Sovereign wealth funds, many argue, aren’t new. Kuwait set up its fund in the 1950s, Abu Dhabi’s fund was established in the 1970s.

True enough. But this argument still misses a key point.

In the past, these funds were small. Now they aren’t. The existence of sovereign funds isn’t new. But their current pace of growth is. They now have a far bigger impact on the global economy – and particularly cross-border capital flows – than in the past.

And with oil now trading above $125 – and, at least according to Goldman – set to rise further, the Gulf funds in particular are poised to get even bigger. Fast.

We still don’t know exactly how big the Gulf funds now are. Abu Dhabi continues to insist that it cannot match Kuwait’s level of transparency. We also don’t know quite how big they will become. But it isn’t all that hard to come up with a guess.

If oil averages $115 over the course of 2008 (a price consistent with $125 a barrel oil for the rest of the year), the Gulf’s current account surplus should approach (if not top) $350 billion. The big existing Gulf funds (Qatar’s fund, Kuwait’s fund and Abu Dhabi’s fund) should get about $150 billion of surplus oil revenue to invest abroad. The Saudi Monetary Agency (and the new Saudi investment fund) should get another $200 billion.

The math isn’t hard. Brad Bourland calculates that the Saudis’ oil export revenues top $1 billion a day if oil is above $115 a barrel. The Saudis only need $55 a barrel oil to cover their budget. The rest is stashed abroad. And even more will have to be stashed abroad if the Saudis follow the IMF’s advice and tighten fiscal policy to fight inflation …

Rachel Ziemba and I have been trying to update our analysis of the Gulf’s foreign assets – and a key part of our analysis is trying to better understand how the big Gulf funds have evolved over time. Since the key Gulf funds don’t report data, this involves making some big guesses. However, it should be possible – using the information that the Gulf funds have released about the contours of their portfolio (most of the Gulf sovereign funds, for example, seem to have around 60% of their portfolio in equities) – and the balance of payments data to produce some estimates.

Our preliminary estimates suggest that there is something new about the current size and pace of growth of the Gulf funds. The 2008 increase in the foreign assets of the Gulf oil exporters should be roughly comparable to their total foreign assets at the end of 2000.

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In 2006, Norway’s Government Pension Fund (Global) — managed by Norges Bank Investment Management – famously bet against Iceland’s banks.

Norway claimed this was just business; Norges Bank believed that Icelandic banks were more risky than the market thought, and thus produced a trading opportunity. Iceland claimed Norges Bank’s bet was a hostile act by another government. The Economist:

IN REYKJAVIK almost two years ago the Norwegians were throwing their weight around and the locals were furious. Having spotted that an Arctic boom was about to end, a government-owned fund from Oslo must have thought it had found an easy way to make money in a market it knew well. It began to sell short the bonds of Iceland’s over-stretched banks. Only common sense, you might argue.

Halldor Asgrimsson, then Iceland’s prime minister, did not see things quite like that. Why was the Norwegian state investing hundreds of millions of dollars to undermine Iceland’s economy? Had not both countries signed a Nordic mutual-defence pact against financial destabilisation? “We must protest against this action,” he told Morgunbladid, a newspaper.

In 2008, Norway’s central bank agreed to lend some of its reserves – also managed by Norges Bank Investment Management – to Iceland. Norway, Sweden and Denmark agreed to enter into a swap contract with Iceland’s central bank that allows the Iceland’s central bank to acquire euro 1.5 billion from the other Nordic central banks in an emergency. David Ibison of the FT:

Three Nordic central banks unveiled an unprecedented €1.5bn emergency funding package on Friday to support Iceland’s troubled currency and stabilise its banking system as the tiny north Atlantic nation tries to fend off the effects of the global credit crisis. The plan allows Iceland’s central bank to acquire up to €500m ($775m, £400m) each from the central banks of Sweden, Denmark and Norway in the case of an emergency, the first time the region’s central banks have joined forces to help a troubled neighbour.

Norway is now effectively long Iceland’s banks – since Iceland’s central bank would, in an emergency, act as the foreign currency lender of last resort to Iceland’s banks.

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It is appropriate, I suspect, for my first post over here – and I want to reiterate my thanks to Nouriel for hosting my blog at RGE for the past 8 months even I after I moved to the Council – is on the latest Treasury capital flows data. The TIC data is both amazing – no other country puts out a comparable data series – and intensely frustrating.

The March data highlights why trying to read the TIC data can a challenge.

The data on long-term flows matches what we more or less know about the world. It shows a lot of official demand for US long-term debt — with total central bank and sovereign fund purchases of a bit less than $50 billion (mostly Treasuries). It also shows the ongoing absence of demand for US long-term “corporate” debt from either private or official buyers. Foreign investors sold more US corporate debt than they bought in March. That is a change from the pre-August 2007 world. Monthly purchases of $40-50 billion were the norm for a while.

The frustration comes from the data on short-term claims. A $34.1 billion fall in official short-term claims larger offset the $48.1 billion in net official (central bank and sovereign fund) purchases of long-term bonds. The resulting $14.0 billion total was further adjusted (by around $4.7 billiion) for principal repayment on asset-backed securities, producing $9 billion in net official inflows.

That isn’t much for a world where Saudi reserves are growing by $15 billion a month and Chinese foreign assets are growing by $50 billion a month. The total growth of central bank and sovereign fund assets now exceeds $100 billion in an average month.

Net private inflows were negative $48.2 billion in March – and only $35.3 billion for all of q1 — largely because of a huge fall in short-term bank claims.

The US needs a net inflow of around $175 billion to cover its external deficit, so that leaves a rather substantial gap. I doubt all of it was filled by FDI inflows.

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This is not a post about the gas tax. Nor is it a post about how the United States existing energy-inefficient capital stock makes it harder for the US to adjust to higher oil prices. Dr. Krugman has already covered that ground well. It is rather a post about how the global balance of payments has to respond to what increasingly looks like a significant oil shock.

If oil — using the price for sweet light crude — stays to $125 a barrel for the rest of the year, the average price of oil over the course of 2008 will be around $115 a barrel. The average 2007 price was around $70 a barrel. The $45 a barrel y/y increase in the average price of oil is equivalent to going from $25 a barrel oil to $70 a barrel oil in a single year. It is a large jump.

It would lead to something like a $650-700 billion transfer of wealth from the oil-importing economies to the major oil-exporting economies

Assuming that the oil exporters don’t spend and invest all that much more than they already were planning to do in 2008, the rise in the oil export revenues will translate into a comparable increase in the oil exporters’ current account surplus – and a comparable rise in the oil importers deficit. Of course, there will be some adjustment in the imports of the oil-exporting economies. But spending and investment in the oil-exporting economies tends to adjust with a lag to rises in the price of oil. And it was already on a sharply upward trajectory, in part because of the exceptionally low real interest rates in the oil-exporting world. If oil had stayed at its 2007 level, it is safe to assume that the oil exporters surplus – roughly $425 billion in 2007 according to the IMF – would have fallen by $100 billion, if not more.

The Spring IMF World Economic Outlook assumed that oil would rise from $70 a barrel to $95 a barrel average oil price — pushing the oil exporters (Fuel exporters in the WEO) current account surplus up to $620 billion. If oil says at $125 a barrel for the rest of the year and oil averages $115 a barrel for the year, the oil exporters’ current account surplus could approach $900 billion range.

That forecast assumes that the oil exporters collectively would need an oil price of about $55 a barrel to cover their import bill. It relies on a lot of ballpark math too — I haven’t done a detailed update of my 2007 paper on oil and global adjustment.

But in some sense, the precise details do not matter all that much.

We know that there will be a big rise in the oil-exporters collective surplus.

And we also know that there will also have to be a big fall in the oil-importers collective deficit.

This adjustment though could happen in a bunch of different ways.

The world, broadly speaking, has three oil importing regions – Asia, Europe and the US – and each imports roughly 15 mbds of oil. The US and Europe import a bit less, Asia a bit more. The EU (which excludes Norway) actually imports a bit less than the US these days – 13 mbd v 14 mbd. So the “shock” will in the first instance have a roughly similar impact on all three regions (all data comes from BP). Each region should see its deficit rise (or surplus fall) by around $200 billion.

Nothing though guarantees that the adjustment of various regions to an oil price shock will be symmetric. In the past, it actually has often been asymmetric. MORE FOLLOWS

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Sovereign funds argue that they are only interested in financial returns.

And to be sure, they do care about financial returns. Losing money generally isn’t good for a sovereign fund’s long-term health. But many are also expected to at least try to invest in ways that contribute to the economic development of their home country. This is often quite explicitly part of the fund’s mandate. Qatar’s investment fund indicates that its investment criteria include “economic synergies or benefits for Qatar and its people.”

Gerald Lyons of Standard Chartered has recognized that sovereign investments are sometimes motivated by concerns that go a bit beyond risk-adjusted return. Stephen Foley reported a while back:

Gerard Lyons, chief economist at Standard Chartered bank and a leading expert on SWFs, said in a recent panel discussion in Washington that funds’ behavior is likely to be a mixture of commercial consideration and “state capitalism”, where investments are likely to reinforce particular government goals, such as spurring the development of natural resources in Africa – already a key area of Chinese government investment.

Finding investments with positive spillovers and synergies is often hard — see Reuter’s Alan Wheatley for an excellent discussion of the constraints sovereign funds face. The most obvious way to promote domestic economic development would be to invest at home rather than to invest abroad. But if a fund exists to manage surplus foreign exchange accumulated to resist pressure for appreciation, it has to invest abroad.

Or at least appear to invest abroad. An investment abroad that triggers a reciprocal domestic investment doesn’t produce a net outflow.

Examples of investments that seemed geared toward promoting the home country’s own economic development are not hard to find.

Mubadala’s investment in Ferrari likely contributed to Ferrari’s decision to build a theme part in Abu Dhabi.

Dubai’s interest in the NASDAQ stemmed from its desire to cement its position as a regional financial center.

Dubai now seems to intend to use its sovereign fund – DIC – to raise the profile of the Dubai International Financial Center. DIFC has had trouble attracting listings. No problem. Firms that the DIC invests in will be encouraged to list on the DIFC. Roula Kalaf in the FT, last week:

DIC is putting $500m into the $1bn fund, set up with Hong Kong-based First Eastern Investment Group, and designed to invest in small and medium-sized companies with the hope of bringing some of them public on the Dubai International Financial Exchange.

While expressing his disappointment with the performance of the DIFX to date – it still has few companies trading and one expected initial public offering was pulled last week – Mr Ansari insisted that the exchange was headed for “revolutionary change” once its tie-up with Nasdaq is implemented.

The new Saudi fund — which thinks of itself as an investment fund rather than wealth fund — also seems to have a mandate that is focused as much on domestic economic development rather than increasing the returns on the Saudis investment abroad. The Saudi finance minister, quoted in Reuters:

“The focus at the beginning may be on the technology sectors, especially in the fields that could attract technology to the kingdom in alliance with global companies,” Ibrahim al-Assaf told Al Arabiya television. The focus would be on investments inside the world’s largest oil exporter, where opportunities abound, Assaf said, adding foreign investment was not ruled out.

Countries have long required that companies wanting to do business with their government show their bona fides by buying locally made parts. Airline orders are an example. Seeking to use the state’s buying power to spur economic development isn’t new.

However, the scale of the funds now at the disposal of many emerging market governments is something that is new. The Gulf’s city-states efforts to use their foreign investments to bolster their efforts to transform themselves into regional financial centers hardly seem to threaten US or European interests – or jobs. Europe, though, has been far more worried by the purchases of a stake in EADS by a Russia’s state bank. And it does seem — based on the Wall Street Journal’s reporting — that Russia’s government hoped that VTB’s stake in EADS would prompt EADS to do more to support Russia’s aerospace industry. MORE FOLLOWS Read more »

If all goes according to plan, my blog will be migrating to cfr.org later this week. The transition should be pretty seamless — at least that is the goal.

It obviously is a bit of a change for me, after being a part of the RGE site for so long. I am particularly grateful that Nouriel and RGE hosted my blog for the past several months, even after I moved to the Council on Foreign Relations. It also will be a bit of a change for the Council and for the Center for Geoeconomic Studies. I trust that the high quality of comments that has distinguished this blog will continue – and that the comments will remain focused on global economic issues. I’ll have more later in the week.

Peter Goodman looks at the dollar – and the growing dollar reserves of emerging market central banks — in today’s New York Times.

He captures the poles of the debate well. Ken Rogoff argues that it doesn’t make sense for poor countries to provide the US with a form of foreign aid by holding more low-yielding US assets that they need: “central banks know that holding these low-yielding Treasury bills is just an aid program to the United States.” Some analysts – a group that clearly includes me as well as Jim Fallows — question whether it makes sense for China to be financing, indirectly, real estate speculation in the US rather than schools in Shanghai.

“Investing money in the United States requires spending that much less on enormous problems at home, like pollution and a shortage of health care. By indirectly making mortgages cheap in the United States, China has helped foster the boom that saturated Miami with glittering condos even as tens of millions of Chinese live in dilapidated concrete block apartments.

Mike Dooley, on the other hand, argues that emerging market financing of the US is the best development program the world has yet devised. Emerging markets get a market for their exports; the US – uniquely – can run up big external debts without taking on a lot of currency risk because of the dollar’s global role.

There is a comparable debate over whether enormous central bank financing of the US is a “good” or a “bad” thing for the US. The growth of central bank dollar reserves has unquestionably provided the US with cheap credit. And many Americans are worried about the diminution of the dollar’s global status – in part because the shrinking international purchasing power of the dollar is a powerful symbol of America’s own shrinking global standing. It is hard to argue that it is “Morning again” in America when a dollar only buys 65 euro cents and, for that matter, when one dollar buys less than 1/100^th of a barrel of oil.

On the other hand, there is – I suspect – concern about the extent the US has come to rely on other governments rather than private markets for financing. A country that relies on other governments for financing – and to recapitalize its banks – potentially puts own policy autonomy at risk. And the US has traditionally valued its policy autonomy.

The US would like to maintain the dollar’s global status – and not run up ever larger debts to the People’s Bank of China and the Saudi Monetary Agency. Right now, though, the dollar’s global status hinges in no small part on their willingness to hold dollars. Seriously. It really is hard to overstate how much the dollar’s current status as a reserve currency hinges on decisions made by the King of Saudi Arabia and China’s Communist party. That Saudis are on track to add $200 billion to their reserves, and most will be dollars. The Chinese are on track to add $600 billion to their reserves (and perhaps more), and a large share will be in dollars. Those two governments alone could finance the US current account deficit if – and it is a big if – all existing holders of US assets were willing to hold onto their claims.

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Unless your family is in the wheat or beans business (wheat and soybeans exports have more than doubled when q1 08 is compared to q1 07; total food and feed exports are up 50% y/y), there actually wasn’t a lot to like in this month’s trade release.

Yes, the headline deficit fell relative to February, but February looks to have been a blip. The rolling 3m deficit has been stable at around $59.5b since December. And much of the fall in the deficit came from a big fall in the volume of imported petroleum. Petrol imports (in volume terms) were running ahead of last year’s pace in January and February. March brought the year to date total down below last year’s total, as the volume of imported crude was about 15% lower than the volume of imported crude last March. The fall in volume was large enough to offset a rise in price. The price of imported crude jumped from $84.76 to $89.85, but the seasonally adjusted US petrol import bill still fell by $2.2b, from $37.4b to $35.2b.

The real problem though was on the export side. Export growth looks to be slowing. The headline nominal growth numbers look good. Y/y non-petrol goods exports are up by a healthy 14.8% — far more than the 3.3% growth in nominal non-petroleum imports. But if the rise in agricultural exports and exports of industrial supplies (petrol, chemicals, metals) is stripped out, export growth was only up 5.2% 8.8% in nominal terms (oops; my bad).

Slower growth among those exports whose price hasn’t obviously increased is a warning sign.

A plot of real goods exports and imports shows a small monthly fall in exports in March.*

The data bounces around a lot, but it certainly seems that the pace of growth in real US goods exports is slowing. March real goods exports fell back below their level last June (see Exhibit 10). The usually reliable FT missed this part of the story, opting to highlight ongoing growth in nominal exports (“second-highest monthly” total in history despite the down tick from February) rather than the not-so-strong real growth.

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The US housing bubble. Bursting.

The “the triple bubbles in property prices, mortgage debt, and the shadow banking system.” Burst.

Soros’ thirty year super-bubble in leverage and financial assets. Bursting. Perhaps.

The bubble in Chinese stocks. No longer bursting. Who knows, China’s policy makers might even do enough to cause a bit of froth — if not a bubble — to reemerge.

Oil. Still going up. Maybe way up. And perhaps not a bubble. Perhaps the bubble that burst was the assumption that the supply of conventional (i.e. low-cost) oil was as elastic as it seemed to be in the 1990s. We still don’t know.

Emerging market government financing of the US and Europe? Still very bubblicious. Look at this chart, drawn from data presented in the statistical appendix of the IMF’s WEO.

The IMF data includes emerging market sovereign fund, the Saudis non-reserve foreign assets (which are counted as reserves) and valuation gains. It excludes China’s state banks and Asian NIE (Korea, Singapore, Hong Kong and Taiwan) reserve growth. Rather than do a ton of adjustments, I’ll just note that I believe that the increase in emerging market government assets that the IMF doesn’t pick up is about equal to the valuation gains that they include, so the overall picture isn’t that far off. The IMF data only covers the emerging world, so it also leaves out Japanese reserve growth and the increase in Norway’s sovereign fund. Together they amount to about $100 billion.

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The blogosphere’s eyes and ears in the London foreign exchange market — Macro man — thinks so. China has, he thinks, been a net seller of euros over the past few weeks.   That is something of a change.  It has been a large net buyer for some time — whether to hit its portfolio targets or in an effort to push the dollar share of its reserves down a bit.
If China’s foreign assets are rising at an annual rate of between $600 billion and $700 billion — as Wang Tao, who just moved to UBS, believes — just maintaining China’s existing portfolio targets might require selling something like $200b of dollars for euros a year. That amounts something like $1 billion of sales a business day, minus whatever euros come directly into the central bank from its intervention in the euro/ renminbi market. My calculations assume the central bank intervenes entirely the dollar/ renminbi market.

I find Macro man’s anecdotal evidence plausible because something clearly changed about a month ago.

Once the RMB reached 7, its appreciation against the dollar stopped cold.   Over the last month the RMB dollar looks a lot like a tightly managed peg.

That clearly reflects a policy decision inside China.   And it possible that China made a two-fold decision, first to slow (or stop) the appreciation against the dollar and second to do what it could to push the dollar up against the euro.    Stopping dollar sales is a rather obvious way to support the dollar if you are a big net seller.

The idea behind such a strategy would to be to get real appreciation through dollar appreciation rather than through renminbi appreciation against the dollar.   Or to get Europe off China’s back once China decided to slow its own appreciation against the dollar.  Or perhaps just to try to profit from a view that the euro has risen to the point where it is likely to fall.

I of course don’t whether China has actually scaled back its euro purchases. I would be curious what other think.  And I certainly don’t know if the decision to scale back euro purchases was tied to the decision to slow the RMB’s appreciation against the dollar — that is pure speculation on my part.

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