Wednesday, October 24, 2007

Sovereign Wealth Funds -- Behemoths at the DoorStep

With rising US current accounts deficits – resulting in increased demand for foreign denominated assets and foreign currencies, the pressures on the CNY, INR, BRL etc., is well known. Predictably, the sterilization (complete or incomplete) has led to CB intervening in the FX markets – selling their own currencies and buying foreign currencies (typically USD denominated assets). To put this accumulation in perspective, some numbers (in millions) are:

China: 1,334,590

Japan 907,346

Russia 407,495

Taiwan 266,287

Korea 250,667

India 220,223

Central banks (in the emerging markets) control over 5.6 TRILLION dollars of US denominated assets. There are estimates that more than 50% of the US current account deficit was financed by these Emerging Market Treasuries. This financing is slowly declining – because one of the, only (?), benefits of the present credit crises is that the US domestic savings are expected to improve, primarily because they are so far in the hole – there seems to be only one way to go! This financing is also slowly declining because the Central Banks have two primary options – opt for other “major” currencies (Euro, Yen) or opt for more risky ventures (like China investing in BlackStone, Norway’s Global Pension Fund, Dubai in global Ports etc.,) “Sovereign Wealth Funds” are explicitly mandated subsection of foreign Treasury holdings that act on behalf of the domestic Treasuries – and are more likely to invest in non-standard asset classes. i.e., they are likely to be the primary agents that drive the risk premium lower in the coming years across the globe. The size of the numbers being projected is beyond my comprehension (in any meaningful sense). Where are these risky returns like to come from? Potentially innovative financing deals and projects like those done by Macquarie!

In the FX markets, this diversification towards other asset classes and non-USD ‘majors’ is inevitably linked to a decline in the USD value. (one number thrown around is that around 1,200 billion USD is likely to move out of the dollar denominated assets!) I would very seriously look into buying global blue chips – since while still being “risky”, these will fit within the SWFs criterion of being “risky enough”. I would look seriously at global real estate – buy property in semi-industrialized nations.

The secret, I suspect, is to ride the coat-tails of the global central bank investment philosophy changes. The unspoken, unheard of elephant-in-the-room is the United States government. Excessive decline of the dollar, with no perceptible change in consumption/savings in the US, might result in, to use a Lou Dobbs phrase, “selling America to foreigners”.

In essence, I would not be surprised if 5 years from now, a Pulitzer prize winning non-fiction entry is solely geared to explaining the complexities and conspiracies that went behind the spectacular but ultimately unsuccessful management of the Dollar slide.

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