The short answer is: something the United States will never have. The long answer is quite fascinating. But in order to understand a sovereign wealth fund we must first look at government budgets. In the United States for the last few years and the next few years we are expected to run a budget deficit. That is to say we will spend more money than we’ll make. These deficits are financed by debt, which we often refer to as Treasuries.
But what happens when your budget runs a surplus? In our case of course we should pay down some of that debt. But what do you do when you don’t have much debt to pay down or any at all? You have two options. You can increase your budget to make the surplus a break-even budget, or create a sovereign wealth fund.
So what is a sovereign wealth fund then? It’s basically a government investment company. Like any investment company the objectives vary from fund to fund. Many seek to provide stable and safe returns that may support their own future monetary needs. Were the US to have one they could have used it as a government stimulus, or to cover a shortage of tax revenue, or even to add to the Social Security fund. All over the world these funds exist for various needs. The Australian Government Future Fund is expected to be used to help fund the pension of government employees. Russia has a reserve fund and a wealth fund. The reserve fund is meant to protect from oil revenue shortfalls and any overflow over 10% of GDP goes into the wealth fund. Sometimes the fund just tries to generate a decent return that can be thrown into the government’s normal revenue stream, like in Alberta, Canada.
So what are these SWFs investing in? They are as diverse as hedge funds. Some limit themselves to just the most conservative investments, like government or corporate bonds. However many have the freedom to take greater risks than that. For example, the Kuwait Investment Authority owns 6% of Citigroup. Hedge fund and investment company Blackstone has the China Investment Corporation as a shareholder. In fact, a number of these funds made bad investments in Wall Street firms in 2007. You likely won’t see many of these SWFs investing in index funds and mutual funds because they are so big they can do this on their own for cheaper. Though data is limited, it is not out of the question that some of these companies may invest in oil futures, options, and currencies. More recently, many have started buying up bad loans and real estate being dumped by all the name-brand financial institutions around the world
Now these funds seem like a good idea for the countries they represent, but it isn’t always a bed of roses. As these funds grow, their potential to cause political problems grows too. Their vast wealth could eventually become a political weapon. A SWF could corner an entire industry and hold it hostage given enough funding. With so much foreign investment in American finance, a conflict of interest could arise between helping the typical American customers and strong-arming the American government. Political tension is never fun. As long as these funds focus on investment gains instead of political ones there shouldn’t be any problems, but the temptation exists.
On top of geo-political issues, the thought a wealth of cash to spend is hard to turn down for many politicians. The United States has used the Social Security surplus to make up for budget shortfalls. If a sovereign fund exists simply to fund a pension like Australia’s, then some politicians may be interested in using that money for something else. This has been proposed. If the US had a sovereign wealth fund just for one purpose, like Medicare, I’m very confident our government would borrow some of that money to meet a need that has nothing to do with Medicare.
The sovereign wealth funds vary widely in the amount of money they have. The largest is getting close to $1 trillion in assets (Abu Dhubi Investment Authority ~ $875 billion) while others have much smaller funds (Iran Stabilization Fund ~ $13 billion). Many of the countries with SWFs are oil rich, while it seems others have become wealthy by producing for the US, such as China and South Korea. Since these funds a relatively new in the investment world we don’t yet know how functional they are. They certainly make sense for countries that have literally more money than they know what to do with, but we have yet to see any one fund really need to draw on these resources. These are little more than powerful emergency funds so what happens to Wall Street when an oil crisis forces all the oil funds to sell their holdings in New-York? Hopefully we’ll never find out.
 By The Weakonomist |
The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice. |
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