Jim Kaplan, the Chairman of Cubic Asset Management LLC in Boston, has kindly allowed me to republish a thoughtful and insightful article of his.

Here is the article’s text in full:

2010 2nd Quarter Stock Market Commentary

THE TYRANNY OF THE FEW

“The best argument against democracy is a five-minute conversation with the average voter.”
– Winston Churchill

Billy Joe Johnson is a man you would not like to meet in a dark alley. Johnson is a white supremacist, drug and alcohol abusing, serial killer. In 1991 he savagely beat another inmate to death with an ax handle. In 2002 he executed a snitch with a point blank shot to the head in Anaheim. Two years later he murdered another man by clubbing him with a claw hammer. Currently serving a 45 year sentence in the California state prison system for his crimes, he has also confessed to two previously unsolved murders. The state psychiatrist has described him as a low IQ sociopath. But in requesting that he receive the death penalty, Johnson has performed a risk-benefit analysis that would make an economics professor proud. California currently has 685 inmates in San Quentin’s Death Row. Only 13 men have actually been put to death since 1977 when the death penalty was reinstated, none in the last four years. Johnson estimates that the mandatory appeals required by California law before a death sentence can be carried out will take at least 24 years, making him more than 70 years old. In the meantime, he will “enjoy” a larger single cell, while other maximum security prisoners have to share a smaller two-bunk room. Death row inmates have more telephone privileges and have contact visits in private rooms, rather than the communal halls in other institutions. They receive breakfast and dinner in their cells, and have exclusive control over their own television and CD player. It currently costs California $49,000 per year to house a maximum security inmate, compared to $138,000 for a death row inmate. Ignoring inflation, the taxpayers will incur over $2.1 million in expenses because of a dysfunctional appeals process. It is hard to make a case that capital punishment serves as a deterrent when criminals prefer that sentence.
The case of Billy Joe Johnson is a dramatic example of the nation’s collective obsession with placing adherence to the legal process above common sense. Unfortunately, this has dire economic consequences for all of us. Two of the biggest issues facing the United States currently are the stubbornly high unemployment rate and the need to create a cohesive national energy policy. President Obama sees these issues as inextricably linked; the $787 billion stimulus bill included $59 billion in new clean energy tax breaks. The tax breaks, he claimed, will help create 300,000 new jobs and double the supply of renewable energy. According to the White House web site, alternative energy technologies should reduce our dependence on foreign oil and the destabilizing effects of climate change.

One technology which would seem to be consistent with the guiding principles set forth is solar power. Renewable (as long as the sun rises the next day), abundant, non-polluting and silent, it would seem to be a source of energy whose “day in the sun” has arrived. Over the past few years, utility giants Pacific Gas & Electric and FPL Group (Florida Power & Light), with financing provided by Goldman Sachs, in conjunction with a passel of Silicon Valley start-ups, have filed applications to build solar power plants on federal land in California’s Mojave Desert. They have the support of such prominent environmental groups as the Natural Resources Defense Council, the Environmental Defense Fund and the Sierra Club.

But the supporters didn’t anticipate the vehement opposition of the less well-known Wildlands Conservancy, which persuaded California’s Senator Diane Feinstein to introduce legislation banning renewable energy development on more than a million acres of the Mojave, including the land on which the coalition had filed its application. While hundreds of thousands of acres remain available as potential solar farm sites, the prohibited land is nearest to power transmission lines and the populous Southern California market. A separate lawsuit has challenged the project because of its potential impact on water resources. And for good measure, yet another suit has challenged any development because of the threat it poses to the desert tortoise. To quote Governor Arnold Schwartzenegger, “If we cannot put a solar power plant in the Mojave Desert, I don’t know where the hell we can put it”.

This inability to allow the needs of society at large to trump the procedural maneuvers of organized minorities translates directly into lost job opportunities. Most of the technological breakthroughs over the past forty years that made solar cells economically feasible occurred in labs that were federally funded with tax dollars. Yet Japan was the first to commercialize the construction of solar panels for homes and businesses. Now China has overtaken Japan to produce 35% of the world’s solar cells and 49% of polysilicon wafers, the main material used in solar cells. The U.S. makes just 5% of cells. Even American companies like First Solar, which is opening a new plant every three months and creating 4,000 jobs/year, is building 86% of its capacity in Germany and Malaysia, as both Asian and European countries have done more to stimulate domestic demand.

The other alternative energy source which is currently economically viable is wind power. Once the capital cost of erecting wind turbines has been incurred, wind is free, produces no greenhouse gases, and is available both at night and on cloudy days. While turbines are tall, they occupy a small footprint, and so the land on which they are constructed can be used for other productive purposes, such as agriculture. Even in rural areas that are remote from the electrical grid, wind turbines can generate power that can be used locally. In 1999, a consortium called the Cape Wind Project proposed building the nation’s first offshore wind farm in Nantucket Sound, to help mitigate New England’s heavy dependence on oil. Despite the overwhelming support of most environmentalists for promoting the use of non-fossil fuels, various levels of environmental review stalled the project for years. But the delaying tactics were just beginning. Senator Ted Kennedy vehemently opposed the project, because it would spoil the view from the Kennedy family compound in Hyannisport. Another lawsuit was filed claiming the project would lower property values by destroying the view. Other suits claimed that it would kill migratory birds, represent a threat to private aviation, and destroy the fishing industry. The Cape Wind Project successfully overcame every obstacle, at a cost of over $45 million, and late last year it looked like construction might finally begin. The Project’s developer, Energy Management Inc. placed an order for 130 turbines with Siemens. But then the project hit an unexpected roadblock when the National Park Service agreed with the Wampanoag Aquinnah and Mashpee that Nantucket Sound should be listed on the National Register of Historic Places. They ruled that the Project would disrupt the tribes’ spiritual sun greetings and submerged burial grounds, despite the fact that the National Register has previously only been used for specific properties, and that the tribes only used the land under the Sound before the last Ice Age. If this decision is ultimately upheld, it will mean that other federal bodies of water can receive similar designation, slowing any offshore development. As bizarre as this decision seems, it could have been worse. The Aquinnah had actually tried to get the entire Atlantic Ocean added to the National Register.

In late April the Interior Department gave approval to proceed with this long delayed project in a scaled-back form, but ordered additional seabed surveys. Three hours after the decision, the Alliance to Protect Nantucket Sound filed yet another lawsuit. Legal experts estimate that lawsuits may be able to stall the project for yet another five years. Contrast this decade-long delay with the fact that the entire Hoover Dam project went from conception to completion in five years.
Compare this to Europe, where 2,000 megawatts of offshore generating capacity are already operating, and 40,000 additional megawatts are scheduled to be built by 2020, enough to power 25 million homes. Not surprisingly, General Electric has just announced that it is investing approximately $150 million in a turbine plant in the United Kingdom, creating jobs that could just as easily have been created here if only there was end-market demand. I am sure that our oil producing friends around the world will continue to supply us with an unlimited supply at reasonable prices despite our unwillingness to take constructive action to reduce our oil dependence. Aren’t you?

Renewable energy projects are not the only victims of “proceduralism”. Consider the efforts of Rio Tinto, one of the world’s largest mining companies, to develop the Kennecott Eagle nickel mine in Michigan’s Upper Peninsula. The United States is fortunate to have vast reserves of many raw materials, but is one of the last venues that mining companies consider when planning a project. Rio Tinto first proposed this mine on a 90 acre site in 2002. It would create 500 construction jobs and 200 permanent jobs in an area currently suffering from over 20% unemployment. Rio Tinto has had to obtain literally dozens of permits from local municipalities, the state and federal government, all of whom regulate pollution in water and air. The company has had to provide air and water quality samples, survey maps of potential water leeching, designs for wastewater storage, and plans for reclamation, such as replanting of vegetation. It has faced lawsuits from the Yellow Dog Watershed Preserve concerning the project’s impact on wild blueberries that grow in the area, among other issues. After more than seven years, a state agency finally issued the water, air and mine permits necessary to begin. But Rio has yet to receive a federal water permit. According to an international mining advisory group, of the twenty five top mining countries in the world, the United States is tied with Papua New Guinea for the longest approval process. In the meantime, we remain one of the largest purchasers of raw materials from Australia, Brazil, Canada and Africa of minerals which we could mine at home. It is worth noting that both Australia and Canada have environmental laws governing mine construction that are comparable to those in the U.S., but projects typically move from the drawing board to approval in one to two years in both countries. It is the legal and regulatory climate that creates the difference.

The examples above are by no means isolated. Chicago’s O’Hare International Airport has long been notorious for frequent delays which, because of it’s prominence as a hub for both United and American Airlines, tend to snarl air traffic across the country. Nearly every frequent flyer has a horror story to tell about missed meetings and flights because of time spent on the runway or waiting for a gate at O’Hare. But late last year O’Hare opened a new runway, and the results are startling. Despite being the second busiest airport in the United States, and the fourth busiest in the world, the on-time arrival rate has soared 27% in the ten months since the new runway opened. Delays at O’Hare are now less than at Dallas, Atlanta or Denver. But this was the first new runway at O’Hare in an unbelievable 37 years. On the same day that this runway was opened, Seattle’s Sea-Tac Airport opened another runway that was first proposed over two decades ago. Despite the astonishing growth in air travel, these (and another in Washington, D.C. which also opened on the same day) were the first new runways to be opened in over twenty years at any of the twenty-five largest U.S. airports. NIMBY lawsuits (not in my backyard), environmental lawsuits and noise pollution lawsuits are causing the waste of billions of dollars and billions of man-hours of lost productivity as the nation’s air travel infrastructure falls woefully behind demand.

Nuclear power plants have been similarly stymied. The last nuclear power plant to be built in the United States was the River Bend plant in Louisiana, whose construction was started in 1977. There are over 60 anti-nuclear groups active in the country who have successfully blocked every proposal. This is despite the fact that in the United States there have been zero fatalities or adverse health effects from radiologic exposure from any commercial nuclear power plant. In independent studies over the period from 1970-1992, it was found that there were only 39 on-the-job deaths of nuclear power plant workers. During the same time period, there were 6,400 on-the-job deaths of workers at coal fired power plants, 1,200 on-the-job deaths of natural gas power plant workers and members of the general public caused by natural gas power plants, and 4,000 deaths of members of the general public caused by hydroelectric plants. Even worse, coal power plants are estimated to kill 24,000 Americans per year, due to lung disease as well as causing 40,000 heart attacks per year in the United States, and to collectively emit more than 100 times as much radiation as the nation’s nuclear plants. Contrast the American nuclear landscape with that of France, where 80% of the nation’s electricity is generated by nuclear power plants and that country has become the world’s largest exporter of electricity.

As noted, many of our principal economic competitors do not face the same hurdles when implementing industrial policy. China is currently the third largest economy in the world, and its growth rate is roughly triple our own. But this growth comes with social and environmental costs. China’s Three Gorges Dam, for example, is the largest electric generating facility in the world. Its 34 generators produce a staggering 22,500 megawatts. Construction began in 1994 and the project began generating power in 2008. While some construction is ongoing, the project is coming in roughly $3 billion under budget. In order to build this facility, over 1.3 million people were displaced from their homes, water flows were changed which caused landslides, and numerous cultural and archeological sites have been flooded.

Brazil is the world’s eighth largest economy. But its rapid growth has resulted in massive deforestation of the Amazon rain forest. Since 1970, deforestation has destroyed roughly 600,000 square kilometers of forest, equal to the areas of Great Britain, Italy and Switzerland combined. Brazil has more fresh water than any other country in the world. Yet its two largest cities, Rio de Janeiro and Sao Paulo, which have a combined 30 million people in their metropolitan areas, suffer periodic shut-downs of their water supply because pollution makes it unsafe to drink.

Few people would argue that we should permit the same unfettered growth here. But in a global economy, American manufacturers must compete head-to-head with those in countries that have far fewer barriers to low cost energy production, manufacturing, and infrastructure expansion. The painful lesson to be learned is that we can no longer have it all. Our willingness to tolerate endless procedural delays, which undoubtedly provides us with a safer and cleaner environment, comes with a higher unemployment rate, and a dependency for raw materials, like oil or rare metals, upon economies with less refined sensibilities.

The economic and political ties between Iran and China are often brought up in the context of geopolitical negotiations, with China’s oil purchases leading the headlines. That’s understandable, given Iran’s importance in the Middle East. Overlooked, however, is another country that is even more important to China’s oil supplies – Angola.

Angola sent 235 million barrels of oil to China last year, or about 640,000 barrels per day. That’s 66 million barrels more than Iran, and only a bit less than the largest supplier, Saudi Arabia. In fact, Angola eclipsed Saudi Arabia as China’s top supplier last month, although that may change as the year goes on. According to Royal Dutch Shell, Angola will produce double the amount that Nigeria does within 10 years – though that prediction hinges as much on Nigerian instability as it does on Angolan development.

Angola emerged from a bloody war of liberation against Portugal and a prolonged struggle between Marxist and anti-Communist factions. Its diamond mines and oil reserves promised both future prosperity and foreign interest or even meddling in its affairs. Though it’s been the fastest-growing economy in Africa with double digit growth from 2006-2008, it’s also plagued by rampant corruption, separatist guerrillas, and millions of landmines. Formerly an agrarian economy and exporter of agricultural products, the countryside was so thoroughly devastated by war that it now imports 90% of its food.

As it exports more oil and discovers more fields, Angola will grow in importance on the global stage. It’s also an important front in the Chinese effort to secure African assets and allies, as China’s largest trade partner on the continent. Estimates of Chinese loans to Angola vary wildly, from $2 billion (the official figure) to as much as $9 billion with confidential, behind-the-scenes loans.

Angola illustrates the complex interplay of sovereign debt, resource extraction, and competing national and extra-national interests in the new global marketplace. Angola has about $19bn in public debt, and recently made amends with the IMF after walking away from the fund in 2007. Its rising oil revenues and strong Chinese financing gave it flexibility in negotiating the terms of its obligations that other African nations do not have.

However, Angola isn’t placing all its chips on China. It is seeking to raise as much as $4bn by issuing debt, its first international debt sale. In order to do so, it must get a credit rating from the big agencies like Moody’s, Standard & Poor’s and Fitch. Obviously, either Chinese lending is insufficient to cover Angola’s needs, or it wants to keep its options and obligations diversified throughout the globe.

Investor sentiment is ambiguous, with analysts predicting that nervousness over sovereign debt will mean that Angola only gets about a quarter of the funding it’s looking for. Nevertheless, there does appear to be demand for sovereign bonds from Africa, according to PIMCO, the world’s largest bond fund.

This might make Angola’s auction an opportunity for emerging market debt investors, though – Angola may be forced to offer more attractive yields to buyers made shy by default scares in Dubai and Greece.  Yields will certainly have to be high given Angola’s history of default, as well as the intractable issue of corruption.

In Transparency International’s Corruption Perception Index for 2009, Angola ranked 162 out of 180, tied with Venezuela and the Congo, among others. In this climate, Chinese firms – which aren’t saddled with inconvenient Western laws about bribery and graft in foreign nations – have a distinct advantage.

On the political front, President Jose Eduardo dos Santos has ruled the country since 1979, and appears to basically be President-for-life. Presidency-for-life hasn’t worked particularly well in oil-rich Venezuela. Furthermore, separatists continue to struggle for the independence of the exclave of Cabinda, a small region separated by a sliver of Congolese territory which produces more than half of Angola’s oil. The rebels hit headlines this January in a recent attack that left several members of the visiting Togolese soccer team dead. A violent flare-up in the region could cripple Angolan exports, with most of the offshore reserves located in this volatile region.

The violence in Cabinda is eclipsed by the chaos in Nigeria’s Delta State, where government troops, oil companies, and their workers are in a state of constant tension and sometimes all-out warfare with rebel groups and separatists. Compared to this conflict, Angola’s is relatively subdued.

Many questions still remain regarding Angola’s ability to service its debt, given its past and corruption. It was in default for years, a fact that bond buyers with short memories are likely to ignore. Having invested in Angolan debt before, I know how important willingness to pay is; different countries have different national characters, and they do not just change overnight.

Some of  the incentives to invest in Angola are there,– a reasonable debt-to-GDP ratio of 16.8%, large oil fields with a high rate of new discoveries, and economic ties to the world’s two biggest economies. The question is whether these facts will be enough to sway investors nervous about the future of sovereign bonds in general and Angolan creditworthiness in particular. In the end, the appeal of an Angolan bond offering will depend on a number of key factors – the credit rating they receive from the major agencies, the state of the global sovereign bond market when the government goes to auction, and the geopolitical stability of the nation and its neighbors.

Robert P. Smith, is the founder of the Boston-based Turan Corp., an investment firm specializing in emerging-market debt, and the author of “Riches Among the Ruins: Adventures in the Dark Corners of the Global Economy.”

This isn’t my article, but it’s an insightful analysis of the state of sovereign debt – including the seismic shift of high debt ratios from emerging to developed nations.

Many metrics speak to the generalised nature of the disruption to public finances. My favourite comes from Willem Buiter, Citi’s chief economist. More than 40 per cent of global GDP now resides in jurisdictions (overwhelmingly in the advanced economies) running fiscal deficits of 10 per cent of GDP or more. For much of the past 30 years, this fluctuated in the 0-5 per cent range and was dominated by emerging economies.

Second, the shock to public finances is undermining the analytical relevance of conventional classifications. Consider the old notion of a big divide between advanced and emerging economies. A growing number of the former now have significantly poorer economic and financial prospects, and greater vulnerabilities, than a growing number of the latter.

It’s now nations in the developed world that have surging deficits and total debt closing in on 100% of GDP, while emerging markets like Brazil are cleaning up their balance sheets thanks to competitive manufacturing businesses, commodity exports, and hawkish central banks.

While there are a lot of factors el-Erian leaves out, it’s a good overview of the future of sovereign debt.

My latest op-ed for the Providence Journal is now available online. I discuss the crisis in Greece and the lessons it holds for the United States.

Read it online at Projo.com, and join the discussion there!

International headlines have recently focused on Greece, one of the 16 countries in the European Union whose currency is the euro.

Greece is in danger of defaulting on its national debt. The reasons are obvious: too much spending and not enough tax collection. The Greek budget deficit reaches 12.7 percent of its gross domestic product and its national debt represents 113 percent of GDP. These numbers are worryingly similar to our own balance sheet, with debt equal to 73 percent of our GDP (but growing fast) and budget deficits at 10.6 percent.

Greece’s potential default has sent shockwaves through global bond and stock markets, which could end up equaling or even dwarfing our subprime housing and banking crisis. As a result, the U.S. dollar has strengthened against the euro and the interest buyers demand on Greek bonds has gone up. A few other E.U. countries, perhaps most notably Spain and Portugal, are also in trouble because of their uncontrolled borrowing and spending.

Read more…

A few days ago, Venezuelan president Hugo Chavez devalued the bolivar. This comes as no surprise. As I wrote in this space in November,

Buffeted by the fall in oil prices and high inflation, there are signs that the Venezuelan economy, and with it Chavez himself, is almost certainly going to implode. He may be able to buy time with various measures to stabilize his currency (the bolivar), such as the sale of dollar-denominated bonds to those willing to risk the investment, but the long-term outlook for the economy is dim…

Inflation is the highest in Western hemisphere, officially around 30%, but likely higher. All this drives demand for a more stable currency such as the dollar. The recent issuance of dollar-denominated Venezuelan bonds, purchasable in bolivars, is intended to soak up the demand for dollars and allow the purchaser to obtain a rate somewhere between the official and the parallel market rate. The big question, of course, is whether Venezuela can make good on the promise…

This weekend, Chavez devalued the bolivar right on cue, sending the people of Venezuela scrambling to buy goods which will spike in price once the measures take effect. The country actually has two exchange rates now – one of 4.3 bolivars/dollar, close to current black market rates, and the other subsidized at 2.6/dollar. The second rate applies to a few classes of goods deemed necessary for the country, including heavy industrial equipment, food and medicine, reported Reuters.

As usual, this will create privileged class of well-connected cronies who snag contracts to buy at 2.6 and sell at 4.3. This has been a recurring problem with the current CADIVI (the government office which controls foreign exchange policy in Venezuela) regime, and it remains a serious criticism of Venezuela’s tightly managed currency regime. Dual exchange rates have a long and ignominious history in Latin America, from Mexico to Argentina. Indeed, Venezuela used to have a body called RECADI in the 1990′s, which established preferential exchange rates to strengthen certain sectors of the economy. As the black market adjusts to the new system and people strive to take advantage of the difference in rates, Chavez will find that the dual rate is not a sustainable system.

The move will benefit certain politically and economically vital industries, said several Venezuelan officials. State oil company PDVSA will get relief from stagnant oil prices, as each barrel of oil sold in dollars yields more local currency with which to pay many of its outstanding debts. Export industries like coffee will find their competitiveness increasing as Venezuelan exports become cheaper.

Chavez’s popularity may take a hit as prices rise. Indeed, the president has threatened to deploy the army in order to shut down and seize the stocks of speculators seeking to take advantage of price differences and shortages, according to the Financial Times. “Go ahead and speculate if you want, but we will take your business away and give it to the workers, to the people,” the British financial paper quoted him as saying.

At this time last year, Chavez did not even acknowledge the existence of a parallel market in the bolivar. For him to now create a dual-rate exchange scheme set near the level of that same black market deals a serious blow to the regime’s credibility and confidence.

Control of his planned economy is slipping through Chavez’s fingers. Eventually, he may realize that trying to strangle private enterprise and market forces will simply delay the inevitable. Hopefully, that realization comes before the country suffers too much more, as Venezuela faces a long and painful road back to economic health no matter what it does.

Global Finance magazine sought me out for comment in their latest issue. The article discussed the state of global credit markets and the significant distortions introduced by massive monetary expansion and stimulus.

Some analysts say government stimulus packages could prove to be a double-edged sword. “Injecting massive monetary stimulus into the world economy is like taking huge doses of anabolic steroids into your body; expect urges to take risks that you would not normally take, and to have some body parts shrink, while others bulge,” says Robert Smith, founder and managing director of Turan Corporation in Boston and author, along with Peter Zheutlin, of Riches Among the Ruins: Adventures in the Dark Corners of the Global Economy. He says shrinking body parts are a metaphor for the US dollar, while commodity prices, high-coupon currencies, debt and equity prices, and Chinese real estate represent the bulges.

“Investors, crazed by monetary steroids, are playing Russian roulette with a pistol loaded with duration and credit risk. Investors are crawling out farther and farther on the yield curve looking for higher yields; they are taking greater and greater credit risks just to get a few hundred basis points above the paltry yields of US treasuries,” says Smith. He points to access to international bond markets by El Salvador, Angola, Nigeria and Vietnam, and the expected market return this year by Russia at just a few percentage points above US treasuries, as proof.

Overconfidence in the liquidity and creditworthiness of emerging markets led to minor panics in places like Greece and Dubai, as investors suddenly realized they had overestimated the security of those investments. It remains to be seen how long surging asset values can continue, but central bank interest rates will surely be a key factor.

A few tidbits from this weekend. First, the social stuff – the NYPost ran a brief about the comedian Jackie Mason, who graciously accepted my invitation to perform at my 70th birthday this year.

I also ran into Massachusetts Senator John Kerry at an event, pictured here admiring Riches Among the Ruins.

Finally, and more substantively, Barron’s ran quite an in-depth piece on Riches Among the Ruins, Turan Corporation and myself. It goes into my work at Turan with Saleh Daher, and we discuss how to make money in a market with very few bargains.

Unfortunately, registration is necessary – but worthwhile!

Interesting stuff – as Saleh put it, the more we lend to banks, the less they lend!

In Crazy New Landscape For Banks, Taxpayers Are The Big Losers

Saleh talked to Marketplace about “frontier bonds” and the ocean of liquidity.

Listen here.

Read it here.

JEREMY HOBSON: Bond investors are awash in dollars. One told me it was time to pass the snorkel. What to do with all that money? Forget Uncle Sam — his bonds aren’t paying much of a return these days.

Saleh Daher is managing director of the Turan Corporation. He says the best interest rates come from countries you need a passport, and maybe a couple of shots, to get to.

SALEH DAHER: There is a tremendous appetite for return all around the world. Even faraway places like Nigeria and Angola.

He says so-called frontier bonds can pay as much as much as 8 percent more interest than U.S. treasuries. And if you have a taste for adventure, some upcoming issues include bonds in Vietnam, Belarus and Iran.

But remember, there’s a reason they’re called frontier:

DAHER: If times are good, maybe they’ll get paid. If times are bad, they may not see their money ever again. This is the problem.

Over the past decade, a free-flowing ocean of capital brought unprecedented prosperity – and unfathomable risks – to everyone from Bangladeshi rice farmers to Bear Sterns brokers. The Gulf city-state of Dubai became one of the iconic symbols of globalization’s latest era, with ambitious, even hubristic development projects that challenged gravity and common sense in equal measure.

Now, however, the home of the Burj al-Arab and the Atlantis-like Hydropolis undersea resort may find that the receding tide of global finance has left it high and dry. The emirate owes nearly $80 billion, $50 billion of which will come due over the next 3 years, most of it in 2011 and 2012.  In the positive column is the rising price of petroleum, the original engine of the city’s growth. Investors tend to assume that the oil-rich federal government in Abu Dhabi will back Dubai’s obligations. On the other hand, Dubai’s finances are murky and secretive – local officials rarely speak about them, and foreigners who mention any negative facts to the press have been silenced, deported, or even prosecuted. In fact, Dubai still has no credit rating for its sovereign debt.

More than perhaps any other place in the world, Dubai relies on heavy inflows of foreign direct investment to fuel its enormous boom in property development.  The late Sheikh Rashid bin Saeed al-Maktoum helped funnel the profits from Dubai’s limited oil resources into long-term development in making the city a hub of trade, tourism and finance. This freed Dubai, to some degree, from the fluctuations of energy prices, but exposed the emirate to potentially devastating bubbles and crashes in trade and finance.

In order to cover its looming obligations, Dubai has moved to issue $6.5 billion in dollar- and dirham-denominated bonds, its first such sale since 2007. There are indications that investors may demand as much as 7 times the previous premium for these mid-term bonds, up to 400 basis points over the benchmark. Dubai’s raised $10 billion earlier in the year by selling bonds to the Abu Dhabi central bank.

Dubai still holds value, to be sure. But with the state’s propensity for obscuring what’s on the books, it’s hard to be sure what is safe and what sits on quicksand.  The sovereign wealth fund Istithmar World is freezing new investments as it struggles to deal with its current holdingsof over $25 billion, which is rumored to be leveraged as heavily as 90%. Property values have fallen 40% and could sink by up to 70%, a shattering blow to the foundations of a city built on the dream of eternally appreciating real estate.

Dubai’s prosperity hinges on a sturdy global recovery; even then, it requires sustained confidence that the high-leverage, high-flying model which built the city can continue. With Dubai World laying off almost 12,000 employees this year, it’s clear that the those days may have passed. The city must refocus on the core of its business in trade and finance, and step back from the publicity-grabbing but unsustainable architecture and acquisitions.