While Brad is away your widsdom is overwhelming. No critical comments on my part this time. Although, a little shift in the rationality with which I endowed my character could mean a challenge. For instance suppose that politicians in SWF states had good (i.e. selfish) reasons for having SWFs. What about stationary bandits? Autolycus is no Zhuge, but Zhuge never had real power. Figure this one out over the weekend.

GIC is partially a SWF, partilally a CB (remember that GIC also invests on MAS’s behalf. Its funding is GVT o S accumulted budget surpluses, CPF funds (not much these days) and anything else that is not funding Temasek. Temasek should be a stand alone entity, but who knows it may borrow from CIC, or one of its own minority investments like DBS. Perhaps Mr Dhanabalan or mr Qianlong knows. If they spend their time wisely, they will surely set some time aside to read this blog.

But really, if Temasek is an SWF what are other state conglomerates? Does it matter if state owned conglomerate is owned by a government that calls itself democratic, or a less hypocrite one that calls a spade a spade and simply trie s to delver “good government”. Anyone interested in Singa pore should, of course, like Twofish, familiarize with the Greek classics.

SWF is simply a term coined by a few salesmen in an investment bank to differentiate certain clients from the genus “central bank”. Same discretion, ;less boring (and unprofitable) product range, and with a little bit of luck managers who consider themselves sophisticated. I have a lot of respect for the people at both GIC (a true SWF and a very experienced and well run one) and at Temasek. It makes me wince what some people write about these entities, but perhaps tthe Spore gvt should stop trying to be an unusually good one and make fewer ennemies among he people who try to make a living off the vain and gullible. Being a staunch ally of the US does not mean that the nation’s wealth must be handed over to the wizards of Wall Street.

Probably, Judy, you’ve caught my drift. I doubt many others have.

I think your factbook dates back to the time of Upper Volta. German and French government debt alone amounts to over $2.7bn outstanding, and then there are other reasonably liquid AAA bonds such as Dutch State Loans. There are about $2bn of Italian government bonds, and lots of covered bonds which might be regarded as the equivalent of agencies.

Central banks may use SDR BIS deposits because they are administratively convenient (like holding an index fund instead of the index) or because their base currency is SDRs.

Bank of China has cut its portfolio of securities issued or guaranteed by troubled US mortgage financiers Fannie Mae and Freddie Mac by a quarter since the end of June.

The sale by China’s fourth largest commercial bank, which reduced its holdings of so-called agency debt by $4.6bn, is a sign of nervousness among foreign buyers of Fannie and Freddie’s bonds and guaranteed securities.

Foreign investors have been a mainstay of the market for such debt, but uncertainty over the mortgage financiers’ capital positions and the timing and structure of a potential government rescue has made some investors reassess their exposures. Asian investors in particular have become net sellers of agency debt, said analysts.

Federal Reserve custody data shows that for the year to July, foreign official and private investors bought an average of $20bn of agency debt a month, including debt issued by other government agencies such as Ginnie Mae and the Federal Home Loan Banks. Purchases of US Treasuries averaged $9.25bn.

From July 16 to August 20, foreign investors sold $14.7bn of agency debt, trimming their overall holdings to $972bn. They purchased $71.1bn of Treasuries in the same period…..

Chinese skyscraper builders to put up equivalent of 10 New Yorks, says Rio Tinto
Wednesday August 27 2008
http://www.guardian.co.uk/business/2008/aug/27/riotinto.commodities

Rio Tinto yesterday shrugged off talk of an impending collapse in the commodities market, pointing to recent research that suggested China will build up to 50,000 skyscrapers in the next 20 years, the equivalent of 10 New Yorks, creating sustained long-term demand for steel and other raw materials.

Metal prices have come off their highs after five years of strong growth, but Skinner said the credit crunch had had only a “modest” impact on Rio’s markets.

The company said that North America and Europe were becoming decreasingly relevant to the setting of metals prices, as demand is driven by China, India and other emerging markets – Chinese imports of iron ore are running 20% ahead of the same point last year. In the first half of the year, Rio lifted prices of iron ore by an average 86% compared with 2007, even as economies in North America and Europe were weakening. The average copper price charged by Rio in the first half was 20% higher than last year, gold was 38% higher and aluminium prices were up 2%. The company said 2009 was likely to be the sixth successive year of higher prices.

By 2025, the report predicts that China will have 221 cities with more than a million inhabitants, compared with 35 in Europe today. As well as the need for huge spending on infrastructure, McKinsey projects that China will build between 20,000 and 50,000 skyscrapers, many of them in less developed interior provinces far from Beijing and Shanghai.

If your performance is absymal then your boss gets annoyed and you lose your job. Also it’s standard in finance to have performance related bonuses so your salary depends on how well you do.

However, defining performance is very, very tricky. For example, if you define performance as the amount of return then the money manager is under huge pressure to take lots of risks to maximum return since if he wins the lottery, he makes megabucks, but if he loses then it doesn’t matter if he loses $10,000 or $10 billion, he is going to get fired anyhow. And then you have the ‘who watches the watchmen’ problem. You are hiring the money manager because he supposedly is an expert, but then who tells you that he is an expert, and then who tells you that the person that tells you that he is an expert is an expert…. etc…. etc…

However, these are some well known problems in portfolio management, and people have come up with solutions to these problems. Curiously, I’m not worried about accountability. In most private corporations, senior management is effectively not accountable to anyone. Theoretically they report to the shareholders, but because shareholders are unorganized, there’s pretty much nothing that they can do. If you end up losing a bunch of money in the Russian, Chinese or UAE SWF, someone is going to be very upset, and they are going to have the will and ability to do something to you.

You actually see this in the case of CIC, in which the bad banking investments it made last year have seriously damaged its political authority.

The things that worry me are:

1) small countries. China and Russia can afford experts to manage their SWF’s, but I worry about Upper Volta and Mozambique. This is a huge problem in the US because there are horror stories about small counties and states just not having the right managers and they end up relying on salesman to make investment decisions. The fact that you had all of these salesmen telling people that GSE corporates are the same as agency pass-throughs worries me.

2) coordination. Country A does something that seems rational. Country B does something that seems rational. Country C does something that seems rational. Put them together and then they end up messing up the world economy. This also happened with quant hedge funds last year. The IMF working group on SWF’s seems like a reasonable forum for SWF’s to talk to each other about what they are doing. The trouble then becomes that no SWF is going to discuss what it is doing if it is going to be in tomorrows Wall Street Journal.

3) complexity. The world financial system is just getting more complicated, and we are doing things that have never before been done in human history. Unexpected things will happen.

Rien

So what would you see GIC as? Temasek may not have started off as SWF but it has almost definitely been behaving like one. Is it really just the name or the function?

In the case of the China Investment Corporation, investing in financials seemed like a good strategic move at the time, However these were small experimental investments, and when they seem to have blown up there seem to have been a lot of political ramifications back at home.

One thing about managing a $700 billion fund is that there are just limits to what you can do. If you have $50 million, you can do matress arbitrage which means that if things get bad, you go to the bank, make a $50 million withdrawal in paper money and the stuff it into your matress so that you worst possible return is zero percent.

You can’t do that with $700 billion. There is only about $900 billion in paper money in circulation, and so getting to the point where you end up with zero percent return is non-trivial.

Yes and yes.

Rebel: I know a little about the BIS, and I dare say that they would accept an SDR deposit from a central bank in the order of a few billion dollars worth.

That’s fine. However, what if someone wants to deposit US$500 billion instead of US$5 billion? Also what does the BIS do with a US$500 billion deposit. Well it has either absorb currency risk or split them out into the various parts and then invest those funds, but then what’s the point of doing that, since the investor can do currency allocations by themselves.

Rebel: I would expect settlement to be in the dollar, euro, yen and sterling constituents of the SDR though.

In which case, what’s the point of buying SDR’s rather than the constituents directly?

Rebel: There are enough AAA euro government bonds, plus supranationals etc to absorb as large an allocation to the euro as most central banks or SWFs would like to make.

There are about $4.3 trillion in treasuries and then another $4 trillion in GSE’s. There is about $2.5 trillion in EU national government debt, and EU rules prevent the amount of EU national debt from increasing substantially, so if SWF’s where to suddenly move from US treasuries to French/German treasuries, there isn’t an coordinated way of increasing the supply of EU national treasuries.