Middle East might be perfect locale for debt restructuring

A global bankruptcy reorganisation? When Komal Sri-Kumar, the TCW market strategist, suggested the idea two weeks ago, it was partly a proposal and partly a forecast. As he surveys the world's fragile financial system, which appears to be growing more imperilled as the crisis in Greece remains unresolved and as other countries on the economic and geographic fringes of Europe queue up to be the next trouble spot, he believes such a bankruptcy plan should and will happen.

But Mr Sri-Kumar is a realist. He understands that before it can happen everywhere, it has to happen somewhere, and he believes that the Middle East, particularly the UAE, is just the sort of somewhere for a test of the concept and its workability. "It's easier to achieve in the Middle East than worldwide because of the commonality of religion and language that dominates, and there are even close family relationships," he explained.

The extensive equity stakes that government bodies in the UAE and other Gulf states hold in businesses within their borders make the programme that he envisions less problematic to implement. It would just be a matter of governments taking positions in businesses in other countries. "We're looking at a world where financially solvent powers like Saudi Arabia and Abu Dhabi will have a much greater say in running things than they have so far," Mr Sri-Kumar said. "One way this takes place is where a richer entity takes over debt service obligations and gains greater control over operations."

That could pay dividends for owners of Abu Dhabi shares as the emirate extends its influence and captures more attention and money from global investors. "Say Abu Dhabi gets greater control over developments in Dubai in exchange for writing down some value on loans," he said. "Thereafter Abu Dhabi establishes itself as a major [economic] power and its stock market can perform well even if Dubai has a downturn."

Fine, maybe Abu Dhabi will take an equity stake in a troubled Dubai property company or two, with positive results all round. But how will Mr Sri-Kumar's idea work for massive creditors like China and massive debtors like the United States? He concedes that China isn't going to be handed Exxon Mobil or Microsoft, or even a company beholden to the US government like Citigroup or General Motors, in exchange for some of China's stockpile of Treasury bonds. Given that protectionist sentiment seems to be on the rise and that midterm congressional elections will be held in November, it's unlikely that US authorities for the time being will sign up for, or even discuss, anything as controversial as a global debt restructuring.

But the time may be ripe for the major sovereign wealth funds, such as China's and Abu Dhabi's, to raise equity positions in private foreign companies that need capital. That could further lift Abu Dhabi's global profile (China's is already sufficiently elevated). As with a UAE trial run of his plan, Abu Dhabi would benefit from this modest expansion of influence. Investors in the emirate stand to come out ahead, too, and no politically contentious implementation of a formalised new world financial order is required.

If the world were to warm to Mr Sri-Kumar's idea, the investment ramifications would be extensive. Bonds issued by governments in the United States and elsewhere that run large fiscal and/or current-account deficits would fall and interest rates would rise as the prospect of less than full payment is factored in. The effect would be the opposite for fiscally prudent countries. The investment on which a global debt reorganisation might have the greatest impact is gold. The metal's price has soared in recent years as governments have continued to rely on Plan A - printing or borrowing money - to stimulate their economies and meet financial obligations.

The shock of a global debt deleveraging, an inherently deflationary act, could send the price of gold, the classic inflation hedge, plummeting, Mr Sri-Kumar said. "Gold goes from $1,100 an ounce to $700 in a week if they agree to this plan," he predicted. And what if nothing comprehensive is done to bring down the enormous amount of debt on the world's books? Mr Sri-Kumar offers a bleak assessment.

"Global economic growth doesn't recover, and there is no sustainable recovery in global stock prices," he warned. "It will be like Japan in the first half of the 1990s. We could have something similar in a world where we don't face up to the immensity of the situation." Conrad de Aenlle writes from Los Angeles about investment and personal finance issues. His blog on contrarian investing for MoneyWatch.com, "Against the Grain", can be found at http://bit.ly/NjaBa