[Senate Hearing 110-765]
[From the U.S. Government Publishing Office]
S. Hrg. 110-765
SOVEREIGN WEALTH FUNDS: FOREIGN POLICY CONSEQUENCES IN AN ERA OF NEW
MONEY
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FOREIGN RELATIONS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
JUNE 11, 2008
__________
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COMMITTEE ON FOREIGN RELATIONS
JOSEPH R. BIDEN, Jr., Delaware, Chairman
CHRISTOPHER J. DODD, Connecticut RICHARD G. LUGAR, Indiana
JOHN F. KERRY, Massachusetts CHUCK HAGEL, Nebraska
RUSSELL D. FEINGOLD, Wisconsin NORM COLEMAN, Minnesota
BARBARA BOXER, California BOB CORKER, Tennessee
BILL NELSON, Florida GEORGE V. VOINOVICH, Ohio
BARACK OBAMA, Illinois LISA MURKOWSKI, Alaska
ROBERT MENENDEZ, New Jersey JIM DeMINT, South Carolina
BENJAMIN L. CARDIN, Maryland JOHNNY ISAKSON, Georgia
ROBERT P. CASEY, Jr., Pennsylvania DAVID VITTER, Louisiana
JIM WEBB, Virginia JOHN BARRASSO, Wyoming
Antony J. Blinken, Staff Director
Kenneth A. Myers, Jr., Republican Staff Director
(ii)
C O N T E N T S
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Page
Barrasso, Hon. John, U.S. Senator From Wyoming................... 42
Bhagwati, Jagdish, Professor, Law and Economics, Columbia
University, and Senior Fellow in International Economics,
Council on Foreign Relations, New York, NY..................... 5
Prepared statement......................................... 8
Biden, Hon. Joseph R., Jr., U.S. Senator From Delaware........... 1
Cardin, Hon. Benjamin L., U.S. Senator From Maryland............. 39
Corker, Hon. Bob, U.S. Senator From Tennessee.................... 32
Dodd, Hon. Christopher, U.S. Senator From Connecticut............ 42
Drezner, Daniel W., Professor of International Politics, Fletcher
School of Law and Diplomacy, Tufts University, Boston, MA...... 12
Prepared statement......................................... 15
Isakson, Hon. Johnny, U.S. Senator From Georgia.................. 37
Lugar, Hon. Richard G., U.S. Senator From Indiana................ 4
Marchick, David, Managing Director and Global Head of Regulatory
Affairs, The Carlyle Group, Washington, DC..................... 18
Prepared statement......................................... 20
Menendez, Hon. Robert, U.S. Senator From New Jersey.............. 34
Webb, Hon. Jim, U.S. Senator From Virginia....................... 30
Additional Material Submitted for the Record
Prepared Statement of Douglas Rediker, Co-Director Global
Strategic Finance Initiative, the New America Foundation,
Washington, DC................................................. 49
Responses of David Marchick to Questions Submitted by Senator
Biden.......................................................... 57
Responses of David Marchick to Questions Submitted by Senator
Lugar.......................................................... 53
(iii)
SOVEREIGN WEALTH FUNDS:
FOREIGN POLICY CONSEQUENCES
IN AN ERA OF NEW MONEY
----------
WEDNESDAY, JUNE 11, 2008
U.S. Senate,
Committee on Foreign Relations,
Washington, DC
The committee met, pursuant to notice, at 9:35 a.m., in
room SD-419, Dirksen Senate Office Building, Hon. Joseph R.
Biden, Jr. (chairman of the committee) presiding.
Present: Senators Biden, Dodd, Nelson, Menendez, Cardin,
Webb, Lugar, Corker, Isakson, and Barrasso.
OPENING STATEMENT OF HON. JOSEPH R. BIDEN, JR.,
U.S. SENATOR FROM DELAWARE
The Chairman. The hearing will come to order, please. I
apologize to the witnesses and my colleague for starting a few
minutes late here.
We have a very distinguished panel this morning. I should
start by saying that in the beginning of the year Senator
Lugar's staff and mine sat down to talk about what hearings we
thought were important ones to conduct. Back then the chairman
said we should be holding hearings on--and I'm sorry it took so
long, Mr. Chairman--on sovereign wealth funds. So I thank him
for his leadership here and I look forward to hearing from each
of you.
Most Americans know all too well from their trips to the
gas pump that record oil prices are now overtaking the housing
crisis at the top of their economic worries, anyway. On top of
the weakness in consumer and financial markets, now we have the
threat of inflation rooted in energy prices, adding to the pain
and complicating the task of restoring growth and stability to
our economy.
There is another effect of those high oil prices and our
continuing dependence on imported oil. That is the historical
shift which we saw back in the 1970s, but in earnest now, is
the historical shift of wealth from our country to the oil
producers, from Russia to the Persian Gulf.
At today's prices, the United States is sending $800
million a week to OPEC--every single--excuse me--every single
day of the week, $800 million. In exchange for full tankers of
their oil, we're sending them boatloads of money. Their bulging
treasuries have now become powerful investment tools, so-called
sovereign wealth funds, a phrase I think most Americans never
heard of. Although they've been around since the mid-1950s,
only recently they have caught our imagination, attention,
wonderment, and concern.
In addition to those oil-based funds, other nations such as
China with export-based economies are accumulating their own
large piles of money, which they are now using to buy assets
around the world.
Today the Committee on Foreign Relations will look at
sovereign wealth funds and examine their foreign policy
implications. I want to thank again the ranking member, Senator
Lugar, for urging us to focus on this.
Sovereign wealth funds are not new, as I've mentioned. In
fact, the first sovereign wealth fund was established in Kuwait
in 1953. Yet only recently have they found themselves in the
public eye. This is partly due to the fact that they are big
and getting bigger. Today analysts estimate that these funds
are worth somewhere between $1.9 and $2.9 trillion, and some
predict that by 2012 they could control $12 trillion worth of
assets.
What should we make of all of this? Should we be concerned
that the Governments of Russia and China control billions of
dollars in assets and directly invest in U.S. institutions and
companies? What threat does this exposure hold for us, if any?
What financial imbalances does it create?
The IMF has called for an international effort to increase
the funds' transparency. Where is the money coming from? Who
controls it? Where is it going?
Some senior officials of this administration also seem to
consider sovereign wealth funds as a serious risk. The Director
of National Intelligence Michael McConnell said in testimony in
February, ``Concerns about the financial capabilities of
Russia, China, and OPEC countries and the potential use of
their market access to exert financial leverage to achieve
political ends represents a major national security issue.''
From the financial perspective, however, these funds could
be an important source of capital in our global economy. Wealth
funds can bring benefits to our economy. They have helped keep
our banks afloat in the midst of the subprime mortgage crisis
and ensuing credit crunch. They could offer a fresh infusion of
capital to fuel employment and stimulate U.S. industry.
When Citicorp needed capital to stabilize its balance sheet
after the subprime mortgage crisis, the Abu Dhabi Investment
Authority injected $7.6 billion, or a 4.9-percent stake, in the
bank and bailed it out. In fact, on his recent trip to the gulf
Secretary of the Treasury Hank Paulson struck a very different
tone than McConnell on sovereign wealth funds. He said,
``America will keep our markets open at home to investment from
private firms and sovereign wealth funds. We reject measures
that would isolate us from the world economy.''
Threat or opportunity, that's the question everybody's
asking. Sovereign wealth funds have more than one dimension.
They defy in my view simple definitions and simplistic
responses.
We've called this hearing so we can get a better
understanding of these funds: What are the threats,
opportunities, and challenges along the way. As we move
forward, I believe there are three issues that we should bear
in mind, at least from my perspective. First, we need a
strategy to identify and deal with sovereign wealth funds which
use their assets to achieve political objectives. We have
already seen indications that Russia may be using its fund to
promote strategic objectives, such as its recent interest in
acquiring a large stake in Airbus's parent corporation.
Similarly, Singapore's Fund has been linked to political
turbulence in Thailand and Indonesia.
What should be our response? Greater transparency alone, at
least in my opinion, will not resolve this issue. But punitive
defensive regulation could be self-defeating, depriving us of
potential benefits out of the fear of potential harm.
Second, I think it seems to me we have to strike an
appropriate balance between protecting against threats and
remaining open to economic opportunities. While we cannot
overlook the national security implications of sovereign wealth
funds, neither can we overlook their potential for providing
needed investment and resources.
Finally, as we develop a policy toward sovereign wealth
funds we should be careful not to confuse the symptoms with the
cause. What I mean by this is these funds exist and are growing
because we have no national energy policy in my view and no
coherent trade policy. Short-sighted restrictions on
international investment won't eliminate these underlying
problems. We need to be smarter, more strategic, and more long
term in our thinking, as we need to get our own house in order
to reduce our economic vulnerability.
Our panel today is in a good position to offer advice on
these funds. Let me emphasize again that I hope listeners don't
confuse our interest in discerning how these funds function and
whether they're good, bad, or indifferent with the underlying
reason why these funds exist. This committee under the
leadership of Chairman Lugar in previous years, and I've tried
to follow suit with his help, has been trying to focus on those
underlying causes, because the truth of the matter is until we
deal with them we've got a real problem that goes well beyond
the existence of these funds.
We have one of the best known and most respected voices
from Columbia University, Professor Bhagwati. He's a noted
economist and well-known financial commentator. He's
particularly well placed to discuss sovereign wealth funds in
the context of globalization.
Dr. Drezner comes to us from the Fletcher School at Tufts
University and he's going to provide what I would characterize
as a political science perspective, which I always like to
have, to sovereign wealth funds. I'm surrounded by a lot of
economists, but political science guys like me I keep looking
for.
Finally, David Marchick, currently at the Carlyle Group and
former official with the Clinton administration, is going to
offer us a U.S. business perspective, although he spent
considerable time in government as well, perspective on
sovereign wealth funds.
I look forward to hearing each of their testimony and will
end by again thanking the three of you for making yourself
available. I know this is a pain in the neck and you have to
alter your schedules to do it. But it's important to us and we
truly appreciate it.
Chairman Lugar.
OPENING STATEMENT OF HON. RICHARD G. LUGAR,
U.S. SENATOR FROM INDIANA
Senator Lugar. Well, thank you very much, Mr. Chairman. I
thank you for holding this hearing and I welcome, with you, our
distinguished panel.
The rapid expansion in the number and the size of sovereign
wealth funds is one of the most consequential international
economic developments in recent years. The United States
Treasury Department estimates that the number of sovereign
wealth funds doubled between 2000 and 2005. As oil prices
remain well above $100 a barrel, the incomes of oil exporting
nations are soaring, as you pointed out.
By some estimates, these national investment reserves now
hold close to $3 trillion. Russia has about $130 billion in its
stabilization fund. Venezuela has an estimated $18 billion.
News reports indicate that the Saudi Government is developing
plans for the largest sovereign wealth fund in the world, which
would exceed $900 billion. According to Treasury Under
Secretary David McCormack, sovereign wealth fund assets are,
``larger than the total assets under management by either hedge
funds or private equity funds and are set to grow at a much
faster pace.''
The expansion of sovereign wealth funds is not an
inherently negative development. They have infused helpful
liquidity into international financial markets and in some
cases promoted beneficial local development. Yet sovereign
wealth funds are not ordinary investors. Their ties to foreign
governments create the potential they will be used to apply
political pressure, manipulate markets, gain access to
sensitive technologies, or undermine economic rivals.
Some observers have argued that the primary goal of
sovereign wealth managers will almost always be to produce a
good return on invested assets. Consequently they are unlikely
to engage in political or economic manipulation. Yet, producing
a good return on investment is often stated as the primary goal
of state-owned energy companies, but we have witnessed in
recent years numerous instances of nations using or threatening
to use their energy assets for political purposes.
In this context we must examine whether United States
agencies have the resources and the expertise necessary to
effectively respond to the policy complexities inherent in
sovereign wealth funds. We also need to study how the United
States, working with like-minded nations and international
institutions, can promote transparency in sovereign wealth
funds to reduce concerns about political and economic
manipulation.
The high level of transparency demonstrated by the
sovereign wealth funds of some countries, such as Norway, has
shown that transparency can be internally beneficial. The
Norwegian fund's transparency helps maintain public support for
its investment strategy.
In addition, our government must find the right balance
between promoting investment in the United States and
safeguarding security interests through regulation. The United
States rising government debt and continued dependence on
foreign oil have intensified our reliance on foreign
investment. We certainly do not want to discourage healthy
investments in the United States. As we have seen, some
sovereign wealth fund investments helped provide potential
stability to a number of United States banks.
The Treasury Department has undertaken efforts designed to
balance our need for foreign investments with prudent
safeguards. Domestically it has been working to improve
accountability within the Committee on Foreign Investment in
the United States for review of foreign government-controlled
transactions and it is creating a working group on sovereign
wealth funds.
Globally, the Treasury Department is supporting the
International Monetary Fund and the World Bank in their
development of voluntary best practices for sovereign wealth
funds. It has also proposed that the Organization for Economic
Cooperation and Development identify best practices for
countries that receive foreign government-controlled
investments.
In addition, the Securities and Exchange Commission
requires that sovereign wealth funds disclose holdings of 5
percent or more in a public company and the Federal Reserve
imposes a number of regulations on sovereign wealth fund
investments in United States banks.
I look forward to this opportunity to discuss the foreign
policy consequences of sovereign wealth funds, to examine with
members here whether additional public policy responses are
necessary. I thank the chairman again for the hearing and look
forward to hearing the witnesses.
The Chairman. Thank you, Mr. Chairman.
A more detailed background about your careers will be
placed in the record. I didn't want to take the time to do it
now. Professor Bhagwati, it's an honor to have you here and why
don't you begin, and then we'll work down the line, Dr.
Drezner. The floor is yours, sir.
STATEMENT OF JAGDISH BHAGWATI, PROFESSOR, LAW AND ECONOMICS,
COLUMBIA UNIVERSITY, AND SENIOR FELLOW IN INTERNATIONAL
ECONOMICS, COUNCIL ON FOREIGN RELATIONS, NEW YORK, NY
Dr. BHAGWATI. Chairman Biden, Ranking Member Senator Lugar,
and members of the committee, it's a pleasure and a privilege
to be before this distinguished committee. As both of you
pointed out, these are not, sovereign wealth funds, are not a
new phenomenon, but they are new in the sense of the very rapid
acceleration with which they've arrived and the speed at which
things happen can of course create anxiety.
We have underlying reasons why we have got these SWFs,
which Senator Biden referred to, and I think I want to turn to
that a little bit toward the end, because you're dealing with a
surface phenomenon, but we still have to regulate the surface
phenomenon and react to the anxiety which is created by these.
Now, in the United States in particular, though you find
some bit of this anxiety also in the European countries, but in
the U.S. the political anxiety really comes from a variety of
reasons other than the sudden acceleration of these phenomena
which are so new in our public consciousness. One of course is
it represents a dramatic reversal of the role which we have
played, because we are so used to investing abroad ourselves
and being the top dog, the Rotweiler on the block, and suddenly
we find ourselves in a state of what looks like dependence on
foreign funds, particularly controlled by governments. So
that's a double whammy, which I think naturally creates some
anxiety.
When we teach in the classroom, we always say trade creates
some political problems. Investment creates even more in terms
of being able to sell it to the people and to allay anxiety.
And immigration, particularly illegal, we know is a most acute
problem. So I think we have to confront that particular fact.
The second reason why we have these--these anxieties--of
course, is these are not transparent, as Senator Lugar in
particular was pointing out. The nontransparency comes because
several of the funds actually belong to countries which
themselves are not democracies in the sense in which we are
used to it, because good practices tend to spread. When you
have good governance, democratic governance, you're
accountable, like the hearing here and so on. But where you
have authoritarian or sheikdoms and so on, there you don't have
the transparency. It just runs right through the system.
Of course, it offers certain advantages, which I'll mention
later, in terms of how to handle the SWF anxiety. But basically
there's a good relationship, which I have a chart which I
borrowed from one of my CFR friends, Brad Setzer, which shows
the level of transparency as measured by an agency and the
governance in terms of authoritarianism. It's amazing how good
that fit is. So it's entirely understandable that you would
have that.
But that, plus the fact that you are dealing with the UAE,
China, Russia, which has sort of fallen out of favor, I think
probably excessively so, all of these make you feel these are
not countries which are really allies or sympathetic to our
aims, and that is yet another factor which makes us worry,
because if it was coming from Norway we wouldn't really bat an
eyelid.
So I think all of this creates the worry that we're going
to be dealing with governments and their funds which are
actually--may be used for strategic noncommercial, political
objectives. It's a perfectly reasonable worry in my opinion to
think like that.
Now, of course we need to have a little perspective, which
I say in my testimony, which is we normally don't have
government investments abroad. We, of course, have aid programs
and so on and so forth, but mostly we are into private
investment abroad. But that doesn't mean that we leave politics
out of it, because we have other instruments by which all of
you actually try and influence political and economic and
social objectives. Think of Helms-Burton, think of the free
trade agreements, which are all in deep trouble because we want
to advance social agendas, rightly or wrongly, but that is our
objective.
So we have other sets of instruments, given the way we are
set up in our system economically and politically, by which we
actually advance the state agendas, while leaving direct
private flows more or less alone. Now these other countries
seem to be using--certainly through social welfare funds,
sovereign wealth funds, we are actually--those countries are
not using a multiplicity of instruments to advance their
strategic objectives. So I think we need to have a little bit
of perspective on this in the sense that politics and economics
cannot be divorced altogether, and not in our system either.
As Peter Mandelson wrote recently, one more perspective,
which is that we've had them around for 50 years, not in the
same degree, and there's very little evidence that actually,
even from the Middle East and so on, people have actually used
the SWFs in order to advance any real strategic political
objectives. So the track record is something which is a little
bit more comforting, if you want to say, look, does the past
tell you anything about the future.
But let me now come just very quickly to why I'm not
terribly worried about these in particular, because I feel that
they're going to be very practical in terms of the way they
invest. I was at a meeting in Florence with Tony Blair being in
the chair and Joe Ackerman and others, a small group, and a big
Chinese guy, high up, was there. He said--you know, Ackerman
and Tony Blair both asked: What are you going to do about the
SWFs and all the political anxiety? He said: Oh, we're just
thinking now very seriously about simply handing over our
investment portfolio to Goldman Sachs. Which means it takes the
politics, the worries right out, aside from pleasing our Wall
Street firms actually, so killing two birds with one stone.
The Chinese are a very practical lot and I suspect that
model will probably work out with the UAE and others, because
they don't want--they do want to invest abroad. We have to
remember that, because they've got all these enormous funds,
and they want to invest. When they see that we are worried
about how it might be misused for strategic and political
purposes, they'll try, regardless of cost and so on, try and do
what is in fact necessary to make these palatable to us.
At the same time, right now we need the funds. You just
have to talk to the former Secretary of the Treasury, who is
now running Citigroup. He clearly is happen to get some
infusion of funds. There's competition for these funds.
So we also I think are going to be not going off the some
extreme measures and so on. So I think on both sides there is
likely to be convergence toward a reasonable way of dealing
with this particular anxiety. In my view, therefore, we don't
need any codes. Of course, there's no harm in keeping all these
economists and others occupied in the international agencies
doing something useful. But I think essentially a code is
necessary if you think the system really requires a whole lot
of guidelines and so on and so forth. And I'm not a
libertarian; actually I'm a Democrat. And I feel----
The Chairman. It's obvious from how well you speak. I knew
that right off the bat. [Laughter.]
Dr. Bhagwati. So I would say you need intervention when it
is useful, but I don't think it's really necessary and you
might just gum up the works, and this might resolve itself.
But we still have to do something at our end because, just
remember the Dubai fiasco. I think we need to tell our
committee in case it doesn't have it--all of you are lawyers
and so you know about critical scrutiny, but you can have
enhanced scrutiny for certain sectors. Now, of course the
French would do it for Danon's Yogurt, which we are more
sensible than that. But we could do it for seaports, airports,
and a variety of sectors where we think handing over the equity
to a foreign power which might be hostile, which might be
unstable, and so on--but I think it should be done across the
board, not to provoke--not to fix on one particular country and
so on. But it should be sectorially done, and there you could
have enhanced scrutiny and Congress being involved right at the
beginning, so we minimize the possibility of a Dubai kind of
situation.
So that would be my recommendation that we really need to
do. A final word on why this happened, and I think Senator
Biden was absolutely right to say this is a surface phenomenon
and we have to deal with it, with the political anxiety in the
system, and you can't just take a purist attitude saying it'll
solve itself and so on. I think the underlying problem is in
fact the huge imbalances in the world economy right now and the
food crisis has compounded it. But there's also a plus side too
to the food crisis, foolish as it may seem, because countries
like India, which has also accumulated large reserves, and we
are more transparent in India, but the reserves are going to be
used up to import the food.
So it's something where you're going to get a
redistribution of surpluses and deficits and so on. So there
might be some bright side to it.
But in the end I would say that unless you take some more
fundamental measures like on oil, like you were suggesting,
Senator Biden, that you really have to get at the dependence on
oil, which means going very intensively into the substitutes, R
and D financing, and so on, and even I think we've got to work
hard at actually selling GM foods and so on, because in so many
countries, because of the Europeans and the NGO concerns and so
on--we talk of Frankenstein foods as soon as you get out of the
United States, but on the one hand you've got Frankenstein
looming large in the imagination, and if you indulge him, if
you feed him, indulge him, then you've got the grim reaper
facing you, and also the enormous amounts, amount of dependence
on these.
So I think we have to take a fresh look at the underlying
problems. It spills over to the environment as well. But I
think we need a holistic approach to how to handle the
underlying problems which are giving rise to these enormous
funds in places where we're not entirely happy, that they're
not the areas where you want these surpluses to arise. But I
think that needs to be looked at, so the hearing cannot just be
detached from the basic issues which you are raising, Mr.
Chairman.
So that's mine.
[The prepared statement of Dr. Bhagwati follows:]
Prepared Statement of Dr. Jagdish Bhagwati, Professor, Law and
Economics, Columbia University Senior Fellow, International Economics,
Council on Foreign Relations, New York, NY
Permit me to start with a few salient observations about Sovereign
Wealth Funds (SWFs) before I proceed to policy implications.
sovereign wealth funds
Sovereign wealth funds are over 50 years old, not an entirely new
phenomenon.
What is new is their rapid growth and the fact that they have
spread almost worldwide, spanning many different countries. There are
the so-called ``Super Seven'' SWFs, each with assets of over $100
billion. They are in: Singapore (two), Abu Dhabi, Norway, Kuwait,
Russia, and China.
By most estimates, SWFs recently exceeded $2 trillion already. Some
forecast, using current trends, that they could exceed today's U.S. GNP
by the end of 2020. Still, the overall world stock of financial assets
is estimated variously in the range of $165 trillion and up, so that
the SWF assets, while ``large,'' are also ``small.''
What exactly are they? They represent government-controlled funds.
So, typically (but not exclusively) they reflect either (i) monetary
authorities' foreign investments (traditionally, central banks invested
their reserves in foreign treasuries, rather than in equity) or (ii)
more typically (in areas such as the Middle East) the funds that
government entities have earned through exports of oil and other
commodities (and which are typically beginning to invest in equity in
the U.S. and other rich countries).
anxiety over swfs
A general anxiety over SWFs has arisen for several reasons. First,
we confront the sheer speed at which these funds have increased. The
``role reversal'' where we have others buy into our banks and
businesses instead of being the top dogs ourselves, is a painful
reality which makes many of our citizens uncomfortable. Second, many
Western governments (including France and Germany) and their publics
are worried about the ``nontransparency'' of these funds' investment
strategies. With some, we know that they invest here; but we have
little clue about their governance and decision criteria in any form or
degree whatsoever. So, the fear has grown about their pursuing
noncommercial criteria in investing their funds (sometimes referred to
as ``strategic'' investing). In particular, the potential noncommercial
aspect of the investment strategy by SWFs, has created a general
anxiety that we are laying ourselves open to political exploitation by
the governments that own these SWFs. Third, this fear is particularly
likely to arise because the politics of these countries is not one that
excludes potential rivalry and even political instability and/or
hostility. Thus, in the United States, Chinese and Middle Eastern (SWF)
investments have attracted particular opprobrium especially because
these are areas where there is feared political instability (the Middle
East) or even potential hostility (China and the Middle East). Even in
regard to Russian SWFs, the continual Putin-bashing that has afflicted
most of the media, and the hostile and jaundiced coverage of Gazprom,
has added to the fear that somehow we are laying ourselves open to
exploitation by a Russia that is undemocratic and moving away from us
in democracy and from international policy convergence. Again, in
regard to China, their equity investments lead to the fear, voiced
daily by Lou Dobbs, that China is out to get our technology and to spy
on us. He and his likes influence and feed uninformed public opinion on
trade, immigration, and now China, with hardly any politician daring to
take him on frontally: Only Senator Obama, to his credit, has denounced
him in no uncertain terms while others have had their allies and
spokesmen appear on his show without any sense of embarrassment or
shame.
Let me elaborate on some of these observations; and then turn to
the question of how to deal politically with this general anxiety over
SWFs.
First, it is indeed true that many SWFs have limited or no
transparency. The lack of transparency happens to have some correlation
with whether the government controlling these funds is democratic or
autocratic (i.e. ``nondemocratic'' in one way or another). In the chart
below, my CFR colleague Brad Setser and his research associate, Arpana
Pandey, have plotted the form of Government on the vertical axis and
the Level of Transparency on the horizontal axis, showing how
nontransparency and lack of democratic governance tend to go more or
less together. This is not surprising. Democratic governments typically
have to meet, in their governance and in their institutions,
transparency standards that dictatorships and sheikhdoms do not have
to. But because a fair number of such SWF countries are nondemocratic
(e.g. UAE and China for sure), the nontransparency makes recipients of
these funds afraid that noncommercial ``strategic,'' political and
social factors would prevail in the making of their investments.
But remember that even transparency does not ensure that the SWF
will not be used to promote noncommercial, noneconomic objectives.
Thus, the Norwegian SWF proudly refuses to invest in sectors and
countries which do not satisfy Norway's own menu of social
responsibility criteria. Is it alright for Norway then to be
influencing other countries' social policies while it would not want
other countries to influence (in however limited and paltry a fashion)
Norwegian politics? In fact, before outlining my views on what the U.S.
needs to handle the anxiety over SWFs, let me proceed to put the SWF
question in the context of the U.S. itself using private investment,
aid and trade, among other phenomena to advance U.S. political and
social objectives.
public policy on swfs: putting it into context
In deciding on Public Policy to address the anxiety over SWFs
especially concerning their possible use of ``noncommercial,''
``strategic'' objectives, it is necessary to put the matter into
context. Our own policies on private investment outflows and on trade,
for example, are not free from attempts at advancing our political and
social, broadly ``noncommercial,'' agendas. At the same time, there is
little evidence that SWFs have been used significantly for
``strategic'' investments.
Thus, we have used Preferential Trade Agreements (PTAs), such as
Free Trade Agreements, to use our political and economic power to
compel the smaller countries in one-on-one negotiations, to accept a
variety of trade-unrelated, noncommercial objectives, ranging from
environmental and Labor agendas to restrictions on the ability to use
temporary controls during financial crises.\1\ Important developing
countries such as Brazil and India, both democracies, reject such PTAs
with us, and with Europe, unless they are free from such political and
social demands that piggyback on trade negotiations and advance
unilaterally defined ``noncommercial'' objectives reflecting domestic
politics and domestic lobbying agendas. I could also cite the
deliberate use of trade retaliation under section 301 of the 1988
Omnibus Trade and Competitiveness Act to impose on others our own
unilaterally defined views as to ``unreasonable'' practices which
reflected our own political and social agendas: A practice that
attracted worldwide opprobrium.
---------------------------------------------------------------------------
\1\ These issues have been addressed fully in my book, ``Termites
in the Trading System: How Preferential Agreements are Undermining Free
Trade,'' Oxford University Press, July 2008.
---------------------------------------------------------------------------
More importantly, the U.S. has often exercised pressure on private
U.S. investors to conform, not to ``commercial'' criteria, but to
national ``noncommercial,'' ``strategic'' priorities and objectives.
Most tellingly, the 1996 Helms-Burton Act was aimed at extraterritorial
demands on foreign firms to advance the objectives of the Cuban embargo
(which was operative in any event on U.S. firms). The act caused an
uproar internationally, with the EU and Mexico denouncing the act and
enacting counterlegislation, while the EU threatened to take the matter
to the WTO. It is naive to believe therefore that we allow only
strictly commercial objectives to guide the volume and direction of our
private investment outflows. It would, in fact, be astonishing if
politics were kept out of commerce in this pristine fashion in a
constituency-and-lobby-responsive democracy like ours.
In fact, even private pension funds have been known to use
political and other noncommercial agendas to seduce or intimidate
foreign governments into compliance with these agendas, bypassing
strictly ``commercial'' objectives. Thus my colleague at the Council on
Foreign Relations, Ben Steil, has written in the Wall Street Journal
(March 7, 2008) about such political investing by California's Public
Employees' Retirement System, Calpers which has $259 billion in assets
and ``would rank fifth among the world's SWFs,'' and by the California
State Teachers' Retirement System (Calstrs) which has $169 billion, the
two together making California ``the second largest SWF in the world,
just behind the United Arab Emirates.'' Maybe foreign governments and
impartial observers are not ``anti-American'' when they contrast our
own behavior with U.S. anxiety over and demands on SWFs abroad.
By contrast, as Peter Mandelson (the EU trade commissioner) has
written recently in the Wall Street Journal (June 7-8, 2008) that ``In
my meetings with them, sovereign fund managers have often bridled at
being the subject of suspicion. They rightly point out that for more
than five decades they have been quietly investing the proceeds of oil
and gas wealth for future generations without raising the slightest
concern. Some have standards of transparency that are exemplary.''
which way for u.s. policy on swfs
But U.S. policymakers cannot ignore the anxiety in the body
politic, no matter how unjustified it may be. This became obvious
during the uproar during February-March 2006 over the proposed
purchase, after approval by the Committee on Foreign Investment in the
United States (CFIUS), by DPW, owned by the government of Dubai, of 6
major U.S. seaports and takeover of management of 16 other lesser
seaports. Dubai is an ally or a satellite, depending on your political
viewpoint; but it is certainly not a hostile or unstable government.
But the political uproar was quite enormous, accompanied by
congressional hearings and widespread condemnation. My own view was
that this fuss was entirely irrational. But, once the security issue
had been raised, with sabotage feared from the Middle East, it made no
sense to persist with it. Suppose that the sale had been approved
despite the political tsunami. And then some sabotage had happened at
one of the 6 ports (as is always possible). That would then have killed
the possibility of a more enlightened policy in this regard.
To handle the politics of the issue, therefore, it is necessary now
to develop a short list of sensitive sectors where ``enhanced
scrutiny'' is exercised over inflows of funds, whether private or SWF,
leaving all other sectors with free entry. The French do it and more
for their ``national champions'' (which include, believe it or not,
Dannon which produces yogurt). But we can be more sensible. Bipartisan
involvement of congressional leadership on particularly sensitive
investments (like seaport and airports) would also preempt later
political surprises and embarrassments with political fallout in terms
of our image abroad as champions of an open world regime on trade and
investment. Indeed, we must recognize, and not compromise on, our
openness which has been so rewarding to us (including to our workers as
much empirical work shows that the pressure on our worker's wages
cannot be attributed to trade and indeed some studies, such as mine,
provide evidence that trade openness may actually have moderated the
fall in real wages resulting from acute and repeated labor-saving
technical change).
Do we also need an international, voluntary Code of Conduct on
SWFs? This is the current thinking.
Mandelson states that the IMF is interested in masterminding such a
code but that SWFs are suspicious of the IMF. We merely need to recall
that, unlike the WTO which had an open and fiercely contested election
where the Brazilian candidate was a close front-runner who lost to
Pascal Lamy, the choice of the IMF Managing Director was basically
regarded as a European prerogative. The newly emerging countries were
denied the place, with the Europeans saying: Next time, not now. It was
reminiscent of the famous remark of St. Augustine in his bacchanalian
youth: ``Dear God, grant me chastity but not yet.''
The OECD also wants to embark on formulating such a code. But its
credentials are also weak: Except for Mexico and South Korea, it is a
club of the rich countries who represent the countries receiving SWF
funds, not the countries that own them. Unfortunately for the OECD, its
attempt at formulating a code on multinationals revealed the flaw of
such unbalanced representation. Its attempted code on multinationals
failed because it contained mainly the rights of multinationals, and
virtually nothing on their obligations (e.g. Corporate Social
Responsibility) or on the rights of the receiving countries. The code
should have been a tripod with all three legs; instead it had only one
leg and the stool collapsed as critiques multiplied.
But, leaving aside the question of who oversees the formulation of
a code, do we really need one? My view is that the problems currently
about the SWFs will iron themselves out as both the SWF-investing
countries and the investment-receiving countries have incentives to
arrive at a workable solution without a bureaucratic code having to be
formulated, with all the attendant compromises that leave behind much
dissatisfaction.
First, the SWF owners have little incentive to get themselves shut
out of desired investment outlets. So, they will surely hire Wall
Street firms like Goldman Sachs to do their investing, for example: I
heard a Chinese high official say precisely this when the SWF matter
was raised at a small meeting I recently attended in Florence. [I might
add that rewarding Goldman Sachs with a juicy contract would counter in
the U.S. eyes the fear that the Chinese SWFs are going to be used for
noncommercial purposes; it would also have the added advantage of
pleasing Treasury Secretary Paulson.]
As for the U.S. and other rich countries, the enhanced influx of
SWFs is, at least as of now, a matter of high priority. Where would
Citigroup be without SWF infusion? Indeed, the competition for SWF
funds is likely to be sufficiently intense for the U.S. and others to
not create too many obstacles, and to put in place just a few
procedures (such as the one recommended above for ``enhanced
scrutiny'') to shield their political flank, in the way of the SWF
investments.
Hence, the need for a code seems to be negligible; it is really a
red herring.
The Chairman. Thank you very much, doctor. I read your
statement and we probably all have. I'm going to, with your
permission, have it placed in the record as if read because I
think it's worth having in the public domain here, if you don't
mind.
Doctor, the floor is yours.
STATEMENT OF DANIEL W. DREZNER, PROFESSOR OF INTERNATIONAL
POLITICS, FLETCHER SCHOOL OF LAW AND DIPLOMACY, TUFTS
UNIVERSITY, BOSTON, MA
Dr. Drezner. Mr. Chairman, Ranking Member Lugar, thank you
very much for allowing me to participate in this. Thank you
also in particular, Senator Biden, for the kind words you had
for political scientists. My profession is normally not praised
so highly in this chamber.
The Chairman. I think very highly of it.
Dr. Drezner. You're a wise man.
In the interest of time and keeping everyone awake, I'm not
going to go into the background of sovereign wealth funds,
which has been ably done by my distinguished colleague to my
left, as well as by both the opening statements.
I would just give three take-away points from my testimony.
The first is that, to use a health analogy, sovereign wealth
funds are a symptom of much more serious health causes, crises
affecting
the United States. Sovereign wealth funds are fueled primarily
by extremely high energy demand in the United States, which is
giving rise to petrodollars in oil exporting and energy
exporting economies.
It is also being driven by a large current account deficit,
of which oil is obviously one part. There are a combination of
factors driving this. Obviously one is the intervention in
exchange rate markets by certain Pacific Rim economies that
that will go unmentioned, and the other is a dramatically low
U.S. savings rate, which is the fundamental way you're going to
have to fix this problem.
In defense of these capital-rich economies, the reason
you're seeing them develop sovereign wealth funds is that,
frankly, they're sick of holding large amounts of dollar-
denominated reserves. After you have a trillion of them it does
make kind of sense to see if you can diversify your portfolio a
little bit and try to earn higher rates of return. So it should
be stressed that part of what they're doing is hardly
malevolent in intention.
If you're really concerned about sovereign wealth funds,
you need to address those fundamental problems. It should be
pointed out that market forces to some extent are contributing
in this direction. You're already seeing a devaluation of the
dollar vis-a-vis the renminbi since early 2007 and the best way
to create energy conservation is having oil prices at the rate
they are now. It's painful, but it's also probably necessary.
The second point I would say is that as symptoms go
sovereign wealth funds are relatively benign in their effects.
In OECD economies, particularly the United States, the historic
pattern of investments by sovereign wealth funds has been
relatively passive and relatively long term in their intent. A
study that was released this week by the Monitor Group showed
that less than 5 percent of sovereign wealth fund investments
in OECD economies have been intended--have been targeted for
controlling interests in so-called strategic sectors; that on
the whole sovereign wealth funds have been intended to pursue
noncontrolling stakes or stakes that would not trigger the
CFIUS process; and furthermore, that they were holding for the
long term.
That's not terribly surprising. The comparative advantage
of sovereign wealth funds in financial markets is that they can
hold long positions. They presumably do not face the same
pressure to maximize their short-term rate of return that
private sector investment funds do. This is a good thing, I
would add, because in the year to date I believe sovereign
wealth fund investment in the United States has earned a
negative 10-percent real rate of return. So it's probably a
good thing, and the data suggest that the overwhelming majority
of sovereign wealth funds, not all of them to be sure, but the
overwhelming majority are interested in maximizing profit and
not acting for geopolitical reasons, again for the reasons I
was talking about before: They want to diversify their
portfolios, they want to maximize the rate of return on their
investment. So it's not terribly surprising that they're going
to be interested in profits much more so than geopolitics.
Historically, the effect of having overseas investors
controlling or having large investments in the U.S. economy has
not in the end amounted to much in terms of the way of foreign
policy influence. The reason is in times of crisis the assets
are still physically in the United States. During World War II
and other eras of crisis, foreign direct investment in the
United States did not impair the functioning of the U.S.
economy. So, although it is an interesting specter to discuss,
in the end in times of crisis the assets are here and that's
not going to change any time soon.
Furthermore, I would add that prior waves of foreign direct
investment by private actors, admittedly not public, there's
been never any sort of suggestion that there's been any
malevolent intent from those investments.
Furthermore, in this sense, once again due to the wisdom of
the U.S. Congress, you already have an infrastructure in place
to deal with concerns that sovereign wealth funds might bring
up with regard to investments in strategic sectors and the fact
that they are government-controlled entities, namely the FINS
Act that you passed last year and the guidelines the Treasury
Department is going to be issuing.
That combined with the regulatory procedures in place at
the SEC and the Federal Reserve suggest that for once there is
a problem that you actually have all of the institutions in
place. I don't necessarily think you need to have further
reform in the United States to deal with this kind of problem.
Now, all that calming logic said, let me offer one warning,
which is in terms of foreign policy I think the one significant
crimp that sovereign wealth funds pose to the United States is
that they will retard significantly U.S. efforts at peaceful
democracy promotion abroad. There are three reasons for this.
The obvious one is that most sovereign wealth funds are
from nondemocratic countries and sovereign wealth funds
presumably give these governments greater resources with which
to maintain power, to buy off disaffected interests in their
own country. It allows them to maintain state stability in
their own country, not terribly surprising.
The less obvious reason is that the United States might not
have incentive to want these countries to democratize. Here
we're talking about the combination of anti-Americanism and
nationalism in the countries that have the largest sovereign
wealth funds, namely the Pacific Rim and the Middle East. This
sort of combination will create if you have democratic
governments, newly created democratic governments, they're not
necessarily going to be big fans of the United States, and they
might very well decide to take costly actions in order to
punish the United States for what they see as past historical
grievances.
While this would hurt their own economies, I would stress,
it is a tendency of newly democratic governments to do things
that might hurt themselves for costly political reasons.
Furthermore, it should be stressed that it is sovereign
assets from democratic countries that are most likely to attach
political conditions. All we need to look to here is our own
country, where you see restrictions placed on, let's say, the
California pension system in terms of investing in Sudan, or
the Divest Terror campaign in terms of trying to place
restrictions on investing in Iran.
One final point, which is that in the long term--and I
don't think this is a huge possibility, but I do think you have
to consider it--sovereign wealth funds are part of a component
of a sort of state-led development approach, in which you're
talking about sovereign wealth funds, state-owned enterprises,
national oil companies, government regulations of the Internet,
other extensive government regulations, that appear to be
succeeding in the short term at generating relatively large
amounts of economic development.
The rest of the world is looking to see what is the best
recipe for economic growth, and for decades we have told them
the past is liberal free market democracy. If it turns out that
sovereign wealth funds are a component of this alternative form
of development, then suddenly our own sort of model is going to
look less attractive and that's going to cause an erosion of
American soft power. Fewer countries are going to want what we
want.
Now, I should stress that I don't know in the long term if
this model is viable. But if it is that is certainly a source
of concern.
Thank you very much.
[The prepared statement of Dr. Drezner follows:]
Prepared Statement of Dr. Daniel W. Drezner, Professor of International
Politics, Fletcher School of Law and Diplomacy, Tufts University,
Boston, MA
Sovereign Wealth Funds (SWFs) are government-controlled pools of
assets designed to engage primarily in foreign portfolio investment.
They are distinct from other sovereign assets--central bank reserves,
state-owned enterprises and banks, and government pension funds--
because of the emphasis on cross-border equity purchases. Their size,
rate of growth, and national origins have raised concerns about whether
and how SWF investments impact America's economy and foreign policy.
This testimony focuses primarily on the latter.
In most respects, the growth of sovereign wealth funds has marginal
effects on the contours of U.S. foreign policy. SWFs are, rather, a
symptom of other national ailments--persistent macroeconomic imbalances
and a failure to diversify America's energy supply. As symptoms go,
sovereign wealth funds are relatively benign in their foreign policy
effects. Indeed, SWF investment patterns have been less aggressive than
the similar wave of Japanese foreign direct investment during the
eighties. If anything, these investments demonstrate the ever-
increasing interdependence of the Pacific rim and Middle East with the
American economy. There is, however, one foreign policy wrinkle from
the rise of sovereign wealth funds. Their growth will significantly
impair America's democracy promotion efforts.
background
Sovereign wealth funds are not a recent invention--Kuwait created
the first modern one in 1953. Nor are they un-American: The State
governments of Alaska and Texas both have sovereign funds designed to
manage the revenues that have arisen from their energy booms.
What is new is the size of recently created funds, their
anticipated rate of growth, and their countries of origin. Over the
past 3 years, these funds have been growing at a 24-percent rate. In
2007 these funds invested $48.5 billion globally; in the first 3 months
of this year, they registered more than $24 billion in overseas
investments. SWFs have been involved in high-profile equity purchases
of high-profile financial institutions, lincluding Blackstone, Credit
Suisse, UBS, Merrill Lynch, Morgan Stanley, Visa, and Citibank. The
combined heft of sovereign wealth funds is currently estimated to be
between $3 trillion and $3.5 trillion. To put this in the proper
perspective, this is between 1 and 2 percent of global asset markets.
Private sector analysts project that by 2015 their total valuation
could range in size from $9 trillion to $16 trillion. In 2007, Russia
and China created new sovereign wealth funds. Saudi Arabia created one
this year, and press reports indicate that Japan and India might create
their own funds in the near future.
Two kinds of governments are pumping the most money into sovereign
wealth funds: Energy exporters and Pacific rim economies. For the oil
exporters, the incentive to create a sovereign wealth fund is twofold.
First, these economies want to create assets that ensure a long-term
stream of revenue to cushion themselves against the roller coaster of
commodity booms and busts. As many economists have observed, these
countries are simply converting assets extracted from the earth into a
more liquid form. Second, by focusing on foreign direct investment,
these governments are attempting to forestall the Dutch disease of
rapidly appreciating currencies. Overseas investment via sovereign
wealth funds can accomplish both tasks simultaneously.
Export engines like China are also using sovereign wealth funds to
keep their currencies from appreciating too quickly. As of 2007, China
had accumulated more than $1.8 trillion in foreign assets in order to
prevent the yuan from rising--and therefore keeping Chinese exports
competitive in the United States. More than 80 percent of these assets
exist in the form of foreign exchange reserves--safe investments with
very low rates of return. As these reserves have accumulated, the
Chinese Government has been willing to diversify its holdings into
higher risk investments--hence the creation of the China Investment
Corporation last year.
the pattern of sovereign wealth fund investments
To date, the effects of SWF investment in the United States have
been benign. The general consensus among financial analysts is that
sovereign wealth funds have taken a long-term, passive approach to
their American investments. The bulk of recent SWF investments has been
for either nonvoting shares or stakes too small to trigger the CFIUS
process--somewhat defusing concerns about foreign state control of the
U.S. financial sector. A majority of sovereign funds have explicit
policies preventing them from acquiring controlling interests, and most
of the rest have implicit policies following the same course of action.
Compared to the wave of private Japanese foreign direct investment
during the 1980s, sovereign investments have been considerably less
controlling. They have consciously avoided the purchase of ``trophy
assets'' such as Pebble Beach or Rockefeller Center. The more mature
sovereign wealth funds outsource the management of many of their assets
to outside managers.
Indeed, the high-profile purchases of equity stakes have permitted
firms like Citibank to recapitalize in the wake of the subprime
mortgage crisis. The specter of China's SWF presence has also been
exaggerated. While the China Investment Corporation (CIC) has $200
billion to invest, the bulk of its assets have been invested
domestically. As of March of this year, CIC's overseas investment total
less than $20 billion, though this is expected to grow. CIC's most
notable foreign investment--Blackstone--was made by a subsidiary prior
to its takeover.
The comparative advantage of sovereign wealth funds is that they
can hold large positions for long stretches of time, weathering short-
term panics and downturns (this is a good thing for them--between
February 2007 and February 2008, high-profile SWF investments earned a
real rate of return of negative 10 percent). If these funds are
attempting to maximize profits, they would therefore function in a
countercyclical manner akin to hedge funds. This kind of investment
pattern does not pose a threat to American interests.
overall effects on u.s. foreign policy
One foreign policy concern is that SWFs are sprouting up primarily
in countries not commonly thought of as reliable U.S. allies. Could
they use their stakes to exercise political influence over American
firms? Testifying before the United States-China Economic and Security
Review Commission in February, Alan Tonelson articulated this concern:
``If, for example, the Chinese Government held significant stakes in a
large number of big American financial institutions, especially
marketmakers, and if our Nation's current period of financial weakness
persists, how willing would Washington be to stand up to Beijing in a
Taiwan Straits crisis?'' That same month, Senator Hillary Clinton
observed: ``You know, you cannot get tough with your banker. You cannot
stand up if they have very different interests in the Middle East or in
Asia than we do and they basically say, fine, you want us to dump
dollars? Do you want us to pull our investments out?''
This fear rests on some tenuous assumptions. First, it presumes
that foreign governments will know how to strategically invest so as to
maximize foreign policy leverage. This might give governments too much
credit. As Kenneth Rogoff pointed out in congressional testimony last
year: ``Governments have a long tradition of losing massive amounts of
money in financial markets. This tradition is not likely to end anytime
soon.'' Second, because of existing U.S. laws and guidelines, it is far
from clear whether sovereign wealth funds could exercise malevolent
control over firms even if they tried. The Foreign Investment and
National Security Act of 2007 already requires heightened scrutiny when
a foreign government-controlled entity acquires a controlling stake in
a U.S. firm--and the Treasury Department's suggested guidelines suggest
that CFIUS will investigate proposed acquisitions below the controlling
level. Third, a cursory review of past waves of foreign direct
investment reveals that in times of global crisis, what matters is the
actual location of physical assets, not the identity of their owner.
Many analysts predict that capital exporters will possess
bargaining leverage on regulatory questions. However, the tatonnement
process of bargaining currently taking place between home and host
countries of sovereign wealth funds suggests that concerns about
transparency will be addressed. Last year the International Monetary
Fund (IMF) and the Organization for Economic Cooperation and
Development (OECD), in response to a G-8 request, initiated reviews of
best practices for sovereign wealth funds appropriate inward investment
regimes for recipient countries. Both international organizations have
made reasonable progress in their remits, and experts in both
organizations seem unperturbed by their investment patterns to date.
Individual sovereign funds are also adapting to the changed
political environment. Two of the largest sovereign wealth funds--
Singapore's Government Investment Corporation (GIC) and the Abu Dhabi
Investment Authority (ADIA)--agreed to principles of transparency with
the U.S. Treasury Department in March of this year. The head of CIC
pledged on ``60 Minutes'' that his fund would match Norway's sovereign
wealth fund in transparency. Singaporean officials have made it clear
earlier this year that it recognizes the need for greater transparency
in its investment plan. GIC's deputy chairman explained, ``The greatest
danger is if this is not addressed directly, then some form of
financial protectionism will arise and barriers will be raised to
hinder the flow of funds.''
This last quote indicates why American foreign policy does not face
significant constraints from SWF investment. The interdependence
created by sovereign wealth funds cuts both ways. At present, the
United States needs SWF investment to finance its large current account
deficit. However, most other asset markets are neither big enough nor
open enough to cater to large-scale sovereign wealth investments. Large
market jurisdictions--the United States and European Union--should be
able to dictate most of the rules and regulations regarding these
funds. While the OECD economies--and prominent firms within these
jurisdictions--might need SWF investment, it is equally true that
capital exporters need America and Europe to keep their jurisdictions
open to capital inflows. These two markets remain the only ones deep
and liquid enough to absorb inflows in the trillions of dollars.
Indeed, the very countries ginning up sovereign wealth funds at the
moment are the most protectionist when it comes to foreign direct
investment.
Sovereign wealth funds are unlikely to disrupt the functioning of
the American economy. They are symptom of other problems. U.S.
consumption is keeping energy prices high. A low U.S. savings rate,
combined with the foreign manipulation of exchange rates, has allowed
some Pacific rim economies to inflate their current account surpluses.
Those are the macroeconomic forces that are causing foreign governments
to expand their sovereign wealth funds. Addressing those problems
sooner, rather than later, will go a long way toward eliminating
sovereign wealth funds as a political hot potato. Improving the savings
rate of Americans, for example, would help to reduce the large current
account deficit that is fueling the growth of sovereign wealth funds in
the Pacific rim. Reducing energy demand would also reduce the growth of
sovereign wealth funds among energy exporters--though such a reduction
would be partially offset by rising demand around the globe. Recent
trends suggest that market forces are moving in the preferred
direction. In recent years the Chinese renminbi has appreciated by 20
percent against the dollar. High prices will likely contribute to
greater conservation efforts and reduced energy demand.
effects on democracy promotion
The biggest effect of sovereign wealth funds on American foreign
policy is their effect on democracy promotion efforts. These funds
impact U.S. foreign policy in this area on several dimensions. SWFs aid
and abet in the persistence of ``rentier states''--governments that do
not need their citizens to raise revenue. Democratization is a much
more difficult policy for the United States to pursue when the target
government is sitting on trillions of dollars in assets to buy off
discontented domestic groups. Authoritarian governments in the Middle
East and East Asia will be more capable of riding out downturns that
would otherwise have threatened their regimes.
More generally, the growth of China's sovereign wealth fund belies
the notion that as China grows richer it will become more democratic.
Embedded within America's current national security strategy is the
assumption that as China integrates itself into the global economy, it
will face a growing demand from its own people to follow the path of
East Asia's many modern democracies, adding political freedom to
economic freedom. If the Chinese Government can blunt pressures toward
democratization through its financial muscle, then the United States
will need to recalculate its long-term approach toward Beijing.
More perversely, the growth of sovereign wealth funds, combined
with rising nationalism and anti-Americanism in capital exporting
countries, would give the United States even less reason to want
democratic transitions in these parts of the globe. Consider the effect
of a populist or fundamentalist revolution taking over in Saudi Arabia
or the gulf emirates. Rampant anti-Americanism among the Arab populace
could encourage a new government to purposefully sell off SWF
investments in the United States in order to induce a financial panic.
While such moves would also be economically costly to these countries,
such actions are not inconceivable in the early stages of a
revolutionary government.
Even if China or the Persian Gulf emirates were to democratize more
gradually, one could easily envisage nationalist parliaments using
their SWFs to constrain U.S. actions. Sovereign funds in democratic
societies are more likely to inject political conditionality into their
capital markets. In the United States, for example, interest groups
have been eager to use America's financial muscle to alter the behavior
of foreign actors in Sudan and Iran. There would be no reason to expect
other democratic, capital-rich countries to behave differently.
Looking at the long term, sovereign wealth funds are one component
of an alternative development path, suggests a possible rival to
liberal free-market democracy. In state-led development societies,
governments could use sovereign wealth funds, state-owned enterprises
and banks, national oil companies, extensive regulation, and other
measures to accelerate economic development, buy off dissent and
promote technology transfer. If this model proves sustainable over the
long run--and this is a big if--it could emerge as a viable challenger
to the liberal democratic path taken by the advanced industrialized
states. More countries might think of sovereign wealth funds as a
signal of being a ``successful'' country. One could then envision the
proliferation of such funds--even in situations in which there is no
economic rationale for its creation. This would have corrosive effects
on America's soft power. It would be an open question whether the rest
of the world would look at the democratic development model as one to
emulate. Crudely put, far fewer countries would want what America
wants.
In conclusion, sovereign wealth funds have made headlines over the
past year because of high-profile purchases of prominent firms. As long
as global macroeconomic imbalances and demand for traditional
hydrocarbon fuels continue to persist, SWFs are projected to grow at an
accelerated rate over the next decade. Sovereign funds have, to date,
played a constructive role in injecting liquidity into the global
economy during the current period of uncertainty. There is little
reason to believe that, on their own, sovereign wealth funds will
exercise any significant constraint on most dimensions of U.S. foreign
policy. Over the long term, the trouble with sovereign wealth funds is
not that they will fail, but that they will succeed--in which case they
pose a challenge to American national interests.
The Chairman. Thank you very much, Professor.
Sir, the floor is yours.
STATEMENT OF DAVID MARCHICK, MANAGING DIRECTOR AND GLOBAL HEAD
OF REGULATORY AFFAIRS, THE CARLYLE GROUP, WASHINGTON, DC
Mr. Marchick. Thank you very much, Mr. Chairman, Senator
Lugar. Thanks for the opportunity to participate. I will try to
be brief for a couple reasons. One is that it is always the
chairman's right to preempt and say what the witness was going
to say and the chairman by definition always does it better.
The Chairman. No; that's not true, but I'm flattered you
think I did. Thank you.
Mr. Marchick. So I think that you hit the nail on the head
when you said let's focus on don't confuse the symptoms and the
cause. All of this is driven by the huge and growing current
account deficit that we are running, the combination of our
trade deficit, our low savings rates, and our increasing
dependence on oil combined with the high price of oil. Until we
get those issues under control, which have huge public policy
consequences and very difficult decisions, we're going to
continue to see the changes that we're seeing today.
Part of this has resulted in the growth of sovereign wealth
funds, which you and others have said are growing quite
rapidly, $3.2 trillion today, going up to maybe 12, 13 trillion
in 5, 6 years.
There is anxiety resultant from this because the
investments are coming from nontraditional sources of
investment in the United States. It's not just the U.K. or The
Netherlands or Canada, which are traditional long-term
investors, but it's now coming from China, the Middle East,
Russia.
This reminds me somewhat of the situation 20, 21 years ago
with Japan, where there was great concern on Capitol Hill. I
think in July 1987 there was a press conference where Members
of the House took sledge hammers to Japanese products. At that
time there was great concern about whether Japan was going to
buy up our assets, whether we were going to be eclipsed by the
Japanese economy, and whether we were losing our leadership
position in the world.
Well, what happened after that was that Japan went through
a prolonged period of economic slump and the United States went
through a period of great economic dynamism, where we were
actually encouraging the Japanese to get their economy growing
again. So none of the fears that occurred in the late 1980s
actually came to pass. But today we're seeing some of the
similar anxieties.
So the key issue for us I think as a nation is what do we
do about this? It's been documented unequivocally by economists
and others that foreign direct investment has a positive impact
on the U.S. economy. It creates jobs, it creates high-paying
jobs. There's a disproportionate investment in our
manufacturing base, which is absolutely critical for our
economy; that there's heavy investment in R & D; that overall
it's a net benefit.
Most sovereign wealth funds are passive investors, so there
shouldn't be any problem with passive investment. Senator Webb
has done some I think very good work on this issue in the CFIUS
context. If a company has a third party management, whether
it's Fidelity or Goldman Sachs or like our 401ks, there's no
control, there's no issue.
Then the issue is what if sovereign wealth funds take
controlling stakes. In most sectors of the economy there
should--there are no national security issues associated with
investments, controlling investments in particular sectors--
real estate, retail, most services, insurance, et cetera.
In a small subset of the economy, there are sensitive
sectors where foreign investment does raise legitimate national
security issues. Then the question is, Are our processes
adequate and rigorous enough to address those threats? In my
view they are and, thanks to the Congress, CFIUS has been
strengthened and under the new law there is heightened scrutiny
of any government-controlled investment.
Let me just give you 2 minutes on our own experience at the
Carlyle Group. We have been around for 21 years. We invest in
all sectors of the economy. We have two investments from
government-affiliated organizations. One is CALPERS, which owns
5.5 percent of Carlyle, and the other is a company called
Mubadala, which is based in the UAE, which owns 7.5 percent.
Both those investments are structured exactly the same.
They invest in us, we have total control over how we invest, in
what companies we invest, how we manage those entities, and
when we exit, when we sell the companies. They have no seats on
our board, they have no right to control our decisions. So
they're completely passive investments, just like when you and
I invest in Fidelity or our thrift savings plans.
They've been very positive investments and they've helped
us expand our investment in the United States, which I think is
a positive thing. What they're looking for is hopefully a good
dividend, a good return, and hopefully we will do well with
their money and meet their investment criteria. But they're
completely passive and have no control over what we do or how
we approach things.
So I think that overall we should welcome sovereign wealth
fund investment in the United States. Most of it is passive, so
there shouldn't be any concerns. And for those few investments
where they do trigger national security issues, as Senator Webb
has focused on this issue, there should be a very active,
rigorous review by Federal authorities to determine whether
there are any national security issues, and if there are CFIUS
should either mitigate those concerns or block the investment.
Otherwise, we should welcome the investments.
Thank you very much.
[The prepared statement of Mr. Marchick. follows:]
Prepared Statement of David Marchick, Managing Director and Global Head
of Regulatory Affairs, The Carlyle Group, Washington, DC
Chairman Biden, Ranking Member Lugar, members of the committee,
thank you for the opportunity to testify, and for holding this hearing.
I worked on foreign investment issues during my time in government and
for the past 6 years before I joined The Carlyle Group, a global
private equity firm. I am speaking as much from my previous experience
as from my current perspective at Carlyle.
historical context for this debate
Mr. Chairman, 21 years ago next month, seven Members of the House
of Representatives held a press conference outside the Capitol where
they smashed Japanese products with sledgehammers. At that time, there
was great anxiety over the rise of Japan--over whether Japan was going
to buy up our key assets, and whether Japan would eclipse the United
States as the leading economy. None of those fears materialized. Japan
subsequently went through a protracted economic slump where the United
States was actually encouraging Japan to increase economic growth, and
the United States entered one of the most dynamic periods in its
economic history. Although Japanese investment stirred controversy in
the 1980s, today, Japanese firms are part of the fabric of American
society. In 2005, 613,000 Americans were working for U.S. affiliates of
Japanese companies.
Today, similar fears are being raised about another growing source
of investment--from Sovereign Wealth Funds (SWFs).
Just as with respect to Japan in the 1980s, a significant amount of
today's anxiety exists because foreign investment is coming from new
countries. For example, in 2006, the United Kingdom, Switzerland, the
Netherlands, and Japan accounted for almost 60 percent of the
cumulative stock (e.g. the cumulative amount of investment) of Foreign
Direct Investment (FDI) in the United States but only accounted for 31
percent of the inward flow (e.g. the amount invested in that year).
Other countries, including developing countries, are becoming much
larger outward investors. This represents a dramatic shift in the
paradigm that we have seen for many years--China, Brazil, India, and
Russia have traditionally been large recipients of FDI; today, they are
starting to be significant sources of investment. From 2000-2006,
outward FDI from China grew 6.9 times, from Russia 5.9 times, and from
some Middle Eastern states more than 35 times.
Also evident is the fact that investments from developing countries
are more likely to be affiliated with government ownership than are
cross-border investments from developed countries. Of the top 100
multinational companies in the world, only 5 are government-owned. By
contrast, of the top 100 developing-country multinational companies, 25
are government-owned.
Sovereign wealth funds are also becoming larger sources of cross-
border investments. Sovereign wealth funds have been around since 1953,
when Kuwait, then controlled by the United Kingdom, established the
Kuwait Investment Authority. SWFs invested either directly or through
asset management firms in relative obscurity until the last couple of
years, when the growing size and number of SWFs attracted the attention
of the press and officials primarily in the United States and Europe.
There have been two predominant factors driving this growth: Higher
commodity prices, primarily in oil; and growing current account
surpluses, particularly in Asia. Much of the growth has occurred in the
developing world, including China, Russia, and the Middle East, and
there have been more high-profile investments from government-
affiliated entities. The growth in SWFs has come at a time of overall
growth in outward investment from developing nations.
While the number and size of SWFs has grown in the past few years,
SWF investments represent a small slice of the global investment
market: In 2007, the value of SWF mergers and acquisitions (M&A)
activity represented only 1.6 percent of total global M&A volume. The
percentage may be larger in 2008, but overall will still represent a
small component of global investment.
Sovereign wealth funds have a lot of money--$3.2 trillion according
to some estimates--but are tiny compared to the $52 trillion in global
pension and mutual funds and even smaller when considered in the
context of the more than $160 trillion in global financial assets.
Further, while there have been a number of high profile investments,
the vast majority of SWF investments are for passive, minority stakes.
SWFs have, in fact, served as an important source of stability at a
time of great uncertainty in financial markets.
swfs and foreign policy
The regular flow of investment from SWFs does not, in my view, give
rise to foreign policy concerns for the United States. The U.S.
benefits from foreign direct investment--it creates jobs and fosters
growth. SWFs have been investing in the United States for decades
without any problems. To my knowledge, no sovereign wealth fund
investment has compromised the United States' or any other country's
national security.
In fact, most SWF investment is completely passive and/or managed
by third party investment managers. For these investments, it is hard
to even create a hypothetical foreign policy or national security
concern that could arise. Even where SWFs take controlling stakes in
companies, most transactions do not raise any national security or
foreign policy concerns. For example, there should not be any national
security concerns associated with investment in most sectors of the
economy, including the retail, real estate, or hospitality sectors,
each of which have been the focus of SWFs. For those investments in
more sensitive sectors, the United States has a robust, layered set of
laws and regulations that protect important governmental interests
associated with any investment, sovereign or otherwise. Last year,
Congress passed the Foreign Investment and National Security Act, which
strengthened the foreign investment review process in the United
States. FINSA protects against threats to national security, and CFIUS
has demonstrated its willingness to block or mitigate problematic
investments. Other laws and regulations are in place to address other
government interests, including antitrust, consumer welfare and safety
and security. Even if there were cause for concern associated with
sovereign wealth funds, our existing legal and regulatory structure
should capture and fix--or block--any problematic investments. Bottom
line: When foreign entities invest in the United States, the U.S. is
sovereign, not them.
By contrast, official or even informal actions to restrict SWF
investment in the United States could cause foreign policy problems, or
at a minimum, create unnecessary tensions with our allies and nonallied
sources of investment. Legislative or regulatory steps to restrict SWF
investments will not only cause harm to the U.S. economy, but also
alienate countries which are critical allies on a variety of issues
that are core to U.S. interests. Actions to curb SWF investment would
not only impact China and Russia, it would also negatively impact
Australia, one of our closet allies; Singapore, with whom we have a
strategic defense alliance; and the UAE, which
has troops in Afghanistan and is a critical ally against extremism in
the Middle East. Even unofficial actions--including politicization of
investments--can have a negative impact on the U.S. economy and U.S.
national interests. Several significant sovereign wealth funds have
recently stated that they will look to invest outside the United States
or Europe because of the political environment. This unfortunate
development harms our economy and potentially causes unnecessary
tensions with other countries. Finally, if we start blocking
investments in the United States, we can be certain that other
countries will retaliate against U.S. investment abroad. Since the U.S.
is the largest source of FDI in the world, we have more at stake than
any other country in the world.
Mr. Chairman, SWFs are growing fast because of high energy prices
and our large current account deficit. American dollars are going
overseas, and SWFs are one important way that foreign countries can
recycle these dollars. I would much rather have SWFs invest in the
United States than abroad--their investments creates jobs, economic
activity, and opportunities for American firms and workers. Their
investments further integrate these countries into the global economy,
and align their interests with those of the United States. These
investments also could help create economic security and a stronger
middle class in the source countries, and as we know well, a vibrant
middle class is an important source of stability.
In my view, a more important foreign policy and national security
concern is the United States' growing dependence on foreign countries
to finance our current account deficit. At $738.6 billion in 2007, our
current account deficit now accounts for about 70 percent of the
world's total across all deficit countries. Beyond traditional surplus
countries like Japan, fast-growth countries such as China, Russia, and
Saudi Arabia have assumed a larger financing role. There is nothing
unhealthy about foreign financing of deficits. However, the
unprecedented size, trajectory, and sustained nature of our deficit,
combined with growing structural imbalances, does raise concerns.
We have little control over some of the factors leading to these
structural imbalances. For example, some countries are clearly
intervening at significant levels in order to lower the value of their
currency. And the U.S. is uniquely positioned to continue to attract
large amounts of investment to finance our deficit. But we can and
should take steps to reduce the growth of our fiscal deficit, to
encourage greater private savings rates in the United States, and to
reduce demand for oil.
carlyle's experience with government investment organizations
I'd like to take a moment to explain The Carlyle Group's positive
experience with two investments from government-affiliated entities.
First, the California Public Employees Retirement System (CalPERS), the
largest public pension fund in the world, acquired a 5.5-percent
interest in Carlyle in 2000. Second, the Mubadala Development Company,
a firm that invests funds on behalf of the government of Abu Dhabi,
purchased a 7.5-percent stake of Carlyle in 2007. The terms of these
investments are pretty simple: CalPERS and Mubadala acquired passive
stakes in Carlyle. They exercise no control or influence over our
investment decisions. Their investments have allowed us to create
strong U.S. companies, grow jobs and spur innovation. CalPERS and
Mubadala each receive a quarterly or annual financial report, and we
will work hard to produce an attractive rate of return for both
entities. Both CalPERS and Mubadala are sophisticated investors, and we
are grateful for the confidence they have shown in us.
summary
In summary, SWFs are having a positive impact on the United States
and international economies. They have proven to be a source of capital
for the U.S. at a time of volatility in our financial markets. Indeed,
if some of our largest financial institutions did not receive large
infusions of capital from SWFs late last year and early this year, it
could have led to economic disorder, which itself conveys a sense of
weakness and vulnerability.
To date, SWF investments have been typically passive, minority
stakes. For active, controlling investments, the United States has a
proven set of laws and regulations that protect our national interests
associated with any foreign investment. Barring a particular problem
with a particular transaction, our doors should be wide open to foreign
investment. Formal or informal steps to close our economy or restrict
investments would not only harm U.S. interests but also unnecessarily
cause tensions with our allies and other countries with which we have
important strategic objectives.
The Chairman. Thank you very much. Thank all of you.
Mr. Chairman, 7-minute rounds?
Senator Lugar. Yes.
The Chairman. We have good attendance and we'll do 7-minute
rounds.
To state the obvious, there's a number of questions I'd
like to ask, but I'm sure that my colleagues will ask them as
well. I'd like to focus on something and maybe go to you,
doctor, the political scientist in the group here. There's
something that I'm a little more concerned about that's a more
subtle influence. The subtle influence, quite frankly, that I
focused on, and none of my colleagues nor any of you may think
is worth the concern and I'd be anxious to hear if it's not and
it would allay my concerns. But I think there is a subtle
impact on our conduct of foreign policy when investments in the
United States affect the powerful groups in which the
investments are made, for them to determine and put impact on
the Congress and the President ought curtail and/or enhance a
certain foreign policy action.
So that, let me overstate the case for a minute. One of the
things that's become clear to all--I'll speak for myself--clear
to me is that our overwhelming dependence on imported oil,
coupled with our low savings rate and coupled with particularly
the Chinese, at least in my view, policy of mimicking what
Japan did and expanding it multifold in the first decade of the
20th century regarding exports, has put us in a position where
those nations whose conduct we wish to influence toward a more
benign or, how can I say it, to be more responsible actors in
the international community have no reason to have to listen to
us. They're floating in a sea of oil.
I mean, can you imagine Putin's circumstance in Russia in
terms of the impact of any pressure relating to his de-
democratization of that country were he not floating in a sea
of oil? If oil had gone down, as predicted by the
administration, to $10 a barrel after we went into Iraq, where
would Putin be at this moment? In a very different position, to
take one example.
Conversely, it has profound impact, as the Chairman has
pointed out, on the willingness of our friends to act in my
view responsibly, because they are held hostage by oil. I'll
make a very subjective comment. I think the Chairman and I both
agree that the expansion of NATO, including the preliminary
steps for Ukraine, would have been a positive thing. Well,
Russia used oil as they used their 40 divisions prior to the
collapse of the Soviet Union to basically in my view say to the
Germans: You've got a real problem; you go ahead and vote to
expand NATO by bringing the preliminary steps for Ukraine, we
may, figuratively speaking, cut off the spigot.
So it has profound impacts on our foreign policy. I'm not
picking on Russia, doctor. I am not one who views they should
be kicked out of the G-8. I'm not--if you know, any of you know
a little bit about me, I am not saber-rattling about it. But I
think it's a statement of fact that there's real impact, that
is subtle and not clear to the average American or European or
anyone.
So, having said that, I think you add on top of that, if
there is an overall by the year 2012 or 2015--if you have an
$8, $10 trillion investment benefiting--benefiting the United
States economic growth engine--but particularly benefiting
those who control the growth, I think it becomes much harder
and divides us up here when the President would come along and
say: We're taking the following action against Saudi Arabia for
reasons unrelated to sovereign wealth funds, or Russia or China
or whatever.
You see the pushback--let's argue that it's totally
legitimate. You see the pushback that comes from American
manufacturers. You see the pushback that comes from IT
companies when we say to them, whoa, what the hell are you
doing turning people over to Chinese authorities for violation
of human rights--I mean, for violation of Chinese law? What are
you doing? They say, whoa, hey, man, you guys shouldn't be
legislating in this area; it will cost us a lot of money.
You saw the impact when they sent us dogfood. If that
dogfood had come from France, we'd have cut off that brand like
bang. It'd be done, finished, gone, over. It would have been
done within 2 days. But it was China and there's a whole hell
of a lot of American investors who view, as the overused
phrase, why invest in China, why Willy Sutton robs banks,
robbed banks? That's where the money is. That's where the
people are.
So I'm sure, as an old friend of mine used to say, you
understand my point. I'd like you to comment on it. What about
the subtle impact on domestic American pressure from major
patriotic--I'm not making any claims about patriotism, whether
they are labor or business--on impacting upon the conduct of
U.S. foreign policy when they, the beneficiaries of America
investments, which I agree with you, Dr. Drezner, is most times
fairly benign.
I was going to ask--my very first question was about,
remember Japan Incorporated was going to--that was my first
question. You've mentioned it already. It didn't have much of
an impact, but it went to our pride. It went to our sense of
ourselves. But it also now seems to me to go to the conduct of
foreign policy in terms of legitimate interest groups in the
United States, able to, and appropriately, putting pressure on
the United States Government in the conduct of foreign policy.
It's a very broad question. Would you please respond, and I
invite either of the other two to respond as well if you'd like
to after Dr. Drezner does.
Dr. Drezner. Thank you, Mr. Chairman. There's no question
that the most effective kind of power you can exercise is the
power that you never see, is the power that's sort of implicit
in the other person's mind. So to some extent you're correct in
terms of saying that if these interest groups, recognizing that
they owe their livelihood in part to the ownership by sovereign
wealth funds from overseas, would implicitly affect their
behavior--in fact, I'm sure if you gave them a lie detector
test and asked them, is it affecting your behavior, they'd pass
it saying no. But it might have some sort of implicit awareness
of the extent to which they're relying on foreign investment.
So might that happen? It's certainly a possibility and if
you look particularly at, let's say, the Senators from New York
and what their attitudes are going to be after sovereign wealth
funds investments into the U.S. financial sector, that might be
an interesting political science exercise.
Now, that said, I do think you're overstating the situation
a little bit in a couple of ways. First, this kind of power
cuts both ways. The more sovereign wealth funds investment
there is in the United States, it doesn't just increase our
dependence on foreign capital; it also increases the dependence
of these other governments on our economy functioning
relatively well.
So in that sense I would argue this is an increase in
interdependence, not an increase in asymmetric dependence.
The Chairman. It may be an increase in economic
interdependence, but that doesn't necessarily comport with the
promotion of human rights. That doesn't necessarily comport
with our view of where our strategic interests lie unrelated to
our economic concerns. I mean, I would argue the President did
not make the judgment to go into Iraq, notwithstanding what
people think, based on oil. I would argue he made that judgment
based upon what he thought the national security interest--I
think he's wrong, but the national security interests of the
United States were in the region.
So I don't doubt for a moment the interdependence that it
breeds. But what I do wonder about--and you've answered the
question--is whether or not it has the effect of having
economic policy in effect trump other legitimate, legitimate
foreign policy and national security concerns in terms of our
action. What is economically in our interest is not always
necessarily strategically in our interest, I would argue,
unless you are a political science professor who's gone over to
the economists, and then what the hell, you're lost.
Dr. Drezner. I have to confess, I also have a master's
degree in economics.
The Chairman. I knew you were suspect. [Laughter.]
Dr. Drezner. I have consorted with other known economists,
sir.
I think in the long term the pursuit of wealth and the
pursuit of power tend to go hand in hand. So it's not clear to
me--while there might be some short-term conflicts, I think in
the long term the sort of issues you're raising do not
fundamentally impair U.S. foreign policy.
As I said in my testimony, I agree that the promotion of
sovereign wealth fund investment is going to retard the
promotion of democracy and human rights abroad. That has to do
with the origins, the countries of origin. But that said, these
countries now have a greater stake in making sure that the U.S.
retains its economic growth and the stability of the global
system, and that's not for nothing.
The Chairman. I'm not suggesting it is. I appreciate your
answer.
Do either one of you like to comment? I'm over my time, but
if it's brief.
Dr. Bhagwati. Yes, sir, very quickly, Mr. Chairman. With
China it's really our investment there----
The Chairman. I agree.
Dr. Bhagwati [continuing]. In the provinces, rather than
their investment with us----
The Chairman. No; I absolutely agree with that.
Dr. Bhagwati [continuing]. That's constraining us. And as
far as Russia is concerned, it's just the luck of the draw that
the oil price increases have actually made them so much better
off. I mean, they've gone from being a superpower to what I
call a super-beggar, when they were completely flat out. Now,
thanks to oil, they've risen up again. I think it's just
getting a little hard for us to accept that in the sense that
they're now speaking their minds, following their interests as
they see relevant, and so a divergence is opening up.
But I think as far as sovereign wealth funds are concerned,
I would be inclined to agree with my political science friend
that it really doesn't amount to a hill of beans right now. But
there's a subtle influence which you were talking about, like
when they start buying up Citigroup and so on and so forth.
These are not--Senator Obama is not here, but these are not
exactly innocent, poor, ineffective lobbies. As far as their
influencing what the firms will say and do in Washington, I
think there may be--I mean, that's something we need to think
about.
I don't know which way it would go, but certainly it's an
important point which you're raising. I think at the moment I
don't see any clear pathway which would be followed, but
certainly when the going gets tough on some issue you can be
sure that the financial firms which have been bought into a
little bit are going to be more cautious compared to NGOs and
others who want to push human rights, and so on and so forth.
So I think you've got a good point there.
The Chairman. I've not reached any judgment on it, but I do
think we don't talk about it much and that's why I wanted to
raise it, because it's just not in the line of questions my
incredibly competent staff has prepared for me. I just wanted
to because others will ask those questions as well.
David, would you like to make any response?
Mr. Marchick. Just very briefly, these are age-old issues.
I dealt with them when I was in the administration, where
business or agriculture wanted one thing and there were other
interests. Good policymakers have to balance the various
interests and make the judgment on what they think is the best
interest of the United States overall.
But I agree with my colleague that sovereign wealth funds'
impact on that is probably negligible.
The Chairman. Thank you.
Mr. Chairman.
Senator Lugar. Thank you very much, Mr. Chairman.
One of the good things about discussing the sovereign
wealth funds is it brings to the fore a host of other questions
other committees and the whole Senate is dealing with. For
example, Mr. Marchick, you mentioned that one problem that we
have is that we're running a very large trade and current
accounts deficits. We are also running a large fiscal deficit
of $400 billion. There are plans in 10 years of how that might
get down to zero or so, but these are not altogether credible,
given what we're doing.
So as a result we have a need for a lot of money. We've
been borrowing through our Treasury bonds from all these
countries quite apart from sovereign wealth funds for a long
time. There are disagreements as to how many trillions of
dollars other countries have, but it is a large sum.
It would appear that our low savings rate, which some
estimate at sort of a net zero after credit cards and
everything else are factored out, is not going to change very
rapidly, especially given the stresses on families and on
mortgages. So these things are not inevitable, but these would
appear to be trends that are intermediate in our own future and
maybe even fairly long-term that dictate a lot of policies that
we may have.
Now, they may verge, as you point out, Dr. Drezner, into
foreign policy in this sense, that the President in his second
inaugural address stressed democracy, said it was demeaning to
suggest any country was unprepared for democracy. Yet others
are noting, not necessarily cynically, that our emphasis upon
human rights and democracy, has been in decline, in some cases
hardly spoken. This may have to do with strategic problems with
regard to war and peace, but it also may be related to, as the
chairman pointed out, oil and natural gas and other resources,
and maybe even ultimately the sovereign wealth fund issue.
This is more than a subtle change in terms of our own
outlook or, as you pointed out, Dr. Drezner, the suggestion
that some countries might adopt the so-called Chinese model, in
which you have an authoritarian government, but a lot of market
activity, investment, and prosperity. It's a very, very dynamic
situation.
So somebody looking at this might say that for some
developing countries that this model may be the best way to go,
given the per capita benefits.
But that runs aground to some fundamental thoughts in our
country about democracy, human rights, market economics,
freedom of world trade altogether, although the Chinese don't
necessarily restrict that. They want money coming in. We've
certainly accepted their money going out. I just mention these
not subtle changes.
When I was in Azerbaijan last year, the gentleman running
their sovereign wealth fund--it's a much smaller one right
now--was stressing the transparency. I thought that was
admirable, and they claim they're going to use the Norwegian
model.
This country, like many countries, has a lot of money
accumulating pretty fast. But the fact that they're going
transparent is a benefit to their citizens. Now, this is hardly
a democracy, but it's moving in that direction. In other words,
if we were to encourage some models that's a pretty good one to
take a look at and to at least congratulate people when they do
the right thing. I think this is an example of that.
On the other hand, what I wonder in Azerbaijan, as well as
in any of the countries that have the sovereign wealth funds,
is it likely that sovereign wealth fund holdings may go from $3
trillion to $12 trillion or higher. Also, when do governments
in order to either pacify their populations or because they do
run into difficulties--it might be a world food shortage or
something else--have to use the money?
The demand, whether it's transparent or not, the suggestion
in our press that somehow trillions of dollars are coming here
to satisfy our lack of saving and our deficits, and back in the
oil producing countries people are saying, why aren't the roads
any good or how about the schools, or so forth. What is your
prediction in terms even of the immediate trend, as well as the
long, as to whether there really will be great sovereign wealth
funds? Or is this a trend that is spurred by the particular
energy evolution of the moment and that we are simply
witnessing in that form?
Do you have a thought, doctor?
Dr. Bhagwati. If I may just to respond to that, I think
it's a very important point. I think the other witness actually
pointed out that we were so concerned about Japan at one time
and Japan went into a tailspin. So I think it's a very good
question because typically we, economists included, tend to
extrapolate from whatever is going on. And there's no reason to
think, as I was hinting at from the point of view of the Indian
experience, to think that these funds are going to keep growing
at the same rate, because, take China and India both. Both of
them badly need infrastructure investments at home. They're
talking about it. There's big discussion in India on using
reserves for infrastructure. And China as well, as doubtless
you know, Senator Lugar.
As a result, a lot of those reserves are going to
disappear. And now, with the food crisis the Indian ones are
going to go fast because they won't be able to go and borrow
from the Fund and the Bank when they have so many reserves
already to be able to spend on that.
So I think these things come and go. I think currently if
we keep at our oil policy of trying to create substitutes and
so on and hopefully the environmental policies reinforcing our
security concerns, so if we finally mean business on this issue
and really move into that, I think that will certainly depress
the price of oil down the road, there's no question about it.
Right now, of course, the weak dollar is in fact extending to
the notion that all currencies are likely to be weak and
therefore people are moving, hedge funds included, from
currencies into commodities. This has happened before. So
commodity prices are moving up.
But that's a temporary phenomenon. It's not a long-run
phenomenon if you're looking at the future. So I think the huge
oil price increase I think certainly is, you might call it
speculative, but it is just portfolio diversification by people
who are holding assets. They think commodities are the place to
go.
So I think it cannot be expected to continue. There are
some long-run factors also why food prices might keep
increasing, but that's where you have to take decisions on GM
foods and a variety of things like that. But I don't see this
particular distribution of surpluses and deficits continuing.
We are also--we're going to enter into a new
administration, whether it's Republican or Democratic, and the
rather profligate policies on the budget, et cetera, will be
put in line, because that can be brought in line a little more
quicker than getting people not to--to increase savings in a
dramatic fashion. So there are possibilities, and I would say
I'm not concerned that much about the underlying trends unless
people don't take fairly straightforward decisions which I
think are obviously in need of being taken. And I don't see any
fundamental problems about these decisions being taken right
now.
So I think we should not get too carried away by the
current situation.
Senator Lugar. Dr. Drezner.
Dr. Drezner. Senator, as a well-trained academic I can
provide at least 30 answers to a single question. Let me try to
do that here in terms of sort of contradicting what I said a
little bit on terms of how sovereign wealth funds might
actually help democracy promotion. There are a few
countertrends, particularly if there's adroit uses of policy.
As you suggested, one of the ways in which this can promote
democracy in some countries is the transparency of sovereign
wealth funds and whether this information gets to the citizens
of those countries. You're correct that there is resentment in
some countries where there is significant amounts of poverty
and yet you read about trillions of dollars being invested in
the richest country in the world. So there is no doubt that
sovereign wealth funds have to tread carefully and governments
have to tread carefully in terms of managing domestic
discontent.
Another way in which they can potentially contribute to at
least democratization or rule of law is that by operating in
financial markets, reputation matters and the rule of law
matters a great deal. So as a result the governments that run
sovereign wealth funds have to learn to play by Western rules
to some extent. I think you're starting to see that with the
IMF process of trying to develop more transparent voluntary
codes of conduct by sovereign wealth funds.
I think the fact that you got a commitment from Singapore's
Government Investment Corporation and the Abu Dhabi Investment
Authority that transparency is important suggests that they are
slowly recognizing the political problems they're going to have
to face. So that in some ways could contribute to greater
transparency in these nondemocratic countries.
That said, there is one concern, which is if you actually
have a crisis take place I think the last thing you would want
from a U.S. perspective is for these governments, for these
sovereign wealth funds, to precipitously withdraw significant
amounts of money from the United States in order to fund crises
at home.
To repeat what my colleague said, dealing with the current
situation we've got now is kind of like turning the battleship
Missouri. It's going to take a little while and the last thing
you want is for the turn to be too precipitous. So to some
extent if you have a crisis in these countries and you have
sort of a change in government, as I said, a more populist
revolution, you don't want to do terribly rash actions.
So just as you don't want rash actions by this
distinguished chamber, I also think you don't want rash actions
by the home country governments of these sovereign wealth
funds.
Senator Lugar. Mr. Marchick.
Mr. Marchick. I'll be very brief because I know there are a
lot of Senators here looking to engage.
Two points. The first point that you raised is kind of the
macro issue: Will this continue and what does it mean for the
United States? In my view, running a--having a balanced,
perfectly balanced budget is not essential--and running a
deficit has traditionally not been problematic for the United
States. Having a current account deficit has not been
particularly problematic. But the trend lines are stark and
accelerating. This year it'll improve a little, basically
because the economy is slowing.
But I think that in the next Congress, with the next
President, with whomever it is, hopefully some of the actions
that you can control, there will be action in terms of
improving the deficit, improving savings rates, and getting a
handle on the energy situation. And hopefully that will create
a trend line more toward balance, even if it's never going to
be perfectly balanced.
Second is, Azerbaijan is a good example. It is a small
country seeking to become more independent from Russia, that
suddenly found itself with huge amounts of oil and natural gas,
where if they took that money and invested it back in their
economy there would be hyperinflation and the oil curse, which
would basically wreck the entire economy and make all of the
nonoil parts of the economy noncompetitive.
So the United States and the IMF and Europe encouraged them
to set up a sovereign wealth fund, to invest abroad. They
invest through third party, mostly mutual fund type management,
and they have one of the big accounting firms audit them to
create transparency.
So I think that it would be hard to criticize Azerbaijan
for essentially doing exactly what the United States asked them
to do for so many years, when all of a sudden there are
concerns about sovereign wealth funds.
Senator Lugar. Thank you, Mr. Chairman.
The Chairman. Thank you.
Before I yield to Senator Menendez, I'm going to submit a
question on behalf of Senator Nelson, who had to go to another
hearing regarding the CSX Railroad, a Jacksonville-based
railroad that stretches 21,000 miles, 23 States, connects 13
military bases and 70 ports, shipping more military equipment
than any other railroad in the country. It's currently the
target of a hostile takeover by an investment group called The
Children's Investment Fund, which includes unknown sovereign
wealth funds among its investors. CFIUS review of this
potential takeover at the request of the Department of Defense
is currently under way.
The question he asked, not to be answered now, but I hate
to ask you to do it in writing: Is the Committee on Foreign
Investment in the United States within Treasury an effective
means to safeguard the interests that he's concerned about?
That's the question.
[The information referred to above was not available at
press time.]
The Chairman. I yield to Senator Menendez.
Senator Menendez. Mr. Chairman, Senator Webb has another
pressing engagement and I'd be happy to yield.
The Chairman. Senator Webb?
STATEMENT OF HON. JIM WEBB,
U.S. SENATOR FROM VIRGINIA
Senator Webb. I appreciate both my colleagues over here
yielding to me. I have 175 10-year-olds waiting on the Capitol
steps to get a picture taken. It would be very difficult to
explain to them if I was too much later.
Gentlemen, we have a clear picture obviously of why there
seems to be so much incentive toward moving toward these
sovereign wealth funds. It's liquidity, partly because of bad
investments here, and partly because of tremendous transfer of
wealth outside of this country as a result of oil policies on
the one hand and trade policies on the other.
Just very quickly, Dr. Drezner, I would like to agree with
your comment, which is something that has concerned me. That is
what we're seeing here with this new form of government and
economic cooperation inside these countries, many of which are
not democracies that could down the road actually solidify the
political systems that we have an interest in changing because
they are able to benefit from a free market system. It's
something of an irony, but that's what's going on here.
Mr. Marchick, on your comment, and others, about the
situation in Japan in 1987 and shortly thereafter, I think the
distinctions that we need to make now when we're looking at
sovereign wealth funds is, first of all, this was a compatible
political system. The Japanese political system is compatible
to our own. They're an ally. And the challenge at that time was
an economic challenge and, most importantly, this was not
government investment. Other than T-bills--and ironically, I
wrote a novel, published in 1991, where one of the assumptions
was that if there had been a confrontation, a serious political
confrontation on a specific issue--the issue in the novel was
if they had withdrawn the T-bills--how would that affect our
economy at a time that would illuminate the political issues.
So this has been around.
But this situation here is to me quite a bit different.
Foreign direct investment can be individual, it can be company,
it can be investment in T-bills, it can be direct foreign
government investment, which we are talking about here, into a
free market economy.
Then, much more troublesome, it can be direct foreign
investment from nondemocratic regimes that could have strategic
interests that are different than our own. That really is the
question that we're facing.
We can only deal at present in a limited way with the CFIUS
process because it's an individual process. The difficulty that
we're going to be facing here is the cumulative process--the
process of cumulative investments with the potential for
manipulation or withdrawal, implicit, the nondiscussed ways of
influencing an economy and as a result a government.
So let me just throw one question at you. Why is it that
the United States Government does not directly invest in our
own economy, and why are we so comfortable with other
governments investing directly in our economy?
Dr. Drezner. Thank you, Senator. To respond to your
question, let me quote Ken Rogoff inform his congressional
testimony last year: ``Governments have a long tradition of
losing massive amounts of money in financial markets and this
tradition is not likely to end any time soon.'' That likely
answers your question, which is the belief is in this country
that governments are not necessarily adept at picking winners
and losers in terms of buying companies.
I should point out again, the government invests massive
sums in the United States economy. It just doesn't do so by
buying equities. It invests in education, it invests in
infrastructure, it invests in technology, and so on and so
forth, and these are all appropriate investments.
One of the problems with extrapolations of sort of current
trends is the belief that foreign governments are somehow going
to be incredibly adept at picking winners in terms of their
investments in the United States. As I said before in my
testimony, to date these investments have earned a negative 10-
percent real rate of return over the past year. So do not
underestimate the ability of foreign governments to screw up in
terms of choosing which their investments will be.
Senator Webb. If I may, because I only have a minute and 40
seconds left and I've got 175 kids waiting for me. I
respectfully disagree. I don't think that the reason that the
United States Government has declined to invest in the free
market elements of our economy is because it won't make money.
I believe it's because of the nature of our governmental
system. I keep hearing about the fact that the Chinese lost
money in their original investment. If there is a continued
interest, and there will be, it's probably beneficial,
fortunate in a way, because if they had made a huge amount of
money right at the beginning we'd have a different view of
this.
But the question we have to address is a systemic question.
The United States Government doesn't invest in the stock market
because it would be viewed as picking sides, picking winners
and losers. That's a totally different thing than financing
governmental programs.
Thank you, Mr. Chairman.
The Chairman. Thank you very much, Senator.
Senator Corker.
STATEMENT OF HON. BOB CORKER,
U.S. SENATOR FROM TENNESSEE
Senator Corker. Thank you very much, Mr. Chairman. I think
our witnesses have been outstanding and also have a sense of
humor, which is greatly appreciated.
I would say that, just to follow on to Senator Webb's line
of questioning, though, that I would also add a minor detail.
We have no money to invest, so that is also a pretty limiting
factor that I think is pretty relevant.
I think I like the perspective in the long-term views that
you're sharing with us. I think it's fair to say that relative
to other countries today at this moment in time, at this brief
period of time in history that we're a part of today, that we
are relative to them presiding over a weakening of our country
as it relates to their relative strength.
I think that's a fair assessment of where we are, and I
think maybe the most important thing to take away from this
hearing and other hearings of this type. I think that's a fact
and I'd just like to ask the three contestants to yes or no
that one.
Dr. Bhagwati. Certainly other countries have grown the
required surpluses and so on, which is an added element.
But I would just like to say one more thing in relation to
this whole question of whether sovereign wealth funds are going
to give an added advantage to the authoritarian governments as
against our model, which relies more on markets and human
rights and so on. I think the way I read the evidence on India
and China comparisons, which have been with us ever since
President Kennedy's time and so on--the two countries have
always been compared--many seers I've talked to said that they
would invest in China now, but not 10 years from now relative
to India, because democracy really is the surefire way to have
sustained development. Actually, if you look at China, the
sinologists themselves are deeply worried about the fact that
they don't have a democratic government. This is why people
take to the streets when you have takings. We have takings in a
judicial fashion, but when the commissars take your land away.
You don't have NGOs, no civil society really. You don't have an
independent opposition party. You don't have an independent
judiciary. You don't have an independent press, the four
elements of a functioning democracy.
So people take to the streets, and it's a highly unstable
system actually in China. And if you look at the environmental
damage and if you adjust the Chinese growth rates, as we
should, for the damage they're doing to the environment, and
there are well-established ways of doing it, people bring down
their growth rate by about 3 percent actually. I've seen
estimates to that effect.
So they're not doing all that well. They might go down,
again the same point as Senator Lugar was making.
Senator Corker. That was a pretty long yes or no and I
appreciate it.
I would just--I would say that the other point I was
getting ready to make, and I think you just made it for me, is
that while they are investing in our country today, they are
not investing in themselves. I think that there can be some
long-term bigger issues that they will be dealing with down the
road because they are not investing in infrastructure, they are
not investing in education, they're not doing some of the basic
things that need to happen.
So I do think that the issue of oil--I just want to get to
that. I am not one who believes that--I believe that our future
here as it relates to energy is through technology and changes.
I do think it's interesting that we continue to talk about oil
in the Middle East and yet would not even consider using the
reserves that we have here in our own country.
At the end of the day I would also say, though, that even
if we used our own reserves here, is it not fair to say that
these countries are still going to be awash in cash because
other countries are going to be buying from them? I'd like just
a brief comment if I could from the witnesses on that. The fact
is the imbalances are going to continue either way because of
the high price of oil and their ownership of it; is that
correct?
Mr. Marchick. Yes, sir; it is. The fundamentals are in
place, going back to Senator Lugar's statement. Oil prices are
high. A number of countries are maintaining very high levels of
current account surpluses, which means that they're earning
more than they can consume. And the money has to go somewhere.
The money can either be invested domestically, which some of it
is, but not too much of it can be because then you get into
inflationary situations.
So some of it has to go overseas. It can either go overseas
and buy T-bills, which a lot of foreign countries are doing
right now--we're financing our deficit through basically
foreign borrowing--or it can go into direct investment. In my
view it's better to have direct investment because it's longer
term, it's less liquid, and it's an investment in the United
States. It's essentially a sign of confidence in the United
States.
Senator Corker. Let me follow up with that quickly. I would
just--it seems to me that in many ways we're more fragile as it
relates to our relationships with other countries with them
having tremendous investments in our debt than we are with them
having investment in equities. A change of policy, a concern
about the value of the dollar, sudden desires to be in other
currencies could have, it seems to me, a more immediate
destabilizing factor on our country than investment in equities
spread throughout our country.
I'd just like brief answers or thoughts as it relates to
that.
Dr. Drezner. Just briefly, Senator. There's an old adage
that if you owe the bank $1,000 that's your problem; if you owe
the bank a billion dollars, that's the bank's problem. To some
extent, you're seeing that with respect to the large amount of
U.S. debt being held by central banks overseas, which is it's
so large that they don't want the U.S. economy o collapse.
You're correct, in theory they could do this sort of thing, but
it would be just as disastrous for them as it would be for us.
So I don't think that's a terribly realistic scenario, and I'll
just leave the answer there.
Senator Corker. I do hope--and I know my time is up. I do
hope that these types of hearings that we're having--and I
agree, doctor, that we should not become too alarmist, that we
need to have perspective about where we are, and I know that
many of these countries will even more so be investing through
investment entities, if you will, and not taking as much direct
ownership possibly because of some of these issues we're
talking about.
But the fact of the matter is that the policies that we are
carrying out today in our country today, just at this moment in
time--and this is a great country and we can redirect ourselves
hopefully--and just the sort of the culture that we have in our
country as it relates to consumption beyond the ability to pay,
that today these types of meetings point out the fact that we
need to drastically change the policies that we have in this
country today to cause us to be stronger in the future. Is that
a fair assessment?
Dr. Bhagwati. Yes.
Senator Corker. Thank you, Mr. Chairman.
The Chairman. Senator Menendez?
STATEMENT OF HON. ROBERT MENENDEZ,
U.S. SENATOR FROM NEW JERSEY
Senator Menendez. Thank you, Mr. Chairman. I appreciate the
witnesses.
From what I understand of your testimony, you are all
basically in agreement that we have not much to fear from
sovereign wealth funds. Is that a fair statement? Yes.
So let me ask you in a different context, Hugo Chavez. We
think that countries will respond based upon their financial
interests and so they won't be looking at other political
dimensions. Yet here we have Hugo Chavez, maybe not through a
sovereign wealth fund, but nonetheless using the national
patrimony of Venezuela in a way that is not being promoted for
the financial benefit of its citizens, but ultimately to
promote his foreign policy. Citgo here in the United States
puts out oil to communities that are underserved or have needs.
He does that in promotion of his policy. He uses his oil
throughout Latin America to promote his policies.
There is a perfect example of what in that country is the
sovereign wealth being used for a political purpose. So why is
it that we cannot foresee the possibility of sovereign wealth
being used in a way that doesn't look at strictly the financial
rewards, but at rewards that may very well promote the foreign
policy of another country?
I look at Dr. Drezner's testimony and, while a
hypothetical, in a post-September 11 world I think we have to
think about what things that may seem hypothetical actually
take place. You cite, for example, to consider the effect of a
populist or fundamentalist revolution taking over in Saudi
Arabia or the Gulf Emirates, and that a rampant anti-
Americanism among the Arab populace could encourage a new
government to purposely sell off sovereign wealth funds in the
United States in order to induce a financial panic.
Now, that might not be inconceivable, as you say, in a
revolutionary stage. I think that when we saw an airplane
turned into a weapon of mass destruction or a simple envelope
laced with anthrax into a deadly weapon, that using financial
instruments in a way to undermine the national interests or
security of the United States is not farfetched. That doesn't
mean you stop all sovereign wealth funds or investments, but I
think we have to do a better job of looking at how these
investments take place.
So my first set of questions is: Why do we not envision
that and how can we just be so sure that only financial
interests of sovereign wealth funds will be pursued? Second, in
my other assignment as a member of the Banking Committee we had
some of these hearings and I believe some of you have been
testifying before the committee. It's interesting to see that
they always seem to keep the threshold below the trigger
threshold necessary for review of CFIUS, the Committee on
Investments of Foreign Assets in the United States. It throws a
little red flag up to me and says, well, why, if this is so
good, why do you always keep below the threshold, number one?
No. 2 is, I look at what Chairman Cox said in reference to
sovereign wealth funds, the chair of the Securities and
Exchange Commission, and he said when it comes to transparency
the track record to date of most sovereign wealth funds does
not inspire confidence. How is it that we work around the
paradox that is supposed to uphold investor protection, yet it
depends upon the disclosure of governments that are not subject
to their own regulations?
How is it, for example, if we believe that there are
violations of U.S. securities law, we can do very little and we
get no cooperation from the very governments that are under
investigation?
So these are paradigms that I think are of concern and I'd
like to hear your responses to some of that.
Mr. Marchick. Let me take a crack at that. Senator, I think
you raised some very good points, and I don't think there is,
at least from my perspective, much, if any, daylight between
what you're saying and what we're saying. The first thing to
say is that these funds have been around for 50 years and to
date I'm not aware of any that have compromised either U.S. or
any other country's national security.
Second is, Is it in the United States interest to have
investment from these entities or not? Broadly speaking, I
think the answer is yes. Most of their investment is passive.
It's managed by third parties and they have no control.
Then you take the other investments, where they have
controlling stakes, whether it's a small investment where they
have 11 percent, 15 percent, or even a 6-percent controlling
stake if they have rights on the board, et cetera. Most of that
investment shouldn't be problematic for us either in real
estate, in retail, in sectors that don't have security
consequences.
For the sectors where we have essential security interests
or any other interests, then the U.S. Government should be very
vigilant in protecting our interests, whether it's national
security, competition, chemical security, chemical safety,
across the board. The question is are our laws and regulations
adequate to address whatever risks there are?
Senator Menendez. What's your answer to that question?
Mr. Marchick. My answer is that overall the answer is yes
and that we have--we obviously have room to improve in some
areas that are unrelated to whether an investor is a sovereign
wealth fund or not. Obviously, some of the issues concerning
toys and pet food and consumer safety are troubling to anybody
in the United States, particularly people that have kids. But
that's an issue that we need to deal with from an overall
framework.
Senator Menendez. With respect, that's a different issue.
The reality is that it is not about investment in potentially
critical assets of the United States by a foreign government
who you can't get under the existing Securities and Exchange
Commission law to respond to inquiries if there is an
investigation.
Mr. Marchick. Let me answer it this way, then. For any
issue where there is a delta in the risk between a domestic
investor and a foreign investor and a delta in the risk between
a foreign private investor and a foreign government investor,
my view is that the CFIUS process and other regulatory
processes are adequate to deal with those risks.
Senator Menendez. Can I hear from the rest of the panel?
Dr. Drezner. Senator, I think you started talking about
Hugo Chavez. It's not clear to me that Hugo Chavez's throwing
around money has actually achieved all that much, and if
anything it's increased his unpopularity at home. I think
that's a worthwhile parable to consider in terms of the more
dangerous scenarios you're talking about.
Senator Menendez. It may not be the result, but it's the
intent that I am worried about. You can't just look at negative
results and say, well, it didn't prove well for him. It doesn't
mean that if someone else couldn't be using it more
intelligently and provide a positive result.
Dr. Drezner. Again, never underestimate the ability of
governments to screw things up in terms of their intent. So I'm
actually not sure that you're going to have a Machiavellian
government successful at potentially accomplishing this.
I agree, however, that certainly there's the 1-percent
possibilities that you're talking about. You need to have
constant vigilance, and I would again agree with Mr. Marchick,
we have a regulatory process and we have the legal institutions
in place to guard against those very kinds of concerns. As I
said, the promotion of transparency among sovereign wealth
funds by the IMF process I think would also add an extra level
of assurance to deal with the kind of concerns that you've just
raised.
Senator Menendez. Thank you, Mr. Chairman.
The Chairman. Thank you.
The Senator from Georgia.
STATEMENT OF HON. JOHNNY ISAKSON,
U.S. SENATOR FROM GEORGIA
Senator Isakson. Thank you, Mr. Chairman. Very helpful
hearing and I appreciate the witnesses and their testimony
today.
I'm not a lawyer, so I'm a real estate broker, and in the
1980s I was in the real estate business when Japan Inc. became
the popular fear in the United States of America. I'd point out
that they crashed for three or four reasons. One is they bought
at 100 percent. Second, they bought real estate; they weren't
buying companies. Third, they had no transparency at home and
the banks kept the assets at the purchase level when the U.S.
economy went in the tank in 1990-1991 and the assets plummeted
in value, and eventually they had to recognize that.
The reason I make that point is this. Maybe the sovereign
wealth funds looked at that experience with foreign investment
in the United States and said: Hey, controlling interests might
not always be good and the strength of the United States
economy's going to make this investment a good or bad
investment. So they're a passive investor, in smaller amounts,
spreading their risk over a larger number of investments, and
have a vested interest in the economy being good. Is that a
fair judgment?
Dr. Bhagwati. I think it is a fair judgment, and I think
all experience even with private investment, as you were
pointing out by the Japanese, they bought into the Empire State
Building and they were taken by Hollywood basically, rather
than the other way around. So I think in many cases even not
having an experience of our system, they actually really were
moving into areas where they didn't have any comparative
advantage in terms of investment know-how. They really came a
cropper.
I think it's the same thing. I think they're much more
cautious as a result of that past experience. Like the Chinese
put their foot wrong on the Blackstone Group. They virtually
transferred a lot of money to our people. So they've learned
from that as well. So I think they're going to be very
cautious, and I don't think the Chavez model is a particularly
relevant one. Chavez is just throwing money around, like we
sometimes do with our foreign aid to achieve objectives.
Senator Isakson. We haven't always achieved ours either.
Dr. Bhagwati. It's a tricky business, but I think it's not
particularly appropriate to link that one with the sovereign
wealth funds thing.
Senator Isakson. Given what we're debating on the floor of
the Senate right now and the concurrent concern over gas
prices, 20 years ago my son wrote a master's thesis in
economics on the Dutch disease and its impact on Middle Eastern
countries, their sole dependence on one source of wealth, a
rich natural resource.
We're talking about oil running out in 40 years or going on
a decline. We've got a 40-year period of time to get off of
petroleum and onto whatever the new new thing is. I notice five
of the big seven sovereign wealth funds are obviously getting
their money from oil and selling it to us. Are they in the
process through these wealth funds of reinvesting the money
we're paying them for the foreign oil so that when it does run
out they've got an investment basis to continue to sustain
their type of a society, but with a different singular source
of wealth, that being those pools of investments versus the oil
they had for so many years?
Dr. Bhagwati. I think some of them are. I think countries
like China are going to be investing in their own system
increasingly, I feel. And countries like India are going to be
using it up to meet the food crisis. So it's not a situation
which is going to be extrapolated into the future.
I think the oil, people deriving money from oil, certainly
are making a calculated decision that the internal rates of
return from internal investments, meaning social investments,
infrastructure and so on, don't offer as much prospect as
investing it in our system. I think this is why they are going
to be much more pliable to accepting rules and being obliging
in the way in which they do it.
But I think that is clearly the decision they're making, I
think, that they're better off coming here rather than putting
more money into their own investments. So I think that also
suggests that we need not be too alarmed in the sense they're
simply interested in the rates of return, essentially. I think
they're going to learn from past mistakes like the Japanese
investments, some recent Chinese investments, and I think we
expect to do--I think one thing we need to remember is that
there's been debate, is the current deficit being driven by the
fact that people want to invest money here or the other way
around?
I think to some extent we're still a safe haven, we're
still the smartest economy in the world. We go through problems
like everybody does. But essentially, if you ask people, not to
look at arbitrage operations between the euro and us and the
yen, for example, but if we say, look, if you had a pot of gold
where would you put it on a sustained basis, I think almost
everybody would agree. Everyone I've ever talked to says this
is the country they want to invest in.
So I think fundamentally that's a decision even the oil
guys are making, that this is where they want to be. I think it
is going to be reasonably steady. They aren't going to fool
around trying to use it for political purposes. So I'm
reasonably optimistic on that front.
Senator Isakson. Well, the reason I brought those two
things up, I was in Iraq the day the Dubai Ports deal broke and
they diverted us to Dubai to try and talk to the government
over there and settle everybody down. I realized what a problem
lack of knowledge is. I think, Mr. Chairman, your having this
hearing and subsequent hearings we would do on understanding
sovereign wealth funds will help us to get the information out
on what they are.
Second, if we can have a good system of transparency we can
raise the level of confidence, but also reduce the risk of some
of the fears that you see out there in these investments. After
all, in the end these countries are governments in many cases
different than ours, that are not necessarily democracies, but
they're investing in a democracy. If we maintain its strength--
and we have some things we need to do--this can be good for us
as a country and good for the ``world is flat'' era that we're
going into, where we're so close and so interconnected.
I just want to echo what Senator Corker said, that our
savings rate, our spending habits, and our dependence on
imported oil are three contributors to our current problem.
Every time we can improve our situation vis a vis oil, create
mechanisms where savings become something the American people
do, we can go a long way towards being an even more attractive
place for the world to invest its assets and want America to do
well.
Thank you. Thank you, Mr. Chairman.
The Chairman. Thank you very much, Senator.
Senator Cardin.
STATEMENT OF HON. BENJAMIN L. CARDIN,
U.S. SENATOR FROM MARYLAND
Senator Cardin. Thank you very much, Mr. Chairman, and I
very much appreciate you holding this hearing. I think it's
extremely important and I think we all agree on the fundamental
issues in this country that we need to deal with that have
added to the growth of the sovereign wealth funds and the
diversity of the sovereign wealth funds and the potential for
impact on our own country.
We need to deal with the realities of the balance of
payments deficit in the United States. As our panel has
indicated, a deficit is not always bad, but the uncontrollable
deficits are bad, and the trend lines are problematic. We need
to deal with our own operating budget deficit, our own savings
deficits in this country. A lot of that are issues that we need
to deal with internally.
But when you take a look at whether we have a level playing
field with our major trading partners and you look at some of
the manipulation that's been done, for example China and the
manipulation of currency, that impacts the surpluses that China
has versus the United States, adds to their ability to grow
their wealth funds, and can become an issue for our own
country.
Clearly, the sovereign wealth funds that are operating as
stabilization for the economy of a country that is focused on a
particular natural resource, that makes sense. I don't think
any of us disagree with having that type of a stabilization
fund. However, when these funds grow at such a level or where a
country can potentially use those funds for a strategic
purpose, not having the same pressure that investors have on
the managers of funds, then it can become an issue that we
should be concerned about.
I think about China and I think about the fact that they've
made strategic decisions to invest in countries where they need
natural resources, which clearly give them leverage over that
other country's decision as to how they use their natural
resources. I think of our own relationship with China and the
fact that we have more limited options against China today than
we had 10 years ago because of the ability of China to--their
market impact in the United States.
So let me just challenge our panel if I might. Let's assume
we disagree with your overall conclusions that our current
economic and regulatory system in the United States is strong
enough to protect us against potential harm from sovereign
wealth funds. Let us say that we want to act now while we can
act, looking at the trend lines, concerned about the potential
strategic impact that these sovereign wealth funds could have
on U.S. interests.
My question to you is, Can you tell us whether we can focus
our legislative actions to the areas of potential harm to this
country, those funds that are not transparent, those funds that
are operating with strategic interests rather than pure
economic interests? Is there a way that we could either
strengthen our Committee on Foreign Investments in the United
States Act or look at legislation or regulation that is
targeted to the types of fund activities that we think could be
abusive to U.S. interests?
Is there a way that we can be surgical as we look at ways
of better defining U.S. areas of concern as we go forward?
Mr. Marchick. Senator Cardin, I think it's a very good
question. My view is that the Congress just acted in a surgical
way, thanks to the leadership of Senator Dodd and others, by
passing a new amendment to Exon-Florio, which I believe passed
unanimously last year, and which the administration is
currently implementing with a series of regulations which I
know Senator Dodd, Senator Webb, and others have weighed in on.
That law basically addresses problems that became apparent
during the Dubai Ports issue, which is, whether you agree or
not that Dubai Ports' investment in the United States was a
security risk--in my view it wasn't--the fundamental issue was
that the Congress lacked confidence in the strength and the
transparency of an administrative process. CFIUS didn't provide
Congress with the reports they were supposed to provide. They
didn't adequately brief Congress.
So when you had difficult facts in this case, which made a
political stew, the systems that were in place didn't stand up
to the scrutiny. So that's what the legislation that Senator
Dodd so ably got put into law I think addressed. It strengthens
the communications with Congress. It requires heightened
scrutiny for any government-linked investment, requiring the
Deputy Secretary--
requiring much higher levels of engagement and basically
signatures to the Congress that they personally have looked
into the issue and do not find national security issues. Before
it could be done at a much lower level. So you're going to have
much more exacting scrutiny.
It created a much broader and more appropriate criteria for
examining investments in a post-9/11 world.
Senator Cardin. I would just point out, I strongly
supported that effort and it dealt with the port issues, which
were pretty transparent as to its potential impact on the
United States. But when we're dealing with perhaps natural
resources or dealing with areas that are not as directly
related, it may be more difficult under the current regulatory
and statutory arrangement.
My issue is is there ways to strengthen those types of
provisions.
Mr. Marchick. Again, we should always look to find things
that we can do to improve our national security. It's a
constant effort. But the law that was put in place dramatically
expands the scope of inquiry to critical infrastructure. The
previous law focused on defense assets and a traditional, very
narrow definition of security. The new law that Senator Dodd
led broadly defines much broader subsectors of the economy and
requires exacting scrutiny of those investments.
So the Congress should be vigilant in oversight and I'm
sure that this committee, I think which has jurisdiction, and
Senator Dodd, which has jurisdiction, there will be hearings to
make sure that CFIUS is doing its job. But my view is the
legislative framework is in place for it to be effectively
implemented, and then the question is are they effectively
implementing it. And that's something that Congress should
pursue through oversight.
Dr. Drezner. Just a quick add-on, Senator. First, I believe
the legislation that was passed also has a provision
specifically for government-controlled entities if they
purchase U.S. assets, to address the question about sovereign
wealth funds to some extent. You've already got it in the
legislation.
It should be pointed out that, since Treasury has yet to
finalize, I believe, the implementing regulations, my tendency
is to apply a Hippocratic oath to new policy innovations, which
is, first do no harm. Let's see what the existing process does,
I think, before adding onto it.
Senator Cardin. I'm just going to make a very brief
comment. There was significant concern about moving forward
with that legislation last year. It was clearly in my view the
right thing to do and I congratulate Senator Dodd on his
leadership. My concern is that, while we have the opportunity
to act now and use that model to deal with the realities of
what some of these sovereign wealth funds may be getting into,
it may be the time is right to take a look at that model to
expand its potential areas of interest as to what sovereign
wealth funds may be getting into that could affect the security
of our country that's not currently covered by the act. That
was just my point that we should be doing.
Thank you, Mr. Chairman.
The Chairman. Mr. Marchick, my staff tells me you may have
a plane you have to catch, and if you do----
Mr. Marchick. Yes, sir. I've already missed one. I
apologize.
The Chairman. No, no, no. There's no need to apologize. We
apologize to you.
Mr. Marchick. Thank you very much. I'm very sorry I have to
run if you don't mind. Senator Dodd has already heard from me
many times. He's probably sick of hearing from me.
The Chairman. Well, thank you very much for being here, and
Chairman Dodd is never tired of hearing.
STATEMENT OF HON. CHRISTOPHER DODD,
U.S. SENATOR FROM CONNECTICUT
Senator Dodd. As you are walking out the door, an issue I
was going to raise with you was the new regulations
implementing FINSA, which remove any doubt, I think, that if a
foreign entity holds less than 10 percent of voting interest it
may still exercise control and thus prompt a CFIUS review. I
think the word ``control'' obviously is the operative word; but
moving clearly in the right direction on all of that.
So I know that you're packing up. We'll send a letter.
Mr. Marchick. My view is that--and you and Senator Webb
have done a lot of work on this. My view is that the
regulations tighten the focus on transactions that are less
than 10 percent. So you could have a 1-percent interest but
control the board of directors and you're right in the CFIUS.
Senator Dodd. I appreciate that immensely, because that is
the kind of flexibility. And while he's had to leave
apparently, to Senator Cardin, my sense is too as well that I
don't think you need to necessarily expand the areas covered. I
would suggest that under existing law, unless you tell me
otherwise, that if you start talking about some of these other
investment areas, for someone to suggest that a natural
resource were going to be acquired in some way here, I still
believe CFIUS applies. I don't think because the area that he's
raised is not mentioned specifically it would deny the kind of
operation to examine that to determine any national security
implications.
Senator Cardin. I think one of the positive elements, many
positive elements, of the law you wrote is that it gives CFIUS
incredible flexibility. So in 3 years, if there's a new
national security threat that we don't know about today, CFIUS
covers it. Cyber security is covered now; 4 years ago, 5 years
ago, that wasn't a concern.
Senator Dodd. And if it's not, I presume you'd be back up
or someone would be back up here, from this administration or
the next administration, suggesting that we need to have an
additional authority granted if there's some question about it.
Anyway, I know you've got to run. I apologize.
The Chairman. Thank you.
I thank the Senator from Wyoming for his indulgence. The
floor is yours, sir, and then we'll go to Chairman Dodd.
STATEMENT OF HON. JOHN BARRASSO,
U.S. SENATOR FROM WYOMING
Senator Barrasso. Thank you very much, Mr. Chairman.
If I may as you leave, Mr. Marchick, there'll be a couple
questions. I may want to just submit them to you in writing,
because I am interested in your thoughts on some of these
things. Thank you very much.
Mr. Chairman, we heard a little earlier that Goldman Sachs
had concluded that, while concern about politically motivated
acquisitions in the West might be justified, so far there's no
evidence of this becoming an issue with the sovereign wealth
funds and in their view there wasn't a serious prospect of it
becoming one. But I agree with Senator Menendez that you don't
worry about someone's intention; you worry about the
possibilities and the potential to create problems.
I am concerned, Mr. Chairman, that there is the potential
or the possibility to create problems. I look at this in terms
of nations where they may have an interest in high oil prices
and they at the same time have a sovereign wealth fund and the
possibility of using them--through speculation or
manipulation--to bid up the price of oil on the futures market;
using the sovereign wealth fund to then bid up the prices as
they then sell their product, the oil, to the United States or
to the rest of the world.
I don't know if that's something that you'd given any
consideration to, but I'd be most interested in your comments
on that potential, which would drive the cost of oil even
further up than we're dealing with now.
Dr. Bhagwati. But that possibility, Senator, would be
independent of whether there were any sovereign wealth funds.
They could be doing it right from Riyadh or anywhere in the
Middle East and so on. So I think the possibility of this kind
of deliberate speculation, as it were, to try and raise the
returns to you, if it works it doesn't require them to be
present here in any particular form. So I think it's just not
related really to the sovereign wealth fund issue, but it's a
possibility certainly. If you've large amounts of funds, like
when George Soros was accused by Malaysia of speculating
against the Malaysian currency prior to the East Asian
financial crisis, he was supposed to be such a big player that
when he started speculating against the currency they thought
he was undermining the currency. Maybe he should speculate on
something else.
So I think it's exactly the same point. If you're a major
player you can have--you can actually manipulate prices and
have other lemmings follow you, and then you really have a high
rakeoff. So I think it's certainly possible. Whether it's
likely in this particular case, is that really happening now,
I'm not sure.
Senator Barrasso. I don't know if you want to comment, Dr.
Drezner. I was going to ask you about just the transparency in
a global market, to know if it is happening, even separated
from the sovereign wealth funds?
Dr. Drezner. Just to add, if you're talking about
hypotheticals, there are so much better ways of jacking up the
price of oil. All Mahmoud Ahmedinejad needs to do is issue some
sort of fiery denunciation of the United States and Israel and
oil prices go up by $10 a barrel. That's much more effective
and much more direct than the sort of indirect route which
you're talking about.
It also should be pointed out that, while some actors want
oil prices to simply go up and up and up, the major oil
producers, particularly Saudi Arabia, there is a downside to
oil prices being prohibitively high, which is obviously it puts
political heat on them, and also it can cause a global economic
downturn, which eventually diminishes demand for their
production.
Senator Barrasso. Could I move a little bit to the issue
then of U.S. foreign aid. I look at the fact that the United
States, a major funder of activities around the world, some to
countries perhaps that have sovereign wealth funds. How do we
balance that, where we are as a nation investing, giving money
to foreign countries and they have sovereign wealth funds, and
should that money not be used instead for them to invest in
their own country.
You talked about hyperinflation, if too much money went
into their own countries. But I have a concern about the United
States and the taxpayers of America sending money overseas
while they're just continuing to do well and investing with
sovereign wealth funds.
Dr. Bhagwati. I think it's the general state of development
which you may be interested in, because sovereign wealth funds
may be there, but you may want to give foreign aid just with a
view to promoting health care and all sorts of things. Now,
whether in fact those sovereign wealth funds themselves should
be used for that, it depends on the magnitude of these funds.
You might as well say, look, private investment funds should
not flow out from there. So you're then taking a position on
where people should be investing their money. I think if we
start getting into that kind of comparison I don't think it
really is very helpful, because then you'll wind up doing
micromanagement, as it were, of how a country's resources are
going to be used.
So I think sometimes you just have to take their portfolio
of choices and what they decide as given, and if there are
countries you want to assist with development, then I think you
should just throw it out of the window and really focus on
whether the moneys you're going to provide are going to do
things like affect malnutrition and a variety of other things,
promote liberty, et cetera.
So my choice would be to say, look, unless it's a gigantic
SWF with gigantic reserves--I think this is the sort of issue
which would come up with China. There, would you really want to
put moneys into assisting with development? I doubt it, I doubt
it.
Dr. Drezner. Just to add, I don't think there's a terribly
strong correlation between where our foreign aid is going and
the size of sovereign wealth funds in those countries. So I
don't know how large a concern it is. Certainly I understand
why you would be concerned about the overlap.
It also depends on the reasons for the aid, of course. For
example, given the earthquake in Chungdu, I don't think you
would assume that the United States would not want to
participate in humanitarian efforts because they have a large
sovereign wealth fund. Obviously, this serves our own
interests, not to mention ethical concerns.
Also, a lot of the reasons for the U.S. aid overseas is to
promote democracy, to promote human rights, and it's not
terribly shocking that some of these governments might be
reluctant to invest their own money in such efforts. But I
don't think that should therefore prevent us from at least
trying to nudge these countries in the direction we want to see
them going.
The Chairman. Thank you very much.
Chairman Dodd?
Senator Dodd. Well, thank you very much, Mr. Chairman.
Let me thank our witnesses and our colleagues as well. I
know you've been here a long time this morning and I apologize
for not getting over here at the outset of the hearing.
Let me thank Senator Biden and Senator Lugar for holding
this hearing. It's very appropriate that the Foreign Relations
Committee examine this issue as well and, as you've heard and
obviously because of your awareness of the issue, you're
conscious very much of the fact that the Banking Committee as
well has obviously jurisdiction over a good aspect or part of
this. But the foreign policy implications are significant and
so it's very appropriate that this committee be listening to
witnesses as well.
Over the last 18 months, actually we've had markups of
bills and hearings along this area. We held the first
congressional hearing last November on sovereign wealth,
affirming Congress's legislative approach to addressing
national security concerns. Based on these hearings, the
Banking Committee has undertaken several oversight initiatives,
including a forthcoming Government Accountability Office
report--and we conducted an April hearing evaluating the
regulatory authorities over these funds and closely monitoring
efforts to establish a set of best practices for sovereign
wealth funds by the United States and international bodies,
including the Treasury Department, Securities and Exchange
Commission, the International Monetary Fund, and the
Organization for Economic Cooperation and Development.
Today, as you probably heard already--and I'm repeating
myself to those who were talking about this. I'm sure the
chairman may have noted this. The IMF estimates that 20
sovereign wealth funds, largely financed by petrodollars and
excess foreign exchange reserves, manage somewhere between $2
and $3 trillion globally, and they're anticipating those assets
to climb to around $12 trillion by 2012. I don't know if you
agree with those numbers or not, but those are the numbers
we've been given.
So with that kind of financial muscle and the extensions of
foreign governments, their operations in U.S. markets have
raised questions, obviously, of political intentions,
transparency, and the security of critical U.S. industries.
At the same time, in recent months sovereign wealth has
provided a much-needed source of capital. Without them we'd be
in a very different situation in this country. So it's one of
those issues here. Be careful because without sovereign wealth
funds we would have some serious problems in the country. So as
we look at these issues, maintaining that balance.
Fortunately, I believe the United States can continue to
enjoy an open investment climate while protecting economic and
national security, and I appreciate the generous comments the
chairman tells me you made about CFIUS, the legislation we
crafted, and the very balanced way to deal with those issues.
But CFIUS is only one tool and we're examining obviously the
roles of other agencies in light of this influx of investment,
from the Federal Reserve and the SEC to agencies governing
specific industries like defense, energy, and
telecommunications.
Many questions remain. I mentioned one here already and
that is the control issue and to what extent Treasury can
respond. I appreciate very much Mr. Marchick's response about
the flexibility of the legislation, so we need not necessarily
jump in. And obviously we want to examine through oversight how
this is all proceeding in the coming weeks and months and
years.
How can we ensure sovereign governments cooperate with the
United States in enforcing our laws, including insider trading
protections? Chairman Cox I think had a pretty good quote in
this area. He said: ``The same government from whom we sought
enforcement assistance was also the controlling person behind
the entity under investigation. It creates some inherent
potential conflicts.'' So we need to examine that and how we
can make certain that sovereigns operate in the United States
market strictly according to their commercial rather than
foreign policy interests is obviously an overriding issue.
Perhaps most important to this hearing on foreign policy,
is how can we address concerns over reciprocity. So if I may,
let me ask you about the reciprocity issue if I could, and ask
both of you professors, Dr. Bhagwati and Dr. Drezner. The
reciprocity questions are: How might promoting reciprocity
support such mutual economic interests? What sorts of forums
exist to advance such an agenda, and would demanding such
reciprocity damage foreign relations with any of these other
countries as well?
Dr. Bhagwati, do you want to start?
Dr. Bhagwati. If by reciprocity you mean what they expect
of us when we deal with sovereign wealth funds in their
countries?
Senator Dodd. Uh-hmm.
Dr. Bhagwati. We should also follow the same transparency--
I mean, we are kind of state of the art anyway, and we also
don't use sovereign wealth funds particularly. So I think in a
way it's a moot issue, if that's what you mean. It would be
automatically----
Senator Dodd. There's also other questions, access to
markets, how investments are treated, how private investments
are treated. So I'm not looking for sovereign wealth fund
versus sovereign wealth fund, but giving access to that
capital.
Dr. Bhagwati. OK. That gets back into the problem you
always have with devising a code on investments in general,
foreign investments, which would consist of private and the
governmental ones, the sovereign wealth funds. We haven't
really made much progress. The OECD tried it, as you know, and
the NGOs objected in a big way, the developing countries
objected.
I think if you're going to do that you would have to make
it stand on sort of three legs, as it were. It'll have to be a
tripod where you have the rights of the funds, of the people
who are doing the investments, and the rights of the people
receiving these funds, then the obligations of whichever entity
in terms of corporate social responsibility and so on. The OECD
code, being at the OECD, which is a rich countries club as you
know, was entirely on the rights of the corporations. But I
think we could expand the whole thing, now that we're taking up
the matter again at the OECD and the IMF, into looking at in a
very comprehensive way to include things like CSR, corporate
social responsibility, and what should be the rights of the
countries which are receiving these funds.
It shouldn't be just a matter of--I think having the
sovereign wealth funds would automatically bring in the focus
on the obligations to be transparent and so on and so forth.
But I think it could be expanded in that direction if by
reciprocity you mean a more comprehensive thing which really
looks into all these different dimensions. I think it's time to
look at the entire investment flows in the modern context, in a
much richer way than we have traditionally done in relation to
an investment code.
Senator Dodd. Any comments, doctor?
Dr. Drezner. Senator, Mr. Chairman, first let me preface my
remarks. Having grown up in the State of Connecticut, it's an
honor to be speaking with you, and I can assure you that you've
made my mother very happy by the fact that I'm able to----
The Chairman. Let's not get carried away here. [Laughter.]
Senator Dodd. Where are you living now?
Dr. Drezner. I live in the State of Massachusetts.
Senator Dodd. Well, come on back. All is forgiven. We'll
take you back. [Laughter.]
Dr. Drezner. They have to hire me there.
The Chairman. Hire him at Yale.
Dr. Drezner. Yes; exactly.
I don't disagree--I would say I agree fully with Dr.
Bhagwati. I would point out that one of the reasons why
sovereign wealth funds probably have less leverage than we
think they do vis-a-vis the United States is precisely because
most of the developing world has the kind of investment
protectionism that you're talking about and therefore there's
not a lot of opportunity for them to invest in those places.
Not surprisingly, I think something like 60 percent of
sovereign wealth fund investment is in OECD countries.
Interestingly enough, this might be in essence where a
sovereign wealth fund from one country might actually be acting
in our interests by trying to pry open other developing country
markets as well. So this might be a situation where the sort of
natural trend line works in our favor, and I'm not sure
stressing reciprocity is necessarily going to be a necessary
part of U.S. policy.
Senator Dodd. Let me ask you on a related matter of the
enforcement issues, the question of the importance of
diplomatic arrangements with foreign governments and with
sovereign wealth funds to ensure cooperation with American
authorities, the SEC and others, in the course of criminal or
civil legal proceedings. Can you give us some sense of where
you think that is and to what extent we can be demanding more
of that? Do you have any sense of that?
Dr. Drezner. I'm going to have to plead ignorance.
Senator Dodd. I was going to ask Mr. Marchick more. It's an
area I presume he'd probably have a bit more----
Dr. Drezner. It's not my area of competence, I'm afraid.
Senator Dodd. We will submit the question to him.
As I pointed out, if you end up with the some governments
from whom we're seeking enforcement is also the very entity
making the investment, you've got sort of an inherent problem
here. That very government willing to be supportive of
enforcement areas if in fact they're the provider of the
sovereign wealth----
Dr. Drezner. There is one thing I can say on this. I think
there might be a tendency on the part of the United States to
overestimate the sort of unitary nature of authoritarian
governments, the belief that if there exists a sovereign wealth
fund and it's controlled by an authoritarian government then
surely the government is strategically micromanaging the
sovereign wealth fund. The fact is that you have bureaucratic
politics in those countries just as you do in the United
States. So even though we might think that there's going to be
a direct line of access from the government to the fund, if you
take a look at sort of closer analysis, for example CIC, it
seems pretty clear that there is actually a fair amount of
bureaucratic squabbling going on there about how appropriately
to manage the CIC.
This isn't to say that these issues aren't--I agree with
Commissioner Cox that these are an issue of concern, but
they're not necessarily--it would be dangerous to overstate
them, I guess.
Senator Dodd. He poses a good intellectual question.
Dr. Drezner. Right.
Senator Dodd. And I'm waiting to get some specific examples
of where maybe this has happened, where you're finding lack of
cooperation which would warrant maybe considering something
else.
I thank you both and thank Mr. Marchick. Of course, in
these debates I always find it somewhat interesting. Some of
the strongest supporters, of course, of investments by
sovereign wealth funds are the private sector in the country,
and I just find it somewhat of a contradiction when you suggest
the investment of governments, their own government. Yet when
it comes to this government making investments we find some of
the same constituencies rather antagonistic to the idea. So
it's somewhat amusing to me that the very people who are the
strongest supporters of governments investing here are some of
the strongest opponents of our own government making some
investments in certain areas. But that's my own sort of inside
private smile I have from time to time on these issues.
But I thank you immensely, both of you, and I'm sorry again
I wasn't here to hear all of your comments in response to
questions that others raised. But this is a very important area
and a growing one. As I point out, if the numbers are correct
it's even going to get larger, and it offers some tremendous
opportunities.
We're going to have hearings tomorrow, Joe, on the
infrastructure bill that Chuck Hagel and I have authored trying
to create an infrastructure bank idea, that attracting private
wealth into these--because we're not going to do what we need
to be doing. We've got a $1.6 trillion shortfall just in
maintenance of existing physical infrastructure in the
country--waste water treatment, water systems, roads, bridges,
and the like. This is not going to be done out of the
appropriation process. You're going to have to attract private
wealth to come in and do it.
So sovereign wealth funds become an incredible source of
potential liquidity for us dealing in this area. For those who
are worried about this, I always say you can't pick up a
transit system or bridge and take it back to the country who's
helped you build it. So there's some wonderful attractions of
having private wealth come into this area, which we need
desperately for economic growth in this century. So they're
very important related issues and an area we want to continue
to support, and I thank you.
The Chairman. Maybe they can pick up I-95 as it goes
through Delaware and Connecticut, which are parking lots.
Senator Dodd. We'd be willing to give that up.
The Chairman. We'd be willing to give them those two.
Gentlemen--Mr. Chairman, do you have any further questions?
Senator Lugar. No, thank you.
The Chairman. Thank you for your time and your input. With
your permission, we don't want to make a lot of extra--a little
extra work for you. I have half a dozen questions that I'd like
to submit in writing. There's no time frame on them. With your
permission, we'll leave the record open for a day to see if
some of our colleagues who had other business might have some
questions. But you've covered the waterfront very well. We
appreciate it a great deal.
The only part of this whole exercise that Senator Lugar and
I found difficult was the consistent praise for Chairman Dodd
and the Banking Committee.
Senator Dodd. I'm glad I showed up. [Laughter.]
The Chairman. That's right.
But seriously, thank you very, very much. It was very
helpful, and we are adjourned.
[Whereupon, at 11:47 a.m., the hearing was adjourned.]
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Additional Material Submitted for the Record
Prepared Statement of Douglas Rediker, Co-Director Global Strategic
Finance Initiative, the New America Foundation, Washington, DC
Over the past several months, few issues in international finance
have generated as much discussion and comment as have Sovereign Wealth
Funds (``SWF''s). This committee deserves enormous credit for
recognizing the potentially significant foreign policy consequences of
the rapid accumulation by foreign governments of enormous, growing
pools of capital. These large concentrations of government-controlled
wealth raise complex issues that transcend traditional boundaries
between foreign policy, financial markets, international economics, and
national security.
It is my belief, however, that too much focus on SWFs may, in fact,
divert attention from the more fundamental foreign policy issue that
these funds have come to represent--that of the rise of ``state
capitalism'' and the broader use of finance as a tool of foreign
policy. These, I believe, are increasingly important 21st century
phenomena.
SWFs are simply a particular type of global financial market
investor.\1\ They should not automatically trigger foreign policy
concerns. Too much focus on SWFs as potential tools of political
influence fails to take into account that the world's more than 50 SWFs
are very different in terms of the origin of funds, size, structure,
investment philosophy, and motivation. Other than the commonality of
government ownership, they are really not a definable class of either
political or financial actors. But it is specifically foreign
government ownership and the possibility that these increasingly
wealthy foreign governments may use finance as a tool to advance their
national interests abroad that makes them of interest as a matter of
foreign policy.
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\1\ There are also definitional questions as to what constitutes a
SWF. For example, some analysts include in SWF calculations part or all
of the $327 billion held by the Saudi Arabia Monetary Authority
(``SAMA''), while others exclude these funds, classifying them as
central bank reserves instead. Similarly, the China Investment
Corporation (``CIC'') is that country's acknowledged SWF. But, China's
State Administration for Foreign Exchange (``SAFE''), which manages
China's central bank reserves and is not generally considered an SWF,
has recently made significant investments in international equities.
---------------------------------------------------------------------------
In many cases, SWFs are neither the major repositories of
government controlled wealth, nor the financial tool through which a
country might seek to exert financial influence for political gain.
While SWFs are believed to control approximately $3 trillion of assets,
foreign government-owned central bank assets are estimated to exceed $7
trillion. State-owned-enterprises (``SOE''s) represent an additional
distinct investment vehicle. There is greater likelihood that, if a
country sought to use financial tools to advance foreign policy goals,
it would do so either through the use (or threat of use) of central
bank reserves to impact currency markets or via an SOE. For example, it
is generally taken for granted that central bank interventions in
currency markets have at least some element of political rather than
pure financial motives. Likewise, foreign policy considerations are
very much involved in potential investments by SOEs. For example, past
rumors of interest in acquisitions by Russia's Gazprom have caused
great consternation in many European countries for fear of the
political motivation and impact of such an investment. Such issues are
less likely to be raised by means of an investment by an SWF.
We should be cautious about finding common denominators among the
motives and actions among widely differing governments based on the
particular financial structure through which they hold and invest their
wealth. This is why the U.S. and international community have struggled
to put in place criteria by which to judge SWFs, as well as appropriate
rules and responses to govern their actions. There is little in common
between the risks posed by SWFs of strong democratic allies like Canada
and Norway and those whose political systems and motivations are more
worrying, like those of China and Russia.
I believe the criteria by which many suggest we judge the risks
posed by SWFs has resulted in an overemphasis on transparency and
disclosure, while ignoring the more subjective, but more valuable,
assessment of the political risk that a particular government owner
poses. This is dangerous. While increased transparency and disclosure
should be encouraged, such an overemphasis on transparency of SWFs
alone may, in fact, lead to unnecessary conflict with allies, which,
for a multitude of reasons may fail to meet the requisite level of
transparency. Likewise, we may take false comfort from those SWFs that
comply with transparency rules, but whose government owners' use of a
broad array of other financial tools to advance foreign policy
interests and which should warrant closer attention.\2\
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\2\ For example, the Abu Dhabi Investment Authority (``ADIA''), the
largest SWF with assets estimated to approach $875 billion, has been a
responsible investor in the U.S. and global markets for over three
decades. In financial circles, ADIA is considered a high quality
investor and has never been accused of acting in a manner inconsistent
with international political or financial norms. Yet, ADIA consistently
receives failing grades as an SWF because it does not publicly disclose
information about its holdings, investments, or governance structures.
In fact, ADIA, which, along with Singapore, recently agreed to improve
its disclosure practices, if judged against its financial peer group of
large international hedge funds and private equity funds, rather than
against its political ones, is in line with the industry norm. By
contrast, Russia's National Wealth Fund, established in February of
this year, has announced that it intends to disclose its financial
holdings in a transparent manner, leading to high marks on the various
SWF transparency indices. However, Russia, through various non-SWF
entities, has demonstrated a willingness to use its recently acquired
financial heft to advance its national interests abroad.
---------------------------------------------------------------------------
It is important to note that a comprehensive review of relevant
legislation and regulation already in place in this country should
provide this committee with comfort that we are already well protected
from market-based threats that SWFs may pose to our national or
economic security. Last year's revised CFIUS/FINSA legislation, as well
as existing protections afforded by the SEC, Federal Reserve, Antitrust
authorities and other relevant legislation and regulation, provide a
high degree of protection from improper takeover approaches or unwanted
material investments from SWFs.
But we must acknowledge that over the past several years, many of
the world's emerging nations have accumulated capital at an
unprecedented pace.\3\ At the same time, we have witnessed the rise of
competing centers of global finance not only in Europe but also in Asia
and the Middle East. While the U.S. remains the world's sole military
superpower, we can no longer claim the same level of financial
dominance. While the U.S. is, of course, still a financial powerhouse,
we are no longer the only game in town. This shift has significant
foreign policy and political consequences. We should expect that
certain other countries may seek to further their national interests by
using the financial tools that they increasingly have at their
disposal. In their minds, finance and foreign policy are increasingly
intertwined.\4\
---------------------------------------------------------------------------
\3\ Over the first half of 2007, central banks in the world's
emerging economies accumulated over $600 billion of new reserves--an
amount that is double the total reserve position of the IMF--whose
mission used to include preventing the collapse of many of these same
governments.
\4\ In fact, traditional foreign policy phrases like ``nuclear
option,'' ``balance of power,'' ``mutually assured destruction,'' and
other similar terms are now embraced by many financial, as well as
military, strategists.
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Independent of their commitment to SWF best practices, countries
like China, Russia, and Venezuela can be expected to selectively use
finance as an instrument of power and influence. They have already
begun to do so. For example, last year U.S. financial markets reacted
to veiled threats that China might resort to the ``nuclear option'' of
dumping U.S. dollars. At the same time, Russia called for a new
``balance of power'' by seeking the support of emerging market
countries for their proposals to a new global financial architecture
and Venezuela tried to win some ``hearts and minds'' by refinancing
other nations' IMF debt through its participation in capital market
transactions. None of these initiatives involved SWFs, and yet they are
clear examples of the attempted use of increasing financial might to
exert strategic influence over foreign affairs.
From Britain's use of financial tools to expand its empire in the
18th and 19th centuries to the U.S. threat in 1956 to wreck havoc on
Britain's currency if it did not end its occupation of the Suez,
history is replete with examples of the use of finance and financial
markets as tools of foreign policy. It is, I believe, important to
recognize and address as a top priority the foreign policy consequences
raised by the increasing wealth of other nations. But I do not believe
that we achieve any meaningful economic, foreign policy, or national
security benefits by targeting SWFs with additional burdens. As
significant providers of capital to our markets, SWFs have thus far
been a positive influence on the U.S. and global economies.
______
Responses of David Marchick to Questions Submitted by Senator Biden
Question. How would you assess the level of regulatory protection
in the U.S. versus other regions, such as the EU. Are our regulations
comparatively stronger? Can they be improved? Are they sufficient?
Answer. While I am not an expert on the regulatory regimes in every
country within the EU, I believe that the laws and regulations in the
United States give the executive branch adequate and authority to
protect U.S. national security and/or other important government
interests. FINSA protects against threats to national security, and
CFIUS has demonstrated its willingness to block or mitigate problematic
investments. DOD has its own set of regulations to protect the defense
supply chain and classified information. Hart-Scott-Rodino triggers
antitrust reviews for any significant acquisition. And in any sensitive
sector, there are a host of laws and regulators that provide additional
protection. In the chemicals industry, for example, there are five
federal regulators focused on safety, security, transportation and
other issues; several state-level regulators; and more than a dozen
Federal statutes that impose various, wide-ranging controls on chemical
investments and operations. The Fed, Treasury, OCC, and OTS scrutinize
investments in the banking sector. Similar laws and regulatory
oversight exist in the telecommunications, energy, pharmaceutical, and
transportation sectors, among others. Even if there were cause for
concern associated with sovereign wealth funds, our existing legal and
regulatory structure should capture and fix--or block--any problematic
investments. Bottom line: When a foreign entity invests in the United
States, the U.S. is sovereign, not them.
Several countries in Europe and around the world have recently
amended their laws to strengthen scrutiny of foreign investments.
France, for example, recently issued regulations that require
additional reviews for investments in a number of sectors of the French
economy. Hungary passed a new law that raises obstacles toward foreign
acquisitions of companies that affect ``the security of public
supply.'' Germany is considering new legislation to increase scrutiny
of investments by sovereign wealth funds.
In general, I believe that countries have both a right and
obligation to protect national security, including with respect to
foreign investments. At the same time, national security should not be
a guise for protecting domestic companies or national champions from
economic competition.
Question. Robert Zoellick, President of the World Bank, has called
on sovereign wealth funds to take an active role in investing in the
development of sub-Saharan Africa. What do you see as their role in the
economic development of these countries? Can they have a positive
effect? What are the downsides?
Answer. Foreign investment is absolutely key to the economic
development in Africa, and Africa has traditionally been a location of
under investment with the exception of investments in national
resources and extractive industries. Sovereign wealth funds are an
important and growing pool of capital, and hopefully SWFs can increase
their investment in Africa.
At the same time, the United States, European governments and
various international institutions, including the IMF, have been
putting pressure on SWFs to invest only for commercial reasons, as
opposed to political reasons. I therefore note the irony that the IMF's
sister institution, the World Bank, is calling for increased investment
in Africa by SWFs for development purposes, as opposed to commercial
purposes.
Question. Dr. Edward Truman of the Peterson Institute has devised a
``scorecard'' for sovereign wealth funds that ranks the funds according
to a set of best practices criteria. Does this scorecard represent a
useful analytic tool to rate sovereign wealth funds? Does it measure
the right factors? Or is there little correlation between national
security risk and a fund's scorecard rating?
Answer. I support the transparency initiatives being pursued by the
Treasury Department and the International Monetary Fund, and hopefully
additional transparency can ease some of the concerns that exist about
SWFs. At the same time, transparency is not a proxy for the existence
or absence of national security risks. One can imagine an investment in
the United States by a completely transparent SWF that triggers
national security concerns. One could also imagine an investment by a
completely nontransparent SWF that does not implicate national security
concerns.
Instead of transparency, one needs to look at the country making
the investment, the asset being acquired, and the sensitivity of the
asset to determine the national security risk associated with an
investment.
Question. Recently the Kuwait Investment Authority asked companies
seeking money from it to ``clear our name with politicians before you
talk to us.'' Lehman Brothers is also said to be looking to raise
capital from sovereign wealth fund sources. From your perspective as a
senior executive in The Carlyle Group, are you concerned that the
current political environment in the U.S. is dissuading outside
investors from putting money in U.S. assets? Do we need to consider
sending a different political signal?
Answer. Yes; I know from my experience as an attorney before
joining The Carlyle Group and from discussions I have had with foreign
investors that the political environment in the United States is
dissuading certain investors from investing here. Certain foreign
investors worry that their investments will trigger political backlash
in the United States, either putting their investment or their
reputation at risk. Other foreign investors worry that about the CFIUS
process, either with respect to the timing required to clear CFIUS or
with respect to the conditions imposed by CFIUS. Some investors have
publicly announced that they will look outside the United States and
Europe to invest because of the political environment. Lower investment
volumes by definition lessens economic activity in the United States,
potentially costing jobs and economic opportunities for Americans.
In my view, both the President (and the new President in 2009) and
the Congress need to make clear that the United States remains open to
foreign investment. In addition, both the executive branch and the
Congress (in its oversight role) should work to ensure that regulatory
processes are predictable and nondiscriminatory. The hearing that
Senator Biden held, and the opening statements by Senators Biden and
Lugar, set exactly the right tone, in my view.
Question. To what extent is past behavior of certain sovereign
wealth funds a better indicator of national security risk than
transparency? For example, the Abu Dhabi Investment Authority generally
has a solid investment reputation in the United States, but it is also
one of the least transparent funds. Should this matter when it comes to
national security?
Answer. See above.
Question. Many commentators have expressed specific concern toward
Russia's Sovereign Wealth Fund--the Russian National Wealth Fund. It
has already raised concern with its disclosure that it owns a 5-percent
stake in the European Aeronautic Defense and Space Co. (which owns
Airbus) and is considering increasing its stake to 25 percent. This has
prompted Germany to consider new laws restricting sovereign wealth
funds. Should we be concerned about Russia's SWF in particular? Is the
German response the appropriate one? Should we consider other policy
responses when it comes to Russia's SWF?
Answer. I believe that the FINSA creates an effective, adequate,
and balanced mechanism to ensure that foreign investments do not risk
U.S. national security. The new law and regulations require heightened
scrutiny of acquisitions by government-owned companies, including SWFs,
and require additional reporting to Congress to ensure that Congress
can effectively execute its important oversight role.
The draft German law creates a number of uncertainties for foreign
investors, including uncertainty with respect to whether the government
will act to block or mitigate a transaction for up to 3 months after
the transaction has been completed.
______
Responses of David Marchick to Questions Submitted by Senator Lugar
Question. You noted in your testimony that a more important foreign
policy concern is the ``United States growing dependence on foreign
countries to finance our current account deficit.'' Could you please
outline in more detail how our government's fiscal deficit connects to
the need for foreign financing?
Answer. By definition, if the United States spends more than it
saves (both in terms of public and private savings), it needs to
finance that spending. As a result, the United States requires
investment from abroad through a variety of means, including foreign
direct investment.
Question. What does the growth of sovereign wealth funds mean for
the United States? If sovereign wealth funds reduced their investments
in the United States, what would be the impact on our economy?
Answer. The growth of SWFs has a number of implications for the
United States. First, it points to an unhealthy current account
imbalance, combined with high energy prices, which has led to a
dramatic rise in the accumulation of official reserves in a number of
countries around the world. Second, just like any other investor, SWFs
have many choices with respect to deployment of their capital. So long
as a SWF investment does not create a national security risk to the
United States, we should welcome SWF investments. If the United States
created an unwelcome environment for SWFs, it would ultimately harm US
economic and strategic interests. Just like any other investment, SWF
investments can help create economic activity, jobs and opportunity for
American firms and workers.
Question. What policy proposals would you recommend, if any, to
improve sovereign wealth fund transparency?
Answer. I believe that the proposals outlined by the IMF, with
support from the Treasury department, are generally pointed in the
right direction. Transparency will help reduce concerns and fears about
SWFs; at the same time, even a perfectly transparent SWF might seek to
buy U.S. assets the sale of which would present national security
concerns.
Question. The President of the World Bank, Robert Zoellick, has
suggested that sovereign wealth funds actively invest in the
development of sub-Saharan Africa. What do you see as the role of
sovereign wealth funds in the economic development of poor countries?
Answer. SWFs can and should play an important role in investment in
sub-Saharan Africa but the United States and International Financial
Institutions should not press SWFs to make non-commercial investments
in the region. The U.S. and other countries can and should play an
important development role in sub-Saharan Africa. However, it would be
counter-productive and confusing if the U.S. and International
Financial Institutions call on SWFs to make investment only for
commercial reasons, on the one hand, but then call for development-
related investments on the other.
Question. Should we treat sovereign wealth fund investments
differently than other types of foreign holdings of U.S. assets? Do
U.S. national security concerns differ for sovereign wealth funds
versus other types of foreign investment and foreign purchase of U.S.
debt?
Answer. The recently passed CFIUS reform bill requires heightened
scrutiny of foreign acquisitions of U.S. companies by government-
controlled entities, including Sovereign Wealth Funds. In my view, the
legislation strikes the right balance between encouraging foreign
investment and protecting national security. To date, most SWF
investment have been small, passive stakes which have not implicated
any U.S. national security interests.
Question. Despite concerns about sovereign wealth funds, it is also
possible that they can support U.S. foreign policy and development
goals. Some oil and gas rich countries with surging export revenues
struggle with weak domestic economies. For example, Angola, which
reportedly received $44 billion in oil revenues last year, has the10th
largest amount of arable land in the world but has been unable to
revive its agriculture sector and imports half of its food. How can the
U.S. encourage governments to form well-managed funds? Are our foreign
assistance tools equipped to provide this sort of technical expertise?
Answer. The United States has--correctly in my view--for many years
encouraged small, resource-rich developing countries to take steps to
avoid the so called ``Dutch disease,'' which has undermined the
economies of many oil-rich countries. One of the big challenges that
resource rich countries face is that the dramatic increase in fiscal
revenues at times of high energy prices increases inflation, creates
upward pressure on their currency and make non-energy sector exports
uncompetitive. One way to reduce risks of Dutch disease or the ``oil
curse'' is to set aside revenues and invest them abroad. In doing so,
countries can maintain discipline on spending and reduce upward
pressure on their domestic currency. Both the Treasury Department and
the IMF have done good work in providing technical assistance to
developing countries on these issues but perhaps more could be done at
this time given the extraordinary growth in revenues in a large number
of resource-rich countries.