The US sneezes and Dubai catches a cold!

Last week, when most Americans were busy eating turkeys, the world was hit with news that Dubai, one of the seven emirates in the UAE, now seems to be defaulting on its debt, rattling global markets. This photo feature in the NY Times presents a dark, but interesting picture of the situation.

Dubai had invested tens of billions of dollars in real estate, construction and other activities in a bid to lessen its dependence on oil exports. Diversification is not a bad way to hedge risk, financially speaking. But as they are now learning, dependence on real estate and construction, financed by inflationary credit is not really hedging. Wait a minute! Didn't the US already prove that to the world?

True, but a big difference is the strengths of the two economies - while the US economy is built on a strong foundation of innovation, financial endurance, technological brilliance and entrepreneurial spirit for more than a century, Dubai's is primarily that of an oil merchant, with a spattering of other businesses trying to take shelter in its tax-friendly shores. Dubai has merely exploited natural resources and has been importing talent from abroad with little skills and knowledge-transfer to drive its economy. In other words, the US can catch a cold, close a few banks, foreclose a few homes and survive the swine flu, but Dubai might not.

Also, given its heavy dependence on the US and Europe, this should not have been a surprise at all. Alas, the learning probably came too late for the Arabs.

It is difficult to say with certainty at this point what the repercussions will be. The most likely scenario is that the damage will be largely limited to the Arab Middle East as most of Dubai's dealings are made according to the principles of Islamic finance (which non-Muslims have limited stakes in) and that the repercussions for the rest of the world will be limited. However, a small risk exists that the problems will spread through indirect mechanisms to the rest of the world - definitely India and Pakistan whose expatriates have flooded the Gulf for years.

But, given Dubai's control over the oil supply of the World, it is only a matter of time before a bail-out package arrives from Washington DC, funded by the taxpayers of the US, for a lifetime supply of cheap oil - from Obama with love!