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Simon Johnson of the Baseline Scenario (http://baselinescenario.com/) has some interesting information regarding contagion from Dubai to Europe, specifically Ireland. He notes increased spreads subsequent to the Dubai announcement (http://baselinescenario.files.wordpress.com/2009/11/credit-default-swap-spreads-for-irish-banks.pdf) and suggests some broad reasons (http://baselinescenario.com/2009/11/28/does-dubai-matter-ask-ireland/).

The thinking is that a partial bailout – with creditor losses – for Dubai from Abu Dhabi implies something about how Ireland will be treated within the European Union (and the same reasoning is also more vaguely in the air for Greece).  This may make sense for three reasons.

  1. If Dubai can effectively default or reschedule its debts without disrupting the global economy, then others can do the same.
  2. If Abu Dhabi takes a tough line and doesn’t destabilize markets, others (e.g., the EU) will be tempted to do the same (i.e., for Ireland and Greece).  “No more unconditional bailouts” is an appealing refrain in many capitals.
  3. If the US supports some creditor losses for Dubai (e.g., because of its connections with Iran), this makes it easier to impose losses on creditors elsewhere (even perhaps where IMF programs are in place, such as Eastern Europe).

 

Ireland CDS

Ireland CDS

 

 It’s not clear which European economy is most precarious at this stage, not the magnitude of any situation, but Ireland, Spain, and Greece seem key candidates.

 

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