- The Washington Times - Monday, March 24, 2008


There is a rising chorus from Capitol Hill and beyond warning about the risk that sovereign wealth funds (SWFs) especially those of nondemocratic governments, pose to America’s national security and economic sovereignty. Sen. Evan Bayh, Indiana Democrat, chairman of the Senate Banking Subcommittee on Security and International Trade and Finance, recently argued: “Occasionally, foreign governments will have agendas different from our own. They will pursue them using all resources at their disposal, including financial levers. No great nation can permit such interference with its sovereignty.” Such vagueness cannot be the source for good public policy or protect U.S. investors against the loss of capital freedom.

“If sovereign wealth funds become the global investor of last resort,” the senator also claims, “recipients of their largess in times of distress will have enormous incentives to comply with all manner of requests.” But foreign governments have no jurisdiction in the United States. Moreover, the recently revamped Committee on Foreign Investment in the United States has sufficient authority to vet foreign direct investments that prove to be credible threats to U.S. security.

In fact, SWFs are typically strategic investors with long-run economic goals, and they are sensitive to political backlash from home and abroad. China’s newly formed SWF, the China Investment Corporation (CIC), has no intention of getting involved in another imbroglio like the China National Offshore Oil Corporation’s (CNOOC) bid for Unocal that Congress short-circuited.

More important, one could make a strong case for diversification of SWF portfolios, given the falling dollar and the fact that the People’s Bank of China now holds foreign exchange reserves worth more than $1.5 trillion. So far, the CIC has acquired about $200 billion, with the majority of it going to domestic financial firms. Of the $60 billion or so that that will flow into foreign investments, the initial $3 billion CIC injected into the Blackstone Group has already lost about a third of its value.

An iron law of economics is that when you are spending or investing “other people’s money,” as in all cases of government largesse, inefficiency and corruption will follow. No one is as careful with the taxpayers’ money as with their own. The real question is why China does not allow its citizens to gain control over so-called state assets by widespread privatization, including the establishment of private mutual funds using excessive foreign-exchange reserves. Most of those funds would be invested in China, the world’s fastest-growing economy, rather than in U.S. government securities.

Creating fully funded private accounts, in which the Chinese people could hold foreign as well as domestic assets, would give the Chinese people a stake in the future of global capital markets and help liberalize their own.

At present, the Chinese government is the largest holder of U.S. government debt. China’s willingness to hold dollar-denominated debt helps reduce U.S. interest rates, and it allows the U.S. government to expand at lower cost and thus a faster rate than would be possible without external financing.

Absent the ideal of widespread privatization in China’s socialist market economy, establishing an SWF that invests in the U.S. private sector would give China a greater stake in global capitalism. Moreover, as China’s state-owned enterprises move closer to the market, discover the value of diversification and are held responsible for their investment decisions, market liberalism will take a firmer hold in China.

Deputy U.S. Treasury Secretary Robert Kimmitt has called SWFs “a force for financial stability,” but others have resorted to hyperbole to frighten the American public. In his testimony before the U.S.-China Economic and Security Review Commission in February, Peter Navarro, an economist at the University of California-Irvine, criticized China’s unfair trade practices, especially the undervalued yuan, and argued that “China’s SWFs threaten a loss of American sovereignty.” The danger, Mr. Navarro said, is that China might use its vast foreign reserves to destabilize the international financial system in times of conflict and thereby bully American politicians into submission.

Blocking foreign investment in U.S. assets when there is no real security threat while demanding full access to foreign markets smacks of “investment protectionism.” If foreign governments are not allowed a wide range of investment choices in the United States, they will take their business elsewhere. Without external financing, the U.S. current account deficit would not be sustainable at current levels and the economy would have to contract. The United States would face a deep recession, and the dollar would ultimately lose its status as the key reserve currency.

For its part, China would do well to listen to Justin Yifu Lin, the newly appointed chief economist at the Word Bank. According to Mr. Lin, “It is essential for the continuous growth of the Chinese economy to establish a transparent, rule-based, legal system that protects property rights so as to encourage innovations, technological progress, and domestic as well as foreign investments in China.”

The United States, meanwhile, needs to address its lackluster private domestic saving and its growing fiscal deficit not by increasing taxes but by reducing the size and scope of government. The danger is that sovereign wealth mania will accelerate and result in costly protectionism under the guise of safeguarding U.S. sovereignty. In reality, such a policy would destroy the individual sovereignty that is at the heart of the American dream.

James A. Dorn is a China specialist at the Cato Institute and editor of the Cato Journal.

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