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A $12 trillion monster threatens globalisation

A $12 trillion monster threatens globalisation
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First Published: Fri, Jun 08 2007. 10 11 PM IST
Updated: Fri, Jun 08 2007. 10 11 PM IST
For years, globalization’s discontents have hoped to derail the free movement of goods, capital and people. Most governments held firm, betting there’s more to gain than lose from the phenomenon. Wouldn’t it be rich, then, if many of those governments are unwittingly setting the stage for globalization’s demise? They may be doing just that with the proliferation of so-called sovereign wealth funds.
Such a vehicle, funded by currency reserves, is what China used to grab a $3 billion stake in Blackstone Group LP. It’s also what will make the world’s biggest hedge funds, mutual funds and private-equity outfits seem like chump change.
Until now, sovereign wealth funds grew out of oil revenues and were used to stabilize energy markets. Amid high oil prices, they’re morphing into public wealth accumulation accounts. And as currency reserves swell, governments are scrambling to make better use of them than parking the cash in US Treasuries.
How big are these sovereign wealth funds likely to get? Stephen Jen, London-based global head of currency research at Morgan Stanley, estimates $12 trillion by 2015. That’s nearly the current size of the US economy, and it could create interesting problems for the world economy.
“I believe that SWFs (sovereign wealth funds) will become absolutely massive in size in the not-so-distant future, and will have powerful implications for the financial markets,” Jen says. “I am increasingly concerned about financial globalization as a reaction to the emergence of these funds.”
Risk tolerance
Over time, powerful government investment companies could increase demand for stocks and decrease interest in bonds. The hunger for higher returns might increase the tolerance for risk globally. Jen estimates global bond yields will, on average, rise 30 to 40 basis points over the next 10 years, while price/earnings ratios on stocks rise 5% to 10%.
Such funds have “a longer-term investment horizon with a higher tolerance of short-term risk and so can have more diversified and less conservative asset allocation,” Hong Serck Joo, head of Korea’s $20 billion state-run investment fund, had said last month.
The growing size and reach of sovereign wealth funds are likely to have important implications for technology and commodity companies. In the 1980s, Japanese investors bought US properties. In the early 2000s, Russian investors grabbed football clubs and Middle Eastern investors snagged racetracks. Countries looking for high returns on their reserves will have a different taste in assets.
Asset bubble
Here, Singapore is an interesting example. It has the second biggest sovereign wealth fund after United Arab Emirates and it has done what others are likely to: searched for assets with solid financial returns that boast attributes not easily found in home-grown companies. That’s exactly what China, South Korea, Brunei, Malaysia, Taiwan and other Asian governments are looking to do.
China already has seen its share of trouble. Two years ago, a bid by its third-largest oil company, CNOOC Ltd, for Unocal Corp. was scuttled by the US Congress. Singapore, meanwhile, is embroiled in controversy over its purchase of majority control of Shin Corp. The telecommunications company was owned by the family of former Thai prime minister Thaksin Shinawatra, who was removed in a coup last September.
The question is, will the US sit idly if China goes shopping in Silicon Valley? Will Australia, New Zealand and Canada be okay with foreign governments eyeing resource companies? How might the UK or Japan react to acquisitions of theirinvestment banks? “Financial protectionism is the flip-side of trade protectionism, in my view,” Jen says. “While the arguments in favour of and against trade protectionism are clear, the pros and cons of resisting foreign capital are not yet clear, and how various countries will react is also unclear.”
The upshot is that “there is a distinct risk that foreign funds turning from creditors to owners will trigger reactions from the recipient countries that will undermine globalization.”
Jen admits there are risks to his $12 trillion prediction. If sovereign wealth funds perform poorly fewer financial resources might be allocated over time. The cash could also be sucked back into official currency reserves at any time.
Yet the odds favour these investment outfits becoming huge players in markets everywhere. Over time, they will look more like huge hedge funds and mutual funds that may be harder for investors to track. It’s not clear how much data they will provide on holdings. As their massive funds are combined with private capital, government portfolio shifts could lead to unexpected, unexplainable moves in markets.
In Asia, few questions loom larger than what to do with the trillions of dollars of reserves amassed since the 1997 Asian crisis. Ten years after the turmoil, those assets are allowing governments to wall off their economies from speculators and help exporters. They’ve also created one of the world’s most obvious bubbles.
Officials in Beijing, Tokyo, Seoul and elsewhere have in a sense created a financial monster. They can’t easily dump reserves; markets will get wind of it, drive asset values lower and leave governments with massive losses. They also can’t stop stockpiling reserves because their currencies would surge. Having gotten themselves into an untenable situation, Asian governments are mulling how to use the money. Let’s just hope they do it wisely. Nothing less than the future of globalization may hang in the balance.
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First Published: Fri, Jun 08 2007. 10 11 PM IST
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