What does Dubai mean?

It looks like an excuse for a bit of profit taking.

As the System has signalled over the past several months, investment flows have been away from the US dollar and towards Emerging Market equities. There has been some concern about profit taking in the Emerging Markets now that the dollar has stabilized and looked poised for a small bear rally into the year end.

That environment has not changed with the events in Dubai. In fact, one should not be surprised that a small Arab Emirate, which has been building whole islands of new property in the middle of a Global Financial Crisis, is now having financial trouble of its own. Maybe one is not meant to ski indoors in Dubai.

How to save a Banking Industry

The US Treasury yield curve is a good place to start to understand some of the forces that underpin current financial flows.

The first impact of the steep curve which starts at near zero cost for overnight borrowing is that banks with access to the Federal Reserve can borrow at costs of around 25 basis points and invest in 2 year treasuries at 67 basis points or 5 year paper for a yield of 2.2%. With 20 times gearing and no need for outside customers, this is also the reason we are not seeing a big surge in lending. Nice business, if you are a bank.

The second impact stems from the question: “Who is paying for this?” Answer: Everyone with a bank account or a money market fund.

What are investors doing? Adding risk to their portfolios in order to get any sort of return.

So when you hear the experts saying that current P/Es discount a 5% GDP growth rate, you now know the real reason is a desperate search for investment return.

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