Across the world, a number of previously autonomous republics are being forced to swallow their pride in the wake of the unfurling economic crisis. Often the cost of a bailout from a rich neighbor has been political accommodation, but even here shifts are only just beginning.

One of the more interesting stories deals with Dubai, the previously sleepy smugglers’ port in the United Arab Emirates (UAE) that suddenly had aspirations to global dominance, as exemplified by the Burj Dubai, the world’s tallest building (as an aside, building the world’s tallest building almost always condemns the country to an economic downturn; the skyscraper curse is not urban legend).

Anyway, for a country with global aspirations and supposedly US$100 billion in asset values through the stock and property markets, Dubai found it well-nigh impossible to fund the ruling family’s hobby horses in banks, hotels and ports around the world, not to mention the real-estate boom that has been ongoing from 2002.

The ruling al-Maktoum family of Dubai reportedly approached their cousins, the al-Zayed family, running Abu Dhabi, for terms of a bailout. Initial conversations were allegedly heated, with the latter demanding that Dubai hand over control of its iconic airline, Emirates, as well as stakes in its biggest property firms, including Emaar and even Dubai Holdings (the ruling family’s in-house collection of vanity businesses). With oil prices down and nursing its own losses on ill-fated investments in American and European financial firms in 2008, the al-Zayed family was reportedly not very keen on being on the delivering side of charity.

There were unsubstantiated rumors that both Iran and Saudi Arabia had sent out feelers to Dubai over the terms of a rescue, which galvanized Abu Dhabi into swift action after weeks of dilly dallying. It is not very surprising that a country such as Iran, even on the brink of its own economic collapse, would countenance a bold move to intervene in Dubai’s financial mess, albeit for reasons entirely removed from finance.

The more puritanical rulers of Abu Dhabi now control a greater proportion of the UAE federation, after subscribing to $10 billion of a bond issue launched by the Dubai government this week. With the property market looking to face a multi-year slowdown and its banks beaten down by losses on global investments, it is highly likely that Dubai will default on the terms of this bond, among others over the next five years or so, in turn providing even more control to Abu Dhabi directly.

Germany as the new IMF

Typically, countries that find themselves in the midst of an external financing crisis would tend to approach the International Monetary Fund (IMF), which would in turn impose a bunch of nonsensical “austerity” measures, engineer relative poverty to the country’s immediate neighbors and thereby create conditions for an export-led recovery.

In almost every such case, neighbors that lost an export edge would soon find themselves in a precarious balance of payments problem and then soon enough approach the IMF. In this way, the IMF and the World Bank – the evil twins of global finance – managed to maintain relevance particularly in parts of the world such as Latin America and Africa.

The good news in the current crisis is that the IMF itself has run out of ammunition, and that before any major debtor nation has been pushed to bankruptcy. The multilateral institution has a paltry $200 billion in firepower, barely enough to save a handful of the most affected countries (for example Ireland, Iceland, Hungary, Ukraine, Turkey) let alone the bigger economies now lurching into a permanent downward spiral such as Japan, Italy, Spain and France.

Realizing this, the European Union has proposed that the IMF capacity be raised to $500 billion, although aside from Japan with its contribution of $100 billion, it is difficult to see any other “donor” country with the financial capacity to actually help the IMF. In particular, the idea will be deeply unpopular in Washington, given the spate of personnel changes that embarrassed Republicans no end; similarly other supposed donors like Britain and France will probably need their own bailouts soon enough.

Late last year, I wrote that the sheer size of the banking system in various European countries relative to their gross domestic product, as well as the extremely low recovery rates on various asset categories, simply meant that the countries offering explicit guarantees on their banking system’s deposits would themselves need external assistance sooner than later. (see Europe’s death by guarantee (Asia Times Online, October 11, 2008). This is now happening in the case of countries as diverse as Ireland, Portugal, Greece and the United Kingdom among others.

Meanwhile, other European countries, including Austria, have suddenly found another ticking time bomb in the shape of their banks’ exposures to emerging European countries. With two of its major banks in more than a spot of bother, Austria had to escalate its own crisis-fighting measures, but finds a complete absence of support from other members, including Germany, for any assistance to Europe’s “near abroad”.

It must not come as a surprise to note that Europe’s tilt towards the windmills of global finance only happened after the declining feasibility of tapping the European Investment Bank (EIB) became apparent. This institution, which operates as a quiet instrument of European policy, has often been used to prop up member states. The alarming decline of members like Italy, Ireland and Greece has meant though that market reaction to the EIB proved highly skittish. Credit default swap spreads widened to levels associated with the most risky of European sovereigns, from their previous levels when the EIB had tended to trade in line with the credit of Germany. This widening effectively removed the EIB from the game of providing unremarked subsidies to member states.

In turn, this brings to mind a continent that is unable to act in the collective best interest, instead sundered by selfish policy moves. As I wrote last year, (see Utterly pointless Europe, Asia Times Online, August 16, 2008), the inability to face down the Russian threat on Georgia was but a simple indication of bigger problems festering under the surface. With the recession, all these problems have started coming to the fore.

With the IMF and the EIB without actual ability to rescue countries and the common European mandate weakened by policy squabbles between the east (new EU members formerly in the Soviet bloc), south (the property-market led bubble economies of Greece, Spain et al) and the west (the troubled Old World of France, the United Kingdom and Germany), there is but one hope for any country facing down its creditors. That would be to secure bilateral assistance from the region’s sole solvent sovereign, namely Germany. Indeed, many European government officials have already called on the country to issue an explicit guarantee on the bond obligations of key member states, thankfully not to much avail thus far.

The Germans, though, appear in a funny mood. With a dramatic drop in industrial output going alongside the decline of its banking and insurance giants, there is well-placed fear that xenophobia could raise its ugly head once again. The comparison to Abu Dhabi is fairly straightforward: for all their wealth, the Germans do not feel confident about their place in the world, nor indeed in the likely forbearance of German citizens to further weakness in Europe. That would elicit precisely nationalist moves but effected as pre-emptive gestures: deporting a bunch of Turks or Poles to prove a point to the skinheads.

As the dust clears, it is highly possible that German influence on European policy and institutions will have been strengthened due to the crisis rather than weakened by it.

Power to the center

Elsewhere, the move towards tentative federalism has been halted in its tracks by the crisis. A good example is provided by Scotland, where talk of an independent country that splits with the United Kingdom but attains membership of the EU and uses the euro rather than the pound sterling has died a quiet death in recent weeks.

The reason isn’t hard to fathom: the two main industries in Scotland were banking and oil exploration and production. With the price of oil down a fair bit and the main Scottish banks – RBS (Royal Bank of Scotland) and HBOS (Halifax Bank of Scotland) both perilously close to being nationalized – there is a sense of embarrassment all around that simply doesn’t lend to nationalistic fervor.

The banks were felled not so much by traditional “Scottish-style” lending of the type that continues to be practiced successfully by the likes of HSBC, but rather by the overexpansion associated with a nationalist pride: a desire in effect for a Scottish institution or two to rise to the top of the world’s financial pile. The result has been quite the opposite.

British newspapers report that a furor over a BBC commentator calling Prime Minister Gordon Brown a “one-eyed Scottish idiot” quickly fizzled out because of the widely held belief that the premier in his previous job as chancellor of the exchequer, or finance minister, had laid much of the foundations for the United Kingdom’s current crisis of confidence. Rather than drawing more attention to the remark that was widely seen as a true depiction, the story was quietly buried. What this does to his re-election chances later in the year is anyone’s guess, but many political pundits are now betting on a return to the dominance of the English in all affairs British.

Then there is California. The nearly-bankrupt state had to corral its lawmakers into a deal designed to rebalance its budget and open the state’s access to financing; however, even this deal may soon fail, leaving no alternative but for the state to depend on Washington for a bailout. The state that proudly bills itself as the world’s eighth-largest economy is, in the absence of Federal assistance, for all practical purposes bankrupt

Even that is the tip of the iceberg as US$2 trillion of municipal securities, issued by various US towns and cities, head towards default by the year 2011. In many of these cases, the only potential saviour is the federal government itself. What all this means for the famously proud federal districts of America and the political and cultural independence cherished by generations of people in each of these towns and states, we do not yet know. All that we can surmise is that Americans’ sense of identity will likely face big changes in coming months, all to the benefit of the center.

Whether it is the case of Dubai losing its independence to the ruling family of Abu Dhabi or Germany taking charge of the EU directly, the imperative to concentrate power in the hands of those with demonstrable financial capacity will only increase in coming months.