enough destruction of its infrastructure to last a lifetime. Coupled with that a decline in remittance payments from the Gulf as those economies slow and almost sure decline in tourism receipts on the back of the global slowdown, I still have a hard time seeing the sunshine.

But more troubling is the general message that this crisis might be sending to countries in the region. A colleague of mine asked several months ago whether or not I thought the global economic crisis would create a general distrust of capitalism in the Middle East as countries that were at best reluctant to accept Washington consensus style reforms watched as Anglo-Saxon capitalism collapsed in a big ugly heap. I thought at the time (and said as much) that I didn't think it would make that much of a difference since most regimes in the region saw their fortunes tied to a limited but specific plan of reform- privatization and some liberalization in order to create jobs. Most Arab governments were not, in fact, modeling their efforts on western models but on a hybrid Arab-Asian model- that is, some economic reform with continued authoritarian control over governments.

But here's the thing- the crisis is teaching the countries in the region a potentially scary lesson- the more integrated your banking and financial system is with the global system, the more you will suffer. Look at the two countries that so far have taken the biggest hit- UAE and Kuwait. It was precisely their reliance on, links to the global financial system that have lead to their current weakness. They are essentially getting it at both ends- seeing their export markets shrink (in both cases, export earnings have declined with the price of oil) and their credit markets, which in the case of the UAE, was perhaps the most robust in the region, have dried up. North Africa, specifically Egypt, Morocco, and Tunisia, have proven remarkably resilient in the face of the crisis. Why? Well, their export markets have shrunk, for sure, but their closed banking systems have prevented any contagion effect. So what's the lesson? Don't lend and don't invest internationally.

I would argue, though, that the single biggest issue holding these economies back is their closed financial systems. Credit is largely unavailable to both individual consumers as well as private businesses. Financial systems in these countries, despite the limited reform being carried out, remain largely patronage systems. If you have ties to elite families, you get the loan. One of the most important "innovations" in the Gulf in recent years was to break the back of this system and open credit markets to the masses. Huge windfall oil profits somewhat masked the fact that the private sector in many of the Gulf countries was growing at an even faster rate than oil receipts.

Opening credit markets does have long term beneficial consequences for growth and diversification, even if that's hard to see now. My biggest fear is that this is a lesson that might get lost in the hullabaloo of the current crisis. In the meantime, all other ridiculous bad behavior ala Lebanon will be tolerated.

Forgetting Some Important Lessons

Way back in the day when I was an undergrad, a professor of mine had my class read "The Republic of Cousins" by French anthropologist Germaine Tillion. Although the book was focused on oppression of females throughout the Mediterranean region, what struck me most about the book was Tillion's argument for a basic cultural affinity in the Mediterranean basin that transcended religion and nationality. The basic framework around which societies organized themselves and ultimately conducted themselves was no different if you were talking about southern Spain or Morocco, etc. It's an argument that has stuck with me for at least a decade and a half and one which I have admittedly done nothing with.

I was reminded of Tillion again today after reading this story about Spain in the Wall Street Journal. The parallels between Spain and much of the Middle East, at least according to information in this article, are numerous. A quote: "During the good times, its economy is held back by low productivity, an extensive underground economy and scant labor mobility. Studies show that Spaniards are unusually reluctant to move away from their home region -- a trait that acts as a drag on the economy. Today, however, being close to one's extended family is a lifeline. Members of Spanish families help one another pay the mortgage, so there are fewer foreclosures. Even when they lose their homes, Spaniards rarely end up on the street. For the most part, they move in together." "The family represents kind of a social-welfare network that allows the country to withstand a much higher rate of unemployment," says Rafael Doménech, chief economist for Spain and Europe at BBVA bank. Another interesting nugget from the article- Given the rigidities of its labor market, the country's "natural" rate of unemployment is far higher than that of other countries. Economists at Spain's BBVA bank put the country's so-called Nairu -- the sustainable rate of unemployment that can be reached without the economy overheating -- as high as 14%.

I have to admit to being a bit surprised by all of this. Many, many economists tend to focus on a small handful of things when looking at the Middle East- population growth rates, high unemployment, GDP and GDP per capita. Shockingly, few focus on issues like labor productivity, labor mobility, and social networks. I am not above saying that I've not delved all that deeply into these issues myself although I did recently present a paper at a conference that discussed low labor productivity in passing. And I am almost embarrassed to admit that I've never even heard of the concept of a "natural" rate of unemployment.

I think Tillion's time has come in my own research. I am rather excited to discover what else might be out there to give us a more solid understanding of the Middle East and where it might be going.

The Debate over Oil

Last week, the New York Times reported that the ability of oil to hover around the $50/barrel mark for the past several months may have had less to do with the ability of OPEC to put an effective floor on the price of oil (although Roger Diwan of PFC Energy did attribute at least some of the cause of oil's remarkable stickiness to this) and more to do with the return of speculators to the market.

Before I launch all the way into this post, I want to be clear that speculation in commodity markets has been a long standing fact of life. Everyone from oil producers to farmers growing soy beans to airlines to power companies have traded in futures as a way to hedge against price disruptions, whether demand or supply driven. Before 2000, however, commodities were almost always traded by producers and end users through official exchanges, such as NYMEX or the Chicago Mercantile Exchange (now technically defunct.) In 2000, Enron successfully lobbied Congress to remove the Commodities Future Trading Commission's (CFTC from hereon in)ability to regulate over the counter trades. CFTC's ability to regulate the commodities markets was further weakened by its 2006 decision to allow a consortium of oil and financial firms operating in London under the moniker of "Intercontinental Exchange" to open terminals in the US to trade commodity futures. (The CFTC had no regulatory authority over ICE since it was based in London.) Here's a good summary of the regulatory changes that opened the door for wider participation in commodity trading. Remember, all the arguments that apply to oil also apply to most other commodities, such as agriculture in many cases.

Railing against "speculation" (I'll define it hear as commodity trading that is undertaken by non-end users or producers, such as institutional investors and hedge funds to make things a bit easier) became a favorite rant of OPEC last summer even though it was widely dismissed by most analysts and even the IEA at one point. That is, until the CFTC woke up to something fishy going on and formally launched an investigation into market manipulation in commodity markets. That investigation is still pending.

Even if all of the trading was above board, as I blogged at Open Salon last week (here's a link to the full post), there is in my mind something fundamentally wrong about allowing non-end users to make tremendous amounts of money off of commodity markets. At the risk of being unsympathetic to those who took a bath in the market recently, there is a significant difference between the paper losses of equity investors and end consumers of crude oil and agriculture (i.e., all of us who eat and have to rely on transportation everyday.) Speculation in food and fuel drove families of all race, stripe, and economic levels into potentially disastrous economic circumstances.

This fact has not been lost on the powers that be. In Feb, the Senate referred the "Prevention of Excessive Speculation Act" to the Committee on Agriculture, Nutrition, and Forestry. The bill looks to restore some regulatory authority to the CFTC by essentially empowering the group to report on OTC trades. In March, UNCTAD issued a report that called for the end of excessive speculation in commodity markets citing the devastating consequences of the sharp rise in food and fuel prices last year. Finally, OPEC, in a joint statement with consuming countries in Asia, called for greater oversight in commodity markets to prevent the kind of surge in oil prices that the world witnessed last year.

Sounds good if it weren't for the Times article. Sure, oil prices aren't close to $150/barrel like they were last summer, but $50/barrel also doesn't seem to reflect market realities with demand down and inventories growing. What we need now, before we see another run up in prices, is transparency in the market. Who is trading and why. Until then, most of us are left to rely on the B.S. that passes as market analysis these days. Analysts with big banks and private advisory groups will go on about "market fundamentals" until the cows come home but none of it equates with what's really going on in the market these days. Until transparency happens, we can't be sure $50/barrel is anymore "fair" than $150.

The crisis spreads

News of SABIC's losses in the first quarter yesterday (its first loss since 2001) weighed heavily on Gulf stock markets yesterday. While not surprising, the announcement serves as confirmation that even regional stalwarts not directly connected to oil, real estate, or finance- the three industries in the Middle East hit the hardest by the global downturn- are beginning to feel the impact of the slump.

Most regional governments have been prosaic about the matter- listing the loses and expecting recovery sometime in the latter part of this year, maybe next. Still, the pace of bad news or announcements of moderation remain a bit troubling for a region that was only just beginning to hit its stride. Today's Business Middle East led with a banner headline that said UBS expects Dubai real estate prices to decline by 70 percent. Capitala, a JV between Mubadala and Capitaland, Singapore, is going to concentrate on low income housing and not take on new projects. Victims of DAMAC scams in Egypt are surfacing, adding to the list of possible indictments from Dubai real estate magnates.

Sure, issues like these are happening all over the world so why should the Middle East be any different? I think I am most troubled by the crisis spreading so deeply and completely here because this is a region who had until recently resisted wide-scale reform and openness. Not a particularly great time to be bitten by globalization. Perhaps having spent too much time studying the Middle East, I would like to see them succeed and not return to the statist models that kept regional economies and governments barely afloat. I guess we'll just have to wait and see how deeply faith in a globalized system is shaken.

Some more interesting articles along these lines-

Diversified Economy Can Pay Strong Dividends

Dubai Chamber of Commerce and Industry Report, April 2009

Lastly, for anyone with access to FT archives, I'd recommend an article published on the 15th of April called "The Price of Globalization"

Transparency- the Endless Work in Progress

A few recent interviews by local leaders in Egypt and UAE have confirmed for me how far even the region's most promising economic stars still have to go before truly reaching the "big league." Transparency and honesty before the public is something that most Arab rulers just don't get and, IMHO, it's an issue that will hold them back from further economic development even more than their lack of or progress towards democracy. Perhaps even sadder than the interviews themselves was that both Shaykh Muhammad bin Rashid of UAE and Gamal Mubarak of Egypt gave the interviews with the explicit idea that they [the interviews] were moves towards transparency. But in today's world, investors and consumers don't want to hear platitudes about local markets- they expect rulers to own up to problems and scope out solutions. Talking for the sake of talking does little these days.

UAE first since it's perhaps the more egregious case. On Sunday, Shaykh Mohammad sat down for an online interview (linked here is only part 1 of the interview) about the current global crisis and its impact on UAE through his website, UAEPM.ae. Billed as a landmark move in transparency, the questions and answers were all clearly scripted and carefully vetted. When asked about the crisis in Dubai, the questioners (attributed as members of the media) were always careful to lay the blame for the bad press UAE was receiving on the doorstep of "foreign media." Case in point- "Foreign media are reporting on "the bubble that burst". What would you tell the people who are endorsing this view?" Media reporting was also referred to in the questions as the "media campaign" with the clear implication being that a campaign was unfair. Shaykh Mohammad certainly didn't shy away from any questions and was, as to be expected, fairly effusive in his praise for Dubai and his country in general. He acknowledged the downturn but was upbeat time and again about his sense of the future.

The most offensive part of this exercise was not that Shaykh Mohammad didn't "own up" to any of his mistakes in developing Dubai or that he failed to acknowledge the deep hole his emirate was left in thanks to his ambitions. Overzealous honesty by those in charge is usually a bad thing- just ask Tim Geithner. More offensive was that the Shaykh's handlers believed that he could only handle the softest of softball questions. Even those that were designed to be tough were fluff- "Dubai has been recently criticised for its development strategy in the light of the global financial crisis. How do you perceive this campaign and how are you dealing with it?" And, "The media campaign has focused on pointing that Dubai is facing an economic crisis threatening the foundations of its economic development. What is the actual impact of the crisis on Dubai economically and socially?" If it's a scripted environment, let at least one question be hard hitting. Worse still, apparently believing this little show of ankle was too much for most people and might undermine confidence in the UAE, the interview was followed by a "reaction" piece in one of Dubai's daily business papers. The reactions were from local businessmen, explicitly in the pay of the Dubai government or probably paid off by MBR's office given the level of effusive praise for the exercise. It reminded me of the bad old days of the Saudi press when the King or Al Saud couldn't pass a dumpster without some rag commenting on how wonderful they were.

Second on the hit list is the interview Gamal Mubarak gave to the Wall Street Journal that was published yesterday. As a rule, I generally respect the quality of reporting out of the Journal but talk about buying into the demagoguery of the Mubarak family. The article prominently notes that Gamal once worked for Bank of America and attributes most, if not all, of Egypt's recent economic success to his leadership. Gamal acknowledges some recent weakness and the forecasted drop in GDP growth to 4 percent from recent highs of seven-plus percent growth, but he glibly brushes off criticism of the country's turnaround, including the lack of impact of growth on Egypt's lower classes, noting that there has been "some trickle down" effect. Of course, he gives no actual examples of this. Gamal also dismissed questions about his succeeding his father saying that such discussions as "good media stuff devoid from the issues of the day." In total, the article served as a ringing endorsement of Gamal and gave little, sometimes no, acknowledgement to the hard work and occasional setbacks of the country's prime minister, widely considered the architect of the country's turnaround.

Perhaps Roula Khalaf encapsulates this backwards/forwards movement of Arab leaders in her article in today's FT on government censorship of the media. The article focuses on a new media law in UAE that has yet to be signed by the country's ruler, Shaykh Khalifa. While liberalizing some aspects of the current UAE law on media, a central tenant of the new law- that is, that information that is deemed harmful to the country's economy or that disparages national leaders is off limits- is causing an uproar even among the local media outlets. (Clearly not among those who responded to MBR's interview, however.)

Learning to work with the media and developing a thick enough skin to tolerate the occasional critical article or editorial is a fundamental lesson that most Middle East leaders have yet to master. Until they do, sadly, most of the real progress and growth achieved by regimes will constantly be second-guessed.

Kuwait and the battle for democracy

At the risk of sounding like a Wall Street Journal junkie, the paper ran a somewhat interesting front page piece on Kuwait's democratic struggles last week. The basic gist of the story is this- Kuwait's emir dissolved the National Assembly yet again after the cabinet resigned on parliamentarians' motion to grill the prime minister. As the Journal article notes, the elections to be held this spring for a new assembly represent the sixth government for Kuwait since 2006.

Despite it's being rated as the most free country in the Middle East in terms of political rights by Freedom House, there's very little that's going right in the country. Kuwait has taken a large hit in the recent global economic downturn because of bad bets and investments undertaken by its local banks. It has the dubious honor of being home to the only bank in the region that has so far defaulted on its outstanding obligations. This despite the fact that the government sits on enough reserves to bail out the country several times over. It only passed a stimulus package for the financial sector after the emir dissolved the National Assembly. The measure will need to be returned to a newly elected Assembly which is sure to delay action until after its legislative recess over the summer.

Even before the current crisis, Kuwait was missing out on economic expansion largely because of its dysfunctional democracy. As countries as wildly erratic as Libya, Lebanon, Syria, and Sudan were attracting tens of billions of foreign direct investment from other Gulf, Asia, and European firms, Kuwait had an investment outflow between 2002-2008. Even its ambitious JV deal with Dow Chemicals had to be shelved over National Assembly objections. Sure, Kuwaitis were getting richer by the day on a per capita basis during this period on the back of high oil prices. But in the meantime, their infrastructure was crumbling and their university students were being segregated based on a demand from a few organized and vocal National Assembly members.

So one has to ask, as many Kuwaitis themselves already are and the Journal does in the above linked article, democracy at what cost? What does it benefit the country to go to the polls every few months only to have the government completely unable to effectively carry out most mandates? Kuwait continues to fall behind many of its neighbors when it comes to economic development and diversification. This particularly irritates Kuwait's upper classes who remember when the country was a regional leader. A US academic from George Washington recently speculated at a conference I attended the possibility of Kuwait revisiting its constitution to try and fix the system. But what can the country do? Few would want to see a return to autocracy (it's unlikely the Sabah who have always been seen more as a "ruling family" vice a "royal family" like its neighbors would be able to pull such a move off) but the ethnic and socio-economic status of most voters in Kuwait will likely ensure that regardless of the number of elections the country has, the general composition of the National Assembly will remain unchanged. And that composition ensures government stagnation.

Will Kuwait's sad downturn have ramifications for the rest of the Middle East? The Journal seems to think so but I have mixed feelings on this one. Kuwait's experiments in democracy have long been dismissed by other countries across the Middle East as exactly what not to do. They see the moribundity of the system and its failure to effectively get things done as an excellent example of why they don't want unfettered democracy. So it's not as if this current crisis will make them lose hope they don't have.

More troubling, though, is the implications that Kuwait's failed experiment has for US policy. Even if the Obama administration abandons or lessens the democratization push of the Bushies, US foreign policy is led by US ideology and that ideology more or less ensures that some sort of advocacy for democracy remain part of the plan. In the past, the State Department has always gotten around this by focusing on institution and civil society building. But when you look at the problem in Kuwait,neither institutions nor civil society seem to be the problem. The National Assembly is a pretty good institution- it's enshrined in the constitution, it has free and fair elections, technically anyone can run for office, it has the power of the purse, the right to question ministers, etc. So how do we promote democracy when democracy is so spectacularly failing in the most free country in the Middle East?

I hope someone smarter than me might be willing to take this on...

The Oil Conundrum

The Wall Street Journal on Monday ran an intriguing article on Monday entitled, "Oil Industry Braces for Drop in US Thirst for Gasoline." The article makes the argument that several important factors are contributing to a permanent decline in US demand for gasoline- a decline in driving distances, increasing use of ethanol in gas mixtures, and advances in engine efficiency. These factors will lead to a 22% decline in US gas consumption between now and 2030, according to Exxon-Mobil estimates cited in the article. These estimates are of course absent any additional move to find new and renewable resources for transportation and/or further federal mandates towards engine efficiency. It also largely assumes the vehicle fleet will remain its current mix of cars, SUVs, and pick-ups.

The Journal article explores the implications of this possibly permanent drop in demand on the US, particularly local governments who rely on taxes on gas consumption to fund local transportation projects among other things. But there is another important ramification that the article doesn't touch on that strikes me as equally unsettling: our prestige in the Middle East, particularly with the oil producing countries.

The possible future downturn in US oil consumption likely will not be replicated in the developing world, particularly in India and China. In fact, Exxon-Mobil is expecting passenger vehicle fuel demand in China to triple by 2030. Exxon-Mobil is so sure of this shift in global oil consumption that it is actively looking to get out of the retail gasoline business in the US but is building a refinery complex in China that will feed 750 gas stations throughout the country. If Exxon-Mobil, a US incorporated company, sees this shift, one can only imagine what oil producing countries think.

Much has been written about the gradual shift of the Middle East/Persian Gulf's orientation towards the East so I don't really think it's necessary to repeat here. Instead, I'd like to posit the following: US influence in the Persian Gulf almost entirely stems from our importance as a customer. Sure, since 1990, we've added the role of protector and security guarantor and, more recently, trade and investment partner. But what got us into the region and what keeps us there is our consumption of Gulf oil. And even for those countries that don't export directly to us (in fact, only Saudi Arabia counts the US as a primary customer), our consumption levels keep global demand up and prices higher since oil is fungible and priced on a market, not customer, basis. So local governments are willing to make some concessions towards US policy, in the past have been willing to fund US ventures or adventures overseas, buy US weapons systems, and play a good cop role in the region in order to keep us happy and keep us buying.

But what happens to that flexibility when US consumptions starts to fall? Will the Gulf be so keen to court us once our position as preeminent oil consumer begins to deteriorate? Historians and foreign policy experts will argue that the shared history between the US and the Gulf of the past 80 yrs, a general cultural antipathy still present between East and Middle East, the continued centrality of the US economy in global markets, and the dominance of US military capabilities compared to other countries, will bolster the relationship between the US and the Gulf for years to come. This is possibly and likely true. But in certain ways, Gulf governments and societies remain deeply mercantilistic. They are traders by nature and are willing and able to seek out the best customers. And they like to keep them. It's the only way I can sufficiently explain why the Gulf producers have been so pliable to US requests over the years even when they don't appear to be on the surface to be in those countries national interests. I wonder as the eastward shift of global oil consumption continues if we might not see policies and allegiances also begin to shift more definitively that way as well.

Perhaps the consequences of such a shift won't be quite as dramatic as they may have been. Certainly, we've moved away from the Cold War necessity of having the Gulf producers fund anti-communist movements. And as the Obama administration contemplates bringing far enemies closer in (today's papers indicate that Iran might be willing to table a new suggestion for restarting talks on its nuclear program), the need to use the Gulf as buffer from other regional aggressors might also be waning. Still, China's interests don't line up quite as neatly with ours as we would perhaps like to think. And it would be more comforting than not to know that you have natural resource producers with endless commodity supplies and significant cash reserves on your side.

How Bad is it?

Maktoob and Bayt.com both released the results of their consumer confidence surveys in the past few days. A word of warning here: methodologies on both surveys is a bit sketchy since both are web based polls and the respondents are self-selecting. What does this mean? Well, only people with Internet access are likely to respond (so represent a relatively small sample pool from the region) and may have a particular bias or agenda that led them to fill out the survey.

All that said, both indicated declining optimism by respondents in the health of their home economies. Bayt.com's survey appears to be a bit more comprehensive and it found that by far, UAE citizens are most pessimistic on almost all fronts about current and future economic performance. Second to the UAE is Kuwait. Both polls found that Gulf residents in general as well as Jordanians and Syrians are more pessimistic than their counterparts in North Africa, particularly Morocco and Tunisia.

I'm not too sure either survey tells us much that is new, but it is interesting to learn that North Africa appears to be weathering the downturn a bit better than the Gulf. Perhaps it is an issue of managing expectations. Having never enjoyed the excessive riches of the Gulf economies, North Africans are not quite as let down by the downturn?

Links to the two surveys here: Bayt.com consumer confidence survey Press release on Maktoob survey

A Cautionary Tale for Iraq

Dunia Frontier Investments just released an excellent, detailed study on investment trends in Iraq from 2003-2009 (YTD). According to a synopsis of the report posted on the Business Middle East website, Iraq has gone through roughly three phases of investment trends since 2003: the period immediately after the US invasion was largely characterized by large lump sum EPC and service agreements in oil and gas and infrastructure awarded by the US government, mostly to US companies. Phase two, which Dunia defines as lasting from 2005-2007, saw a sharp drop off in investment as violence in the country increased. Phase three began largely after the relative drop off in violence following the surge. According to Dunia estimates, investment during this third period (and investment here must be defined as project announcements versus actual FDI flow), increased by 1500%.

As always, the devil is in the details here. FDI in Iraq, as I long suspected it might, is beginning to resemble investment flows in the rest of the Middle East. That is, many countries, from Libya to Tunisia to Egypt to Morocco to Syria, in the MENA region have become dependent on investment flows from almost a single source: UAE. In 2008, UAE announced two large real estate development plans in Iraq, which together accounted for 58 percent of new investment in the country that year. Considering that the other major concessions are service agreements in oil and gas, that number gets even larger if you isolate only for foreign direct investment.

Relying on Emirati money was not a bad bet between 2003-2008. The Egyptian and Jordanian macro economies grew at rapid in the former case and strong in the latter case rates during this period largely on the back of privatization proceeds and FDI inflows. Egyptian growth rates topped 7 percent for several quarters. Not bad for an economy that was stuck at an average of 2 percent (more or less) for close to a decade.

The bigger problem here, though, is that as the UAE economy begins to slow down (and tries to avoid a meltdown in the case of Dubai), its taste for overseas expansion is sure to wane. The most recent estimates for the UAE is that at more than half of its own domestic construction projects have been put on hold or shelved entirely with more expected this year. Emaar Properties, the country's leading real estate development firm, was recently downgraded by Standard & Poors and given a negative outlook. It has already shelved a couple of international projects, including one in Indonesia. DAMAC Properties, one of the firms investing in Iraq, has not appeared to slowdown yet, announcing earlier this month its intentions to sign $545 million in new contracts this year but it has added new fees to its agreements and laid off 200 employees late last year.

Finally, from a development perspective, relying on real estate ventures to diversify your economy has always been a dicey bet, even for the rest of the region. One could plausibly argue that in the best case scenario (in this case Egypt is a good example), real estate usually brings with it other money, especially if privatizations are in the offing. Egypt has had a tremendous amount of investment in the real estate sector but it also has been able to attract Gulf money into other industries, notably oil and gas, food processing, and transportation/logistics. If Iraq could accomplish similar interests, Gulf money is not something to look askance at. But if Iraq is only to become another Syria or Lebanon where most of the money remains in real estate (largely because of a continued distrust of foreign investment in those markets and a government unwillingness to allow for more sectors to go on the chopping block) and is subject to the whims of the global credit crunch and the saturation of real estate projects in the region, we should expect Iraq to benefit little from the new investment.

Lessons Learned from Ratings Agencies

The ratings agencies have been busy these days in the Gulf. Perhaps out of real concern or perhaps out of a need to be perceived as doing their jobs after failing to so spectacularly in rating US financial products, the agencies have re-opened their books on the Gulf and don't really like what they see. Standard and Poors recently downgraded Emaar Properties, perhaps the standard bearer of the "new economy" in the UAE, to a BBB+, down from an A- and gives the company a negative outlook. In its analysis, S&P cites the continued weak real estate markets in Dubai and the lingering uncertainty over the length and severity of the downturn.

Likewise, Moodys has taken a new look at Kuwait and has publicly announced the country's sovereign rating is in review for a downgrade. Among the reasons Moodys cites in its call for a review are the recent resignation of the cabinet and the dissolution of the National Assembly. To quote directly from the press release issued today, "In Moody's opinion, these events reflect an erosion of institutional strength which is of particular concern given the current challenges presented to Kuwait by the global economic and financial crisis."

Although neither the downgrade of Emaar nor the potential downgrade of Kuwait's sovereign rating should be surprising, one hopes that each country and market take away some lessons learned from the downgrade. In UAE, development needs to move away from a single track focus. Stretching yourself so thin, both from a borrowing and a profit perspective, in real estate alone has led to a host of problems for the Emirates. Besides subjecting your domestic market to inflationary pressures (cost of labor and construction materials have been accelerating) and speculation due to easy and cheap credit which in turn exacerbates the inflationary pressures, you leave your economy vulnerable to any number of possible downturns. It's a lesson that the UAE well understands now that Abu Dhabi has bailed Dubai out and may have to again. Still, I am not entirely sure it's a lesson that will prompt them to do things differently. Looking at the UAE press, there isn't a tremendous amount of self-reflection going on. No calls for tougher regulations to prevent bubbles from developing. No talk of diversifying away from real estate. Maybe it's too early to see those signs. But I hope the lesson doesn't go unheeded.

Likewise, I think Moody's has hit the nail on the head when it talks about institutional erosion in Kuwait. I would argue that it's not only because of the National Assembly, although that certainly is playing a role. But the lack of oversight and the inability of the government to anticipate troubles in its own domestic financial industry suggests that many things aren't working in Kuwait these days. Kuwait could use the opportunity of the crisis and the dissolution of Parliament to get its governing house in order but one senses that it's inertia that has and will rule the day in that country.

All in all, it's a shame that both countries don't seem to be flexible enough to learn from these painful lessons. The UAE is particularly disappointing because of all places in the Gulf, and the the Middle East quite frankly, the UAE was proving to be innovative and new. Granted, the country never left the statist model behind (in fact you could argue that with groups like Dubai World, they reinvented it), but with a dash of flash, credit, and private-public partnerships, it would seem that country in fact could become the next Singapore. It's too bad that Emirati decision makers may only be innovative on the up side and not on the down. As a result, the next time a crisis hits, they might not be so well positioned to withstand it.

Some food for thought

Rather than blog today about Middle East developments, I'd like to flag some ideas that I think can and should serve as useful frameworks in understanding the economic universe as we go forward through this crisis:

The FT ran an excellent synopsis of "what went wrong" in financial markets in yesterday's paper. It's a bit funny but a bit sad that many of the best economists have spent more time trying to understand what the past few months really means or how much worse things can get (if you are Roubini) rather than trying to understand how we get out of this. They leave that, I guess, to the bureaucrats.

But the FT article raises some concepts that I think should apply not only to banking and investment but also to how everyday analysts like myself look at the world. The article lays out the concept of disaster myopia, or, as defined by the article, the tendency to underestimate the probability of disastrous outcomes, especially for low frequency events last experienced in the distant past. The author then goes on to explain that the markets' over-reliance on "the wisdom of crowds," ratings agencies, and econometric models led to what was fundamentally a lack of independent thinking, or for a better term, creativity. No one was able to see the fundamental errors in the investment styles that predominated the market from 1998-2008.

Untangling that web will be the work of economists for decades and while the FT article attempts to start to unravel some of the multi-layered issues that lead to the current crisis, it simply cannot account for everything. But the issue of a lack of creativity when it comes to economic analysis seems to be absolutely correct. In a less charitable mood, I would almost call it a lack of common sense rather than creativity. Inevitably, it seems, economists, financial gurus, and bankers are hard wired to dismiss contrary evidence. I would say this is true as much on the upside as it is on the downside. When noted geniuses like Warren Buffet can admit to not seeing the downside risk on oil prices last year and losing billions of dollars as a result, you know you have a problem. Why is it then that we cannot recognize changes in paradigms before they get too extreme? Why does a bubble have to burst before anyone recognizes that a bubble existed in the first place? And why do economists persist on believing that the laws of nature (what goes up must come down) do not apply to economics?

I think there may be a few large issues that need to be addressed if economics is to become more flexible and dynamic a discipline as it can be. Despite the discipline's dismal record of forecasting, economists persist on seeing themselves as quasi-scientists. The more hard data we have, the better. We rely on macro statistics to determine what's happening and what's likely to happen. The problem is that macro statistics are always historic. They tell you what's happened not what's going on currently. And econometric models more often than not forecast based on a straight line from those macro indicators. They are fundamentally unable to anticipate the discontinuous event.

But signs of the discontinuous events are always out there if you are able to keep an open mind. In September 2007 I listened to a trader warn of an impending disaster on Wall Street. He talked about the collusion of ratings agencies in rating CDOs, talked about the toxic assets that banks were hiding, and predicted the problem was going to grow much, much larger since those toxic assets were going to become even more toxic as sub-prime mortgages reset. The macro data did not support such analysis at the time, so his forecasts were largely dismissed. (We'll leave aside here that the data didn't support the analysis because the banks had not yet owned up to their looming balance sheet troubles.) Again, in June of last year, I heard commodities traders talk about how inflated the price of oil had become and predict that the collapse would be less likely to come from a disruption in the physical market but more from a disruption in financial markets. But, once again, despite the seemingly inexplicable run up in prices, analysts still argued that it was the fundamentals market and Chinese oil demand that were keeping prices up. That prices collapsed rapidly a few months later was something that analysts dealt with later.

A very smart and insightful colleague has for years argued that the devil is in the details. If you want to understand how the world works, there is little use to studying the macro numbers. Look for the micro stories instead. Because micro trends can add up to macro tsunami. If you need proof of that, think about how one speculator in Las Vegas, betting on the price of real estate continuing to rise, made up a market and a market took down a global financial system.

It's something to think about...

Comprehending the Incomprehensible

What is it like to live through a revolution?  Do you appreciate what's happening in the midst of change or is it only in hindsight that you truly understand how comprehensive the change actually was?  A few pieces of news and an op-ed today in the Washington Post finally brought the magnitude of this recession home to roost.  The idea that we could possibly emerge from this economic crisis looking much like we did going into it seems increasingly unlikely.

First, the news that Citicorp has agreed to essentially be nationalized with the federal government converting its preferred shares to common stock and upping its holding to 40 percent is almost incomprehensible.  It's not just that the US is nationalizing one of its banks, but Citicorp is a global institution.  Presumably the federal government will act much like a private equity investor- get the institution functioning again, stream line, and sell off.  Depending on how Washington does it, there will certainly be repercussions throughout the global financial community.  

Second, and perhaps more remotely, is this report in Business Middle East.  The Gulf's raft of Islamic banks have taken a big hit in the past year due to the downturn in the real estate market in the region.  Because Islamic banks' operating principles dictate that they underwrite loans with tangible assets, many of them are directly exposed to declining home values in the Persian Gulf.  While this has prevented these banks from the same kind of exposure to structured products (like CDOs) that banks globally are facing, it still exposes a significant vulnerability to this system of banking.  It would appear then, that it's not only traditional banking models that needs to be rethought but also more recent innovations like Islamic banking.  Going back to the theme of this blog entry, it's hard imagine how a new vision for banking evolves, especially one that it is likely to be an across the board effort.

One last thing for today- I'd recommend this op-ed.  It does wander a bit, but the observations of Edmund Wilson might definitely be worth perusing.  

Dubai's Knight in Shining Armor

Abu Dhabi yesterday announced a $10 billion loan to Dubai to help the emirate with its substantial debt obligations. The loan would come in the form of bond holdings. Dubai plans to issue $20 billion in 5 year notes with the first installment of $10 billion completely accounted for by the UAE central bank.

So ends weeks of speculation about whether or not Abu Dhabi would again come to Dubai's rescue. Last week, Zawya Dow Jones posted an article speculating that Abu Dhabi would not, in fact, bail Dubai out short of some major concessions in the form of shares in Dubai's most profitable businesses. Worry over a bailout grew so pronounced that the spread on Dubai's credit default swaps were second only to Iceland globally.

The terms of the deal, at least as announced yesterday, seem pretty benign. The bonds will be unsecured with a fixed rate, yielding a 4 percent return annually. No quid pro quo was listed in the announcement. Still, the ease of the deal makes me wonder if there is something in the fine print we're missing. Certainly Abu Dhabi was willing to prolong the speculation to some extent, perhaps to test the waters to see if Dubai could come up with international refinancing. When it was clear that it couldn't (the best it could do was to recently refinance one loan for $3.8 billion), perhaps the capital was spurned into action. But the relationship between Abu Dhabi and Dubai has never been easy and the fact that Abu Dhabi let Dubai off with nary a wrap on the wrist seems unusual.

But no means is the problem over, however. It's far from unclear that Dubai will be able to recover in any measurable way in the short term as its local real estate market continues to spiral downwards. The combination of the mass out-migration of its labor pool as well as structural changes in the state-owned companies (for example, Dubai Holdings' decision to stream line its back offices) will only create an even greater stock of available housing. As the Wall Street Journal article linked above also suggests, the stock of half-finished and abandoned projects also continues to grow. At the end of the day, it's unclear whether Dubai can settle its debts with the $10 billion loaned from Abu Dhabi and if it's not enough, will more be forthcoming?

Long Live the Labor Force

It would seem that the troubles in the Gulf, which until now have been focused in financial markets and oil prices, are beginning to trickle down to the grassroots level. Specifically- jobs are at risk. This is not necessarily new. In UAE, firms have been laying off workers left and right. Until now, however, most of these workers have been expats. A 12 February article in the New York Times detailed how expat workers are being put in a bind in Dubai- left without a job but with debt (many times mortgage related), many expats have just up and left the country. A new report put out by National Bank of Kuwait suggests that unemployment among Gulf nationals will also soon be on the rise. NBK forecasts that contraction in the private sector will be significant across the Gulf in the next year limiting the number of jobs being created. It's worth noting that the significant expansion in jobs across the Middle East in recent years has come from the private sector. NBK estimates that in the Gulf, private sector employment opportunities were rising at a rate of eight percent annually between 2003-2007. These jobs went largely to expats, but a gradual shift of the Gulf national workforce out of the public sector and into the private sector had begun: according to the same NBK report, across the Gulf, 58 percent of nationals employed worked for the public sector while 42 percent worked for the private. This is a significant increase even over five years earlier.

This decline in employment opportunities has obvious ramifications as the region continues to work through its demographic boom. It also has worried local governments, particularly in UAE. Gulf News reported today that the UAE Ministry of Labor introduced new regulations "guiding" the firing of UAE nationals. Farouk Soussa, head of the division that handles sovereign ratings for the region for Standard & Poors, cautioned Dubai's government from going ahead with all the planned reorganizations of it's state-owned companies, such as Dubai World, since it would only further aggravate the unemployment picture in the emirate.

The Gulf's labor market has for a long time harbored serious structural inefficiencies with an over dependence on foreign labor and a domestic labor pool that is payed more and has less skills than some of its regional counterparts. On the face of it, the expat community taking the first hit in the declining economy should be a good thing by opening up opportunities for local labor. Unfortunately, when the expat labor is more efficient and lest costly, it's unlikely that those businesses laying off employs will rush to fill the bill with local hires. And so the situation gets worse for everyone.

Can Infrastructure Really Save Us?

Yesterday I attended a luncheon at the Peterson Institute for International Economics to hear Dr. Justin Lin, chief economist at the World Bank, discuss the current economic crisis and its impact on emerging markets.  Dr. Lin took the opportunity (which he noted was his first outside speaking engagement since assuming the position of chief economist) to posit some ideas of how the world might effectively get out of its downward growth spiral.  Dr. Lin proposed something he termed a "Global Recovery Fund" in which developed countries would allocate a percent of their resources intended for stimulus purposes domestically to a fund which would be used to provide stimulus in those less developed countries that could not afford to take such measures themselves because of fiscal constraints.  He further argued that the less developed countries should follow China's model (I will note here that Dr. Lin is a Chinese national), and use the stimulus funds to address infrastructure deficits and bottlenecks so that when the world begins to recover, the LDCs will have more efficient economies and more capable export resources.  Here is a link to USA Today's coverage of the talk: "World Bank Economist Urges New Marshall Plan."

Leaving aside the political impracticalities of Dr. Lin's proposal (I have a hard time believing that anyone in Congress, the White House, Beijing, or Riyadh for that matter would listen to the proposal for more than 1 min), I was struck that Dr. Lin focused on infrastructure development as a panacea to all that ails the global economy.  Infrastructure is everywhere these days.  Beyond the widely discussed portions of the stimulus package in the US which devotes funds to infrastructure, China, Saudi Arabia, little Bahrain, Egypt, and multitudes of other countries have all announced their intentions to use budget resources to fund infrastructure projects in their domestic markets.  The fact that so many policy makers of so many stripes across the globe have focused on infrastructure makes me deeply wary that we're pushing ourselves into another bubble situation at best or wasted money at worse.  Here's why-

As Dr. Lin pointed out in yesterday's talk, infrastructure can only get you some bang for your buck if you have actual structural inefficiencies that can be remedied by adding the road or improving telecommunications.  In much of the developed world, this is rarely the case.  As much as people in Minnesota would cringe to hear this, totally rebuilding the bridge that collapsed won't bring you much in terms of extra efficiency unless it was somehow rebuilt in a way that would allow for more than just automobiles and trucks to take advantage of it.  Connecting two cities in Africa through rail or road links would bring much more tangible benefit, however.  I would agree with Dr. Lin that money used towards "green" technology might be the exception to this since it offers a way to re-industrialize much of the world in a way that is more environmentally sustainable.

Beyond what you do with your infrastructure investment capital, it makes no sense for everyone to pursue the same kind of development at the same time.  First off, you risk creating massive redundancies- do all countries need to rehab their air and sea ports and if everyone develops super efficient export capabilities to whom will you export?  If your infrastructure improvements help stimulate domestic demand because goods can be shipped cheaper and faster internally, than good for you.  But if you only look to improve your export capabilities, we're looking at another situation of global imbalances.

Second, let's face it, there is only so much material in the world that can be devoted towards infrastructure development.  In 2007, long before infrastructure development became the "du jour" option it is today, the world was looking at a shortage of construction cranes because Dubai and China had sucked global supply dry.  That's right- China and Dubai.  Not China, the US, Saudi Arabia, half of the rest of the Middle East, and the developing world.  Imagine how desperate and expensive the situation could get if everyone with some cash is looking for cement, electricity, engineers, and architects?  Here's an interesting little article on looming shortages:  Materials industries face a "perfect storm" of long term challenges  

Finally, I think it's very possible to overdraw lessons from what China accomplished between 2003-2008.  Dr. Lin argued for infrastructure development by citing China's incredibly strong growth rate of more than 10 percent annually during this time frame (up from averages of 8 percent in the previous decade) and posited that this growth improvement came about because of infrastructure development.  I say that this is a bit of hooey.  Dr. Lin's argument ignored two critical factors- rising US demand for Chinese products during this time frame and China's own domestic spending on the Olympics.  Both led to improvements in infrastructure (particularly in the latter case) but this was an extraordinary circumstance.  Time will tell if these infrastructure investments will actually pay off in the long run for China.  I think the only way it could is if it stimulates internal domestic demand.  Most of the time, infrastructure, while constituting necessary spending, only marginally contributes to growth.  Dr. Lin himself used the example of Japan repaving roads in the 1990s.

All this being said, I don't think spending on infrastructure is a bad thing.  In fact, it is necessary in the same way that having your teeth cleaned twice a year is necessary if you want to prevent cavities.  It doesn't get you much in the short term, but if you want to prevent long term system failures, it needs to be done.  The idea of infrastructure as a panacea, however, needs to be taken with a grain of salt.

I wish someone would come up with another idea... 

The Coming Catastrophe

I offer a small disclaimer before I formally launch into this post: I'll admit here that I tend to be much more of an intuitive thinker than a rationalist, especially when it comes to economics. I tend not to need reams of data to believe something to be true. Not relying on reams of data is of course dangerous since you can read a trend the wrong way just as easily as you can read it correctly. With all this said, I've suddenly become very worried about UAE and Kuwait.

Conventional wisdom is that as bad as things get in both Dubai and Kuwait, local governments and financial markets can always fall back on "big daddy" oil funds to stabilize the situation. For example, despite a significant default in one of the region's largest investment banks and an earlier multi billion dollar loss by its second largest bank, Kuwait still maintains pristine sovereign risk ratings based on its savings and still significant oil income. But a number of reports have been recently released that makes me wonder if the situation in both Dubai and Kuwait could unwind so quickly that not even Abu Dhabi or the Kuwait central government can fix it.

Dubai first. A whole slew of more bad news has been hitting the emirate. Today, Business Middle East is reporting that 20,000 Indian construction workers are being sent home from Dubai on bulk flights in March. They are being sent home on long leave or redeployed to other Gulf countries. Dubai-based property analysts Proleads reported late last week that 52.8 percent of projects, worth $582 billion, have been put on hold in UAE with more expected in 2009. (The remaining ongoing projects are estimated to be worth $698 billion.) Dubai World again went on the defensive yesterday, attempting to squash reports that it would have to sell Barneys to pay down some of its outstanding debts. But perhaps most worryingly, the spread on Dubai's credit default swaps grew by 75 basis points between Wednesday and Thursday last week after Abu Dhabi announced a plan to inject $4.36 billion into 5 of its banks. Traders feared that Dubai might not be able to take similar steps to provision its banks against the almost certain defaults from mortgages and consumer loans.

In my mind, Dubai's troubles offer a double whammy which have fairly broad and serious consequences globally. That's because both the government and the private sector in Dubai went on a spending spree during the last 5 or 6 years. Banks and other financial institutions made massive amounts of loans to support the booming real estate market as well as huge jump in domestic consumption. The government borrowed to finance the large expansions of its state-owned companies, such as Dubai World. The list of companies that the government of Dubai has stakes in is quite large. In fact, foreign investment by Dubai entities drove increased FDI in the rest of the Middle East, Africa, Asia, and parts of the western world. Should these entities begin to default, the fallout could be quite significant. (I'll explore Dubai investment patterns and potential fallout in a blog entry later this week.) If both the government and private financial sector in Dubai were to face imminent danger, would Abu Dhabi have the wherewithal to intervene? It's a question that should start concerning more people.

On to Kuwait- I honestly don't know entirely what to make of the situation but recent reports suggest that many Kuwaitis are becoming frightened and that frightens me. Why Kuwait remains a conundrum is two-fold: the economy (and the government) generally remains opaque. You're not likely to know about a problem until it hits you full in the face. Sadly, I think this applies as much to government oversight of Kuwait's financial markets as it does to external observers' ability to discern what in fact is going on within the country and its investments overseas. Second, relations between the government and National Assembly also remain deadlocked which suggests that any moves to correct a crisis could easily become wrapped up in politics. That seems to be already happening. The Kuwaiti cabinet approved a a stimulus package last Thursday intended to prevent a serious domestic fallout from the global crisis. The plan would guarantee $13.8 billion in new credit facilities to local companies. The plan, which is estimated to cost public investment funds around $5.2 billion, would also guarantee against loss in local bank's investment and real estate portfolios for up to 15 years.

Debate over the plan is intended to begin tomorrow in the National Assembly. Fast passage does not seem assured. One parliamentarian, Dr. Hassan Johar, predicted in an interview with a local paper that Kuwait would be close to an economic catastrophe in the coming months. MP Abdul Al-Wahid Al-Awadhi, chairman of the parliamentary committee, said the National Assembly would not offer criticism on the proposal but that it would need time to study it, given the enormity of the scope of the package. This, of course, does not bode well for things moving quickly in the country.

My assumption on Kuwait has always been that the private sector is so small and almost meaningless when it comes to economic activity in the country that surely the government could handle any bad debts private Kuwaiti citizens and institutions might have. And I am still not convinced this has changed in any meaningful way. But how much has Kuwait sovereign investment been compromised in the global crisis and at what cost will the government face bailing out its citizens? In both the case of Dubai and Kuwait, the sums could be rather large.

Somehow, I don't think this issue is going away anytime soon.

The Gaza Problem

With the announcement of a cease fire in Gaza over the weekend and the withdrawal of Israeli ground forces just in time for the inauguration of Barack Obama (the timing of which cannot be coincidental), the problem of Gaza has suddenly shifted back to the Arab world.  Not surprisingly, they are already dropping the ball.  At an Arab League summit in Kuwait Monday and Tuesday, Arab leaders could not agree what to say about the situation in Gaza officially. Apparently, they found it more efficacious to argue about how much to blame the situation on Israel rather than doing anything productive to help address the calamity that has befallen the people of Gaza.  Even more pathetic than the statement (which even Amr Mussa was embarrassed about) was the League's inability to establish a mechanism for transferring reconstruction and recovery aid to the Gaza Strip.  Instead, only Saudi Arabia and Qatar vaguely promised funds and the League vaguely promised to figure out a way to get those funds to the Palestinians.  Which Palestinians is of course the problem.

The issue of Gaza is an incredibly tortured topic for most Arab leaders.  Many, particularly the less aggressive regimes, dubbed the Arab moderates in western press, tend to loath Hamas and would rather seen them go, even if it means that Palestinians living in the Strip have to suffer to achieve those goals.  The more aggressive regimes of the region prefer to egg on Hamas to stick it to the Israelis but use no opportunity or means to actually do something productive, like build a viable state there.  All sides harbor a certain and sometimes equal distaste for Fatah, believing that faction to be corrupt and untrustworthy, especially when it comes to delivering funds and acting as toady to the west when it is convenient.  Before the Palestinian parliamentary elections in 2006 which handed Hamas a clear majority, many Arab donors, with the possible exception of Saudi Arabia, were looking for ways to bypass official Palestinian bodies altogether by giving aid in the form of direct investment/charity.  Gulf countries built hospitals, schools, etc without the direct participation of the PA.  This is an issue that western policymakers and even some Israelis tend to overlook or conveniently forget since they lack any other alternative: Gaza suffering does not equate with an increase in support or a new found trust in Abbas or the PA.  In an interesting comment to a Kuwait Times article on the summit posted on Zawya this morning, one reader said, "the Arab world is divided between those people who support Hamas and those who do not; I know almost no one who supports Abbas as he is seen as a puppet."   

As if the situation isn't complicated enough, the Israeli penchant for destroying Palestinian infrastructure as soon as it is built makes donors incredibly reluctant and hamstrings any government or private group's attempt to get back on their feet.  And, of course, there is the perpetual problem of the borders.  I would argue that no Israeli politician can be considered serious about a long term solution while advocating border closures.  I know that many Israelis believe that they are safer as long as Palestinians are kept locked behind walls, but no lasting, stable, and reasonable neighbor will emerge if Palestinians are not allowed to trade and have freedom of movement.  At the very least, the Arab League, UN, and Quartet (if such an entity still exists now) should demand Palestinian control over its air and sea borders and its border with Egypt.  

At the end of the day, it's hard to determine who in fact is the worst enemy of the Palestinian people- the Israelis who keep them locked up to keep themselves "safe," the Palestinian leaders who would rather keep the loot for themselves and watch their people die as long as they can claim moral victory, or the Arab states who twiddle their thumbs and tsk and say what a shame it all is.

How Much Drag Can the UAE have?

A number of reports were released this week that cast more pallor over the UAE miracle.  First, Brad Sester and Rachel Ziemba estimate in a new report for the Council on Foreign Relations that the Gulf sovereign wealth funds likely lost as much as $82 billion in 2008, largely due to investment loses, despite record high oil prices.  ADIA, in particular, took a big hit.  Sester also estimates that the fund was never as big as other analysts projected and guesses that the fund did not exceed $330 billion by the end of 2008, down significantly from his estimates of $453 billion in 2007.  

A second report suggests that Dubai will witness a significant population outflow over the next few years as construction projects dry up.  Over 90% of Dubai's population is expat.  UBS estimates an 8% reduction in the number of expats living in the emirate in 2009 and a further 2% decline in 2010.   

Moodys issued a warning about deteriorating asset quality of loans made to Dubai developers in recent years.  The rating agency suspects that as the real estate markets continues to slow, those "opportunistic" developers who came to the market in the past 4 or 5 years might be tempted to default as property prices fall and liquidity dries up.  Moodys has downgraded its outlook on 4 UAE banks (Dubai Islamic Bank, Dubai Bank, Abu Dhabi Commercial Bank, and First Gulf Bank) because of this fear.

In a rare move, Dubai's government published a few details on the emirate's budget last week, projecting a 42% increase in government spending on infrastructure and economic services but anticipating a fiscal deficit of $1.14 billion.  Meanwhile, the emirate had to delay issuing a tranche of medium term notes worth about $4 billion citing little market demand with the credit crisis.

Finally, as if this all weren't enough bad news, the FT reports today that the threat of recession now hangs over the Gulf, one of the last regions thought to be able to manage the global downturn.  HSBC is forecasting the most severe retrenchment in GDP in 20 years.  HSBC believes that recession would be inevitable if oil drops to $25/barrel.

One can't help but wonder what the long term psychological impact of this current downturn will be for the Middle East.  True, things are made easier (if only from the perspective of justifying the downturn) by putting the numbers in global context.  This time, for better or for worse, the Middle East is linked much more closely with global fortunes than it was during the economic downturn of the 1980s.  This linkage raises the prospect of a faster recovery in coming years.  But I wonder if this will prove to be small consolation, especially when it comes to the UAE.  As I wrote in previous posts, the UAE (Dubai specifically) miracle inspired an entire region both with its audacious vision and later its funds to seek out an economic path forward that did not exclude the west but also did not rely on it for its own fortunes.  This may have been unique in the Arab world.  As Dubai is exposed as being over-extended, corrupt, and possibly without solid foundations, could other countries experimenting with economic freedoms reject all the lessons Dubai taught, even the good ones like individual, and foreign, ownership of property, a measure of cultural tolerance, openness to foreign investment, a willingness to experiment with new ideas?  For the economies of the region to be productive in the future, innovation on the personal, business, and government levels must be pursued.  The region is bound to fail if it simply tries to duplicate the development path of other countries of the world.  Dubai, if somewhat shallowly, offered a way beyond those truisms.  Let's just hope that doesn't all get lost in the coming months.