The Sovereign (Wealth) Question

Although still relatively murky compared to other investment vehicles, Sovereign Wealth Funds, or SWFs (in various complexions) manage around $3,000-4,000 billion of assets. They were instrumental in helping to recapitalize broken western banks in 2007/8, and if nothing else, perceived self-interest made sure that the global financial system was kept afloat. Citigroup, Merrill Lynch and Morgan Stanley were some of the gleeful recipients of sovereign funds; ironic, given that the US government had long billed sovereign funds as a potential threat to 'national security'. 'Poster boy of global capitalism' was perhaps a more fitting epithet given the losses incurred by the funds at Wall Street's behest.

Sovereign funds have traditionally looked to three core policy mandates: stabilization; long-term savings; and economic development - instantly dubbed the 'impossible trinity'. Systemically important players in SWF come not only from oil rich Gulf States, but also from Norway, Russia, China and Singapore.

But the mantra for sovereign funds is less about stability these days, and more about earning higher returns. This entails higher risk in terms of volatility, but more importantly, means investing in the East. This is where geoeconomic power is shifting, and the highest yields can be found. That applies as much to GCC funds as to those in Asia.

Moving East

China's changing role in the world economy is a case in point. Although the debtor-creditor relationship between Washington and Beijing is still hardwired into the global economy (in what economists dub 'imbalances'), it is becoming more than apparent that from the debris of the financial crisis, China no longer sees the US as a 'one-stop shop' for exports. The US has long relied on China to soak up its treasuries to keep credit lines flowing, but China is not only looking toward its own domestic and regional growth as an economic Plan B, it has also been busy recycling dollars into commodities as a massive hedge against the greenback and to drive growth. The activities of the China Investment Corporation and Chinese Development Bank directly reflect this shift; only last month, CIC took a $1bn stake in Noble Energy, adding to the $50bn (approx) that China spent on commodities in 2009.

In the long-term this poses serious questions for the US-China 'Chimerica' model should Beijing continue to focus on commodities and regional demand. The blunt question is who will be taking up the $9 trillion of new US issuances expected over the next decade if China turns its cheek? Few in Washington have credible answers beyond a nod to the Middle East, but even the Gulf States have serious concerns about the long-term value of dollar-denominated securities. Lax 'monetary policy' (in this instance, printing money) always comes with costs. Like their Chinese counterparts, the Gulf States are increasingly looking East to enhance investment portfolios, be it the Qatar Investment Authority, Abu Dhabi Investment Authority or the Kuwait Investment Authority. Fixed incomes, equities, infrastructure; you name it. All assets are up for grabs.

It thus comes as little surprise that a debt-soaked EU has been desperately courting investment for bond auctions. As government debt burdens spiral higher, and the eurozone tremors from turmoil in Greece, Portugal, Spain, Italy, Ireland and Belgium, it was ironically Germany that was first on the boat to Singapore and China. If Germany is actively courting buyers for bonds, the prospects for the eurozone look pretty bleak, particularly as Berlin has been unwilling to do the heavy lifting needed to stop the eurozone's rot. With a single eurozone bond seemingly as farfetched as ever and a fiscal union even more unlikely, weaker European states are forced to look to China as a sort of 'lender of last resort'. For China, Greece certainly offers politically interesting options for the Black Sea and Eastern Europe, but the appeal of other troubled European economies remains to be seen. One thing is for sure, however: China won't be doing it for the money.

A 'sovereign future'

The broader question of whether sovereign funds continue to grow or diminish down the line largely depends on how global imbalances, and associated movements in natural resources and commodity markets, pan out. At present more and more states want to join SWF ranks. Japan is considering establishing a SWF to raise returns on its $1,000 billion official reserves, while discussions are raging in Delhi about the possibility of setting up a commodities fund.

This rise of 'state capitalism' might well carry political baggage, but it is fast becoming a game that few states can ill afford not to play, not least because financial services inevitably evolve where capital actually sits - London, Frankfurt and New York might be top of the shop now, but it won't be long before we add Sao Paulo, Shanghai and Mumbai to the list. This is not to say that western fears of SWF funds as little more than political vehicles in disguise does not still hold water, but at this stage, engagement with them is a political risk that OECD countries would love to be able to take.

For all the talk of currency frictions and the specter of restrictions on capital inflows in the West, or worse still, full scale trade protectionism from Asian-led export growth, few deficit countries can afford to bite the hand that feeds them with capital. The 'state' and 'capitalism' have never looked so crucial for balancing 'sovereign debt' and 'sovereign wealth', but if creditors show mercy and come to our rescue, there is no doubt that it's those with the wealth who are in the ascendency. The fact that they have bigger and better games to play amongst themselves in Asia speaks volumes. We were the future once; but no more.