State Capitalism a Bigger Threat than Sovereign Wealth
Quite the interesting column in the Wall Street Journal this week:
Don’t Pick on Sovereign Wealth
By DOUGLAS REDIKER and HEIDI CREBO-REDIKER
FROM TODAY’S WALL STREET JOURNAL EUROPE
July 17, 2008
Under pressure from the U.S., Europe and the IMF, representatives of 25 sovereign wealth funds managing about $3 trillion in assets met last week in Singapore to discuss how to allay fears about their investments. These large pools of government-controlled wealth are investing in everything from Barclays and Citigroup to New York’s Chrysler Building. As they transcend traditional boundaries between foreign policy, financial markets and national security, it is natural that Western capitals are worried.
However, shining the spotlight too brightly on sovereign wealth funds (SWFs) may divert attention from the more fundamental foreign-policy issue that these funds have come to represent — the rise of “state capitalism.” The broader use of finance as a foreign-policy tool is an increasingly important 21st-century phenomenon. SWFs, though, don’t necessarily pose the biggest risks in this category.
If a country wanted to use financial tools to advance its foreign policy, it would more likely do so through the use (or threat of use) of its generally much greater central bank reserves to affect currency markets. While SWFs are believed to control about $3 trillion worth of assets, the IMF estimates that government-owned central bank reserves exceed $7 trillion.
Central banks’ decisions often have significant and overt political motivations. Many Gulf states, for example, appear to have made a political decision to continue to support the U.S. dollar by linking it to their own currencies, despite the negative inflationary impact that such support causes them at home. They apparently do so in return for, among other things, the military protection afforded by the U.S. Likewise, if China really wanted to use its financial power to influence U.S. policy, it would be far more likely to use its $1.8 trillion of central bank reserves than its $5 billion SWF stake in Morgan Stanley.
Another more probable financial tool that governments may exploit for political gains is the state-owned enterprise — i.e., an operating company in which a government is the major shareholder. Its corporate mission statement is likely to include acquiring, managing and operating businesses for the benefit of its government shareholders. That’s why the mere rumor that Russia’s Gazprom wants to buy a foreign company tends to cause anxiety in Europe, where governments are worried about their dependency on Russian energy.
The financial structure through which widely differing governments hold and invest their wealth says little about the risks their investments may pose. In the case of sovereign wealth funds, beyond government ownership, there is no other single common defining characteristic to link them to one another. This is why the international community has struggled to put in place criteria by which to judge them, as well as appropriate rules and responses to govern their investments. There is little in common between the risks to the U.S. posed by SWFs of strong democratic allies like Canada and Norway and those whose political systems and motivations are more worrying, like those of China and Russia.
The attempt to create one-size-fits-all rules for sovereign funds is what has led to the creation of the IMF-sponsored SWF International Working Group that met last week in Singapore. While the agreement on “generally accepted principles and practices” will not be finalized until this autumn, it is widely expected to place significant emphasis on voluntary transparency and disclosure. Given the recent emergence of new SWFs from Russia and China, it will likely ignore quasi-objective criteria like past investment track records.
It will almost certainly ignore the ultimately more valuable, albeit more subjective, assessment of the political risk that a particular government owner poses to the country in which an investment might be made. This is dangerous. While increased transparency and disclosure should of course be encouraged, such an overemphasis on transparency of SWFs alone may lead to unnecessary conflicts with allies which, for a multitude of reasons, may fail to meet the requisite level of transparency. Likewise, some governments may try to reassure the West by complying with transparency rules for their SWFs but may at the same time use a broad array of other financial tools to advance foreign-policy interests.
The Abu Dhabi Investment Authority (ADIA), for instance, the largest sovereign fund with assets estimated to approach $875 billion, has been a responsible investor in the U.S. and global markets for over three decades. In financial circles, ADIA is considered a high-quality investor and has never been accused of acting in a manner inconsistent with international political or financial norms. One would assume that, after 32 years, if they were up to something suspicious, there would be some evidence to point to.
Yet ADIA’s strong track record is often ignored and it consistently receives failing grades as an SWF because it does not publicly disclose information about its holdings, investments or governance structures. In fact, ADIA’s limited transparency is not inconsistent with its financial peer group of large international hedge funds and private-equity funds.
By contrast, Russia’s National Wealth Fund, established in February of this year, has announced that it intends to disclose its financial holdings in a highly transparent manner, leading to high marks on the various SWF transparency indices. However, Russia, through various non-SWF entities, including its central bank and vehicles such as Gazprom, is surely contemplating how to use its recently acquired financial heft to advance its national interests abroad.
The European Union and the U.S. should be cautious about specifically targeting SWFs. As significant providers of capital to our markets, SWFs have thus far been a positive influence for the global economy, the financial sector and in particular debtor nations like the U.S. We should think hard before imposing unnecessary burdens on SWFs. We may only further weaken the already fragile global economy while gaining false comfort that we’ve actually addressed the more strategic issues that state capitalism legitimately raises.
Mr. Rediker and Mrs. Crebo-Rediker are co-directors of the Global Strategic Finance Initiative at the New America Foundation.