The Dubai Debt and Financial Crisis: A Case of the Inevitable

Dr. Mohd Nazari Ismail

Following recent headlines on Dubai’s billion-dollar debt problem, there has been a spate of analyses. Some were very detailed and contained a list of lessons to be learnt by other countries. One recent and notable analysis emphasized the need for predictable, sustainable, clear and certain policies and argued that it is because of the lack of all those factors that Dubai is currently facing problems. In other words, the writer is saying that not only is it possible for countries to avoid financial crises, it is also very simple since what is needed is to make sure that the countries’ policies are not unpredictable, not unsustainable, not unclear and not uncertain.
The question that springs to mind will then be: How come all those brilliant Ivy League-educated policy-makers in countries that have experienced debt-related financial crises in the past such as Iceland, Britain, Korea, Indonesia, Thailand, Argentina, Brazil and of course the US itself (which boasts of having the top universities in the world and the most number of Nobel laureates in the field of economics and finance) have not figured these simple rules in the past?
And come to think of it, if avoidance of financial crisis is so simple, why do people bother so much in carrying out detailed research in order to prevent their recurrence? Maybe we should also not be too agonized with the fact that Malaysia has not produced any Nobel Prize winner in the field of economics or finance. The experience of the US has shown that having the best economics brains in the world is not going to help a country avoid the occurrence of financial crises.
Coming back to Dubai, it is worth pondering why financial crises continue to occur even though there had been so many crises in recent years which ought to have yielded important lessons. These include the 1987 Black Monday Crash, the 1994 Mexican Financial Crisis, the 1997 Asian Financial Crisis, the 1999 Brazilian Financial Crisis, the 2001 Argentina Financial Crisis and the 2007 US Sub-prime Financial Crisis. Surely policy-makers have had enough data, facts and information at their disposal to help them prevent the occurrence of financial crisis, especially if it as simple as coming up with policies which are predictable, sustainable, clear and certain.
To be sure, financial crises are not a new phenomenon. They have been taking place for hundreds of years. One of the most famous was the Tulip Crisis in Holland which took place in the 1630s. What happened was that many highly indebted people could not repay their debts, enough to cause a crisis in the Dutch economy. While the Tulip Crisis was caused by over-speculation in tulip bulbs, in the case of Dubai, the cause is over-speculation in the property sector. But the essence of the two stories is the same: people got excited with the booming price in a particular sector. They then borrowed heavily to engage in speculative transactions causing further increase in the size of the speculative `bubbles’. Eventually the bubbles burst and many people became financially unstuck causing a downward spiral of price and more trouble to the economy which eventually led to financial and economic crises.
Strangely enough however, it seems that this simple lesson on the importance of having predictable, sustainable, clear and certain policies was not easily learnt because well after that episode, financial crises continued to erupt in Europe and the US. The most famous ones include the 1720 South Sea financial crisis in London, the US panic of 1873, and the Great Depression of the 1930s. They all have one thing in common. Many people borrowed money in order to engage in speculative transactions in a variety of assets such as property and stocks. These activities led to asset bubbles which eventually burst, resulting in widespread financial insolvencies and, thereby, economic crises.
One notable fact is that these financial crises during the 17th, 18th and 19th centuries took place mostly in Europe or America and not in places such as the Middle East or South East Asia. So a question worth asking is whether in these regions, predictable, sustainable, clear and certain policies were in place to regulate their financial sectors? Well, obviously that is not true for the simple fact that these regions, in those eras had no financial sector to regulate. In other words, the main reason they did not experience any financial crisis was simply that they did not have any significant financial sector to start with. Of course eventually they began to develop their own financial sectors and soon they too experienced financial crises. The most serious one for South East Asian countries was the 1997 financial meltdown and just as in the case of other financial crises, it was also a story of debts, speculation and the bursting of asset bubbles.
Truth be told, once a country developed a lending-for-profit sector of its own, there is no avoidance of a financial crisis even if predictable, sustainable, clear and certain policies are in place. Britain and America are the best examples of this. As is well known to many, these are two countries which are models to others in terms of financial regulations and supervision. Nevertheless the fact remains that the same two also happened to be among the ones which are experiencing the worst financial crises in the world. One very important, maybe the most important, lesson we should learn is that the occurrence of financial and debt crisis is an inevitable outcome of the existence of a lending-for-profit sector. And the more `developed, sophisticated and advanced’ the sector is, the bigger and more serious will the crisis inevitably be.