A sovereign remedy for sovereign wealth funds

STONE the crows! Now the Productivity Commission has injected objective economics into the carbon tax and trade debate, showing the economy might survive a price on the stuff what are we to worry about?

How about sovereign wealth funds and what they can be used for?

Eric Weiner thinks we should. He warns in his new book The Shadow Market that most SWFs are not intended to improve their own people’s circumstances but are a vehicle for “nationalistic capitalism”, where government controlled companies and investment funds buy strategic assets and public debt in other countries:

The money generated by these entities does not belong to the company, its workers or shareholders … instead most of the money from these companies and investment vehicles rolls up to the state, giving the government the power to determine how to deploy the bulk of the capital generated by its economy. [i]

There is certainly a lot of cash stashed in SWFs. China, Singapore and oil producers from the Middle East to Norway are all saving surplus spondulicks. In 2009, SWFs controlled assets worth US$2.5 trillion, which was growing by US$500 billion annually.[ii] According to The Economist, China leads the pack with $US800bn in its SWF, add Hong Kong and the amount increases to around $A1.1tr.[iii] It’s an impressive amount, considering the comrades only created Beijing’s SWF in 2007.[iv] And, with the exception of Norway and (sort of) Singapore and Russia, most of the nations with big SWFs are neither democracies nor free market economies. As such they are not always inclined to play by the rules good globalists use.

It is easy to argue that fund managers in the service of a state are the twenty-first century equivalent of the Prussian general staff – technocrats devoted to advancing the interests of governments that use their people as economic conscripts.

Certainly, there is no denying SWFs have foreign policy potential for states where the permanent leadership does what it likes. China for example can twist Washington’s arm quite hard thanks to the US$1.149tr the US Government owes Beijing, which is only less than the Federal Reserve’s holding of Treasury Department paper. (The Yanks owe us a paltry $US10bn). [v]

Scary stuff, albeit more for the Europeans and Americans than us. As Weiner puts it, because the old capitalist economies are not living within their means,

… the groups with access to capital and natural resources hold the power. And everyone else is just a pawn in a much larger chess game going on over their heads. [vi]

Except that in a globalised economy we are all in it together. Sure the Chinese could thug the US economy by selling off Washington’s debt, thus forcing the Americans to increase the interest rate paid on its paper. But why would the comrades decide to throw the US into an even more severe slump than it is in now when Beijing has close to half its assets invested in US debt? [vii]

The real risk from SWFs is that, as with carbon trading, the protectionists will use their existence as an excuse to close off the economy, to save us from what they say is unfair competition from overseas. Weiner makes the point that SWFs are not going to invest forever in under-performing economies and that the Europeans and US will have to reduce their standards of living.

Now where have the crows heard about foreigners intent on making everybody poor before? Well, just about every time rent-seekers want something. We heard it in the 1970s when protectionists in Europe, the US and Australia warned against “unfair competition” from (insert name of agricultural/manufacturing rival here). One of the reasons we are in better shape than the EU is that we opened our economy, where they didn’t.

We heard it again in the 1980s when multinational corporations were supposed to subvert the nation state – like, say, General Motors – which was reduced to a mendicant during the global financial crisis.

Now the SWFs are the demon de jour, a convenient excuse for capital account protection intended to insulate local industries from foreign funds, which will expect efficiencies. As the IMF argues,

Recent developments in the world suggest there may be a perception that certain foreign governments shouldn’t be allowed to own what are regarded as an economy’s ‘commanding heights’. This is a slippery slope, which leads quickly and painfully to other forms of protectionism. It’s important to preempt such pressures. [viii]

Quite right, caw the crows. In any case, there are two fatal flaws in using SWFs as an arm of foreign policy to attack the economy of nations where they invest. If SWFs do not maximise their return on investment, which generally depends on the companies they buy making money, sooner or later they will be in strife at home.

The Chinese are prodigious savers, sticking 30 per cent of their disposable income in the bank because there is not much of a welfare system and they know they have to look after themselves.[ix] Moreover, individuals are not allowed to send their savings overseas.[x] So, much of the money they salt away with the state ends up in US debt. They will not be best pleased if their government pushes the American economy into depression.

There is also the inevitability of SWFs that are not open and responsible to the voters will not be a big threat due to the greed or incompetence of the people who run them in their own, rather than the people’s interest.

As Daniel Dresner points out,

In a best-case scenario, like Norway, democratically elected parliaments must approve changes in investment strategies. This kind of oversight is consistent with the spirit of counterparty surveillance. In places like Russia and China, however, the lack of transparency, oversight and accountability is much more problematic.[xi]

Gosh, now where could we find evidence of mismanaged public investment funds? Here’s a hint, have a look at what happened to state banks in Victoria, South Australia and WA in the 1990s.

If SWFs are not so efficient as to be a political risk, but have big buckets of money to invest, what is a capital importing country to do?

The sovereign remedy to the risk of sovereign wealth funds investing in Australia is to accept they are inevitable and as long as they are subject to our laws and competition rules when they do business here they are no threat to an open economy.


[i] Eric J Weiner, The Shadow Market: how sovereign wealth funds secretly dominate the global economy (OneWorld, 2011) 11

[ii] Jonathan Kirshner, “Sovereign wealth funds and national security: the dog that will refuse to bark,” Geopolitics 14, 2 (summer 2009), 305-316, 305

[iii] The Economist, “Largest sovereign-wealth funds,” March 10 @ www.economist.com/node/18335007

[iv] Michael F Martin, “China’s sovereign wealth fund; developments and policy implications,” (US) Congressional Research Service, September 23 2010, @ www.fas.org/sgp/crs/row/R41441.pdf recovered on June 12

[v] Terence P Jeffrey, “Fed passes China as top owner of US debt,” CNS News, @ www.cnsnews.com/news/article/fed-eclipses-china-top-owner-us-debt recovered on June 12, US Treasury,” Major Foreign Holders of Treasury Securities,” March 2011 @ www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt, recovered on June 12

[vi] Weiner, op cit 115

[vii] Adam Davidson, “What to make of US’s debt to China,” NPR, March 4, @ http://www.npr.org/2011/03/04/134272775/What-To-Make-Of-U-S-s-Debt-To-China recovered on June 12

[viii] Simon Johnson, “The Rise of Sovereign Wealth Funds,” Finance and Development 44 3 (September 2007) www.imf.org/external/pubs/ft/fandd/2007/09/straight.htm recovered on June 12

[ix] Chris Hogg, “Can China’s frugal savers help the economy,” BBC

@ http://news.bbc.co.uk/2/hi/8153469.stm recovered on June 12

[x] Tom Orlik, “China slowly brings the world to the yuan,” The Wall Street Journal, June 2

[xi] Daniel W Drezner, “Sovereign wealth funds and the (in)security of global finance” Journal of International Affairs 62, 1 (Fall/winter) 2008, 115-130, 118