Beware Our Foes' Motives for Investing

Long after the market turmoil calms down and the banks have been forced to write their assets down to market value, one serious consequence of the current repricing of risk will remain: the investments of the sovereign wealth funds (SWFs), with combined assets estimated by the US Treasury at somewhere between $1.5 trillion (£747 billion) and $2.5 trillion – more than the total investment of all the world’s hedge funds. Morgan Stanley estimates that their assets will soar to $12 trillion by 2015.

These assets have been accumulated by governments, such as the oil exporters and China, which have been running huge trade surpluses.

US treasury secretary Hank Paulson, who says, “we must . . . welcome foreign investment”, nevertheless has asked the International Monetary Fund and the World Bank to draw up guidelines for investments by government-run funds. Peter Mandelson, the EU’s top trade official, has gone further. He wants European governments to adopt a variety of techniques, including golden shares, to control acquisition of their nation’s companies by these government investors. Germany’s Angela Merkel is also worried. British policymakers are unconcerned.

Consider the words of Adam Smith. Were he with us today, Smith would have had China in mind when he wrote that, “when some foreign nation restrains” imports, “retaliation” is required to persuade those foreigners to abandon such restraints. Surely China’s need for the jobs that its exports support makes it vulnerable to such retaliation. And Smith would have had Russia and many of America’s oil-producing enemies in mind when he defended some deviations from free trade by noting that there are times when “defence . . . is of much more importance than [the] opulence . . .” to which free trade contributes.

The end to free-and-easy credit makes it essential to devise a policy towards sovereign wealth funds that does not unduly interfere with the free movement of capital, but protects national security. Investment banks’ new aversion to risk has reduced the flood of funds into private-equity deals to a trickle, prompting the resilient entrepreneurs who make up the private-equity business to shop elsewhere. And where better to shop than where the money is – the SWFs.

China, Russia, Saudi Arabia and antiAmerican Venezuela are not run by politically neutral investors seeking merely to maximise returns. Wen Jiabao, Vladimir Putin, the Saudi royal family and Hugo Chávez are not Warren Buffett with foreign accents. They are political, not economic, actors.

Until now, much of the wealth of these nations has been invested in the IOUs of the US government. That created a risk for America: unhappy with US foreign policy, these creditors might dump their dollars and Treasury bills, driving up interest rates in America to recession-inducing levels. But such a policy would have caused huge losses to the dumpers, since the value of their dollar-asset holdings would drop like a stone. In short, the risk to the US was tolerable.

Now things have changed. The private-equity crowd is wooing SWFs such as the China State Investment Corporation. It got its fingers burnt when it bought $3 billion of Black-stone’s shares, only to watch the opening price drop from $36 to $23. Nevertheless, China has bought into a company that is one of America’s largest employers. More of the same will follow: these government funds “are on a shopping spree”, reports an unconcerned, free-trade-advocating Economist magazine.

These completely nontransparent entities are in a position to create two sorts of mischief. First, they can make the recent turmoil in financial markets look like a walk in the park. If the Abu Dhabi Investment Authority, the largest of the SWFs, finds it necessary to unwind a big position, perhaps to respond to some internal crisis, even The Economist concedes “it could start a panic”.

Second, they can invest in security-sensitive companies – Dubai International Capital owns 3% of EADS, which makes Eurofighters – and Vneshtorgbank, a state-owned Russian bank, has bought another 5%, purchased with $1.2 billion of its pet-rodollars. Anyone who thinks Putin doesn’t intend to use his government’s investments for political purposes when it suits Russia’s foreign-policy interests has not been follow ing his moves in the European energy market. Or that the China Development Bank had purely financial objectives when it bought a piece of Barclays bank and obtained a seat on the board, has not read its charter, which requires it to pursue “the state’s policies to . . . build a harmonious society”, a goal that can reasonably be interpreted to include pressuring Taiwan to rejoin the Communist mainland by withholding investments.

Lest all of this sounds like protectionist paranoia, consider the views of two confirmed free traders. Lawrence Summers, professor at Harvard, points out that capitalism depends on shareholders forcing companies to maximise profits and shareholder value, but “it is far from obvious that this will . . . be the only motivation of governments as shareholders. They may want . . . to extract technology or to achieve influence”. And Jeffrey Garten, professor at the Yale School of Management, thinks it reasonable to wonder “what the governments of countries such as China, Russia and Saudi Arabia may look like a decade from now, and what their political motivations might be”.

No need to wonder about a decade hence. We know what their motives look like now. That should be enough to justify Western governments’ reexamination of policies that are so welcoming to investment by sovereign wealth funds.