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Bonfire of sovereign wealth funds?

by Brad Setser
November 25, 2008

Only a few sovereign funds disclose their performance. But it reasonable to think that many sovereign wealth funds – particularly the well-established funds that invested heavily in equities – have had a bad year. Any sovereign fund overweight emerging economy equities – say those who were seduced by talk of a new Silk Road linking the Gulf to Asia – would have done worse. Ask some prominent US institutional investors.

Indeed, the United States Social Security Trust Fund likely has outperformed most sovereign funds over the past few years. The Social Security Trust Fund invests in nothing other than US Treasuries. That currently looks to have been a good choice. An enterprising Norwegian journalist supposedly has calculated that Norway would be better off now if it had just put all its spare oil revenue in the bank.

The fall in equity markets this fall implies that sovereign wealth funds now likely manage far less than $2 trillion in foreign assets. We don’t know how much sovereign funds had at their peak — in part because there isn’t a consensus on what constitutes a sovereign fund and in part because key funds don’t disclose much. And we don’t know how much they have now. But if funds that have been managed by central banks and invested fairly conservatively (Russia’s future fund as well as the non-reserve foreign assets of the Saudi Monetary Agency) are excluded, the size of the external portfolio managed by sovereign funds likely fell this year. Sovereign funds received large inflows in 2006, 2007 and the first half of 2008 – high oil prices increased inflows into many existing funds and new countries created funds.

Norway offers a case in point. I think it had around $380 billion in assets earlier this year. It now has around $300 billion. Norway has more exposure to Europe than most funds, so it has been hurt by the euro’s fall against the dollar. But it also has a relatively high share of its assets in bonds, which helped. It probably isn’t atypical.

The confluence of four trends suggests that the sovereign wealth fund moment has passed – at least for the time being.

— One, sovereign funds are fundamentally vehicles for investing government funds in equities and equity markets have not performed well. Nor for that matter have many “alternative investments.” Hedge fund returns have been not been great – and have been correlated with the equity market. Private equity is still “equity.” I would guess that London real estate isn’t doing that well these days.

Some countries with sovereign funds are subject to democratic pressure and it isn’t clear that there is still consensus in those countries to put public money at risk of (further) large losses. Korea is the most obvious example. Norway’s fund argues that the fall in equity markets provides an ideal time to rebalance Norway’s portfolio toward equities. Perhaps. I will be interested to see if the formal release of Norway’s third quarter results triggers a debate inside Norway over the wisdom of adding to Norway’s equity exposure. My guess is that Norway hasn’t been able to rebalance its portfolio fast enough to offset the market’s fall, and its “equity’ share is now well below target.

— Two, lower oil prices will dramatically reduce new inflows into sovereign funds. The biggest inflows into sovereign funds generally have come from the oil funds – not from the reallocation of Asian central bank reserves toward sovereign funds. But as long as oil stays at $50-55, only Norway will be adding large sums to its sovereign fund. Abu Dhabi, Libya and Kuwait might still be adding to their funds. But not at the same pace as in recent years. And not if they have to bail out domestic banks and prop up domestic stock markets. Reports suggest that Kuwait is now selling foreign assets. if true, that is a rather large change. Indeed, with oil at $55, several countries may need to draw on their existing funds to support their spending plans. Russia now plans to tap its reserve fund.

— Three, several external funds will turn into domestic funds. See Reuters’ Steven Johnson. If a country taps its sovereign fund to bailout domestic banks and firms and gets domestic stakes in the process, it no longer is a sovereign fund in the conventional sense. Its external assets will have been used to pay off the external debts of private (or quaisi-private) firms. Russia’s sovereign fund seems likely to become a vehicle for supporting Russian firms rather than a vehicle for investing abroad. And once a fund becomes the custodian of the country’s stakes in strategic domestic sectors, it will be viewed differently in the rest of the world.*

— Recent events have underscored the value of a traditional, liquid reserve portfolio. Not only have central bank reserve managers performed better than higher-priced sovereign wealth fund managers over the past five years, but liquid central bank reserves have proved more valuable than illiquid sovereign wealth funds during the recent crisis. The Korea Investment Corporation cannot sell its stake in Merrill to finance its intervention in the foreign exchange market – at least not easily. Indeed, Korea is now considering issuing a bond to raise additional foreign currency cash – cash that is currently tied up in the KIC.

The foreign exchange needs of large emerging economies in the recent crisis have been enormous – Brazil has committed $50 billion of its reserves to a set of currency swaps to help address a dollar shortage, Korea has committed $100 billion to backstop its banks and Russia’s commitments add up to something like $200 billion. They likely will want to hold more, not fewer, liquid reserve assets going forward.

So may Abu Dhabi. It may have to write a large check to help out Dubai. Dubai’s domestic state firms relied heavily on borrowed money. Abu Dhabi has more than enough foreign assets to cover all of Dubai’s debts, but it may not have all the liquid foreign assets it now thinks it needs.

Throw it all together and I now expect sovereign funds to fall well short of earlier high end estimates of their growth.

Those pitching sovereign wealth funds to emerging market governments timed the market poorly: they encouraged sovereigns to take additional risk when risky assets were already over-valued and they encouraged sovereigns to sacrifice liquidity for returns when it turns out emerging economies still needed liquid assets. A lot of sovereign funds effectively bought into a host of markets at close to their recent peaks.

Sebastian Mallaby now says that sovereign funds now look like a bull market luxury.

Korea, Brazil, India and Russia aren’t going to have big funds in the near future.

Setting SAMA aside, the Gulf funds almost certainly shrunk in 2008 – despite high oil prices. If oil stays at its current levels, the future pace of their growth will likely slow sharply. My guess is that combined foreign assets of the large gulf funds now are under a trillion dollars.

The big wildcard? China. Its reserves are not just large but still growing. And it isn’t clear if the CIC’s visible losses (and SAFE’s hidden losses – its roughly $100 billion equity portfolio must have fallen in value substantially) will deter China’s top leaders from taking on additional risk. The signs are mixed. SAFE doesn’t seem to be able to buy anything other than Treasuries right now – and the CIC is trumpeting its large cash position. But the CIC also at least considered adding to its large stake in Morgan Stanley.

If oil stays at its current levels, the only real way growth in sovereign funds could come close to matching the investment banks revised projections (see Morgan Stanley and Merrill) is if China effectively channels all the foreign exchange it is buying to support its currency into a sovereign fund …

* The US is in some sense going in the opposite direction. It has taken large stakes in domestic US firms with extensive operations abroad. As a result, it is acquiring foreign assets as a result of its domestic bailouts rather than shedding foreign assets to cover the foreign debts of domestic firms.
AIG is the most obvious example.

Note: I have drawn on work I am doing with Rachel Ziemba of RGE in this blog post


  • Posted by Euraussian

    I had written such a nice paper about those unrealistic projections for SWFs (no doubt dreamed up by MS people trying to stroke clients’ egos) that implied a future with ver increasing oil prices, an ever increasing US trade deficit and idiots running NIC (including China) that would sell labor way below market prices for ever. Still, I would expect that the good SWFs (like GIC, KIC, ADIA etc) were managed well enough to do better than your average pension fund. Given the mandates of funds like Norway and Alberta, a pension fund like return should not be surprising. They do not have a hedge fund mandate.

    And, of course, every economist (why is there no student of Fama in the new adminstration) should know that the risk free return is very hard to beat. Right now, it is still slightsly positive in nominal terms and that with cash appreciating by some 3% on an annual basis..

  • Posted by Euraussian

    O, forgot to publish the paper before I went on a three months’ holiday. Pity.

  • Posted by vauxhall

    OSLO, Nov 25 (Reuters) – The return on Norway’s sovereign wealth fund was a negative 7.7 percent in the third quarter, hit by the global financial crisis, and was the weakest performance in the fund’s 10-year history, the central bank said on Tuesday.

    The total return on the fund was 1.8 percentage point lower than that of a benchmark portfolio set by the finance ministry.

  • Posted by bena gyerek

    “Norway has more exposure to Europe than most funds, so it has been hurt by the euro’s fall against the dollar”

    why? are norway’s future liabilities dollar denominated? methinks you are suffering from dollarhegemonitis. how 20th century.

  • Posted by Chidambaram

    I think you’ve already realized that the US dollar note is simply another Treasury Note that is defined as legal tender. This makes it mathematically impossible for Treasury to default on its own debt.
    At the same time I hope you will agree that the legal tender is inside our Territories and a legal tender currency of one sovereign has no utility for another sovereign or private investors in another sovereign.
    You can easily underestimate the intelligence of all the global monetary authorities by insisting that our accumulation of deficits and their accumulation of surplus is a result of their mercantilism.
    This argument fails unless you have a cogent thesis as to the economic value of the dollar. If the dollar is simply a United States legal tender currency in a world of market determined exchange rates, then accumulating a surplus denominated in dollars or Treasury securities or Agencies etc is simply an accumulation of worthless pieces of paper from a foreign perspective.
    One thesis as to the economic value of the dollar is that it derives that value from its exclusive convertibility to petroleum. This thesis argues that throughout the centuries the dominant social construct of economic value was gold. Beginning in 1971 the dominant social construct of value switched from the yellow gold to the black gold. This thesis looks to the history of bloodshed and notes that behind all diverse ideological, racial, monotheistic, etc …. various reasons justifying conflict through the centuries lies the glitter of the yellow gold. This thesis looks to the continuation of conflict with a ever increasing variety of reasons since 1971 and notes the glitter of black gold, even in unlikely places like Afghanistan and Lebanon.
    The only cogent argument I’ve come across so far is from William Engdahl (my summary is duly followed by quotes and links).
    Engdahl argues that global domination is an end in itself, and economic domination is simply an adjunct to that end. If we accept Engdahl’s argument, then we need to search for alternative motivations to bloodshed, deeper in the human mind than ‘pursuit of economic value’.

    “Since 1979 the US power establishment, from Wall Street to Washington, has maintained the status of the dollar as unchallenged global reserve currency. That role, however, is not a purely economic one. Reserve-currency status is an adjunct of global power, of the US determination to dominate other nations and the global economic process. The United States didn’t get reserve-currency status by a democratic vote of world central banks, nor did the British Empire in the 19th century. They fought wars for it.

    For that reason, the status of the dollar as reserve currency depends on the status of the United States as the world’s unchallenged military superpower. In a sense, since August 1971 the dollar is no longer backed by gold. Instead, it is backed by F-16s and Abrams battle tanks, operating in some 130 US bases around the world, defending liberty and the dollar.”

    Engdahl continues:
    “A full challenge to the domination of the US dollar as the world central-bank reserve currency entails a de facto declaration of war on the “full-spectrum dominance” of the United States today. The mighty members of the European Central Bank Council well know this. The heads of state of every EU country know this. The Chinese leadership as well as the Japanese and Indians know this. So does Russian President Vladimir Putin.

    Until some combination of those Eurasian powers congeal in a cohesive challenge to the unbridled domination of the United States as sole superpower, there will be no euro or yen or even Chinese yuan challenging the role of the dollar. The issue is of enormous importance, as it is vital to understand the true dynamics bringing the world to the brink of possible nuclear catastrophe today.'s%20oil%20bourse%20can't%20break%20the%20buck.htm

    Hope the link works. You can easily google up any of the topics from my ponderous charging bull analysis of the truth about everything, concluding all over that this is only a monkey cap crisis and not a golden crisis. You’ll find plenty of links saying the same thing as I have.
    (PS: There’s a lot of scintillating fluorescence behind my ideations, such as an ostrich egg spiral flow of global capital, or a monkey cap credit crisis. Even the elephantine ideological extensions are based on reference to the symbol of the Grand Old Party)

  • Posted by Chidambaram

    The only OTHER cogent argument I’ve come across …is from Engdahl.

    Accepting Engdahl’s thesis, if you were to follow the jackboots around through history you would find that the glitter of gold follows in close step. So that makes it reasonable to think that the reserve currency status of the dollar cannot be challenged except through greater military supremacy.

  • Posted by otto

    I’d venture that Norway has been one of the more conservative SWFs of the bunch.

    A sub 30% loss sounds lightweight compared to the carnage in the financials (that must have attracted SWF money the same way a 60w bulb attracts a moth).

    On a general note, your blog is required reading as always. Sincere thanks for all your efforts, Brad. That goes for the top-class regular commenters such as twofish (to unfairly pick just one). This blog rocks.

  • Posted by bsetser

    bena gyerek — norway’s fund doesn’t have explicit liabilities, but it is reasonable to think what matters most its krona performance, which is more correlated with the euro than the dollar. I reported its dollar size and simply wanted to acknowledge that the dollar’s move v the euro had more than a little to do with the fund’s fall in $ terms.

    eurassian — well, for a while when oil was $120 plus, those projections didn’t look totally far fetched, especially if china and japan shifted toward sovereign funds. if i had to guess tho i would guess that norway has significantly outperformed the more aggressive sovereign funds (ADIA, GIC). Remember, Norway was until recently mostly a bond fund. ADIA reportedly liked emerging market equities

  • Posted by bsetser

    Otto — agree that Norway has almost certainly outperformed most sov. funds even if it lagged its benchmark. I was cautious b/c — absent more transparency — i cannot point to hard data. This is a period when more conservative portfolios did better.

    Chidambaram — this isn’t the time or place for the oil-dollar debate; comments need to be short and on target.

  • Posted by Euraussian


    You are not going to leave for the fleshpots of Georgetown are you? Note the fact that most of these incoming cabinet types did not study at a proper university? (MIT etc are hardly centres of higher learning, compared to a place in Hyde Park. Why no Chicago economists with a president who’s last real job was at Chigcago. This cannot be right. Pse. Yr Honor, do something about it!

  • Posted by fatbrick

    You cannot say that SAFE lost money becasue it invested on treasury when equity market is high. Then a few days later, you said it lost money becasue it invested equity when treasury market is hot….

  • Posted by bsetser

    fatbrick — i am not sure what you are arguing, to be honest ….

    China is in a fundamentally impossible position:

    a)if it invests in treasuries it loses money on the currency conversation; it is buying assets that will not hold their value in rmb terms.

    b) if it takes on more $ risk (as it did) to try to get a higher $ return it may end up with a larger $ losses.

    Dollar losses on China’s US equities don’t get rid of the currency losses on Treasuries

  • Posted by Chidambaram

    @ Brad
    I hope you will agree that State needs to closely track the geo economic developments to guesstimate the intentions of other sovereigns.

    The most crucial factor in this analysis is the analysis of foreign exchange reserves of foreign central banks and now we have to add the activities of the foreign sovereign wealth funds.

    The only way the monetary expansion response to improve confidence followed up with fiscal stimulus to boost demand can fail is if something happens to collapse the dollar while this is on. Gradual adjustments in exchange rates to help with trade balance are not going to make the policy response fail.

    So I think that calling you to State makes more sense for the new administration than calling you to Treasury, though your past experience and expertise is in the Treasury area.

    Following is a highly controversial quote from Kissinger, and it’s not my job to go substantiate it with links. If you google the quote and kissinger’s name you’ll see plenty of links. It’s not intended to offend anyone but I’m just re-inforcing the point in a more dramatic way.

    “Military men are just dumb stupid animals to be used as pawns in foreign policy.”

    If that’s what Kissinger thought of the Eagle’s jackboots, I bet he would also consider the Treasury folks are just there to print money and distribute it around as the foreign policy dictates.

  • Posted by fatbrick

    Ok, let me rephrase. You said social security funds in US probably is the best performer since it only invests in T. Well then SAFE also invests hugely in T…I guess that the investment on the offrun T still also enjoy better than average return this year so far. Thus although SAFE might lose some money on its 100billion in equity, it would make a lot of money on the other 1.9 trillion, roughly speaking.

    About the currency losses, we went over this before, it really does not matter economically. Of course politically speaking, it is not a good PR story. China is worried more about USD’s losing value against to other currencies and commidities than about its depreciation toward RMB. The former makes China’s spending power shrink. The latter really has little impacts.

  • Posted by nick gogerty

    Any thoughts on how the world’s largest sovreign wealth fund will do going forward.

  • Posted by Nice Job

    FYI: India never had a SWF and even opposed the idea to set-up one…

  • Posted by credulous_prole

    Monetary policy is a form of warfare.

    You can bomb Japan or crash the dollar: either one has the same effect.

  • Posted by el presidente


    The difference between CIC/SAFE and the SSTF is that the Social Security Trust Fund is investing in Treasuries to fund itself against future dollar liabilities. CIC and SAFE are investing in Treasuries against what are (almost certainly) RMB liabilities: that is, the future need of China to expend assets on (for instance) economic stimulus.

    China’s “impossible position” is being caught between an undervalued currency and FX-denominated assets. Every Treasury it buys to maintain export led growth increases the overall imbalance and FX risk to its entire dollar portfolio.


  • Posted by Dennis Redmond

    Two comments: first, we shouldn’t confuse falling American trees for the multipolar forest. Sure, SWFs are having their difficulties, though nothing like the ones facing the hedgies and shadow banksters. But over the long run, sovereign wealth funds will continue to grow in size and scope, for one simple reason: the semi-periphery wants out from neoliberalism and US hegemony.

    Second, not all SWFs are the same. Latin America is making crucial investments in science, education and social services which will have a huge payoff in terms of competitiveness over the next few decades. So is China, Russia, Vietnam, much of SE Asia and Eastern Europe. Their SWFs or SWF-like structures will do fine, because they’re investing in the future. The Gulf states, I’m less optimistic about – Dubai will do fine, but the other Middle Eastern oil exporters are still mostly classic commodity exporters, with highly dependent economies.

  • Posted by MakeMeTreasurySecretary

    If the foolishness of Sovereign Wealth Funds is finally revealed, so be it. It is good news.

    Here is another issue. It should be considered absurd for a Sovereign Wealth Fund to check performance on a quarterly basis. Does the US government checks whether the value of its post-office buildings, highways, and bridges has gone up or down every quarter? You might say it is different but I think they are basically the same. Mr. Market is famously manic-depressive. If even governments of sovereign nations lose their mind because the Market does, then we are in real trouble.

    Somehow, it looks like we are coming increasingly under the tyranny of financial markets. I predict that the financial markets will soon recover but I am much less optimistic about the so-called “real economy”.

  • Posted by fatbrick

    el presidente ,

    FX reserve cannot be used in fiscal stimulus in China. China can just print money or borrow domestically to come up with the money. Both case you are going to see that RMB becomes less undervalued without the change in the exchange rate.

    Also I believe that part of the imbalance between China and US comes from the export restriction at the US side. Can a seller blame the buyer for his not wanting to sell?

  • Posted by adam mateyko

    Something to think about…….

    There is more afoot than we are led to believe by the news. No wonder Paulson is so nervous about all this, he is riding 2 maybe 3 horses: strategic ie US order in the world, tactical ie. bailouts of banks etc. and selfinterest ie not swamping the NYbanks and friends ….. the rest is collateral damage.

    This was yesterday:
    Fed Pledges Exceed $7.4 Trillion in Rescue of Companies With Frozen Credit

    (Bloomberg) — The U.S. government is prepared to provide more than $7.76 trillion on behalf of American taxpayers after guaranteeing $306 billion of Citigroup Inc. debt yesterday. The pledges, amounting to half the value of everything produced in the nation last year, are intended to rescue the financial system after the credit markets seized up 15 months ago.

    Today there is another 800bn. 8.2 trillion. So far. In the USA alone.

    The printing of USd and the swaps business is explored in this art.

    “The Fed could blow through the BOJ’s ceiling,” he adds – – ballooning the central bank’s holdings to more than $4 trillion. “By the time all this ends, the TARP is going to be closer to $2 trillion than $1 trillion,” ISI’s Gallagher says.
    They just did.


    What does this really mean??

    OK so the US Fed.. a private institution get to have 8 trillion on its asset books…so is it the NEW WORLD ORDER BANK????

    This is more than China, Japan and Russia / Arabs have so that can negate their “dumping USd” threats??? Why not go to 6 or 8 trillion???? Just to make sure. Ooops they just did.

    Does the whole world then need to go to it to beg for USd in the future??? This would be a form of control of financial systems.

    Can it then Rule them All by threatening to reverse the swaps and dumping their holdings???…. better than bombs. ANd one upping CHina at the same time. There have been accusations that the US Fed does not have “reserves”.. vis a vis other countries ie China… except by printing in time of need, but that is disruptive or to transparent as to motive.

    If this is a switch from military to financial rule; then the military might be able to be slimmed down. Only need enforcement of the US Fed. So the military will become the US FED collector division.

    Is this why Lehman (as a Trojan Horse), was “allowed” to fail??

    I see bigger goals than just “saving” banks or consumers. Those are just small wheels withing the bigger wheel of power.

    We should look at the bigger geopolitical goals and strategies at work here. Not just in terms of what might happen, but see if the past actions fit such a model. I believe they indicate strong signs of just such action/strategy at work.

    Better than another war, like a neutron bomb; all facilities left standing. Only the people are gone.


    Meanwhile the Chinese with their 2 trillion USd hoard… have gotten the message that they had better spend it before it goes under in a wave of inflation: Recall the 580bn announcement was a headline maker. Yet in todays Globe, the followup… is a footnote:
    Beijing shopping list totals $1.4-trillion

    Trying to dispel doubts about the true size and effectiveness of a giant economic stimulus package, Beijing rolled out an eye-popping figure to show its determination to spend its way out of trouble: a $1.4-trillion (U.S.) shopping list of possible investments.

    The proposed list of projects from provincial authorities gives investors an idea of how part of the government’s four trillion yuan, or $586-billion (U.S.), stimulus package announced Nov. 9 might be spent. But the 21st Century Business Herald, a Chinese newspaper, said many of the projects on the list were already under way, had been under discussion for some time or were planned but not started due to lack of money.

    The government says it is hoping to boost consumer spending by injecting money into the economy through higher spending on construction, tax cuts and aid to farmers and the poor.The cabinet’s planning agency is working on an additional stimulus plan to supplement the Nov. 9 package with spending on schools and health, according to a Chinese business newspaper, the Economic Observer.

    The new plan, to come up for official consideration in early December, also may call for injecting money into China’s stock markets to boost investor sentiment, the newspaper said.

    Associated Press

    The central govt takes the lead, but village, county, city and state organizations wield a big stick in China….. so 1.4 trillion is like the US spending 7 or 8 trillion in the US re GDP.

    This is one way to balance out the past few years of imbalances in trade/accounts. Here is the prior chart on Euros and USd in the world as M2:

    Just add 8 trillion to the US figure and maybe 1 trillion to the Euro figure…. to the total of 20 trillion as of July 2008.

    The world is going to float on a tide of US dollars, 8 trillion. So that is how they are solving the USd iou’s held outside the US… instead of repudiation or by direct inflation, they now have a good excuse or cover to do this repudiation program. Plus it neutralizes the threat of the BRIC fx holdings. Japan signaled this by offering to give 100bn to the IMF….. more to come…


  • Posted by DJC

    Malaysian Prime Minister Mahathir was Right, Robert Rubin Neo-liberalism was Wrong

    Nov. 26 (Bloomberg) — Much is being made of how the next U.S. Treasury team includes Robert Rubin’s former posse.

    Timothy Geithner, Lawrence Summers and the handful of other Rubinites set to run the U.S. economy have something else in common: direct experience with Mahathirism. As fate would have it, the policies of former Malaysian Prime Minister Mahathir Mohamad may make a comeback in Asia.

    When Malaysians speak of Mahathirism, they are often referring to the authoritarian or outspoken ways in which Mahathir ruled their nation for 22 years until 2003. For investors, the phrase conjures up images of an anti-free-market firebrand.

    The truth has always been somewhere in between. Yet the return of Mahathirism is the talk of Malaysia as Prime Minister Abdullah Ahmad Badawi’s stock falls as fast as those comprising the Kuala Lumpur Composite Index. Mahathir’s presence is again being felt by the nation’s 26 million people. His blog is getting millions of hits.

    The spread of Mahathir-like policies will be of even greater interest to Geithner, selected by President-elect Barack Obama to be Treasury secretary. That’s because the U.S. may fight an uphill battle to keep Asia on the road toward open markets.

    ‘Mahathir Was Right’

    Making the rounds in Asia these days, one increasingly hears the words “Mahathir was right” in his reaction to a regional crisis 10 years ago. Rather than join Indonesia, South Korea and Thailand in accepting International Monetary Fund bailouts, Malaysia took matters into its own hands.

    As fallout from the U.S. credit crisis zooms Asia’s way, it’s an open question how governments will respond. The IMF said yesterday Asian growth will probably weaken “substantially” amid slowing demand for exports, faltering consumer confidence and a drop in bank lending.

    The idea that Asia is less vulnerable to global events is dying a quick death. The IMF expects growth in Asia, including Japan, Australia and New Zealand, to slow to 4.9 percent next year, from a 5.6 percent pace predicted in October.

    Let’s face it: 4.9 percent is overly optimistic in a world in which the U.S. is bailing out a single bank — Citigroup Inc., in this case — to the tune of $306 billion. As the U.S.’s woes catch up with the global economy, growth will slow more dramatically than is currently appreciated.

    Avoiding the IMF

    Faced with such prospects, Asian governments may be tempted to turn to Mahathir-like capital controls and pegged currencies. Aside from a desire to stabilize markets, doing so might enable developing nations to avoid aid from the IMF, which tends to come with strict strings attached.

    Such concerns have led Turkish Prime Minister Recep Tayyip Erdogan to delay seeking emergency funding from the IMF. Escaping IMF tutelage has been a goal for Erdogan since he became premier in 2003. He chose Malaysia for his first official overseas visit and asked Mahathir how he managed without IMF loans in the 1990s.

    Asia has experienced a currency-reserve arms race of sorts since then to achieve a similar goal. Korea, for example, is sitting on $212 billion of reserves, while Malaysia has stockpiled $109 billion.

    There’s no guarantee Asia will turn inward. Doing so may do more harm than good for such open and export-dependent economies. Yet if global growth is headed for its worst period since the 1930s, governments will be on the spot to shield living standards.

    Waning Influence

    This time, the U.S. will have little leverage in Asia.

    Geithner has first-hand experience with Mahathir’s policies. In July 1998, he and then-Treasury Secretary Rubin traveled to Kuala Lumpur, where they tried to persuade the Malaysian leader to give the IMF’s prescriptions more time. A day later, Mahathir announced he was giving up on high interest rates and budget tightening. He imposed capital controls and pegged the ringgit in the months that followed.

    The U.S. will have zero moral high ground to counsel against such steps. In Lima last week, President George W. Bush urged governments to avoid onerous regulations, spurn protectionism and stay on the free-market path amid a “demanding” global outlook.

    Such rhetoric flies in the face of efforts in Washington to bail out banks, insurers and automakers with borrowed money. It bumps up against the Federal Reserve’s unprecedented steps to print dollars.

    It’s worth noting how the descendents of Rubinomics — with its focus on balanced budgets, financial deregulation and free trade — are changing with the times. Geithner and Summers, whom Obama chose to be director of the National Economic Council, will find it’s easier to prescribe tough medicine than to take it.

    “I can’t help feeling I’m vindicated,” Mahathir said in an interview last month. In December 2002, the IMF said Mahathir established a “stability anchor” that helped the economy.

    Rubin’s stock also isn’t what it used to be. He’s facing questions about his role in Citigroup’s woes and efforts to avoid regulation of derivatives while in government.

    Geithner and Summers may find that the more they try to inject some Rubinism into the global economy, the more Mahathirism may push back.

  • Posted by Twofish

    bsetser: China is in a fundamentally impossible position.

    The dilemma you mentioned assumes that the market moves in certain ways, and I don’t think that it is possible to predict currency exchange rates and equity returns over the next ten years.

    bsetser: Dollar losses on China’s US equities don’t get rid of the currency losses on Treasuries

    But there might be a hedge, here. We are seeing huge losses in equities right now, as a result of a flight to safety which is ending up causing Treasuries and the dollar to appreciate. If the situation reverses itself and you see a flight from Treasuries, you may see a boom in equities.

    What is important to point out is that the currency markets are moving in ways that people thought were impossible six months ago.

    The other thing is that with $2 trillion dollars you can’t do mattress arbitrage. if you have $2000 or $2 million you are never going to accept a certain zero percent nomimal return, because if you do, you are going go to the bank and pull out all your money and stuff it into a mattress.

    This doesn’t work with $2 trillion, and you may be in a situation were the PBC has to accept extremely large losses, because those losses are smaller than any alternatives, or because the PBC thinks that it is getting something in return for those losses.

  • Posted by Sam Roggeveen

    Lowy Institute economist Mark Thirlwell has responded to this post on The Interpreter:

  • Posted by Twofish

    bsetser: Those pitching sovereign wealth funds to emerging market governments timed the market poorly: they encouraged sovereigns to take additional risk when risky assets were already over-valued and they encouraged sovereigns to sacrifice liquidity for returns when it turns out emerging economies still needed liquid assets. A lot of sovereign funds effectively bought into a host of markets at close to their recent peaks.

    With hindsight, this wasn’t a coincidence at all. What happened was that all of the domestic capital had already been invested in equities, and the only capital that was left undeployed was foreign SWF capital. Once all of the capital had been fully invested, you ran out of things to keep the bubble inflated and things started to collapse.

    bsetser: The signs are mixed. SAFE doesn’t seem to be able to buy anything other than Treasuries right now – and the CIC is trumpeting its large cash position. But the CIC also at least considered adding to its large stake in Morgan Stanley.

    There was talk of a CIC bailout of Morgan Stanley, but the governments on both sides of the Pacific stomped on that idea. One problem with the CIC investment into Morgan Stanley which I think you are seeing with the Fed investment with AIG is that once you have a quasi-government entity own a private bank, it becomes difficult to see who is responsible to who.

  • Posted by gv

    Somewhat off topic here (of this thread not of this blog).
    Word goes that last week the FED in cut interest rates in an unorthodox way. The Fed did so by divorcing the quantity of reserves from the interest rate target.

    The balance sheet shows that reserves expanded by 624 trillion

    It would explain why the dollar tanked after the release of the FED statistics.

    Can we say this equals a rate cut and how does this exactly work because if the banks deposit the excess reserves at the Fed then they don’t really need it?

    Thanks in advance for your comments

  • Posted by gv

    sorry 624 billion
    ( “.” = european “,”)

  • Posted by gv

    Concerning the last question I’ll be a bit more specific , I know it is to cope with intraday settlements between banks, but at such a level?

  • Posted by cent21

    Perhaps now would be a good time for the SS trust fund to divest its treasury IOUS.

    At the recent rate, the FED could arrange the transactions in a fortnight or so.

  • Posted by Aj

    GOOD CALL brad!
    “So may Abu Dhabi. It may have to write a large check to help out Dubai. Dubai’s domestic state firms relied heavily on borrowed money. ”

    THIS JUST HAPPENED: The Abu Dhabi government bought merged the largest housing loan lenders in the UAE with a tiny bank owned by it.

    The Ministerial Council for Services approved the merger of the the Industrial Bank with the Real Estate Bank, which had only a day earlier been combined with Amlak Finance and Tamweel, the country’s two largest home loan companies, both severely affected by the credit crisis.

    The Industrial Bank is majority owned by the Federal Government and several national banks have minority stakes.

  • Posted by Euraussian


    Institutional investor staff tends to be quite wary of doing what bond/equity salespeople recommend, probably also when these guys use flattering terms like SWF and silly projections that are supposed to make them feel rally important. But their managers ( and Family members) may (have been) be a little more gullible.


    I believe that the investment mandates (in as far as here are formal mandates in SWF land) tend to be mostly defined in absolute returns (like hedge funds), not in terms of performance relative to an index. However, it looks as if the Norwegians (do not have the link here, but there is an annual public discussion) are more like a pension fund in the sense that they like to refer to a benchmark for the individual components (like equities, bonds, other etc) in their asset mix. So for example, if they would beat an MSCI index that might be good performance. I guess for ADIA that would be rubbish in the current environment. I believe the family owned pools of wealth are managed in a less bureaucratic way than the democratic treasure chest of the Arabs of the North..

  • Posted by Chidambaram

    I believe that the investment mandates (in as far as here are formal mandates in SWF land) tend to be mostly defined in absolute returns (like hedge funds), not in terms of performance relative to an index.

    Apart from investment returns, would you allow for geopolitical intentions in the mandates?
    Here’s a quote from John Mauldin and a really interesting discussion of geopolitical themes with respect to China.
    (I’m yet to update Mauldin’s essay with recent developments and closely re examine his train of logic: I discovered several logical errors in Engdahl’s conspiracy theories but that doesn’t mean the whole theory is wrong)

    Geopolitics is based on geography and politics. Politics is built on two foundations: military and economic. The two interact and support each other but are ultimately distinct.
    – John Mauldin

  • Posted by Euraussian


    Of course there may be elements other than investment performance, but the point under discussion here was financial performance. And there are basically two ways to instruct/mandate the manager of a fund, to beat an index (for instance the S&P 500 when US equities are concerned), or to beat an absolute return target, for instance 10% p.a. on the amount invested. In the first case, if the manager has a negative absolute return of 20 but the relevant index declined by 30%, the manager has done an excellent job. In the second case, if the same manager for an absolute return client has achieved (positive) 9%, he has failed. The Norwegian fund has a mandate (if I understand it correctly) consisting of currency and asset class allocations, and specific performance targets applicable to the various portfolio components. It is ridiculous to compare the performance of something like the Norwegian fund (with its elaborate transparency and accountability aspects) with passive strategy like putting everything in a savings account. Just imagine parking a high percentage of a country’s GDP (and in an independent currency) in savings accounts in the same currency. For small countries like Norway, but also Singapore, the local/local currency markets in short term interest bearing instruments are far too small to do this, hence the need for investing in a range of currencies and asset classes, in the expectation that in the long term the returns may be somewhere close to at least a few percentage points in real terms in local currency equivalents.
    As we see now, that is quite difficult sometimes.
    Central banks (the traditional mnagers of national wealth) are rarely assessed in terms of investment performance (quite a few used to speculate in gold and currency) and very few taxpayers wonder why the government should have high exchange reserves at all. I do not see a lot of difference between CB reserves in excess of strict transactional needs (of course the opinions about what constitutes an adequate level of FX reserves vary widely) and SWFs, and in my opinion the international statistics should ignore labels like SWF etc. We are simply looking at FX holdings of a state, that may be relatively large for a benevolent purpose (i.e. to transfer national wealth to future generations rather that distributing it to taxpayers for current consumption, as a result of transparent and democratic decision making) or large as a result of malignant trade practices, where labels like SWF (or manipulation of a state controlled banking system to a similar effect) are basically used to circumvent international arrangements. The basic principle should always be that it is not the mission of the state to save, unles there is an overwhelming public purpose (like in the case of Norway where simply distributing oil/gas revenue would result in very unhealthy economy plus an enormous decline in affluence once the oil runs out.
    Countries with absurd competitive advantages in say manufacturing should not use those to generate huge national savings controlled by the government and used for trade political purposes, like for instance a country like China (and several others in E Asia. But as we discussed many times on this blog, since it benefits politicians in both the US and China, that game continues without interference.

  • Posted by T

    well almost without: it seems that in 10/08 almost 20% of daily turnover in us treasuries market was not delivered. the undelivered trasuries are said to be reaching 1,3-1,5 bn. i say almost cause if these numbers hold any water, the end should be very very near as, contrary to fed, no mandate to buy all those non existing treasuries seems to be found in any SWFs.

  • Posted by bsetser

    Eurassian — family wealth funds is probably a better term than sovereign wealth funds for some of the gulf countries — though there is often a distinction between the ruling families actual wealth fund (their family office) and the sovereign fund the ruling family runs … my strong sense tho is that both ADIA and KIA had a large amount of simple equity exposure. ADIA indicated that it was about 60% in equities in biz week, with the majority of that in index funds. it also has big RE/ PE/ Hfund investments to be sure — but i wouldn’t discount its pure equity portfolio. read jean paul villain’s interview in euromoney in the summer of 06…

  • Posted by T

    1,3-1,5 trillion, sorry.
    and that s down from 2 trillion in october.

  • Posted by Chidambaram

    if these numbers hold any water, the end should be very very near

    One thing I’ve realized is that looking at the geopolitical context gives fresh insights to expect the direction of economic policy.
    China needs to ensure that the 600 million or so people in the interior who continue to live in poverty and aren’t benefited much from the export sector don’t rebel against the communist party.
    According to me China shouldn’t have any problems with imports even if she brings the dollar denominated forex reserve down to zero. Petroleum supplies can come through the new Kazakh oil pipeline while several bilateral agreements ensure other imports without dollars.
    If you remove wage differentials China has much less to rely on in terms of competitive advantage in manufacturing. This should lead to a policy to increase local demand through a larger stimulus and build a situation where China is not so dependent on foreign sales to sustain the local economy.
    If China were to aggressively sell Treasuries at the beginning of a month it could easily trigger a sell off in the market. That was the classical scenario of a hard-landing collective exit to the prisoner’s dilemma game with the Pacific Rim countries. There would be limited post facto geopolitical recoil because it doesn’t seem to me that it’s possible to determine from monthly data exactly who triggered the sell off.

  • Posted by observer

    bsetser: The US is in some sense going in the opposite direction. It has taken large stakes in domestic US firms with extensive operations abroad. As a result, it is acquiring foreign assets as a result of its domestic bailouts rather than shedding foreign assets to cover the foreign debts of domestic firms.
    AIG is the most obvious example.

    At least in the case of AIG, it looks like the US government is taking on large foreign liabilities rather than assets (AIG’s CDSes were issued mostly by its London office, and many of these swaps were reportedly written to Eurozone banks for purposes of regulatory arbitrage.).

  • Posted by bsetser

    AIG probably had net european liabilities and net asian assets — just a guess.

  • Posted by locococo

    The same as another great bunch, the also lndn-based gordian knot thing?


    1. There is a (huge?) short on long treasuries, does look like s naked or phantom somewhat + some edgy ones must cover here and there
    2. I don t see China as naked on Treasuries (as in some other places), Chidambaram – are you saying you do?
    3. Fed s obviously and finally decided sth on y curve s to be done

    All in all applause on the crunch marketing are in order as the $ flight from EMs to this quality-stuff truly boggles my mind – it s almost succeeded in laying the yield curve down flat on its back on abscissa, were there not swaps, Fed s recent incentives on shorts and short of this short, taken to account. I d almost say that the Fed s been busy keeping governments borrowing costs up, cross the curve. now they ll reshuffle some bits off and hide out the others. anywyz –2 fed: keep up all the great work and

    2 brad and all others: happy thxgiv.

  • Posted by Judy Yeo

    Aww and there goes mr moneybags, now the various markets, financial institutions and even governments have to learn to “rely on themselves” – who knows maybe the biggest good thing coming out of this mess is the everyone relearning self -reliance and a good dose of good sense

  • Posted by el presidente


    I wasn’t saying that China’s FX assets could be used for stimulus; quite the opposite. I was observing that the reason that the U.S. is in a unique position is that it has no FX risk (its assets and liabilities are in the same currency).

    China would have to sell dollars to get RMB to spend domestically out of its FX reserves. Which is exactly the opposite of what it wants to do to create more export led growth.

  • Posted by Rob

    For a good overview of SWFs, see the 4-part series on the Global Investment Watch blog…