Investors are dumping risky assets and seeking the relative safety of the U.S. dollar and bonds on fears Dubai's massive debt crisis could cause a significant correction in emerging markets that would ripple through and weaken demand for commodities.
The U.S. dollar rallied yesterday as Asian stock markets extended two days of major losses following a request by state-controlled conglomerate Dubai World to defer repayment of its crippling $59-billion (U.S.) debt load.
Dubai's failure to make its debt payments has raised the spectre of a possible contagion to other economies just as a fragile global recovery tries to take hold. The potential for the crisis to stem economic growth took a toll on commodity prices, including oil, copper and gold, which fell again yesterday. But the fears eased somewhat on rising optimism that the debt crisis would be contained to the Persian Gulf region.
Strategists at Bank of America warned the situation could lead to a major sovereign default that would choke off capital to emerging markets, which have been key drivers of the global economic revival.
"One cannot rule out - as a tail risk - a case where this would escalate into a major sovereign default problem, which would then resonate across global emerging markets in the same way that Argentina did in the early 2000s or Russia in the late 1990s," Benoit Anne and Daniel Tenengauzer wrote in a report.
A sovereign default by Dubai would lead to "sudden stop of capital flows into emerging markets" and represent a "major step back" in the burgeoning recovery from the worst financial crisis since the Great Depression," the strategists said.
Dubai has accumulated more than $80-billion in total debt over the last four years as part of a runaway building boom designed to transform the Gulf emirate into a tourist destination and financial hub of the Middle East. With access to cheap credit, state-backed companies - most notably Dubai World - pushed forward with a series of ostentatious infrastructure projects, including an offshore palm-shaped tourist resort built on sand foundations and the world's tallest skyscraper.
When the global financial crisis struck last year, however, Dubai's real estate market crashed and property prices plunged by more than 50 per cent.
Now that the United Arab Emirate nation can't afford to pay its creditors, investors are punishing banks with exposure to Dubai and reassessing their appetite for risk. Hong Kong's Hang Seng index skidded nearly 5 per cent yesterday, while Japan's Nikkei index slipped 3.2 per cent, its largest one-day decline in more than eight months.
In his report, Mr. Gartman described the situation as "amongst the worst of news one might conjure up and is one more spear driven into the heart of capitalism by greed and overextension."
Oil futures prices fell as low as $72.39 a barrel in New York before recovering somewhat, to close at a six-week low of $75.95. Copper futures fell the most in a month, dropping 7.1 cents or 2.2 per cent to close at $3.125 a pound. Gold declined $12.80 an ounce to $1,174.20 after briefly touching a new record high.
Most European equity markets, however, rallied yesterday as concerns about the fallout from Dubai's debt crisis began to abate and world leaders played down the severity of the situation.
"While it is a setback, I think we will find it is not on the scale of previous problems we have dealt with," British Prime Minister Gordon Brown told reporters.
"The world financial system is stronger now and able to deal with the problems that arise," he said.
Canada's Finance Minister Jim Flaherty said the Group of Seven industrialized nations has had discussions about Dubai's credit issues and is monitoring the situation.
With files from Bloomberg and Reuters