Debt problems in Dubai struck financial markets hard on Thursday, sinking global stocks, lifting safe-haven bonds and driving the dollar higher.
Gold climbed to a new record high but fell back as the dollar rose. European shares had their worst daily loss in seven months.
Banking stocks came under particular pressure because of potential exposure to any bad debt in the Gulf, as did shares in European car companies, some of which are part-owned by sovereign wealth funds from the region.
Markets were trading without much input from the United States, where it was the Thanksgiving holiday.
Dubai said on Wednesday it wanted creditors of Dubai World and property group Nakheel to agree a debt standstill as it restructures Dubai World, the conglomerate that spearheaded the emirate's breakneck growth.
The announcement triggered widespread concern about the once-booming Gulf region's financial health, although some investors differentiated between leveraged Dubai and other more solidly wealthy emirates and countries in the region.
But the worries fed directly into a general nervousness in financial markets about the real state of the world economy at a time when investors are also seeking to lock in 2009 profits.
The Dubai worries have played a major role in rattling market sentiment at a time when the U.S. is closed and we are not getting anything from anywhere else, said Peter Dixon, economist at Commerzbank.
It is a day in which market uncertainty has been provoked again.
Others, such as Royal Bank of Scotland, said Dubai's bombshell meant investors would now have to re-appraise the quality of sovereign support for state-owned entities in the region.
Dubai sought to ease some concerns about international port operator DP World
But markets stayed nervous and the cost of insuring debt through credit default swaps around the Gulf rose.
MSCI's emerging market stock index <.MSCIEF> was down 2.1 percent, underperforming the broader all-country world index <.MIWD00000PUS>, which was down 1.5 percent.
There were sharp losses in Europe, where the pan-European FTSEurofirst 300 index <.FTEU3> closed down a preliminary 3.2 percent, its biggest daily loss in seven months.
Banks were the biggest drag on the index, but the interlinking of world finance showed up elsewhere.
Shares in London Stock Exchange
It (the Dubai credit issue) does bring to the fore that much of what we have seen in the markets really has been supported by liquidity, said Georgina Taylor, equity strategist, Legal & General Investment Management.
It shows how vulnerable the market still is to newsflow, she said. But it should be seen as a country-specific issue. It's not something systemic. It's about risk appetite.
Within the Gulf, regional bonds sold off and ratings agency Standard & Poor's placed four Dubai-based banks on negative outlook.
Anything from Dubai or Abu Dhabi is getting absolutely hosed, a bond trader in London said. There is massive pressure across the board, exacerbated by the thin liquidity.
Gulf markets were closed for Eid holidays.
The dollar gained sharply as investors shed riskier assets in the Dubai debt storm.
But the euro was also hit also when France's Economy Minister Christine Lagarde said that its strength against other currencies was hurting European exporters.
It hovered near the day's low of $1.4960, down 1.1 percent on the day.
The dollar index, a barometer of its performance against six major currencies, rose 0.9 percent on the day, up from a 15-month low.
Risk aversion also lifted the dollar off a 14-year low against the Japanese yen.
Euro zone government bond prices were sharply higher. The yield on two year debt fell 8 basis points.
Bund futures rose so high they broke out of a trading range that has been in place since June.
(Additional reporting by Jamie McGeever, Sujata Rao, Simon Falush, Brian Gorman and Joanne Frearson; Editing by Ruth Pitchford)