Sovereign Investment Funds are stalking the planet. They are Chinese, Japanese, Middle Eastern and they control trillions of dollars. In the last ten years, the Asian and other trade surpluses wound up as funds in the control of the governments of the exporting nations. This money was used to buy government bonds in countries from where the export surpluses were being generated – Europe, North America, especially the USA.. This kept the importing countries’ currencies strong, and ensured their export orders kept growing.
The flood of cheap money that travelled across the globe from east to west kept two booms going. In the East it was the manufacturing of the goods. But in the west it was property. The easiest way for western democratic governments to translate the wall of money buying up their Treasuries at low rates of interest into political advantage, was not to increase government expenditure and spend all the money that way, but to pass on the bounty to consumers to fund property booms. These in turn have enabled consumers to keep buying the Asian goods that were seeking a market, which caused the funds to become available in the first place. It was the most perfect example of global ‘you scratch my back. I’ll scratch yours’ ever conceived. But these decade long flows of goods and money are suddenly changing in character.
The difference now is that the exporting countries are using less of their trillions to fund western property and consumer booms. After ten years these are running out of steam. The ‘consumer’ currencies are no longer on the rise, and the financial returns of the ‘carry trade’ (where people borrowed at low interest in yen and leant the funds in e.g. NZ dollars or Sterling) are lessening or reversing. While the losses accumulated by the granting of ‘non-performing’ loans – the ‘sub prime mortgage’ crisis and the credit crunch fill the news, the system which drove the world’s growth for the last ten years is gliding to a halt. The wind is no longer in its sails.
But the end of one party is merely the beginning of the next. The funds which were in effect leant to the US government and others by buying Treasuries, are still coming to the West but they are now coming in a different guise, and with a different strategic objective. This time, the funds are being used not to fund consumer booms, but to buy businesses.
The property booms of the last decade will be looked back on as an opportunity where many made their fortunes, or missed out on making one, and when western countries had a unique opportunity to develop their housing and infrastructure while money was cheap. The next phase will see the same wall of money coming in, but this time it is looking for a higher return that it was receiving from buying government bonds. In that search, it will be developing another part of the economy – the financing of business.
The Sovereign Funds are buying big businesses in the West, either strategic investments such as ports, shipping or mining, or taking slices out of hedge funds and big banks needing to fund their sub-prime losses. So few westerners are interested in holding equities, as these are viewed as risky and less attractive than the ‘sure’ returns to be had from property, that while property is valued at historically very high levels, businesses and shares are today valued at historically low levels.
The hedge funds especially have been caught out by the sub-prime crisis and have been distress-selling shares, trying to get back into cash. Financial sector profits are collapsing as a direct result, and the Sovereign Funds, seeing a once in a lifetime opportunity are moving in and cleaning up. The prospect is that after another ten years with business investment as the focus of Sovereign funds, property markets will become less inflated, and business investment will generally become more attractive.
While the initial Sovereign Fund forays will be into large strategic organisations, as the trend establishes, the market for shares of all kinds will be affected by the virtuous influence of large sums of money desiring to own businesses. Western economies will run better if people can raise money more quickly to fund business expansion, and the unhealthy total reliance of our economies on endless consumption and property price rises will be at an end. There will be more highly paid jobs, a wider spread of opportunities, and a feeling that it is worth investing and planning long term once more.
The earth will flatten. Business will become a stronger and more influential force in society. The role of government and easy returns from speculation will become less. It will be a more thinking, less bureaucratic and positive society. Ownership will matter more, as Asian and other foreign influences override the Marxist tendencies which have become so established in Western societies, reducing our effectiveness. There will be a return of respect for owners, as their willingness to invest will be crucial in turning the world away from a depression. It’s about time.
Regulators are beginning to realise the opportunities that Soveireign Wealth Funds might offer. In the IHT today (International Herald Tribune) –
Officials in Europe and the United States have argued that, so far, the funds are proving mostly beneficial, especially since they have helped re-capitalize major banks, including Citigroup, Merrill Lynch and UBS, in the wake of losses linked to the U.S. mortgage market.
Still, European officials are hedging their bets.
José Manuel Barroso, president of the European Commission, said Monday that if the low-key approach of devising a voluntary code proved ineffective, the EU would draft laws that could block investments from the funds.
“We will not propose European legislation,” Barroso said during a speech in Oslo, “though we reserve the right to do so if we cannot achieve transparency through voluntary means.” Barroso said an agreement on the code should be wrapped up by the end of the year.
McCreevy, whose job is to enforce EU rules on the free movement of capital, said that Brussels took “a very liberal view” of the funds, especially since they had not shown any signs so far of interfering in the banks that they had invested in. “But I am political enough to recognize that there are those fears out there,” he said.
Still, McCreevy said that if Europe acted first by devising new ways to restrict investment, it risked retribution in countries that have the funds, including places like Russia and China, where European companies are active.
“Inevitably there will be a tit for tat response,” McCreevy said.
“We should be very, desperately cautious about how we proceed here,” McCreevy said, emphasizing that the code of conduct needed to come first.
The European reaction to sovereign wealth funds has been mixed, but McCreevy lauded what he called a “more balanced debate” than last summer, when Germany set off alarm bells in Brussels by announcing plans to create a new system for reviewing sovereign fund investments.
Though the EU’s founding treaty enshrines the general right to free movement of capital, member states can adopt measures controlling the movement of capital from third countries under limited circumstances.
McCreevy said that the German proposal, still being written in Berlin, was “nothing as restrictive as we thought it would be eight months ago.” But he said he would reserve judgment until he saw the fine print.
At that time, German officials named specific sectors, including energy, banking and telecommunications, where they might review or block investments. But current drafts do not name specific areas, and have been carefully crafted to avoid objections from the EU.