One of the more striking changes in the global financial landscape over the past decade has been the shift in financial power away from the United States and toward a number of East Asian and oil-exporting countries. A reflection of this shift has been the proliferation of sovereign wealth funds (SWFs), the state-owned funds managing these countries’ foreign assets. Although SWFs have been around for a long time, they are now growing at an unprecedented pace. In 1990, SWFs had worldwide assets totaling less than $500 billion; by the end 2007, that figure had swelled to around $2.5 trillion. This makes SWFs almost twice as large as all the world’s hedge funds and private equity funds combined. On present trends, SWFs could easily amass between $10 trillion and $15 trillion in assets by 2015. 

In August 2007, China announced the creation of the Chinese Investment Corporation (CIC), whose initial endowment totaled $200 billion. More recently, the CIC and other SWFs have acquired significant stakes in some of America’s most venerable financial institutions. After getting clobbered by the subprime mortgage crisis, Merrill Lynch turned to Temasek, the Singaporean wealth fund, to which it sold a 9.4 percent investment stake; Morgan Stanley sold a 9.9 percent stake to the CIC; and Citibank sold a 4.9 percent stake to the Abu Dhabi Investment Authority. 

These events have spawned a vigorous debate over the potential “threat” posed by SWFs. Will their overriding goal be the maximization of commercial returns? Or will they be used by their governments to attain political objectives that might conflict with U.S. interests? 

On present trends, sovereign wealth funds could easily amass between $10 trillion and $15 trillion in assets by 2015.

At one end of the debate is the U.S. Treasury Department and former Treasury officials such as Ted Truman and Randall Quarles. They believe SWFs will help forestall an outbreak of financial market protection that would be inimical to America’s long-term economic interests, and thus they favor a voluntary code of conduct for SWFs, to be worked out by those funds in tandem with the International Monetary Fund (hopefully by the time of the IMF’s annual meeting in October). 

Treasury hopes that such a voluntary code of conduct would include clear commitments by SWFs to invest commercially and not politically. Indeed, Treasury is insisting that SWFs operate in a fully transparent manner, along the lines of the Norwegian Wealth Fund, which would make it easier for recipient countries to accurately gauge their intentions. It goes without saying that Treasury also hopes that the SWFs adopt strong risk-management systems, governance structures, and internal controls. 

At the other end of the debate are old China hands, such as Patrick Mulloy of the U.S.-China Economic and Strategic Review. Mulloy thinks the United States is being far too complacent about the investment intentions of countries like China and Russia. He says that proposed investments by these countries in U.S. companies should be subject to more stringent national security reviews, even when they are only acquiring minority stakes in American firms. He is also highly skeptical of the IMF’s ability to influence Chinese investment practices, especially given the organization’s lack of success in getting China to stop manipulating its currency. 

Maintaining open global financial markets without imperiling U.S. political interests will not be an easy task. It certainly will not become any easier as SWFs balloon in size and seek fresh investment opportunities. Whatever else they do, U.S. policymakers should seek to reverse America’s dismal savings rate, which is what made the country so excessively dependent on foreign capital in the first place. 

Desmond Lachman is a resident fellow at the American Enterprise Institute.

Image by Darren Wamboldt/The Bergman Group.