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.

I’m pleased to announce that Audible.com has released Riches Among the Ruins in audiobook form. It’s available for 7.95 with a subscription to Audible, or at the full cover price, and Audible will deliver it in the digital media format of your choice.

So if you prefer to get your books in the car or through your MP3 player, this is definitely the format for you. Check it out, and let me know what you think!

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!

Two weeks ago, I wrote about the debt crisis in Dubai. The markets convulsed on news that Dubai World, the huge state-owned corporation which runs many of Dubai’s buildings and investments, might delay or default on its debt payments.

This week creditors, and markets, were relieved to hear that Abu Dhabi, the richest emirate and heart of the federal government of the United Arab Emirates, would bail out Dubai World to the tune of $10 bn and enable Nakheel PJSC, the real estate subsidiary, to pay back a $4 bn sukuk or Islamic bond.

Just as I predicted, Dubai World was too big to fail. The fallout from a default would have poisoned markets across the region and probably irreparably damaged the U.A.E.’s already tainted reputation. Authorities described the Nakheel sukuk as a linchpin of the ongoing debt negotiations, saying ““The whole capital structure was a web of cross-defaults – the only way to calm this was to pay off the sukuk.”

Anyone who bought the sukuk maturing on December 14 when it hit rock bottom at about 48 cents on the dollar made a tidy sum today as it jumped as high as 109.5 on the dollar. Nakheel was widely expected to enter into bankruptcy.

Dubai has always been the public face of the emirate while Abu Dhabi has always held an outsize portion of the oil revenues and thus, the emirates’ wealth. No doubt there will be a degree of control re-asserted over Dubai, although it’s difficult to say what that will entail – more conservative fiscal, religious, and social policies and priorities seem likely.

The city-state also pledged to push for “transparency, good governance and market principles” and passed a new bankruptcy proceedings law.

For now, it looks like Dubai World’s fat has been pulled from the fire. We’ll see how things develop as more of the debts come due.

As an alumnus of Bowdoin, I’ve worked with them a few times and spoken about my work and writing. Here’s a nice profile they ran in their Fall 2009 magazine.

Bowdoin: Is it still necessary for investors like yourself to visit these countries like you did?

Smith: Let me compare it to the CIA gathering intelligence. They’re big on the technical stuff, the satellites and intercepting code and phone messages. But, where they’ve always fallen on the ground is their human intelligence, human intel. I believe that you have to be on the ground speaking to as many people as possible, asking the embarrassing questions to government officials and executives as to where the country is going, what they’re doing, what the economic plan is. It’s similar to applying for admission into Bowdoin, to get an idea of what the College is all about. You can read all the catalogs, listen to all the videos and the promo material that they send out, but unless you are on campus getting a feel and talking to some of the students and professors, you really don’t have an idea of what Bowdoin is all about.

Dubai did its best to drop the bad news into the Bermuda Triangle of reporting – just hours before markets closed for Thanksgiving and the day before the beginning of the Islamic holiday Eid al-Adha. Dubai World, the investment vehicle and holding company owned by the government of Dubai, asked all of its creditors for an extension on debt issued by Dubai World and Nakheel, its real estate subsidiary.

Dubai World is inextricably tied to the government of Dubai; everything from ports to investment to real estate in Dubai falls under the umbrella of DW and its 90 subsidiaries. Sheikh Mohammed al-Maktoum established the company by decree in 2006 and remains the majority stakeholder in the privately-owned company. Obviously, the corporation falls under the category of “too big to fail,” notwithstanding bureaucratic protestations of the company’s independence from the government.

I’ve seen too big to fail before – I thought the same of Russia in 1998, and I paid the price accordingly. More recently, the United States government declared everything from AIG to General Motors too big to fail. If the US can’t let an ailing automaker sink in a recession, it’s difficult to believe that Dubai would let its flagship enterprise implode. Almost exactly a month ago, I wrote about Dubai’s excessive leverage and the foundation of debt on which it was built. Once again, secrecy is a major problem here. The government sends mixed signals on the degree of backing it will provide for DW – one day lending the Dubai banking system money, the next eschewing responsibility. There are many in Abu Dhabi, whose money comes mostly from petroleum and its derivatives, who would not mind seeing Dubai’s speculative excesses humbled. But the prosperity and reputation of the Emirates is inextricable from that of its most famous member.

Dubai’s biggest problem is simple – it is standing at the edge of a long, unsteady beam overlooking a precipice, and there is an increasingly small amount of real money at the other end holding it steady. There is nothing in Dubai that does not require a constant inflow of liquidity to maintain it; the ventilation systems of its high-rises regularly clog with sand, the city needs armies of underpaid laborers to keep it running, and many of the most ambitious developments, like “The World” and the Palm Jumeirah, are finding that building on artificial islands of sand was perhaps less secure than they had imagined. In many ways, Dubai’s physical reality reflects its fiscal condition – supported with more ambition than common sense.

The consequences of DW’s financial woes will echo into many corners of the world, from subcontinental slums to the marbled halls of European and British banks. India alone estimates that almost 340,000 migrant workers received employment in Dubai and all Indian workers in the city-state sent back $43.5 billion in remittances last year. Conditions are infamously atrocious in Emirate construction companies; many workers have had their passports confiscated, been forced to live in squalid compounds and received far less pay than promised. The article above details how one crew was fired by text message while travelling home for the Eid al-Adha holiday.

On the other side of the scale, Credit Suisse estimates that perhaps half of Dubai’s $80 billion in debt is held by European banks, with Standard Chartered and HSBC the most exposed. These holdings probably won’t be wiped out – Abu Dhabi may let its neighbor take a few hits around the face, but they won’t tolerate a knockout blow. Witness the government’s statement that it would bail out Dubai’s commitments  ”on a case-by-case basis.”

Dubai World’s website still sports the fate-tempting slogan “The Sun Never Sets on Dubai World.” Unfortunately, as history teaches, the sun did set on the British Empire.

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

Forbes.com ran an article written by me today, discussing the potential for a bubble in sovereign debt, particularly that of emerging market countries.

When I started trading emerging market sovereign debt in the early 1980s, the big risk was non-payment. The danger of default always loomed over a deal. It was like buying a Japanese car or a transistor radio made in Taiwan in the early 1970s: cheap, substandard goods that would likely fail early and often. However, some countries we still label “emerging markets” have become economic powerhouses: China, India, Brazil and Russia for example, holding foreign exchange reserves respectively of $2,300 billion, $284 billion, $235 billion and $433 billion.

Today, more than $5 billion of emerging market debt (EMD) is traded daily and prices are sky high in both debt and equities. Since Jan. 1, 2009 the MSCI Total Return Emerging Markets Index is up 65.1%, outperforming the S&P 500 Total Return Index, which is up 17%.

Read on…

MarketFolly.com also featured my overview of the EMD market.

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.