WASHINGTON, D.C.—All day, Feb 7, on Capitol Hill, the US-China Economic and Security Review Commission (USCC) heard testimony on "sovereign wealth funds" and how the investments by foreign governments can potentially compromise U.S. national security and harm the economy. The sovereign wealth funds (SWF) have attracted a lot of comment in recent weeks due to the recent surge in such investments in the United States.
Some people get concerned when they hear a foreign government is part owner of U.S. companies. Several of those who testified were especially concerned with the China Investment Corporation (CIC), which the Chinese communist regime recently established.
"…most of us would see a huge potential for mischief if the U.S. government has an investment in one company overseas but not its competitors," said Senator Sherrod Brown (D-Ohio). "The China Investment Corporation has invested billions of dollars in Blackstone or Morgan Stanley. Can [their respective competitors] Carlyle or Bear Stearns rest easy that they will have an equal opportunity to get access to China's markets? And do we really think that nearly 10 percent is a passive investment in the practical sense of the word?" asked Sen. Brown.
China's CIC invested $3 billion in Blackstone Group LP in May 2007 and $5 billion in Morgan Stanley in December 2007, according to the testimony of Robert Dohner from the Department of Treasury. Both purchases were set to be less than 10 percent of outstanding shares.
"Governments are motivated by a broader range of factors than commercial investors," said Senator Jim Webb (D-VA). "While foreign governments may invest money in our country to make a profit, they may also do so in order to further their foreign policy ambitions, to acquire national security assets, or to purchase a stake in strategic industries."
"I have been particularly concerned regarding passive investments that may nonetheless provide foreign governments and state-owned corporations with control over sensitive national security information," Sen. Webb said.
"Some [SWF] funds are willingly transparent, like Norway's…Others, like the Chinese funds that bring us here today, obscure their investment strategies, and have unconventional investment patterns," said Representative Marcy Kaptur (D-OH).
Senator Webb noted as several others did that the Committee of Foreign Investment in the United States (CFIUS) has authority over all foreign investments. But he and others, such as Rep Kaptur, say CFIUS is too passive or unreliable, that significant foreign interests may be easily overlooked and difficult to investigate when the SWFs are so opaque.
Webb joined Senators Bayh and Dodd in writing a letter to Treasury Secretary Paulson that argued the need for the Treasury Department to further regulate and scrutinize such investments.
The USCC is a bi-partisan commission appointed by Congress that advises the Congress on US-China relations. Most of the lawmakers, government regulators, and experts from academia and think tanks who gave public testimony read aloud their written statements provided to the Commission and then took questions from the commissioners. The quotes used in this article are taken from the written testimony.
Sovereign Wealth Funds (SWF)—How Big?
There was agreement among those testifying that the amount of the world's SWF is estimated to be about $2.5 trillion in assets. And it is growing fast.
"Since 2000, the number of these state-owned funds has nearly doubled from 20 to almost 40 funds managing an estimated $1.9 trillion-$2.9 trillion of global assets," said Daniella Markheim of the Heritage Foundation. She relied on data from Simon Johnson of the International Monetary Fund (IMF).
Linda Chatman Thomsen, from the U.S. Security and Exchange Commission, said that SWF could grow as much as $12 trillion over the next eight years, which was close to Ms. Markheim's and Senator Webb's estimates from their sources.
How big is $2.5 trillion? $2.5 trillion is significantly larger in the assets managed by all the world's hedge funds or private equity funds, and SWFs are set to grow at a much faster pace, said Treasury Deputy Assistant for Asia Robert Dohner. But it is only a "fraction of all global investment," conservatively estimated at around $165 trillion, said Ms. Markheim, while Mr. Dohner put the figure at $190 trillion.
The three largest SWFs are investments from Abu Dhabi, Norway, and Saudi Arabia, said Ms. Thomsen. Each fund is valued at more than a quarter of a trillion dollars in assets. China's new China Investment Corporation does not fall much below that at $200 billion.
Where are the dollars for SWF investments coming from? For one, the U.S. huge trade deficits are the main source. "[China's] unfair trade practices contribute to the enormous imbalance of trade between the United States and China," said Sen. Brown.
Professor Peter Morici (University of Maryland) also mentioned the U.S. "tolerating foreign government intervention in currency markets," probably referring to China's manipulation of the currency.
Prof. Morici said that due to questionable lending practices (e.g., subprime mortgages), U.S. banks need massive infusion of capital that are difficult to raise from domestic sources. Sen Webb said the ascendancy of the SWFs points to the precarious financial position our country is in.
"Instead of rescuing our economy, these investments only deepen America's insecurity, forcing the U.S. further into debt to foreign interests," said Rep. Kaptur. "We cannot keep selling off our country; we cannot continue our excesses of spending and borrowing…, said Sen. Webb.
Two Opposing Views on SWF
The potential to distort the normal economic marketplace was discussed by Daniella Markheim, senior analyst at the Heritage Foundation. If sovereign investors manage assets in a way that promotes something else than a health return on the investment, the market forces would be skewed and resources not allocated efficiently.
Additionally, countries might use these funds to "destabilize markets, protect industries and companies, or even expropriate technology." She notes that France and Germany are taking measures to block SWF in their economies.
However, Ms. Markheim says the above fears are way overblown. SWFs have been around for some time and "there is little evidence that nations use their sovereign wealth funds to intentionally cause harm to the countries and firms they invest in."
She said it is not reasonable to believe that many governments—even those like China that don't always respect free markets—would intentionally acquire an asset for the purpose of reducing their own wealth.
"…the biggest threat to U.S. economic and national security is not sovereign wealth investment from China or any other country; rather, it is the increasing threat that the U.S. will adopt protectionist investment policies," said Markheim. She said that SFWs, when properly monitored and regulated, do not constitute a threat to America's national and economic security.
Sitting next to Ms. Markheim during this discussion was Alan Tonelson, representing 1,500 companies of the U.S. Business and Industry Council, and whose perspective was diametrically opposite to hers. For Mr. Tonelson, the benefits of foreign investment "fall far short of the dangers they pose."
Mr. Tonelson said he worries that the "ballooning role played by SWFs" poses major threats to the fundamentals of a free market—competition, equality of opportunity, transparency, and the free flow of information.
Tonelson noted a new focus of the SWFs that alarms him. He mentioned the sudden way in which state-controlled entities can mobilize capital, making huge investments in major American and foreign banks and brokerages. He also said we should be wary of the secretiveness of the operations of most SWFs, and of many of the governments involved, which are hostile to our national security.
Tonelson says the U.S. should not put itself in the position of having China, for example, holding significant stakes in American financial institutions. "…if our nation's current period of financial weakness persists, how willing would Washington be to stand up to Beijing in a Taiwan Straits crisis?"
We are standing at the beginning of the Age of SWFS, he said, and rather than wait until the threats are clear, we should act now to limit the power the SWFs in the American economy. Tonelson would have limits placed on the share of any one U.S. entity's assets that can be bought by SWFs and by government investors from any one country, for example, a 10 percent ceiling for foreign government ownership.
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