The sub-prime crisis has diverted attention from rising fears about Sovereign Wealth Funds (SWF’s) as the new bogeyman of global finance. But the minute the sub-prime crisis subsides, anxieties about SWF’s will return. For the emergence of this vast and growing pool of state-controlled funds may have implications more far-reaching, and certainly more politically sensitive, than the hopefully temporary distress caused by the subprime crisis.
Indeed, if SWF’s continue to grow their investments are bound to permanently alter the relative weight of state and privately controlled assets in advanced economies. According to Morgan Stanley, SWF’s are expected to manage $12 trillion by 2015, up from about $2.5 trillion today. Both sums dwarf the sums controlled by hedge funds and private equity groups. Thus some of the biggest investors – both passive and strategic – in financial markets in the coming years will be government institutions. That the biggest of these institutions are in China, Vladimir Putin’s Russia and some unstable petro-states adds another worry to the mix.
The growth of SWF’s is a direct consequence of the accumulation of more than $5 trillion in foreign reserves by emerging-market economies in Asia and among oil and commodity exporting countries. These economies’ current-account surpluses, together with massive inflows of capital, have led their monetary authorities to try to prevent their national currencies from appreciating in order to maintain the competitiveness of their industries.
Initially, these countries invested their foreign reserves in liquid assets – short-term United States Treasury bills and government securities issued by other reserve currency countries. Then they realized that their holdings in liquid and low-return assets far exceed what is needed to avoid the type of speculative runs that East Asia experienced in 1997, and Russia in 1998. After all, why hold US T-bills with a meager 5% return, German Bunds with a 4% return, or Japanese government bonds with a 0.5% return when you can acquire foreign firms, invest in real assets, stock markets, or higher-yielding corporate bonds?