What to Make of Sovereign Wealth Funds

With sovereign funds becoming more and more active players in global financial markets we could see a variety of interesting "side effects":

1. Rising Protectionist Sentiment (especially for strategic assets).
   
2. A "sovereign wealth" premium: companies viewed as "strategic assets" will increasingly become targets of foreign governments, increasing their market value.
3. The line between between national and economic interests will be blurred even further, sparking many vigorous debates in economic journals and on the RGE Monitor.
   
4. Renewed vigor for running balanced budgets in the US (unlikely).
5. Renewed concerns about our addiction to oil. After all it is estimated that as long as oil is above $70/barrel, over $2 bln worth of petrodollars flows into financial markets every day.
   
6. Hank Paulson being reduced to tears as another foreign government rebuffs his pleadings to appreciate their currency.
7. Increased calls for transparency about the operation and holdings of SWF's. All of which will be rebuffed.
8. Much confusion about why we call these funds "Sovereign Wealth Funds."
9. Concerns that China plans to infiltrate the US using Stephen Schwarzman's "Skull and Bones" connections. Did you know that Schwarzman and George Bush were college roommates?
   
10. SWF's will become a huge issue in the presidential election after China, Singapore, Kuwait, or Abu Dhabi buys a US airline company, port or bank (oh wait . . . ).
    
11. Much overblown populist rhetoric that overextrapolates the growth of SWF's and is used to scare the American people into raising tariffs and enriching more American farmers.
12. Economists finally being able to explain the true cost of "mortgaging our future" to finance frivolous spending and frivolous wars. Yes, when you run deficits you are basically giving away a part of your country . . . its just that until now country's didn't take advantage of their power over us.
    
13. Very little rational, and realistic dialogue about what is likely to happen as we watch SWF's become the trendy thing to do with forex reserves (Thanks John):

The US has accumulated hundreds of billions of dollars in trade deficits in the past few years. Some of the deficit may be due to undervalued currencies, particularly the Chinese renminbi, but most of it would probably have occurred even if the renminbi was much stronger during this period. The truth is that the US has shifted a vast amount of its production abroad and must deal now with the resulting accumulation of external imbalances that are now being placed in sovereign wealth funds.

Clearly, the US can no longer be too picky on what kind of capital it will accept. For many decades, the US assumed that Asian countries would accumulate forex reserves and purchase Treasuries, as the ramifications of currency appreciation were as bad for them as a rout in the USD/Treasury market was for the US. The Bush administration even condoned Japan’s massive yen interventions in 2003-2004. But now that Asian SWFs are being created, they undoubtedly will be investing in equities soon; it is just a question of the timing and the method.

Many voices in the US government now say that this accumulation of reserves is illegitimate as it was caused by currency intervention, and that Asian governments should not be allowed to buy large portions of the US. While there are justifiable concerns about a communist country such as China owning controlling stakes in many “national interest” industries in the US, the general fear of Asian equity ownership is unfair and impractical. The US allowed this unbalanced system to develop and the natural consequence is for Asians, whether citizens or their governments, to own large portions of US assets, and not just Treasuries. With appreciating currencies, the Asian SWFs must seek higher risk assets such as high-yield bonds, equities and real estate in order to achieve acceptable returns.

The safest way to avoid an asset/trade war is to allow SWFs to invest passively in equities via indexed products or via external, long-only, diversified investment managers. Both sides should agree on a simple reporting system regarding such purchases, with restrictions that would be triggered if the overall SWF ownership level rises above 30 per cent.

If this is not achieved, Asian SWFs may rapidly diversify away from the dollar, with the euro bearing the greatest brunt of appreciation, and also likely causing a sharp rise in commodity prices. Trade protectionism and acrimony would certainly follow. While this has not yet occurred, China’s recent creation of its massive SWF and its growing influence in the world changes the rules. This trend will gain momentum very quickly, so it would be best to seek agreements on the above items as core principles of “SWF best practices” rather than wait for a long negotiation over a complete set of such principles.

If you have any thing to add to this list I encourage you to post.