February 6, 2008

Sovereign Wealth Follies

by Samuel Gregg D.Phil.

Credit shortages make available capital a much sought-after commodity. With the world’s financial industries struggling to find investors to make up sub-prime mortgage-related losses, sovereign wealth funds are taking the opportunity to invest heavily in some of the biggest banks, stock exchanges, and private-equity firms across the globe.

Though often differing in their precise configuration, sovereign wealth funds are essentially state-run investment pools that engage in international investment activities. With names like “China Investment Corporation,” “Qatar Investment Authority,” and “Abu Dubai Investment Authority,” they are presently worth approximately $3 trillion.

That’s only about 2 percent of assets traded throughout the planet. But it’s a 2 percent that’s presently available for investment purposes.

No wonder capital-starved Western financiers are presently beating down the doors of these funds, seeking to prove to their government-appointed directors and managers why their business is worth the funds’ attention – and dollars.

The Economist reported last month that sovereign wealth funds from Kuwait, South Korea, and Singapore underwrote most of a $21 billion investment in Merrill Lynch and Citigroup – two banks that lost billions in America’s credit crisis.

Over the past year, Middle East-based sovereign wealth funds have acquired significant holdings in the Nordic stock exchange operator OMX. The Swiss bank giant, UBS, benefited from a $9.72 billion investment from Singapore’s GIC. Likewise, the China Investment Corporation invested $3 billion in the well-known private-equity firm, Blackstone Group.

The number and scale of these investments has sparked much anxious speculation on the part of some political and financial commentators.

So far there has been no sign of xenophobia about the activities of funds controlled by cashed-up Middle Eastern and Asian governments. But given that it is an American presidential election year, one wonders how long it will be before that type of sentiment emerges.

On one level, these investment developments should be welcomed. Inasmuch as they represent a recycling of capital from one part of the world to another, they testify to the integration of developing world economies into the global economy. All those petrol-dollars are now providing much-needed capital to Western economies. It’s a demonstration of how free markets enable capital to move from countries with excess savings to those economies that need it.

This is surely preferable to central banks printing more money or governments borrowing capital, running deficits, and/or raising taxes.

It also suggests that many developing nations are turning away from squandering their wealth on vain monuments, petty wars, and highways that lead nowhere. Moreover, the same nations are acquiring a stake in North America and Western Europe’s economic well-being.

As the French social philosopher Alexis de Tocqueville observed over 150 years ago, the prevalence of trade and free exchange across often very different cultures increases the chances of lasting peace.

One increasingly-voiced worry about sovereign wealth funds is that, unlike private companies, they are more likely to be driven by political considerations. Invariably, this concern is more loudly expressed when the sovereign wealth fund is ultimately controlled by an Arab-Islamic government or, in China’s case, by an officially Communist regime.

No doubt, such concerns have some validity. Governments generally don’t follow the profit motive. It would surely be preferable if such funds were privately-owned and thus more inclined to follow the promptings of profit than the dictates of political expediency.

The good news is that sovereign wealth funds have thus far demonstrated little interest in pursuing political agendas. Pragmatism seems to be the norm, especially in the case of the sovereign wealth funds of small Gulf States such as Qatar, Kuwait, and the United Arab Emirates.

The long-term hope is that sovereign wealth funds will gradually be transformed into private holdings, much as many formerly government-owned American and European utilities are now privately-owned and publicly-traded in stock markets.

Moreover, it would be harder for developed nations to argue for free trade and open markets in the developing world if they suddenly created a host of regulations that created investment-barriers to sovereign wealth funds. In fact, laws already exist in most countries to address legitimate national security concerns about foreign financial investments.

Those worried about influxes of “foreign-controlled” money from Islamic countries should focus their attention on far more worrying activities.

One such trend is Saudi funding of those mosques throughout America, Europe, and Africa that often host Islamic-fundamentalist imams. The well-documented messages sometimes preached in these mosques — including vicious anti-Semitism and the denigration of Christians and women — are radically incompatible with the preservation of free societies.

Cross-border financial integration is good for everyone. So too is a religious tolerance that acknowledges and argues differences, but without insulting those of other faiths and none.

That’s one globalization still waiting to happen.

Dr. Samuel Gregg is research director at the Acton Institute and author, most recently, of The Commercial Society (2007).

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