New World Disorder
Henry Paulson, who cut his teeth in one of the toughest shops on Wall Street to rise to the top at Goldman Sachs, finds an entirely different dynamic on Capitol Hill these days.
One can charge ahead like a locomotive with great steam within the confines of your own company, but garnering support from both sides of the aisle in Washington during the eye of the storm is a whole new ball game. Secretary Paulson has teamed up -- quite artfully -- with Federal Reserve Board chairman, Ben Bernanke, despite their different personalities and backgrounds, one being a financier, the other an academic.
Cries of “financial socialism” emerged from their Capitol Hill committee appearances for the $700 billion bailout package which has the U.S. government, and therefore the U.S. taxpayer, assuming all the risk for the gambling undertaken by Paulson’s former circle of bankers.
While this remains a U.S.-led banking crisis, it is difficult to find a calm port in the storm. Bankers in Britain and continental Europe are still trying to count up their exposure. This week, the central bank in the United Arab Emirates set up a $14 billion pool of funds to free up lending, primarily in Dubai. Here in this column we have talked about the $1 trillion of projects now on the books in the region, a third of those sit on the sands of the U.A.E. The government is not eager for lending to freeze up and construction to grind to a halt.
The market panic, which has gripped every investor in the past two weeks, hit as it became clear that a re-evaluation of Gulf currencies against the dollar was not a priority. As a result, foreign capital quickly exited the region when the sell-off spread. Most equity markets in the Middle East are down by a third from their peaks.
It is a rare instance when the world’s financial disorder finds its way to the floor of the United Nations, but that was the case at the General Assembly where U.S. President George W. Bush told leaders that Washington was taking the “bold steps” necessary to turn the tide on the crisis. French President Nicolas Sarkozy, following up his recent efforts on the global diplomatic scene in Georgia and with the E.U. Med effort, is looking at the bigger picture.
Sarkozy stated, “The 21st century world cannot be governed with institutions of the 20th century.” The French president is proposing a summit after the U.S. elections aimed at bringing together a cross section of the global economy, the G7 plus Brazil, Russia, India, China (the so-called BRIC countries) to discuss regulated capitalism.
Broadly put, the regulators have been far behind the pace set by the commercial bankers who have come up with a whole range of fancy products that were bought by many but understood by few. That should change and coordination amongst the new and old economic powers needs to improve. The risks assumed by America’s brand name banks should have shown up like flashing red lights on the regulatory radar; ditto for the futures trading that helped drive oil prices to a record $147 a barrel this summer.
The problem is the lack of a global regulator looking at the bigger picture these days. The International Monetary Fund, the World Bank and the Organization for Economic Cooperation and Development (OECD) all have their own briefs, but they have all been noticeably absent during this crisis.
There has been an effort to expand the G7 to include five fast-growing economies, the BRIC countries, plus South Africa. That effort has stalled with some members of the G7 feeling threatened by the emerging players. If there is a silver lining from this crisis, it may come in the form of a rejuvenated effort to see eye to eye on a new financial architecture. While they are looking at new blueprints and new models, it should be more inclusive if the fast growing sovereign funds of the Middle East have a voice. While no individual country in the region can claim a seat just yet, it is pretty difficult to ignore the petrodollars and the $1.5 trillion now on hand for global investment.
The word “contagion” is tossed around a great deal during these periods of intense selling and the word conjures up images of a bad case of the flu which is spreading from time zone to time zone.
It is not far off the mark. The World Bank officially describes contagion as “the transmission of shocks to other countries or the cross-country correlation, beyond any fundamental link among the countries and beyond common shocks”.
Bankers have found out this is no common shock. There was a widespread belief, and one shared by this writer, that the fast-growing developing countries would break out from the shackles of what really is a U.S. banking crisis. The impact of this crisis is directly felt in Europe, especially in London where there is a direct link between the City of London and the health of the British economy. Financial services make up a third of gross domestic product.
That is no surprise and the sluggishness of European and the U.S. economies has been on the cards for months. The Middle East, however, comes into this crisis with a different script altogether. Merrill Lynch’s Turker Hamzaoglu is bullish medium-term, predicting growth of 6.5 percent for the U.A.E. for example, down from the heady days of the last five years of an average 10 percent.
But the real regional concern surrounds the rapid run-up in property prices. Hamzaoglu says it is getting more difficult to manage, “It is certain that there was some kind of a speculation in the prices because I see it as a side effect of this whole macro imbalance in a way, high-inflation, high-liquidity environment, that the government or the central bank has very limited means to control.”
What is emerging is a so-called risk premium factoring in the amount of money borrowed to put more than $300 billion of real estate developments on the books in the U.A.E., a trillion dollars throughout the Middle East. At the same time, regional markets are no longer benefiting from the hot money from the U.S., Europe and Asia which was invested to capture some of the rapid growth.
Former Nomura Securities analyst Anais Faraj who recently relocated to Dubai says the reason for this current contagion is simply down to capital flows, “It is the same liquidity pool. Money invested from the Middle East into Wall Street is taking on big losses.”
Wait and See
Sovereign funds from Kuwait, Abu Dhabi and Qatar put the word out this week that there is no reason to jump and put additional money into U.S. or European banks. As Faraj noted, “No one wants to be a hero catching a falling knife.” All three of those funds have seen their investments slip 40-50 percent since they leapt in at the end of 2007 and early this year. Their forays into the British banks have held up much better.
Which leads us back to what one can expect going forward. The investment fund managers I spoke to see promise in the medium to longer term, but they add it is not a straight line up. The $60 fall in energy prices certainly will impact some of the sky high projections for revenues going forward. And everyone is keeping a watchful eye on the dollar.
The recent recovery in the U.S. currency was taking some of the heat off of regional policy makers to change course to counter record inflation. That concern will move right back onto the front burner and rekindle conversations on whether to peg to a basket of currencies before the launch of a single Gulf currency in 2010.
This story has many more chapters that need to be written, and the word contagion will be part of the text despite the rosy growth scenario still expected.
First it was Hurricane Gustav that had CNN and other television correspondents scrambling down to the Gulf of Mexico. Then, Hurricane Ike ploughed through the Caribbean, leaving 170 Cubans and Haitians dead and causing severe damage on its way to the Texas coast.
Hurricane watchers know that storms are named in alphabetical order, building drama and suspense as they gather momentum along their path. Usually when hurricanes hit they send shivers through energy markets with fears of supply disruptions and damage to refining facilities.
In that context, this hurricane season has been a bit of a yawn, not because the storms lack force, but due to another storm which hit markets well before hurricane season began. Let’s call it Hurricane Ali, named after the veteran Saudi Arabian oil minister Ali al-Naimi. He showed up on the weather radar at the end of June by increasing oil production by a half million barrels a day, using a gathering of oil producers and consumers in Jeddah to underline his point. While it took the markets nearly a month to feel his effects, Hurricane Ali was responsible in large part for a 30 percent drop in oil prices in the last two months.
Hurricane Ali was timed -- either with great calculation or great luck -- to coincide with two other forces in the market: an acute economic slowdown and sharp criticism of oil futures speculators. After seeing a peak of $147 a barrel, today setting a floor of $100 is proving difficult. Saudi counterparts within OPEC, Iran and Venezuela have argued for greater discipline within the cartel as well as adherence to a daily production quota of 28.8 million barrels a day.
OPEC’s communiqué from Vienna this week pointed to an oversupply in the market and noted that members should “strictly comply” with their production allocations. I would not bet on it, despite the group’s efforts. Calculating production and demand is not a simple equation when every day, new figures forecast falling growth.
We already know that consumers in the U.S. and Europe are driving less as a result of higher petrol prices. The airline industry, according to sector’s trade association IATA, will lose up to $5 billion due to higher fuel costs and fewer passengers in the air.
Both these trends are reflected in macro-economic figures as well. The European Commission has dialled back growth projections for this year to only 1.3 percent and is pointing to a “significant downward revision” next year. The Paris-based International Energy Agency once again lowered oil demand forecasts for this year and the next, and I doubt that will be the last of it as the global slowdown plays itself out.
Meanwhile, a report from hedge fund manager Michael Masters does its own share of finger pointing at commodity speculators for the upsurge and subsequent fall. Masters contends that $70 oil would be a more realistic level if fund managers would refrain from buying a basket of commodities through index trades. The U.S. Congress is still contemplating a whole series of measures aimed at curbing speculators.
John Lipsky, first deputy managing director of the International Monetary Fund and a respected former Wall Street economist, is projecting that global growth will recover to 4 percent next year after a dip to 3 percent in 2008. The recovery will be driven in large part by players like China and India who are still seeing expansions of 7-10 percent.
That level of recovery would play well in the Middle East, with producers still seeing their coffers overflowing from three digit oil. OPEC members this week quarrelled over the best way to defend $100. The answer may be as simple as the Goldilocks fairy tale -- with production that is not too hot, not too cold, but just right.
Oil at Work
If some perhaps have not understood what Abu Dhabi is up to before, they got a double dose of what the capital of the United Arab Emirates is planning.
In a span of just two days, “Team Abu Dhabi” announced a planned purchase of Manchester City Football Club, paid a record transfer fee for Brazilian footballer Robinho and threw $1 billion into the movie business.
The ruler of Abu Dhabi and president of the U.A.E., Sheikh Khalifa bin Zayed bin Sultan Al Nahyan, in place for nearly five years, is pursuing a wide ranging investment strategy that is pretty hard to miss.
Let’s call the first batch, brand-driven investments -- a stake in Ferrari, the purchase of the Chrsyler Building in New York, the opulent Emirates Palace Hotel and the soon to be Guggenheim and Louvre Museums.
The second batch fit into what those in government call a "cluster development strategy" -- GE, EADS and the Carlyle Group match that description. Which leads us to the question, where do Manchester City and the $1billion movie fund Imagenation Abu Dhabi fit in?
Chasing football properties is a sport in itself throughout the Gulf. Dubai International Capital, a sovereign fund, has tried and stumbled twice. Gulf flagship carriers Emirates and Ethiad are big sponsors of Arsenal and Chelsea, with Gulf Air involved with Queens Park Rangers. Football is wildly popular in the region and buying a club makes a mark, no doubt.
The name Suleiman Al Fahim was the initial public face on the $360 million purchase, which by the way is not expected to close until September 15. The entrepreneur and star of his own reality television program was immediately being compared to Roman Abramovich, the Russian owner of Chelsea. The story according to those familiar with the deal is that this is really the work of Sheikh Khalifa’s brother Sheikh Mansour bin Zayed Al Nahyan who has shared a desire to buy an English club for more than a year.
The owner of the club, Thaksin Shinawatra, former prime minister of Thailand, knew there was interest in the club and put his long-time London representative Pairoj Piempongsant on the case to get a deal done. It looks like they will net about $100 million on their short-term investment. If all goes as planned, Abu Dhabi can say they are the first from the region to land an English club, but it does not mean this will be a big score for the emirate.
The five-year investment by the Abu Dhabi Media Company into Imagenation immediately puts the group on the map in Hollywood. Edward Borgerding, a former Walt Disney executive, launched this project and hopes the investment will lead to “a technology transfer of the best of class in production and business executives that will migrate to Abu Dhabi and open up production offices in Abu Dhabi itself.”
A look at the math has the group spending about $25 million per film with a target of 40 films. This is small by Tinseltown standards and seems designed to limit the downside risks in a business known for drilling a lot of dry holes.
We will know a lot more about the success of all these investments in about a decade, but it all sounds like the California Gold Rush of the mid-1800s. What was a pretty quiet corner of the U.A.E. will no longer remain that way. The government’s sovereign fund, the Abu Dhabi Investment Authority, or ADIA, has been around for more than three decades. You would be hard pressed to find anyone who knew this group manages nearly a trillion dollars.
$100 oil is only adding to that pot of funds. Abu Dhabi is now the third largest producer within OPEC at 2.8 million barrels a day, having discovered oil in 1958. That is projected to grow to four million barrels a day in a few years. Right now they are bringing in about $100 billion a year from oil alone. Natural gas is another revenue stream. You can say the emirate is sitting pretty, but not sitting idle.
ABOUT THIS BLOGJohn Defterios’ blog accompanies the weekly business program, Marketplace Middle East (MME) that is dedicated to the latest financial news from the Middle East. As MME anchor, John Defterios talks to the people in the know, finding out their opinions on the big business moves in the region, he provides his views via this weekly blog. We hope you will join the discussion around the issues raised.
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