Let Markets Decide the Role of SWFs

The lead story in yesterday’s Wall Street Journal addressed the capital-raising efforts of U.S.-based investment firms from foreign sources. In recent months, various banks have aggressively tapped sovereign wealth funds (SWFs) in Asia and the Middle East to shore up their capital structures amidst continued market uncertainty.

SWFs are of course government sponsored entities that manage a nation’s revenues for the purpose of investment. China’s impressive economic growth since the late ‘70s has given rise to well-capitalized SWFs there, and with dollar weakness in recent years having driven oil prices to all-time-highs, Middle Eastern SWFs have similarly become prominent. The article asked how much overseas investment it would take to attract attention from Washington; albeit the wrong kind of attention whereby politicians and regulators might seek to curtail capital flows from parts of the world seen to be unfriendly.

Beyond the perhaps understandable displeasure some have with government funds moving into private industry, the principle fear when it comes to Asian and Middle Eastern SWFs is that if their investments in U.S. firms become large enough, they might eventually aggregate to themselves a more controlling role in the firms they invest in. Maybe, but if the latter scenario materializes and proves problematic from a business standpoint, there will be no need for government intervention.

Indeed, individual and institutional shareholders, with their money on the line, will quickly correct poor management decisions by selling their shares. SWFs, presumably chastened by actions that reduce the value of their holdings, will necessarily moderate their management to reverse any negative market responses. And to the extent that other SWFs choose to invest stateside in the future, they’ll do so with full knowledge of what investors will and will not accept.

Most important, public and private companies in the U.S. serve at the pleasure of their shareholders, as opposed our federal government. As such, it should solely be up to the owners of companies to decide not just the origin of investment, but to whom they’ll sell their shares.

From a jobs perspective, Merrill Lynch and Citigroup alone employ hundreds of thousands of workers. If politicians love jobs as they say they do, they must also welcome investment. Absent the financial commitments made to Merrill and Citi by Temasek Holdings (Singapore) and the Abu Dhabi Investment Authority, the job prospects of both firms’ employees would be far more tenuous. Those concerned about foreign investment they deem unseemly must consider the alternative of people being put out of work.

When it comes to trade, mercantilist politicians from both sides of the aisle regularly express their displeasure with our mythical trade deficit. They also consistently rail against money being sent overseas, but as the actions of certain SWFs indicate, those dollars must eventually return to the United States; in this case as investment in blue chip investment firms. And while the aforementioned investment won’t factor into governmental calculations of our trade deficit, we should consider this a “teaching moment” for those who presume trade doesn’t balance. We let others make for us what’s not in our economic interest to create, and the money returns in many forms, including as job creating investment.

Furthermore, with the dollar’s weakness already well-chronicled, would we prefer that SWFs hailing from the “wrong” parts of the world simply exchange their dollars for euros, pounds and yen? If we ignore how actions such as this might weaken the dollar further, would we somehow feel better if instead of investing in American companies, the sovereign funds in question were to re-direct their capital to France, England or Japan?

Perhaps most importantly, cross-border investment and trade is probably the purest form of “soft diplomacy” that exists. Just as we as individuals wouldn’t lend money to or invest in people we wished harm, capital inflows from parts of the world some consider threatening represent the best way for warring cultures and countries to achieve peaceful relations. Simply put, enemies real and imagined are far less likely to point a gun or aim a missile at countries guarding their capital.

To President Bush’s credit, he has made plain his sanguine nature when it comes to foreign investment while noting that a bigger mistake would be for us to “say we’re not going to accept foreign capital, or we’re not going to open markets.” Still, as the Journal article made clear, fear of a negative reaction from Washington is a growing concern among companies with capital needs, and that’s too bad.

Irrespective of their geographic locale, fear of SWFs is overdone. To the extent that Washington usurps the role of markets in sorting out government-sponsored investment, its actions will harm the U.S. employment picture, weaken the already flagging dollar, and perhaps worst of all, make the world a scarier place.