Llewellyn

King

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December 3, 2007

Sovereign Funds: Power by Wealth and by Stealth

A new species has invaded the financial markets of the world – sovereign wealth funds. Some see these state-run investment pools as a godsend. For example, Citigroup has just been helped over a hurdle by a $7.5 billion infusion from the Abu Dhabi Investment Authority. Others see sovereign funds, which are growing in size and influence daily, as another threat to the well-being of the United States and its Western allies.

Sovereign funds are set up when countries, often with small populations, have more money than they know what to do with. After the central banks of these countries have accumulated sufficient foreign reserves to meet any contingency, they form sovereign wealth funds that are free to invest in financial assets such as stocks, bonds, property or hedge funds.

On the up side, sovereign funds are pumping a lot of cash into financial markets and are helping to offset banks' losses from the subprime mortgage fiasco. But these are not foreign companies investing – these are foreign countries investing. Abu Dhabi now owns 4.9 percent of Citi, the nation's largest bank. This is not the same as a wealthy foreigner buying a chunk of an American corporation. And that worries some people.

Sovereign funds are not new. What is new is that they are growing at an extraordinary pace and very small, resource-rich countries have the money to demand that they are taken seriously.

Of the 10 largest sovereign funds, seven are based on oil and gas. Only China, South Korea and Singapore have funds that are based on non-oil-and-gas trade surpluses. 

No one knows exactly how much money is being controlled by sovereign funds because there is no regulation or formal reporting mechanism. Best estimates are that $3 trillion to $7 trillion are under management by sovereign funds. It is expected that this sum will increase to $10 trillion in five years.

To understand the implications of this expansion of sovereign funds, take a look at little Qatar – a desert sand pit that protrudes 100 miles into the Arabian Sea. It has some oil and the world's second largest reserves – after Russia – of natural gas. While Russia has more than 140 million people to take care of, Qatar has less than a million, including hundreds of thousands of guest workers.

There is nothing much in Qatar – a large U.S. air base, the pristine capital city of Doha, and, well, a lot of sand. The two big activities, from what I could discern when I visited there, were racing off-road vehicles on the sand dunes and shopping. The Qataris are trying to create a great financial center in their desert home. But this will just be window-dressing for the gigantic flows of cash that their liquefied natural gas exports around the world are going to produce.

It probably does not matter if Qatar buys large chunks of U.S. companies over time, or snatches up a lot of real estate. Americans probably will not have a fit if the Qataris buy chunks of Manhattan.

But there are countries that are a lot less attractive and have agendas that are not benign. They include China, Kazakhstan, Libya and Iran, which is free to invest in parts of the world that are not honoring the U.N. sanctions.

In short, there is an enormous amount of money sloshing around the world, and with hydrocarbons fetching record prices, there will be more money looking for a home in a stock market near you.

Like immigration, sovereign funds have grown quietly but relentlessly, to a point where the governments that control them are going to have a say – political as well as economic – in the countries that need the investment. Sadly, the United States is one of those countries. For all our power and superiority, we are a debtor nation, and we cannot question the color of the money we need.

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