No replies to this topic

[TTHQ Staff]

BEING STREET SMART
___________________

Sy Harding

WILL FOREIGN GOVERNMENTS BUY THE U.S.? September 28, 2007.

Traditionally, governments fortunate enough to have trade surpluses have invested those surpluses in the treasury bonds of those nations with which they have the surpluses. So, it’s no secret that, thanks to record U.S. trade deficits, foreign governments are large holders of U.S. treasury bonds.

Every once in awhile someone expresses concerns about so much of the debt of the U.S., now the world’s largest debtor nation, being held by investors, including central banks, in Japan, China, Brazil, etc. But the worry soon dies down, since no one has the slightest idea of how the problem could be resolved.

However, a new concern has emerged this year, and it is not be too late to do something about it before it also becomes too gigantic a problem to solve.

I refer to the promulgation of so-called ‘sovereign investment funds’ being established not by foreign investors, but by foreign governments. Their purpose is to invest some of their foreign exchange reserves not in the bonds (debt) of other countries, but in hard assets, natural resources, and corporations in those countries.

Sovereign investment funds have been used by Alaska, Kuwait, the United Arab Emirates, and Norway among others, to manage their economies more efficiently, using oil profits when oil prices are high to invest in financial assets, looking to the future when their oil reserves will be depleted.

However, the amounts of money that governments have been moving into such funds, the secrecy of the funds, and the move this year by Russia and China to join the party, has raised concerns around the world.

The International Monetary Fund, estimates there is already more than $2.5 trillion in these sovereign funds (which significantly exceeds the assets of all the hedge funds in the world).

The IMF’s concern is that in international finance, “There is an increasing amount of money flow going through ‘black boxes’. Hedge funds are black boxes. And now sovereign funds are black boxes. We don’t know what happens within them, and we should be worried about that.” Among the concerns are not only what they are buying, but how much risk-leverage is being employed.

Some on Wall Street, probably salivating over the potential fees and commissions, are not concerned about it. They ask, “What difference does it make who pours money into U.S. corporations? It would be great for our economy and stock market.”

However, a growing number of political and economic analysts worry about foreign governments (not individual investors) becoming even minority owners of U.S. banks, brokerage firms, and stock exchanges, and being able to affect the U.S. banking system. Others are concerned that foreign governments could gain too much knowledge about U.S. military and security operations by investing in defense-related corporations.

Most governments have restrictions on whether even individual foreign investors can invest in their markets, and many who do allow foreign investors have various restrictions. I doubt that any would allow the U.S. government itself, for instance the Federal Reserve, or the U.S. Treasury Department, to buy into businesses in their country, and certainly not in businesses that affect their financial or defense systems.

In the U.S. we have few restrictions. There was only a brief debate last spring when the government of Dubai, through its sovereign fund, wanted to buy the company that controls numerous U.S. ports of entry. A few assurances were given, and the deal went through. Can you imagine Germany, or Russia, the United Kingdom, Japan, or China, allowing the U.S. government to own a company that controls their ports of entry? Of course not. It is possible to carry the notion of a free market system too far.

This month it’s in the news that oil-rich Dubai is moving to buy 19.9% of the Nasdaq stock exchange in the U.S., and 28% of the London Stock Exchange.

It’s not just that foreign governments can wind up gaining too much inside information from key U.S defense, medical, or financial institutions.

There is also the risk that what goes in can just as easily come out. It is not too difficult to imagine a time when a group of countries unfriendly to the U.S., unable to negotiate a resolution of their grievances, and unable to wage conventional warfare, could easily send our economy and financial system into a tailspin by simply selling hundreds of $billions of leveraged assets.

More effort needs to be put into analyzing the situation in its infancy, while there is still time.

And time will soon be running out. This weekend the Chinese government finally launches its sovereign wealth fund, which it will call China Investment Corp. It will be initially funded with $200 billion, with plans for more. Without waiting for the fund to be formed, the Chinese government made the first direct investment from its massive $1.2 trillion of foreign exchange reserves into a foreign company a few months ago, when it invested $3 billion in the U.S.-based Blackstone Group.

Perhaps there’s no problem. But the thought of black boxes secretly controlling even more assets than hedge funds, and controlled by governments that may not always be friendly to U.S. interests, is not a calming thought, especially after the financial system’s experiences of recent months.



Sy Harding is president of Asset Management Research Corp., publishes the Street Smart Report newsletter, and a free daily Internet blog at www.SyHardingblog.com. He also authored the 1999 book Riding The Bear – How To Prosper In the Coming Bear Market.