The Asset Bubble of the Future

So, having spent quality time in Qatar for almost two months, I've fully understood why this region has seen unprecented growth concurrent with record government surpluses and accumulated exchange wealth.

70% of it has to do with hydrocarbons. Really, the GCC has struck it rich owing to an abundant supply (per square foot) of oil and gas that has been gifted to them. Qatar alone has amassed about 20% of the total proven natural gas reserves in the world - such a small country with a meager population that claims its stake to such an enormous amount of wealth clearly suggests how much this area is blessed.

Thanks to rising commodity prices in the international exchange markets on the back of a devaluaing dollar, the GCC countries have increased the production of oil/gas to avail of a record margin they are earning on exporting oil/gas and other byproducts. With oil peaking at $148 a barrel, countries with diminishing returns on their reserves, particularly Saudi and their potent Ghawar field, are not only recording unheard of profitability, but also damaging their reserve capacity permanently due to unsustainable production quotas. Nevertheless, thanks to record surpluses, the GCC countries are agressively establishing and consolidating their sovereign wealth funds - a prudent management of funds from excess reserves which will undoubtedly yield more returns than interest bearing assets booked in their banks. And most of these highly aggressive funds are investing in highly lucrative, albeit risky capital ventures abroad - sometimes saving FI's that are in desperate need of capital owing to CDO's (collateral debt obligations), SI (structured investments) and exposure to the sub-prime mortgage market in the US.

However, with every boom there is a very dangerous undercurrent that develops. It's true when my dad says, ''Bad Loans are only made during good times." With so much money coming into this region vis-a-vis a spurt in global demand for hydrocarbons (read India & China), the GCC is facing a tremendous problem with inflation - particular those countries whose inflation is driven by real estate. Inflation at double digits is not uncommon, but coupled with low interest rates, you create an environment where the real price of borrowing is actually negative (where the lender incurs the price of inflation, not the borrower), and in such an environment not only do you have a burst in liquidity and easy credit, but also you have huge development in the real estate - a market which is especially risky in an untested area in the GCC. This rapid development in all GCC countries, notably Dubai, is indicative of an asset bubble - wherein the appreciating price of the properties negates the impact of inflation - and a significant portion of family wealth is tied to the real estate. With an insane pace of development, if more investment finds itself in the real estate market in conjunction with a huge growth in supply (when properties in development are finally finished), we will perhaps witness the largest asset bubble in history (which will pale Japan's problem in the 80's). Nevertheless, if the global market continues to rely on Middle Eastern commodities, govt. may be able to mitigate the potential fall should such a calamity occur - but it remains to be seen by how much, as a large amount of their contingencies are parked in foreign capital ventures, subsidiaries and illiquid assets. This will make emergency bail-outs and recovery programs more restrained.

What exacerbates the problem of inflation is that every country in the GCC, barring Kuwait, has pegged their currency to the dollar, so whatever the mightly Federal Reserve of the United States decides on their interest rate, the countries here must follow suit - this system gives them no control over times where there is a mis-match in macro-economic indicators, such as now. There is no such thing as monetary policy to control run-away inflation and easy credit. So long as the dollar devalues, the price of perishable and non-perishable goods continues to rise, cost of living goes up as most of the countries import commodities such as food and cement.

Qatar has been growing at a phenomenal rate, as its per capita GDP is the highest in the world (at $70k+) - this indicates wealth and prosperity. But don't be fooled by this misnomer. There is a HUGE, and I mean HUGE, skew to the rich, who not only control 90+% of the wealth in the nation (owing to ties with the ruling Emiir and other powerful govt. posts), but also are accumulated more wealth thanks to extremely low labor costs on the back of appreciating real estate values.

It's sad to see that when I walk back from work, I see laborers in such deplorable conditions - and I bet most of them fast during the sweltering heat and humidity. The other day a dilapidated bus came to pick up a swarm of workers, most of which had such dirty clothes and a stench that carried for yards (I'd say they are beyond the point of caring really). Most of them looked so exhausted and deflated from work, that their eyes carried a distinctive vacant look that you'd sometimes see in prison. In a way it is prison for them, thanks to relentless system of sponsorship, most laborers don't have any rights or reprieve even in conditions that border on inhumanity - and I am willing to venture that they are many instances of inhuman exploitation has occured. Contractors have no problems obtaining huge loans from a prosperous banking sector, but their margins are most appallingly high at the labor cost front, where they can boast making just a year turn-around from their investments - that is how cheap the labor is. It's almost free.

Although from a purely capitalistic and practical standpoint, I can't really fault good business sense - but at a human level I do question their greed and lack of empathy. I just hope that when the economy makes a turn for the worst in the GCC region, that the millions of curses of the laborers don't come back to haunt them - and who will suffer the most? I'd say the middle class who've parked their investments in the real estate sector.