There is a Dubai story and there is a wider sovereign risk story. The first is straightforward enough; the second, more complicated, more important and more interesting.
The Dubai story itself comes in two parts. One is the economic proposition that it makes to the world, the idea that it is possible to create sustained growth by becoming an entrept trading and service centre for the Gulf region. That is the justification behind the port, the airport, the banking offices, the medical centre and so on. This determination to become the service hub for the region led to the property boom, indeed was the only justification for it. As everyone knows, things got a bit out of hand. The "build it and they'll come" approach is all very well but it left Dubai vulnerable to any drop in demand. Ultimately Dubai will recover because the core proposition - that the region needs high-quality services - still stands. But there will be a nasty and continuing adjustment for some years and the more outlandish building projects may never be completed.
The other part to the Dubai story concerns finance. On any sort of long view its public finances will be all right. This is not an Iceland. It has assets, including a sizeable sovereign wealth fund. The United Arab Emirates, taken as a whole, has massive oil- generated wealth and that wealth will continue to accumulate as it is very hard to see circumstances when oil will not remain reasonably expensive. But Dubai itself is caught in a classic liquidity squeeze. Property development is its biggest business and this has happened countless times in the property game. Think Canary Wharf here in Britain. But as we have learnt so savagely over the past year, this is a world where assets are at a discount and cash is king. The world is not through this squeeze yet and the financial pressures on Dubai will mount further.
Nevertheless the effective default has led to a shock. You can see that in the global market reaction. That raises the inevitable question of the Queen: why did people not see this coming?
The answer is that to some extent they did. Standard & Poor's downgraded its credit rating on some of the big government-related companies last March. It did however assume that the government would stand behind these government-supported banks and companies, an assumption that now seems to have been over-optimistic. Everyone, too, assumed that Dubai's much richer fellow emirate, Abu Dhabi, would make sure there was no hint of default, and that was over- optimistic too. Much of the problem is timing: the structure of Dubai's debt is short term, for it has made the classic mistake that the maturity of the debt did not matter as it could always be rolled over. It is not alone in making that assumption, but the consequences are particularly serious.
That leads to the sovereign risk story. It is complicated because it has so many elements to it. There is the conventional credit rating system, and I have put on the right a list of selected countries, showing their credit ratings. I have taken the Fitch ratings as they pioneered country risk analysis, particularly among the emerging economies, though they have not done a rating on Dubai. As you can see, there is a clear hierarchy from Finland to Argentina, starting with the AAA countries at the top. The UK for the time being still carries that rating. The agencies take in a huge amount of data when assessing countries, going far beyond the actual size of the debt and rate to which it is being added or paid down. …