The danger of sovereign wealth funds

by Shaun Seifert

Dangers emerge when foreign governments buy up American assets.

SWFs are state-controlled entities consisting of various financial products such as stocks, bonds, and other liquid assets. Cash reserves that have funded SWFs have accrued from several sources such as foreign currency deposits, gold holdings, Special Drawing Rights, petroleum, and state pensionsSWFs are essentially a byproduct of globalization. SWFs are growing larger and at a much more rapid pace with less transparency than the world’s hedge funds.

[More]Foreign direct investment has a homogeneous relationship to SWFs.  However, SWFs present a parlous and menacing quandary. SWFs maintain a distinction from run of the mill foreign direct investment in that SWFs are by definition state controlled. This is not a trivial difference; it is of great distinction and requires meticulous attention. It needs to be empathically stated that this is not a protectionist position. Protectionism is a means of reaching an economic policy goal, whereas being concerned with and vigilant of ownership by a foreign government is solely based on national security. Protectionism is concerning oneself with ensuring jobs remain in the domestic marketplace; national security is concerning oneself with ensuring Americans are alive whether it is to go to work or collect unemployment. The safety and security of Americans takes, and should take, precedence over economic interests.

Maximizing returns long-term may only be the stated goal of foreign governments in creating SWFs. The true intentions of states in creating SWFs can be masked under the veil of economic interest, while offering cries of protectionism as an antidote to security concerns. State-controlled entities have the possibility of enabling governments to leverage their authority to protect their own interest and reach political and/or military goals that are favorable to that interest. Foreign governments can also leverage their ownership in a way that allows them access to sensitive technology which has the potential to highlight vulnerabilities within the information infrastructure and intellectual property of the United States.

States do not have to acquire majority interest (control of 50% or more of the voting stock) or even insider ownership (control of 5% or more of the voting stock) to wield an influential hand in furthering their interest. SWFs could consist of only a small percentage (below 5%) of a specific company’s stock but could do this across an entire industry giving them a large market share of a sector. This prospect is exceedingly more alarming if it is a natural resources industry being acquired regardless of if said companies reside within the U.S. or not. As a country, we consistently rely on natural resources from areas across the globe. If a state controlled fund begins to amass a controlling interest in any sector on which we depend, it can potentially have negative implications with respect to our national security. This is true of industries that do not have direct ties to security infrastructure; if a foreign state can single handily cripple the day-to-day operations of the U.S. economy, we are in grave danger. The irony, or more aptly described telltale sign of the precarious nature of SWFs, is that countries which create and foster SWFs are not countries generally known for their strong belief in or fostering of the principles of capitalism within their own borders, yet they are adamant about exploiting capitalism within the borders of other sovereign nations.

As economies of the world aggregate, monitoring the growth and operation of SWFs becomes an ever-more delicate and indispensable task. The newest legislation that touches on this issue, the Foreign Investment and National Security Act of 2007 (P.L. 110-29), legislates that CFIUS and the president must evaluate transactions resulting in foreign government control. CFIUS only concentrates on transactions taking place within the U.S. though. There is no investigative body for transactions taking place outside the U.S., which as previously stated, can just as easily impact our national security and economic interest. The IMF addressed the issue of SWFs at their most recent meeting in October, but they failed to even acknowledge that SWFs pose a national security risk. The IMF considers such cautious views of SWFs egregiously wrong as protectionism.

Corporate mergers and subsidiaries through which purchases can be made to expand SWF holdings also demand close scrutiny. While such transactions (conducted as part of a merger or through a subsidiary) are legal and thus somewhat easier to audit, far more secretive and as a result threatening are transactions peppered with illegality. Electronic fund transfers with the ability to move trillions of dollars with a little pointing and clicking provide a vehicle for money laundering, making it difficult if not impossible to determine who actually owns what.

States leveraging their cash balance to purchase private property has the potential to quickly metastasize into an ever-more hazardous situation as power and control over enormous influential sectors become consolidated into the hands of actors as a means of reaching political and military goals at the peril of the West. The argument that countries holding SWFs will have too great an economic interest to use such transactions as anything beyond furthering their own economic interest does not hold water. When someone makes a purchase, even if it is just to buy a newspaper for a $1, that person has reasoned that the newspaper is worth more than a $1 to them; if it were not, they would continue to hold the $1. If a foreign government creates a SWF and through it acquires a strategically important company or swallows up an entire sector, and if the political or military goals of that country are perceived by its leaders to be worth more than the actual dollar value, there is no reason they would not forsake their economic interest to further their political and/or military interest.