[Senate Hearing 110-954]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 110-954
 
    SOVEREIGN WEALTH FUND ACQUISITIONS AND OTHER FOREIGN GOVERNMENT 
 INVESTMENTS IN THE U.S.: ASSESSING THE ECONOMIC AND NATIONAL SECURITY 
                              IMPLICATIONS 

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                                   ON

ASSESSING THE ECONOMIC AND NATIONAL SECURITY IMPLICATIONS OF SOVEREIGN 
                  WEALTH FUNDS AND FOREIGN ACQUISITION


                               __________

                      WEDNESDAY, NOVEMBER 14, 2007

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs

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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware           CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey          JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii              MIKE CRAPO, Idaho
SHERROD BROWN, Ohio                  JOHN E. SUNUNU, New Hampshire
ROBERT P. CASEY, Pennsylvania        ELIZABETH DOLE, North Carolina
JON TESTER, Montana                  MEL MARTINEZ, Florida

                      Shawn Maher, Staff Director
        William D. Duhnke, Republican Staff Director and Counsel
                       Dawn Ratliff, Chief Clerk
                          Jim Crowell, Editor

















                            C O N T E N T S

                              ----------                              

                      WEDNESDAY, NOVEMBER 14, 2007

                                                                   Page

Opening statement of Senator Bayh................................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2
    Senator Dole.................................................     3
    Senator Webb.................................................     4

                               WITNESSES

David H. McCormick, Under Secretary for International Affairs, 
  Department of the Treasury.....................................     5
    Prepared statement...........................................    40
Alan P. Larson, Senior International Policy Advisor, Covington & 
  Burling, LLP...................................................    20
    Prepared statement...........................................    45
    Response to written questions of:
        Senator Shelby...........................................   168
        Senator Bunning..........................................   169
Dr. Edwin M. Truman, Senior Fellow, Peterson Institute for 
  International Economics........................................    22
    Prepared statement...........................................    58
Patrick A. Mulloy, Washington Representative, Alfred P. Sloan 
  Foundation.....................................................    24
    Prepared statement...........................................    85
    Response to written questions of:
        Senator Bunning..........................................   172
Dr. Gerard Lyons, Chief Economist and Group Head of Global 
  Research, Standard Chartered Bank..............................    27
    Prepared statement...........................................   101

              Additional Material Supplied for the Record

Table 1.7. Size and Structure of Major Sovereign Wealth Funds....   176


    SOVEREIGN WEALTH FUND ACQUISITIONS AND OTHER FOREIGN GOVERNMENT 
 INVESTMENTS IN THE U.S.: ASSESSING THE ECONOMIC AND NATIONAL SECURITY 
                              IMPLICATIONS

                              ----------                              


                      WEDNESDAY, NOVEMBER 14, 2007

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 2:02 p.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Evan Bayh presiding.

             OPENING STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. I would like to call the meeting of the 
Committee to order. I would like to thank you all for being 
with us today. And I would like to begin by thanking Chairman 
Dodd for making this hearing possible and for elevating this 
important issue to such a priority position. Without the 
Chairman's support this could never have happened, and so I 
want to express my gratitude to him.
    Chairman Shelby, I want to thank you for most especially 
your friendship, but also the good working relationship we have 
had on so many issues over the years, and it is good to be with 
you today.
    And Senator Webb, welcome. Senator Webb is one of the 
driving forces behind this hearing, and so I am looking forward 
to hearing from you today, Jim, and thank you for continuing to 
focus on this very important, very important issue.
    Senator Webb. Thank you, Mr. Chairman. Good to be with you.
    Senator Bayh. I am going to make a brief opening statement 
and then hear from my colleagues, and then we will get right to 
the witnesses.
    The issue of sovereign wealth funds is a significant one. 
The number of these funds is growing. Of the 20 largest, 13 
were started since 1990. With foreign currency reserves up 140 
percent over just the last 5 years, this trend is likely to 
continue.
    The size of these funds is also growing. There are now 
seven over $100 billion in assets, including Abu Dhabi at $625 
billion, Singapore at $215 billion, Norway at $322 billion, 
Kuwait at $231 billion, China at $200 billion, Singapore at 
$108 billion, and Russia now at $127 billion.
    These now dwarf in size the multilateral organizations 
designed to be the governing architecture of the global 
financial system. For perspective, the International Monetary 
Fund now holds assets with a market value of just $76.9 
billion. The World Bank has just $40 billion on its balance 
sheet.
    The number and size of these funds is likely to continue to 
grow. This is being driven by the increasing price of 
commodities, principally oil, trade imbalances and currency 
practices by countries that have the effect of increasing their 
foreign currency reserves. These situations show no signs of 
abating.
    This situation presents the United States with both 
opportunities and challenges. It is better for the United 
States to have capital invested here to create jobs, improve 
our productivity growth, keep interest rates low, and our 
standard of living high. But sovereign wealth funds are 
inherently different than private investors.
    As the Chairman of the SEC, Christopher Cox, recently 
observed--and I quote--government ownership of companies and 
investment funds poses a fundamental challenge to the market 
premise upon which the SEC operates. The lack of transparency 
that characterizes many sovereign wealth funds undermines the 
theory of efficient markets at the heart of our economic 
system. In addition, unlike private investors and their 
representatives--pension funds and mutual funds, for example--
government-owned entities may have interests other than and 
that occasionally will take precedence over profit 
maximization.
    Just as the United States has interests in addition to 
financial ones, so do other countries. Just as we value some 
things more than money, so do they. Why should we assume that 
other nations are driven purely by financial interests when we 
are not? Or are we?
    The issue before us, and the subject of this hearing, is 
how to strike the right balance of interests. How do we attract 
capital from abroad and pursue our financial goals while 
reconciling this with other vital national concerns?
    To help explore this, we have an extraordinary panel of 
witnesses today. But first, we will hear from other members of 
the Committee and Senators. Senator Shelby, I would like to 
begin with you.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Chairman Bayh.
    This afternoon, as the Chairman has pointed out, we are 
meeting to examine the dynamic growth of sovereign wealth 
funds. A lot of this he has outlined in detail.
    I hope this hearing, Mr. Chairman, is the first of several 
so that we have an opportunity here at the Banking Committee to 
examine fully the range of issues that these funds present to 
our economy and to our national security.
    As you well know, we are entering to a different economic 
world where a lot of wealth has shifted from the United States 
and from Western Europe to developing countries like China and 
the Gulf States.
    There are two unique features of sovereign wealth funds, as 
I understand it. First is their size. I have been told that 
they hold in excess of $2 trillion, Mr. Secretary, now and 
could go to $13 trillion to $15 trillion. This is serious, 
serious business. Recent trends indicate that these funds will 
continue to grow no matter what we do.
    Second, sovereign wealth funds are not private investment 
vehicles, as what we have traditionally been involved in. They 
are government-controlled entities, as the Chairman pointed 
out. Government control introduces the possibility that they 
may be used for purposes other than their economic return.
    For this reason alone, I think it is important to try to 
get a basic understanding of the various funds and their 
activities and perhaps their objectives. We need more 
information on how they are managed, how they are structured, 
and the types of investments they make.
    We also need to know more about the objectives that I 
mentioned behind their investment activities. What is their 
motives here? Are they seeking higher returns, as the Chairman 
indicated? Are they also being used as a foreign policy tool, 
oftentimes maybe in the long run, against our interests.
    Is there a role for global financial institutions such as 
IMF, OECD, and the World Bank in dealing with these funds? 
Finally, what effects can these funds have on exchange rates, 
Treasury securities, and the economic health of this country? 
We had better know, and this hearing today will get us going in 
the right direction.
    But we have to remember, because sovereign wealth funds are 
only going to increase in asset size and continue to expand 
their global reach, this Committee, Mr. Chairman, has a 
continuing responsibility to monitor and understand these 
unique and growing investment vehicles. If we let this continue 
to grow, we will not be in control of our own economic destiny, 
as we have in the past.
    Thank you.
    Senator Bayh. Thank you, Senator Shelby, for those 
perceptive remarks.
    Senator Dole, I think we go to you next, as a member of the 
Committee. And then, Senator Webb, to you.

              STATEMENT OF SENATOR ELIZABETH DOLE

    Senator Dole. Thank you, Mr. Chairman, Ranking Member 
Shelby. I appreciate so much your holding this hearing on 
sovereign wealth fund acquisitions and foreign government 
investments in the United States.
    I appreciate this Committee's recent work on currency 
manipulation by foreign governments, namely China, as this 
issue has great importance for my home State and its 
manufacturing jobs. I agree that today's hearing topic, too, is 
of particular relevance to this Committee.
    Sovereign wealth funds have existed since the 1950's and 
the total number of these institutions has grown dramatically 
over the past 10 to 15 years. According to the IMF, there are 
currently more than 20 countries--including China, Russia, 
Venezuela, and United Arab Emirates--that have these state-
sponsored investment vehicles, and half a dozen or more nations 
have expressed interest in establishing one.
    Research conducted by Standard Chartered Bank in the United 
Kingdom indicates that the total investment by these funds is 
estimated at $2 trillion to $3 trillion. Based on current 
projections, this is more than hedge funds manage, with $1 
trillion to $1.5 trillion, and more than private equity firms 
manage with $700 billion to $1.1 trillion.
    The IMF estimates or projects that sovereign wealth funds 
will continue to accumulate international assets at the rate of 
$800 billion to $900 billion per year, which could bring the 
aggregate total up to $12 trillion by $2012.
    One of the issues that has emerged with these funds is 
their transparency and whether they are willing to disclose and 
disseminate information. Some of these sovereign wealth funds 
already provide information regarding specific investments. For 
example, Norway's Government Pension Fund disclosed that it 
owns significant stakes in American financial institutions such 
as Bank of America, Citigroup, and AIG, as of December 31st, 
2006. Unfortunately, other countries such as China and 
Venezuela do not make such data readily available.
    I am pleased that this issue has captured the attention of 
Treasury Secretary Paulson, and I encourage the SEC and the IMF 
to continue monitoring sovereign wealth funds and to keep this 
Committee fully apprised. I hope that increased disclosure and 
transparency will instill a greater sense of confidence and 
understanding with regard to these investment vehicles, which 
no doubt have significant impacts on the continued integrity of 
the United States in international capital markets.
    Again, I thank the Chairman, the Ranking Member, for 
holding this important hearing and I look forward to hearing 
from our witnesses regarding this emerging issue.
    Thank you.
    Senator Bayh. Thank you very much, Senator Dole.
    Senator Webb.

                 STATEMENT OF SENATOR JIM WEBB

    Senator Webb. Thank you, Mr. Chairman, and I appreciate you 
allowing me to sit on this hearing today, to be something of an 
interloper in your business.
    This is a very important hearing. It is a follow-on to a 
letter in September that I sent to Treasury Secretary Paulson, 
along with you, Senator Bayh, Ranking Member Shelby, and also 
the Chairman of this Committee, addressing the importance of 
the Committee for Foreign Investment in the United States to 
take into consideration passive foreign ownership interests and 
assets in the country, including the sovereign investment 
funds. The letter urged Treasury to promulgate regulations 
broad enough to ensure that potential national security 
implications of such investments are appropriately addressed in 
the context of ongoing foreign investment in our economy.
    Although foreign governments have been investing for years 
in the United States through different investment vehicles, 
sovereign wealth funds have risen to recent prominence on a 
wave of high levels of foreign exchange reserve associated with 
increased commodity prices and export led growth. The growth of 
these funds demand that we focus on their strategic 
implications.
    The practice of state capitalism which is a phrase, I 
believe, was coined by Dr. Lyons, who will be testifying before 
us today, allows sovereign wealth funds to potentially improve 
their strategic advantage or to secure access to sensitive 
technology from other countries.
    Relative to our own security, the Committee on Foreign 
Investment in the United States is the primary source of 
protection from investment that threatens our national 
interest. The increased number, size, and growth potential of 
sovereign wealth funds raises the prospect that they may be 
structured so as to escape scrutiny in ways not yet 
contemplated by current law.
    So the question before us really is how we balance the need 
for investment with safeguarding our national security assets 
in the context of these funds. Our witnesses today are going to 
provide us with an opportunity to ensure that we have adequate 
regulations and that we seek policy recommendations regarding 
the risks of these funds as they may affect not only our market 
stability, but also our national security.
    I thank you again for inviting me to participate in this 
hearing.
    Senator Bayh. Senator Webb, thank you, and I am 
particularly grateful for your interest in national security 
related issues, of which this is one. And you are always 
welcome to contribute to the work of the Committee.
    We begin today with the Honorable David H. McCormick. As a 
matter of fact, you constitute a panel of one, David, so we are 
looking forward to hearing from you.
    David McCormick is Undersecretary for International Affairs 
at the Department of the Treasury, where he oversees policies 
in the areas of international finance, trade and financial 
services, investment, economic development, and international 
debt policy. Until August, he was the President's Deputy 
National Security Advisor for International Economics and 
previously served as Undersecretary of Commerce for Export 
Administration.
    In the private sector, Mr. McCormick ran a software company 
and was a consultant for McKinsey & Company. He is a graduate 
of West Point and holds a Ph.D. from the Woodrow Wilson School 
at Princeton University. He is a former Army officer and a 
veteran of the First Gulf War.
    Mr. McCormick, we thank you for your service to our country 
and for you presence here today. We welcome your statement.

     STATEMENT OF DAVID H. McCORMICK, UNDER SECRETARY FOR 
       INTERNATIONAL AFFAIRS, DEPARTMENT OF THE TREASURY

    Mr. McCormick. Thank you, Mr. Chairman, Ranking Member 
Shelby, Senator Dole, Senator Webb. Thank you for the 
opportunity to be with you here today. I very much appreciate 
the chance to come and discuss sovereign wealth funds. At 
Treasury, we have been increasingly focused on sovereign wealth 
funds for more than a year now, and I am pleased to be able to 
share with this Committee our views.
    As was said by many of your statements, sovereign wealth 
funds are not new. The oldest funds date back to the 1950's in 
Kuwait and Kiribati. Over the next four decades, these numbers 
have slowly grown. By the year 2000, there were 20 sovereign 
wealth funds worldwide, managing a total asset base of several 
hundred billion dollars.
    Today, what is new is the rapid increase in both the number 
and the size of sovereign wealth funds. Fueled by high 
commodity prices and rapid accumulation of official reserves, 
20 new funds have been created since 2000, more than half of 
these since 2005. Today there are nearly 40 funds managing 
total assets in a range of $1.9 trillion to $2.9 trillion.
    At the Department of the Treasury, we define a sovereign 
wealth fund as a government investment vehicle funded by 
foreign exchange assets and managed separately from official 
reserves. These sovereign wealth funds generally fall into two 
categories. There are commodity funds, which are funded through 
commodity exports, owned or taxed by the government. Commodity 
funds serve different purposes, including the stabilization of 
fiscal revenues, intergenerational savings, and the balance of 
payments sterilization.
    There are also non-commodity funds, which are established 
through the transfers of assets from official foreign exchange 
reserves. Large balance of payment surpluses have enabled non-
commodity exporting countries to transfer excess foreign 
exchange reserves to these stand-alone funds.
    Now it should be noted that within this group of countries, 
foreign exchange reserves are now sufficient by all standards 
of reserve adequacy and it is our view that greater exchange 
rate flexibility is needed and we are actively engaged on many 
fronts calling for that increased flexibility in a number of 
countries.
    In contrast to traditional reserves, sovereign wealth funds 
seek a higher rate of return and are invested in a wider range 
of asset classes. Their managers emphasize expected returns 
over liquidity and many investments are in the form of stakes 
in U.S. companies, as has been witnessed in recent months.
    Sovereign wealth fund assets are large in their importance, 
but very concentrated. While a fraction of global financial 
assets, sovereign wealth funds are currently larger--as was 
already said--than the total assets under management by either 
hedge funds or private equity. However, by some market 
estimates, only a handful of funds account for the majority of 
total sovereign wealth fund assets. Roughly two-thirds of 
sovereign wealth fund assets are commodity fund assets, while 
the remaining one-third are non-commodity funds transferred 
from official reserves.
    The rise of sovereign wealth funds clearly has implications 
for the international financial system. They bring benefits to 
the economy and they also pose concerns.
    As reiterated by the President in his May 10th statement, 
the U.S. is committed to open investment and advancing open 
markets at home and abroad. The United States economy benefits 
from open investment, including investment from sovereign 
wealth funds. The depth, liquidity, and efficiency of our 
capital markets make the United States the most attractive 
country in the world in which to invest. And the U.S. has 
derived many benefits in the form of jobs, R&D spending, and 
higher wages.
    Sovereign wealth funds also have potential to promote 
financial stability. They are, in principle, long term, stable 
investors that provide significant capital to the system. They 
are not highly leveraged and they cannot be forced by capital 
requirements or investor withdrawals to liquidate positions 
rapidly.
    Sovereign wealth funds also raise potential concerns. 
Investments in U.S. companies or other firms by sovereign 
wealth funds, as with other types of foreign investment, may 
create legitimate national security concerns. Sovereign wealth 
funds could provoke a new wave of investment protectionism, 
which raises the stakes for the health of the global economy.
    Sovereign wealth funds also raise non-security issues 
related to the larger role of foreign governments in markets. 
For example, through inefficient allocation of capital, 
perceived unfair competition with private firms, or the pursuit 
of strategic over return-oriented investments, sovereign wealth 
funds could potentially distort the market.
    Finally, sovereign wealth funds may raise financial 
stability issues as actual or perceived shifts could cause 
market instability or market volatility.
    At the Treasury Department, we are working on a number of 
steps to ensure the United States continues to benefit from 
open investment while addressing these concerns. First, the new 
Foreign Investment and National Security Act, authored by the 
Chairman and Ranking Member of this Committee and signed into 
law by the President last summer, implemented through the 
Committee on Foreign Investment in the United States, ensures 
robust review of investment transactions that pose national 
security concern. It requires heightened scrutiny of foreign 
controlled investments. CFIUS is able to review investments 
from sovereign wealth funds, just as it is other foreign 
government-controlled investments, and it has and will continue 
to exercise this authority to ensure our national security.
    Additionally, the new CFIUS legislation reaffirms investor 
confidence and longstanding U.S. open investment policy. We 
believe the U.S. investment security framework provides a good 
model for other countries where protectionist sentiment has 
been on the rise and we are actively engaged with these 
countries to head off undue protectionist responses abroad.
    Second, we have proposed the creation of a multilateral 
framework for best practices. The International Monetary Fund 
should develop best practices for sovereign wealth funds, 
building on the existing best practices for foreign exchange 
reserve management. These would provide guidance to funds in 
areas such as fund objectives, structure, transparency, and 
risk management, while demonstrating to critics that sovereign 
wealth funds can be responsible, constructive participants in 
the international financial system.
    Third, we have proposed the Organization for Economic 
Cooperation and Development, OECD, should identify best 
practices for countries that receive foreign controlled 
investment. I should say that many of the countries that are 
the holders of these sovereign wealth funds are also 
significant recipients of foreign investment. These practices 
should focus on avoiding protectionism and should be guided by 
the well-established principles embraced by OECD and its 
members for the treatment of foreign investment.
    Meaningful and timely progress has been made. In May of 
this year, the Treasury hosted a G-20 meeting of Finance 
Ministry and Central Bank officials that focused the first 
multilateral discussion on sovereign wealth funds. Just last 
month, Secretary Paulson hosted a meeting with the G-7 Finance 
Ministers and the heads of sovereign wealth funds from eight 
countries: China, Korea, Kuwait, Norway, Russia, Saudi Arabia, 
Singapore, and the United Arab Emirates, to build support for 
best practices. The next day, the IMFC--which is a ministerial 
level advisory committee to the IMF--called on the IMF to begin 
a dialog to identify best practices for sovereign wealth funds.
    Also, at Treasury we have taken a number of steps 
internally and within the U.S. Government to enhance our 
understanding of sovereign wealth funds. Treasury has created a 
working group on sovereign wealth funds that draws on the 
expertise of our international affairs team as well as domestic 
finance.
    We informed Congress in June of some of our thinking on 
sovereign wealth funds in an appendix to the Report on 
International Economic and Exchange Rate Policies, and we will 
continue to provide updates on a semi-annual basis.
    We also created a new market room for ensuring vigilant 
ongoing monitoring of sovereign wealth funds trends and 
transactions. And through the President's Working Group on 
Financial Markets, which is chaired by Secretary Paulson, we 
continue to discuss and review sovereign wealth funds.
    We have also initiated outreach to ensure an ongoing and 
very candid dialog with countries that have these sovereign 
wealth funds. The Treasury Department will continue its work on 
sovereign wealth funds through analysis, through bilateral and 
multilateral outreach, so that the United States can shape any 
international response to this issue in a way that addresses 
legitimate areas of concern while ensuring that the United 
States remains open to and welcoming of foreign investment.
    Thank you.
    Senator Bayh. Thank you, Mr. McCormick.
    Senator Crapo, it is good of you to join us. I would give 
you an opportunity to make a statement at this time, or you can 
waive that, if you would prefer.
    Senator Crapo. I will waive that, and let's go ahead with 
the witness. Thank you.
    Senator Bayh. Thank you.
    I think these are 5 minutes rounds. Five minute rounds. 
Very good. I will try and keep my first round of questions to 5 
minutes. I would ask my colleagues to try and do the same, and 
if need be we will be happy to have another round of questions.
    Mr. McCormick, I am far from being the longest serving 
member of this body, but I have been around long enough now to 
have a little institutional memory. So I would like to take you 
on just a brief trip down memory lane.
    I think it was 2001 when the financial projections for our 
country were that we would run surpluses that were of such 
magnitude that, in fact, we would pay off our national debt in 
fairly short order. There was a big debate at that time that if 
that, in fact, happened what would we do with the extra money? 
One of the things we heard pretty consistently from this 
administration was that well, we should not invest it in the 
private economy. I will read you a quote to that effect. I 
think it was from the then Chairman of the Federal Reserve, 
Alan Greenspan.
    This is a quote from his testimony to the Budget Committee. 
``The Federal Government should eschew--'' that is Greenspan-
speak ``--should eschew private asset accumulation because it 
would be exceptionally difficult to insulate the Government's 
investment decisions from political pressures.''
    That same year, before that same Committee, then-Secretary 
of the Treasury, Paul O'Neill, said ``Government is big enough 
and has no business owning private companies.''
    My question to you is if it was wrong for the U.S. 
Government to invest in our private economy, why is it right 
for other nations? And what do we do to protect against the 
political influences that Chairman Greenspan warned about?
    Mr. McCormick. Thank you, Mr. Chairman. I think it is a 
very legitimate question. Through our policy focus, both with 
the non-commodity funds, as well as the commodity funds, we 
have very active dialogs about how to reduce the accumulation 
of foreign reserve, which I noted in my testimony far surpasses 
any reasonable level.
    Senator Bayh. We wish you good luck with that.
    Mr. McCormick. Yes, sir. It is not an easy task.
    So my discussion of sovereign wealth funds is by no means 
meant to encourage or validate or accept that that is good 
policy on the part of the countries that are accumulating these 
reserves.
    With that said, the fact remains that a very significant 
amount of assets have already been accumulated. Under even the 
most conservative projections they will continue to accumulate. 
And so we are faced with the very real issue that there's a 
significant amount of capital out there which is going to be 
invested abroad.
    Senator Bayh. And as I said in my testimony, we would like 
the capital. But I guess, to get back to my question, if we 
were concerned about political influences on decisions by our 
own Government, why should we not be equally concerned about 
political influences on the parts of other governments? And 
what can we do to protect ourselves from that?
    Mr. McCormick. Mr. Chairman, I think it is an area that we 
should monitor very carefully. And by that I mean if you look 
at the track record of the sovereign wealth in the United 
States to date, it is a track record that has generally been 
very responsible investing, long-term investing, and overall a 
very stable investment track record. That is not to suggest 
that the concern you raise is not a very legitimate one. And so 
I think that puts an added responsibility on us, through the 
CFIUS process, but also through our ongoing monitoring of this 
market and of these developments, to ensure that that is not 
happening.
    Senator Bayh. You make a good point, that the track record 
to date has been a positive one without pernicious influence. 
But as all of us have noted, the size of these funds, the 
numbers of these funds, are growing very rapidly. And now they 
are growing in some countries that view themselves, at least in 
part, as competitors of ours, both economically and in other 
spheres, which raises a host of different questions.
    So I will not continue to ask you about that, but I think 
you understand what I am saying. If it is a legitimate concern 
on the part of our own Government--for example, I just--one 
last point here. We have a big debate about what to do to solve 
the Social Security imbalances in our country. We currently 
invest, at least as an accounting matter, in Treasury bonds 
with the excess fund that are paid in to the Treasury in terms 
of Social Security payments. If our Government decided that we 
could gain a higher rate of return by, instead of investing in 
Treasury bonds, let's say invest in Blackstone or something 
like that, a hedge fund, would our Government encourage such a 
policy?
    Mr. McCormick. Mr. Chairman, you know, it is an interesting 
question, in part because within the United States we already 
have what many would characterize as a sovereign wealth fund in 
the Permanent Fund in Alaska, which is a significant 
accumulation that is invested both at home and abroad.
    I think one of the things that is interesting about the 
discussion on sovereign wealth funds is really there is a whole 
continuum of official reserves, which are increasingly being 
invested for higher returns in the equity markets; sovereign 
wealth funds, as we have just discussed; state-owned 
enterprises; and pension funds. And all of these are becoming 
much more significant global actors. Some of the same issues 
that we are discussing apply to some of those other investment 
categories, as well.
    Senator Bayh. Well, and as a former Governor with a State 
that has a pension fund that does invest in the private 
marketplace, I have seen that as a positive development. But 
there are policies in place that try and insulate those 
investment decisions from political concerns, and I think 
legitimately so. And at the national level, when this whole 
subject was raised, there have been examples where States only 
occasionally--not frequently--have pursued social investing, 
shall we call it. And that raised enough alarm bells that it 
gave rise to Chairman Greenspan's testimony and several others.
    So I raise it as an important issue.
    I see my time has expired. I did have a couple of extra 
questions, but I will save that for the next round, Mr. 
McCormick.
    Senator Shelby.
    Senator Shelby. Thank you.
    Mr. Secretary, I have been looking at a sheet, and I have 
marked it up a little bit. I do not know if you have seen it. 
It shows the compilation of the estimated size of sovereign 
wealth funds in billions of U.S. dollars, and it adds up today 
to over $2 trillion. Some people think it will go up $12, $13 
billion, could go more. And this is not exactly accurate, but 
it is close. About 80 percent of this money is connected to oil 
and gas one way or the other. Does that bother you that we have 
no energy policy, that we have become more and more dependent 
on foreign sources of energy and we are exporting our wealth 
and then they want to come back and invest in our company? And 
that is good to a point, but to what point? Does that concern 
you at times?
    Mr. McCormick. Yes, Senator Shelby, it does. I think this 
is really what lies behind the President's focus on energy 
security and the emphasis that he has placed on that particular 
area.
    Senator Shelby. Now, you do not have any illusions about 
energy security by any of the bills that we have been pushing 
and the President has been pushing, do you? You know, whether 
it is ethanol or whether it is solar power, all that is good. 
But it is not going to make much of a dent in our energy needs, 
is it, unless we really conserve energy, all of us, cut down on 
our energy consumption 25 percent, or build nuclear power 
plants and start walking more? You do not have any illusion 
about that, do you?
    Mr. McCormick. No, Senator, I do not.
    Senator Shelby. OK. So we can look for these sovereign 
wealth funds to grow rather than contract, could we not?
    Mr. McCormick. Yes, sir.
    Senator Shelby. And as they grow, they want to invest 
somewhere, and that somewhere is generally the United States or 
Western Europe, is it not?
    Mr. McCormick. Yes, sir, I think that is true, although I 
do think they are also beginning to see the emerging markets as 
a very attractive investment area as well.
    Senator Shelby. Does it concern you at all that companies' 
sovereign wealth funds would like to buy up some of our most 
strategic materials? What about iron or coal or oil, 
everything, oil companies? Does that concern you?
    Mr. McCormick. Yes, Senator, it does. I think the recent 
legislation that you and others here in Congress--specific 
legislation that you and others have recently passed and the 
President has signed is a great step forward in guarding 
against that possibility.
    Senator Shelby. Could you just highlight some of the 
differences here briefly this afternoon with respect to the 
management, internal controls, disclosure, and investment 
strategies of the different countries? Just pick out several 
that have sovereign wealth funds and how they are used.
    Mr. McCormick. Well, Senator, what is interesting as you 
look at this group of 40 or so is that they fall generally into 
two camps: in addition to the commodity/non-commodity 
distinction that I made, there are those that have been around 
a long time, and those that are relatively new. My experience, 
having talked to many of them on both sides of that divide, is 
that the ones that have been around for quite some time have 
really put in place an investment process, an investment 
decisionmaking, a governance structure that is very much like 
what we would see in a big private equity fund or a big hedge 
fund. The focus, of course, has been in creating 
intergenerational wealth, largely, and maximizing returns.
    The funds that are relatively new I think are very much in 
the process of trying to define how they are going to do 
business, and I think therein lies our challenge, frankly, and 
our opportunity in terms of developing a coherent set of best 
practices that the newer funds might adapt to.
    That is not meant to suggest that the transparency and the 
clarity within sovereign wealth funds is the same as you would 
find in a pension fund or in other areas where there is a great 
deal more transparency, and I think that also is our 
opportunity, is to get a higher level of governance and 
transparency across the entire sovereign wealth fund sector.
    Senator Shelby. How do you separate the objectives of a 
nation to survive, to expand for their own people, and the 
objectives of a sovereign wealth fund which is controlled by 
the nation?
    Mr. McCormick. Well, Senator, I mean, I think at its core, 
we have to acknowledge that they are different. However, the 
path that we have been going down----
    Senator Shelby. And how are they different?
    Mr. McCormick. Well, they are different in the sense that a 
private investment vehicle, a private company is designed, 
exists for the purpose of maximizing profit. The sovereign 
wealth funds can exist solely for the purpose of maximizing 
returns, but there is a possibility that they----
    Senator Shelby. But it is for the benefit ultimately of the 
state, is it not?
    Mr. McCormick. It is indeed.
    Senator Shelby. OK, as opposed to the shareholders that 
you----
    Mr. McCormick. Right. Yes, sir.
    Senator Shelby. So basically what we are doing in a sense 
is exporting our wealth to the world, especially in the energy 
areas, and others, and then they are using our wealth to buy 
back our companies. Is that correct? You know, money is looking 
for its best investment, and the money is going to be invested 
somewhere, is it not?
    Mr. McCormick. Senator, it is. I would look at that inbound 
investment. I would describe that inbound investment I think a 
little bit differently.
    Senator Shelby. How would you describe it?
    Mr. McCormick. I would describe that as in many ways the 
lifeblood of what has allowed companies in the United States to 
grow, to capitalize, to invest in R&D, to create higher-paying 
jobs. So investment as a general rule, as I know you know, 
Senator, has been a very critical part of our prosperity, and 
this sovereign wealth fund investment can also be a critical 
part of our future prosperity, but if and only if it operates 
within our markets in a way that is consistent with market 
fundamentals and market-driven investment decisions.
    Senator Shelby. I know you have a portfolio over at 
Treasury, and we set up CFIUS for Treasury to head that up, but 
you are not alone. But I hope that you will be very careful as 
you look at sovereign wealth funds' investments in this country 
as to who they are, what they are investing in, and the long-
term repercussions for this country, our workers, and our 
companies.
    Thank you, Mr. Chairman.
    Senator Bayh. Thank you, Senator Shelby.
    Senator Webb.
    Senator Webb. Thank you, Mr. Chairman.
    Mr. McCormick, I want to understand your views and the 
administration's views in terms of any level of concern that 
you have about this concept. I did not quite get that from your 
testimony. Do you have concerns, national security concerns?
    Mr. McCormick. Senator, the national security concerns that 
I think can exist from a sovereign wealth fund investment, a 
state-owned enterprise, or other investments, we believe can be 
addressed through the legislation that this Congress has 
passed.
    Senator Webb. So you believe under current policy there is 
no cause for national security concerns about the nature of 
these investments?
    Mr. McCormick. Well, Senator, I would say it a little bit 
differently, which is I believe that any given transaction from 
a sovereign wealth fund could pose very severe national 
security consequences. I believe the legislation that you have 
passed allows us the authority to deal with that appropriately.
    Senator Webb. How would you characterize the relationship 
between the United States and China? Adversary? Competitor? 
Ally?
    Mr. McCormick. I guess, Senator, I would characterize that 
as one of constructive engagement across a number of areas, and 
also a relationship that is tense and where we have lots of 
disagreement in other areas.
    Senator Webb. You would agree that in areas where two 
countries of the size and global interests on the United States 
and China, if there are disagreements that one country would 
want to be able to use leverage against the other?
    Mr. McCormick. As a general rule, yes, Senator, I think 
that----
    Senator Webb. I assume you would agree that there is--or 
maybe not. But I would assume you would agree that there is a 
difference when you look at an investment that actually is made 
by a foreign government and particularly into direct areas of 
the economy as opposed to, say, something like a T-bill?
    Mr. McCormick. Yes, Senator, I agree there is a difference. 
I would describe this as a continuum, so on the one end would 
be investment in T-bills and official reserves. Then you could 
see passive investment in the equity markets, and all the way 
up to a controlling investment in an individual company.
    Senator Webb. So in a situation that would likely--or can 
generally occur with this type of investment, I would think 
that, on the one hand, we could get ourselves into a situation 
nationally where we are dependent on certain levels of 
investment--there are sort of three areas of concern. One is 
that we would be dependent on a certain level of investment 
which would give another nation a form of quiet leverage. You 
have another situation with respect to the potential of access 
to sensitive information depending on what the investment is. 
And then, third, just due to the liquidity of our markets, 
which you commented on, there could conceivably be overt 
leverage in a situation where we would be having a 
confrontation with a country like China.
    Would you care to comment on that?
    Mr. McCormick. Yes, Senator. I think just as you were on 
your second point in particular, access to sensitive 
information, sensitive technology, that was--I want to 
reinforce the point I made earlier, which is that I believe the 
CFIUS legislation that the Congress passed allows us to address 
that very direct national security concern. And I think those 
other areas of potential risk that you identify are legitimate 
ones and ones we need to monitor very carefully to ensure that 
that is not the case.
    Senator Webb. How would we resolve a situation if that were 
to occur? Given the construct of the law and of our 
governmental policies right now, what would we do?
    Mr. McCormick. Regarding market instability, Senator?
    Senator Webb. Both forms of leverage, if we were to find 
ourselves in a situation of some tension, not necessarily even 
military tension but tension between ourselves and China in a 
situation where these types of investments were growing.
    Mr. McCormick. Well, Senator, I think a characteristic, for 
better or for worse, of a global economy and one that is as 
integrated as ours is, is that we are dependent--and other 
countries are dependent--on this inflow of foreign capital. And 
this becomes the basis for growth and continued investment 
within the private sector of those respective countries.
    I think if you looked at the distribution of the investment 
in the United States today, one of the things that would be 
most telling is the diversity of that investment and the degree 
to which we truly are the investment destination for the world.
    Senator Webb. But we do not do this, right?
    Mr. McCormick. Excuse me, sir?
    Senator Webb. The U.S. Government, do we have these types 
of sovereign wealth funds? You mentioned one example in Alaska.
    Mr. McCormick. We have that one----
    Senator Webb. As a National Government, we do not have this 
policy.
    Mr. McCormick. We do not.
    Senator Webb. OK.
    Thank you, Mr. Chairman.
    Senator Bayh. Thank you, Senator Webb.
    Mr. McCormick, as my opening comments indicated, I think it 
is good for our country to attract capital investment into our 
society. We need to do that in a way that does not compromise 
our other interests, and the reason for my quoting Chairman 
Greenspan is that I could not help but think that some people 
who now are desirous of this kind of investment would pitch a 
fit if our own Government was doing the same, and, therefore, 
we do not. But we do have State investment funds, as you 
pointed out, in Alaska, Indiana, and elsewhere, but we have 
built-in protections that insulate that from political 
decisionmaking and so forth. And so it seems to me that is what 
we need to do in this instance as well, and so we can get the 
benefit without the downside, and that is what I would like to 
ask you a couple of extra questions about.
    You mentioned the work of the G-7 in terms of promoting 
transparency and best practices for sovereign wealth funds. Is 
it your opinion that those should be purely voluntary? Is that 
enough to protect the national interest? And whether voluntary 
or involuntary, if they are violated, what should the 
consequence for that be in terms of allowing sovereign wealth 
funds that do not follow best practices to continue to invest 
in our country?
    Mr. McCormick. Senator, to begin with, I think that----
    Senator Bayh. Is your microphone on, Mr. McCormick? The 
little red button. OK. You might pull it a little closer.
    Mr. McCormick. Senator, as we review the current state of 
sovereign wealth funds, I think the starting point is that we 
believe there is a common objective here for most of the 
players involved, which is the free flow of investment. The 
sovereign wealth funds desire markets where they can maximize 
their return, and the investment destinations want to remain 
open to that foreign investment.
    Senator Bayh. Life is easy if everybody plays by the rules, 
but what do we have if they do not?
    Mr. McCormick. At the G-7, I think there was agreement that 
some of the areas we outlined previously in the testimony and 
in our discussion are areas of concern. As I described earlier, 
on the national security front, we feel like we have the 
appropriate authorities to deal with that issue from a 
sovereign wealth fund or another investor in the United States.
    Senator Bayh. So you are satisfied with having voluntary 
best practices?
    Mr. McCormick. Well, Senator, for the national security 
dimension of this, whether it is voluntary or not, if there is 
a sovereign wealth fund investment or any investment in the 
United States that raises a national security concern, we 
believe we have the authorities to deal with that 
appropriately.
    The issues that could be raised that would be dealt with by 
best practices that we do not have a legal authority necessary 
to deal with are non-commercial intent, so investment for non-
commercial reasons.
    As I said before, the track record on this to date has been 
very positive, but we need to monitor it very carefully. And if 
we begin to see evidence that sovereign wealth fund investors 
are not investing in a market-determined way, then I think that 
would raise additional concerns.
    Senator Bayh. Well, let me give you an example. One of the 
largest of these funds is now Russia's, and their behavior 
toward some other countries using energy as a leverage I think 
can best be described as thuggish. They are making substantial 
investments in some of the Balkan nations, perhaps as part of 
their intent to influence policies in those countries. When you 
have a country that has behaved like that, are voluntary 
guidelines enough?
    Mr. McCormick. Well, Senator, it remains to be seen. We 
have initiated a conversation on this. We have asked the IMF to 
take a leadership role. The IMF is now beginning to do that, 
and I think it will be a very telling process to determine what 
those best practices might be and how the sovereign wealth 
funds begin to work together, along with the investment 
destinations, to try to develop those.
    There are other areas where these types of best practices 
have really had a positive effect, and we are optimistic they 
could be very helpful here as well.
    Senator Bayh. As Chairman Cox mentioned in his statement, 
for American investors in America and American-operated 
companies, they are not entirely voluntary. I mean, we have 
mandatory standards of transparency and those sorts of things. 
I would encourage you to think carefully about what the 
consequences should be for non-American investors investing in 
our economy who choose to not play by the best practices. My 
guess is that if there are no consequences, we should not be 
too surprised if some decide that the rules are just simply 
inconvenient and they do not abide by them, and in this area I 
think that is probably not satisfactory.
    Let me ask you one other question. My time on this round is 
up, and I will return to Senator Webb. I did have just a couple 
more.
    You mentioned the IMF, and I think, you know, continuing to 
push on the currency manipulation front is a good one. I 
encourage you in that effort. I know the report due October is 
a little bit overdue. We are going to be interested to see if 
we actually made any tangible progress or whether we are just 
continuing to jawbone them.
    But here is my question: The IMF is a good organization, 
but as a part of their charter, maintaining stable currencies, 
you know, market-based currencies, is a part of what they do. 
They have not had much impact on these countries that are 
maintaining artificial exchange rates. Why should we expect 
them to be any more effective in this area when they have been 
ineffective in the area of exchange rate policy?
    Mr. McCormick. Well, Senator, I think it would be fair to 
say and I think the new leadership at the IMF recognizes that 
it is a very dynamic time for the IMF when they really do need 
to reinvent themselves and define their mission for the next 
coming decades. And a critical part of that in the view of the 
United States is taking a very aggressive posture on currency 
surveillance and implementing the recently designed 
surveillance program that is being put in place--I know the 
Managing Director is committed to that--and taking on issues 
like sovereign wealth funds, which is an issue that is ideally 
suited in my view for the IMF to play a leadership role.
    Senator Bayh. I am going to turn to Senator Webb. I would 
only observe that redefining their mission and, quote, taking 
on an issue, that is all well and good. But if they are not 
able to do anything about it, if people simply do not abide by 
the rules, well, that is not enough. And that is what we need 
to think carefully about, whether that organization, as well 
intentioned as they might be, is capable of being effective.
    Senator Webb.
    Senator Webb. Thank you, Mr. Chairman.
    Mr. McCormick, I have one other question, and I would like 
to presage it a little bit with looking back on a different 
kind of institutional memory. We went through a period in the 
1980's where particularly with the competition against Japan, 
we saw as a result of their ability through MITI to develop an 
economic strategy for their companies, that policies were put 
in place, underpricing, dumping, designed to sort of unfairly 
diminish the abilities of American companies, whether it was 
pianos or guitars or motorcycles or cars, whatever. That kind 
of pales in comparison to what possibly could be the result of 
these practices if they go out of control because, on the one 
hand, Japan is an ally, and on the other, China particularly is 
a competitor, you know, at a minimum.
    But we are having a--we are seeing a new phenomenon here in 
many ways, and that is that you have Government wealth entering 
a direct competition with private corporations in a way that, 
when I go back in my mind and look at what the Japanese were 
doing at that time, when you can concentrate your wealth, you 
can drive out competitors in the same business. You know, just 
totally serendipitously this morning in the Financial Times, 
there was an article--I do not know if you saw it or not--which 
discussed the--David Rubenstein of the Carlyle Group was 
talking about the potential of these types of investments 
taking down the predominance of American corporations that are 
in the same business, saying that these types of funds over the 
next decade could challenge the predominance of U.S. buyout 
firms because of the explosion of wealth and the ability to 
concentrate it, so you can compete in a way with very, very 
deep pockets that corporations cannot.
    Would you have any thoughts on that? Actually, I would be 
interested in hearing from our witnesses on that point, too.
    Mr. McCormick. Well, Senator, I think it is a legitimate 
concern whether the degree to which these funds are so well 
capitalized allows them to invest in non-market ways based on 
non-market principles--in other words, investing more than the 
market would determine, and in doing so gain some advantage. It 
would not be an advantage in terms of its returns because it 
would have paid above market for the asset, but in terms of 
some political advantage.
    So I think that is something we have to monitor very, very 
carefully, and I do not mean to suggest that the past is a 
flawless predictor of the future, but what we have seen here 
are very, very focused investors trying to maximize returns 
that have been largely managed by investment professionals, 
often not from the country themselves, invest in a passive way.
    And the question, I think, that certainly we are 
contemplating, what steps should we take, working with others 
in the international community, to ensure that that is largely 
the kind of investment that we see going forward. And that I 
think is going to require a collection of actions, some 
multilateral, some bilateral, which I tried to describe 
earlier.
    Senator Webb. Thank you.
    Thank you, Mr. Chairman.
    Senator Bayh. Thank you, Senator Webb.
    Mr. McCormick, I just have one last area of inquiry, and it 
has to do with the letter that was sent by Chairman Dodd and 
Senator Shelby and myself and Senator Webb about this sort of 
in-between area, where someone takes a minority interest stake 
in a company; it is not yet 51 percent, so they do not have 
absolute control; and yet it is possible that they exercise 
some considerable influence over the affairs in the company.
    So my question to you is: First of all, what does the 
Department plan to do in response to the issue we raised? Are 
you contemplating anything in this area? That is No. 1.
    No. 2, isn't it possible that the significant minority 
owners can exercise that kind of influence? And if the answer 
to that is yes, well, what do we do when it is short of 50.1-
percent ownership stake?
    Mr. McCormick. Thank you, Senator. As you know, Exon-Florio 
allows the president to take action in situations where there 
is a demonstration of control. But the line, the red line in 
terms of what defines control--let me say it differently. There 
is no hard and fast red line in terms of what defines control. 
Control will be identified based on an evaluation across 
several different factors. Those factors would include 
ownership, voting rights, board seats, and so forth, which, 
when viewed in their totality would be demonstrative of a 
party's ability to significantly influence major decisions for 
the company.
    There has been a presumption----
    Senator Bayh. The ability to influence major decisions. And 
so you take all those factors together and the question is: Can 
they influence major decisions of the company?
    Mr. McCormick. Yes, Senator. There has been a presumption 
up until this point that a passive investment was one that was 
roughly at the 10-percent level or below. But there may even be 
instances when there is a 10-percent investment that the--
because of other factors, that there is actually the ability 
for control.
    So our challenge here is to really review each case on a 
case-by-case basis and do that in a way that identifies whether 
there is a controlling interest, but to also do that in a way 
that does not create so much uncertainty around transactions 
that you have ultimately created an incremental burden or 
chilling effect on investment.
    Senator Bayh. Well, let me give you a recent for instance. 
I do not know how much you followed the recent change in the 
CEO position at Citigroup, which their largest shareholder is a 
Saudi prince who has apparently a 4-percent ownership stake, 
significantly below the 10-percent threshold that I gathered 
that we normally would assume would be passive. And according 
to published reports, he played a very active role in bringing 
about a change in the leadership of that company.
    Now, I am not being critical of him. It may have been 
exactly the right thing to do. But, you know, there is an 
example of someone with a 4-percent stake who, I think by your 
definition, he apparently exerted influence over a significant 
development at that company.
    Does he have a controlling interest in the company? Most 
people would ordinarily say at 4 percent, no, but it is hard to 
say he did not exert some significant influence over a major 
decision. So what do you do in a case like that?
    Mr. McCormick. Well, Senator, obviously all this is within 
the context of national security, so----
    Senator Bayh. That is the largest private financial 
institution in our country.
    Mr. McCormick. Senator, as I said, all this is viewed 
within the context of national security, so if the ability to 
significantly influence decisions that could come at the 
expense of the national security of the United States, then 
control in that case would go into CFIUS and go through the 
appropriate review to ensure that that security interest can be 
mitigated or the transaction is not approved.
    Senator Bayh. Well, one of the--and, again, you have been 
very patient here today, Mr. McCormick, and I know you are just 
here by yourself taking all these questions. But one of the 
things I think Chairman Shelby alluded to and, in fact, the 
CFIUS law spoke to was that in today's world--and you look at 
the Russian behavior as an example, and there are some others--
the definition of ``national security interest'' is broader 
than it used to be. You will see the Chinese going around the 
world acquiring what they view as strategic energy interests, 
and it is not impossible that financial positions might be used 
in a similar vein.
    And so we just need to see the world that is evolving and 
be ever mindful that in some non-traditional areas in today's 
world and tomorrow's world, they may, in fact, implicate 
national security interests where 20, 30 years ago, perhaps it 
was not the case.
    Senator Webb, is there anything else you would like to 
touch upon before we let this good man go?
    Senator Webb. No. Thank you very much, Mr. Chairman.
    Senator Bayh. Mr. McCormick, thank you very much.
    Mr. McCormick. Thank you, Senator.
    Senator Bayh. As I said, I appreciate your service to our 
country.
    Mr. McCormick. Thank you.
    Senator Bayh. We have a very distinguished second panel. If 
it is all right with you, gentlemen, I would like to introduce 
all of you together, and then, Mr. Larson, I think we will 
start with you, then Mr. Truman, and just move in that 
direction down the table.
    Ambassador Alan Larson is senior international policy 
advisor at Covington & Burling where he counsels clients on 
issues of international business and public policy. He joined 
the Foreign Service in 1973 and retired in 2005 as Under 
Secretary of State for Economic, Business, and Agricultural 
Affairs. During his tenure, he served as Ambassador to the OECD 
in Paris and in numerous posts as an economic officer in 
Washington and at missions in Jamaica, Zaire, and Sierra Leone. 
He earned the rank of Career Ambassador in 2004 and was honored 
with the Secretary of State's Distinguished Service Award in 
2005. Ambassador Larson is currently Chairman of Transparency 
International USA. He holds a Ph.D. in economics from the 
University of Iowa. There seems to be a great interest in all 
things Iowa these days, Dr. Larson, so we are glad that you are 
here representing that fine State--at least in part.
    Dr. Edwin ``Ted'' Truman is also with us today. Ted Truman 
is a senior fellow at the Peterson Institute for International 
Economics in Washington, D.C. He served as Assistant Secretary 
for International Affairs at the Treasury Department from 1998 
to 2001. Previously, he led the International Finance Division 
of the Federal Reserve Board and staffed the Federal Open 
Market Committee. Dr. Truman has been a member of a number of 
multilateral working groups on economic and financial issues 
and has published widely on international and sovereign 
investments. He holds a B.A. from Amherst and a Ph.D. from 
Yale. Dr. Truman, thank you for joining us.
    Next is Patrick Mulloy. Mr. Mulloy, you are no stranger to 
this Committee. It is a pleasure to welcome you back once again 
to share your perspective. Pat Mulloy served on the bipartisan 
U.S.-China Economic and Security Review Commission from 2001 to 
2006, including a period as Acting Chairman. The Commission 
reports to Congress on the national security implications of 
our economic relations with China. Mr. Mulloy also served as 
Assistant Secretary for Market Access and Compliance in the 
Department of Commerce's International Trade Administration. He 
spent 15 years on the staff of the Senate Banking Committee, 
including as chief international counsel and general counsel. 
Mr. Mulloy is currently the Washington representative for the 
Alfred P. Sloan Foundation, which funds studies and programs 
regarding the competitiveness of American industry and 
citizens. He is also an adjunct professor of international 
trade law at both Catholic University and George Mason 
University. A native of Pennsylvania, he holds a J.D. from 
George Washington University Law School and an M.A. from Notre 
Dame. Mr. Mulloy, welcome back. We are sorry about the Fighting 
Irish's football team this year, but there is always next year.
    Dr. Gerard Lyons, welcome. Dr. Lyons is chief economist and 
head of Global Research at Standard Chartered Bank in London. 
Although based in the U.K., he travels extensively, visiting 
the bank's operations and clients in Asia, Africa, and the 
Middle East. He has held senior positions at a number of major 
financial institutions. Dr. Lyons is an expert on the world 
economy, the international financial system, macroeconomic 
policy, and global markets, and is invited to speak frequently 
on these topics. Originally from London, he obtained an M.A. 
from the University of Warwick and a Ph.D. from the University 
of London. Dr. Lyons, we are grateful for your presence here 
today.
    Mr. Larson, why don't we begin with you. Technically, we 
are supposed to limit our comments to 5 minutes. If you need to 
run over a little bit, that is OK, but you could also submit--
if it is a much longer statement, feel free to submit that for 
the record.

   STATEMENT OF ALAN P. LARSON, SENIOR INTERNATIONAL POLICY 
               ADVISOR, COVINGTON & BURLING, LLP

    Mr. Larson. Thank you very much, Senator Bayh, Senator 
Webb. It is a pleasure to be here. I would like to submit a 
longer statement for the record, and to summarize it, I would 
just begin by confirmation my name is Alan Larson, and when I 
was a Career Ambassador and an Under Secretary of State for 
Economic Affairs, I often used to deal with policy with respect 
to investment and inward acquisitions. Today, in my current 
private sector position, I sometimes get involved as an advisor 
on inward investment acquisitions, including some transactions 
that involve entities with foreign government ownership. So I 
have seen it from both the public and private sector side.
    My testimony summarizes how foreign investments and 
acquisitions can benefit the United States by putting to work 
here capital that supports investment, growth, job creation, 
innovation, and competitiveness in our own economy. And I think 
all speakers have touched on that point.
    In addition, foreign investments can mitigate the 
disruptive effects of global imbalances. They can transform 
foreign entities into stakeholders in the U.S. economy, 
stakeholders who prosper when our economy prospers.
    There are a number of reasons why foreign entities may want 
to invest in the United States. My testimony goes into those. I 
am just going to touch on three here.
    One is that some foreign government pension funds want to 
invest in assets that are diversified across sectors, across 
countries, and across different types, and in that they are 
like lots of other investors everywhere.
    Second, as we have already discussed, some countries are 
very dependent on a single resource, such as oil, and they have 
economic reasons for wanting to diversify across investments in 
other countries in other sectors.
    And, third--not conclusively--many foreign governments, 
including some of our closest allies, own operating businesses. 
We have discussed that that is not the American philosophy, and 
I agree with the American philosophy, but the fact is that some 
countries do have foreign-owned entities or foreign-owned 
enterprises, and we sometimes go abroad in trying to leverage 
the expertise that they have developed in their home market.
    As has been discussed, these trends look very likely to 
continue to grow. As we know, high oil prices and current 
account surpluses provide some of the financial fuel for the 
rapid growth of these types of investments and acquisitions. 
Studies suggest that these surpluses are likely to continue and 
that a strong energy policy, even if we were to adopt a 
stronger one, and great progress in rectifying international 
imbalances, even if we were able to achieve that, are not going 
to dramatically change this picture.
    Many of the speakers today rightly have emphasized the 
importance and the issue of transparency of Government 
investment entities. I think it is important that the G-7 has 
been prodded by the U.S. Government into leading an 
international exercise. It is designed to identify best 
practices on transparency, and that these best practices would 
be strongly recommended to Government investment entities. It 
is also important that the G-7 has asked the OECD to lead a 
similar exercise with respect to transparency on the part of 
investment-receiving countries so that their investment 
policies are transparent and that they avoid a lurch into 
protectionist policies.
    Here in the United States, we have followed a clear policy 
of welcoming foreign investment while maintaining effective 
tools to allow us to scrutinize any transactions that might 
raise national security concerns. I think that the recently 
enacted Foreign Investment and National Security Act of 2007 is 
a robust tool for addressing any national security issues 
involving foreign acquisitions, including those by Government-
owned entities or sovereign wealth funds.
    FINSA mandates that the executive branch will focus on 
those acquisitions that raise national security concerns. I 
think it rightly does not look at economic factors or 
industrial policy considerations that could distract FINSA and 
lead away from--and dissipate resources on issues that are not 
crucial for national security.
    I think that FINSA also requires--or, excuse me, I have 
lost my place here.
    The acquisitions that do not result in control correctly 
lie outside the jurisdiction of FINSA, and this gets very much 
at the important point that Senator Webb and you, Senator Bayh, 
were raising. When there is not control, there is not, in my 
opinion, a risk that foreign persons might direct, determine, 
or decide core business policies in ways that raise national 
security concerns. I think this language is important. Is it 
influence? Is it the ability to direct, determine, or decide 
what the business strategy is going to be?
    Again, I think that it would be important, if we want to 
protect national security, to keep our eye on those 
transactions that could result in foreign influence--in foreign 
ability to direct, determine, and decide these decisions.
    Whenever an entity that is controlled by a foreign 
government makes an acquisition in the United States that falls 
within FINSA--and, therefore, within the scrutiny of CFIUS--
this law already mandates that there is a presumption that the 
transaction will go into a second-stage review or an 
investigation. I think that is also an important safeguard. 
These transactions that involve Government-controlled entities 
are going to be looked at very, very carefully, and I think 
that is what Under Secretary McCormick was underscoring as 
well.
    It is my understanding that the executive branch is 
mandated to promulgate regulations by next April in terms of 
the implementation of FINSA and that these regulations may 
address, update, and clarify the factors that the Government is 
going to consider when determining whether an acquisition would 
result in control by a foreign entity and the factors that the 
Government will consider in determining whether a foreign 
entity is, in fact, controlled by a foreign government. 
Therefore, I think this is a very important process that will 
take place between now and April and that in writing these 
regulations, it is going to be important for the executive 
branch to look carefully at other control tests that have been 
used and look carefully at some of the considerations that have 
been raised thus far in this hearing.
    I think it is important, as well, that FINSA gives those 
agencies with security responsibilities an appropriately strong 
voice; it also gives the executive branch flexibility in 
defining when national security concerns are present, and this 
gives the administration the flexibility to recognize that 
national security may be touched by different considerations 
this year than it appeared that national security was touched 
by 10 years ago. This is an important aspect of the law, in my 
judgment.
    I think that Congress and the administration should alertly 
monitor the new developments we are discussing today. But I 
think it is also important to recognize that Congress and the 
administration have worked together to put in place an 
effective law and an effective policy to address national 
security issues that may arise and that these equip us to 
address a future where foreign investments and acquisitions may 
well play a larger role in the American economic landscape.
    Thank you.
    Senator Bayh. Thank you very much, Mr. Larson.
    Dr. Truman.

STATEMENT OF EDWIN M. TRUMAN, SENIOR FELLOW, PETERSON INSTITUTE 
                  FOR INTERNATIONAL ECONOMICS

    Mr. Truman. Thank you, Chairman Bayh, Senator Webb. It is a 
pleasure to appear before you here this afternoon.
    In my longer written testimony, which I have submitted for 
the record, I make five main points.
    First, sovereign wealth funds and related vehicles for 
external or cross-border investments by governments have been 
around for a long time, are growing in relative importance, and 
are here to stay.
    Second, the existence and growing importance of these types 
of vehicles raise profound questions about the structure and 
functioning of the international financial system, as was 
reflected in the introductory comments by various Senators.
    Third, the continuation of these trends does not currently 
pose a threat to U.S. national or economic security, in my 
view, that cannot be dealt with under existing laws, 
procedures, and regulations.
    Fourth, it would be desirable to consider possible 
improvements in the U.S. statistical information base on 
foreign-government-related investments in our country.
    Fifth, the U.S. Government should continue actively to 
encourage foreign governments with large cross-border 
investments to develop and follow a set of best practices with 
respect to managing those investments in their interests, in 
our interests, and in the interests of the stability and 
openness of the international financial system.
    The scoreboard on existing sovereign wealth funds, which I 
have developed with my colleague Doug Dowson, provides a 
starting point for the development of such a set of best 
practices for sovereign wealth funds.
    In the remainder of my oral testimony, I will touch on my 
fourth point and elaborate a bit on my fifth point.
    In my view, consideration should be given to improving our 
statistical information in this area. I summarize in my written 
testimony my understanding of the nature and limitations of our 
current data. It would be useful to know about, one, the data 
that are currently available or not available on U.S. assets 
and liabilities of governments and government-owned and -
controlled entities, broken down by the nature of those 
entities; two, the costs and complexities for the United States 
of expanding the collection of such information; and, three, 
the prospects for encouraging similar efforts in other 
countries.
    Now, turning to my fifth point, what should be done to make 
the world safer for sovereign wealth funds? In my view, large 
sovereign wealth funds--at least it got a laugh out of Mr. 
Larson. Large sovereign wealth funds should increase 
significantly their accountability to----
    Senator Bayh. People laugh at my testimony all the time, 
Dr. Truman. Don't take it personally.
    Mr. Truman. No, I was intending--I thought I might get a 
laugh. It is rare that my laugh lines get laughs.
    Senator Bayh. Well, good.
    Mr. Truman. In my view, large sovereign wealth funds should 
increase significantly their accountability--and I would like 
to stop and emphasize the issue is not just the question of 
transparency. It really is a question of accountability. 
Transparency is a means to accountability. Accountability is 
what we are after. Accountability first to the citizens of the 
countries involved; second, to our citizens and Government as 
well as to those of other countries; and, last, not least to 
participants in international financial markets.
    The most promising way to increase the accountability of 
these activities is through the establishment of a standard or 
a set of best practices for international investments in 
general and for sovereign wealth funds in particular. For 
sovereign wealth funds, best practices, in my view, should 
cover four broad categories: structure, governance, 
transparency and accountability, and behavior.
    As I said earlier, to aid in the development of a set of 
best practices for sovereign wealth funds, my colleague Doug 
Dowson and I have developed a scoreboard for 32 sovereign 
wealth funds in 28 countries, which are listed in Table 1 in 
the testimony before you.
    The scoreboard includes 25 elements grouped into four 
categories, and I want to emphasize that at least one sovereign 
wealth fund receives a positive score on each element, so I am 
not asking--maybe I should be, but I am not asking any--the 
collectivity to do anything that somebody else does not do, at 
least one other person does not do.
    Table 3 attached to the testimony summarizes our results. 
Out of a possible 25 points, the highest score of 24 is 
recorded by New Zealand's Superannuation Fund, followed closely 
by Norway's Government Pension Fund at 23 points. The Abu Dhabi 
Investment Authority--ADIA--and its Investment Corporation--
ADIC--in the United Arab Emirates record 0.5 points. The 
average is 10.27 points. Six of the ten largest sovereign 
wealth funds score at or below the average, including two of 
the three largest funds at the bottom of the table. One of the 
two is the Government of Singapore's Investment Corporation, 
called GIC. At the same time, Singapore's Temasek Holdings 
scores considerably above the average. I can answer more 
questions about this if you would like.
    I endorse the Treasury's effort to encourage countries with 
sovereign wealth funds collectively and cooperatively to 
establish a set of best practices for those investment 
vehicles. The G-7, as you have heard, has embraced this 
approach to reinforce the global framework governing cross-
border investment. The willingness of the Fund and the World 
Bank and the OECD to promote dialog on identifying best 
practices is also encouraging.
    In the end, however, it will be the governments of 
countries that the sovereign wealth funds and their related 
activities that must decide that it is in their individual and 
collective self-interest to participate in those efforts. It is 
in our self-interest to facilitate that process.
    Thank you very much.
    Senator Bayh. Thank you, Dr. Truman.
    Mr. Mulloy.

  STATEMENT OF PATRICK A. MULLOY, WASHINGTON REPRESENTATIVE, 
                   ALFRED P. SLOAN FOUNDATION

    Mr. Mulloy. Chairman Bayh, let me begin by thanking you, 
Chairman Dodd, Ranking Member Shelby, and Senator Webb for 
providing me the opportunity to testify today. I want to note 
that the views I will present are my own and not necessarily 
those of any of my employers. I also want to assure the 
Committee that I have no client, except the public interest, on 
these matters and have never been paid by any company or 
government or any other entity to advise it on foreign 
investment matters. I commend the Committee for holding this 
important hearing, and as an alumnus of the Committee staff, I 
am really honored to be here.
    Senator Bayh. It is good to know that there is life after 
the Banking Committee.
     [Laughter.]
    Mr. Mulloy. It was terrific while I was here, let me assure 
you.
    Senator, in May of this year, you had me up before the 
Committee to talk about China's exchange rate practices, and in 
my testimony then, we talked about the provisions of the 1988 
trade bill and the responsibilities given to Treasury in that 
bill--20 years ago almost--to identify countries that are 
underpricing their currencies to gain trade advantage. I told 
you in that hearing that Treasury had completely failed to 
carry out those responsibilities. I think one of the reasons we 
are here today to talk about sovereign wealth funds flows 
directly from the failure of Treasury to carry out those 
responsibilities given it by the Congress.
    In June of this year, the Acting Under Secretary of the 
Treasury Clay Lowery made a speech in San Francisco to talk 
about sovereign wealth funds, and he said that these are 
Government investment vehicles which are funded by foreign 
exchange assets. So where do you get the foreign exchange 
assets to fund these? Trade surpluses are a big help.
    So there are two aspects of these things:
    One are the commodity funds, put together by the oil 
producers, and so they run trade surpluses because we are 
dependent upon imports of oil from them because we really do 
not have a good energy policy.
    But the second part of this which Mr. Lowery identified 
were non-commodity funds. He said these are established through 
transfers of assets from official foreign exchange funds. In 
October of this year, the McKinsey group did a study on foreign 
sovereign funds. McKinsey told us that the Asian central banks 
will have $3.1 trillion in foreign reserve assets. It did so at 
the end of 2006. The study then went on to say, to put that 
amount in perspective, ``it is twice as many assets as global 
hedge funds manage and twice the size of global private 
equity.''
    Now, these are huge amounts, and they are growing rapidly.
    China's central bank right now has over $1.3 trillion in 
foreign currency reserves. Japan has $875 billion. The central 
banks of Hong Kong, India, Malaysia, Singapore, South Korea, 
and Taiwan together have another $1 trillion.
    Now, the McKinsey study says--now, how are they able to 
accumulate these vast amounts of foreign exchange reserves? And 
the report put out by McKinsey says ``exchange rate 
management.'' McKinsey tells us that these governments have had 
these large current account surpluses, and they like it. So in 
order to maintain the money coming in, they intervene in 
currency markets to keep their currencies underpriced against 
the dollar. That way, they get the surpluses. We get the cheap 
goods. They get the money to put in sovereign wealth funds.
    Now, it is very interesting. The McKinsey study said on 
page 78, ``For Asia''--and it is not just China; it is Asia--
``the system has ensured the success of its export-led growth 
model and continuous and growing current account surpluses.'' 
Then the McKinsey study says, well, OK, what is the downside 
for the United States? They said the good side is we get a lot 
of good, cheap goods, and we get them invested in our Treasury 
to help us keep our interest rates down. What is the downside? 
They say we have a dollar, a higher dollar, which is propped up 
by the Asian central banks, which hinders our ability to 
export, particularly to Asia. We are getting some relief now on 
the euro because the euro is falling in value--I mean, is 
raising in value against the dollar. But we cannot--with Asia, 
they prop up the dollar. It harms our ability to export, and it 
knocks out our domestic industries that are competing against 
imports. It is a very--and then they say there are hazards for 
our country to be overreliant on foreign capital. I think these 
sovereign wealth funds are part and parcel showing that it is 
dangerous to be so overreliant on foreign capital.
    Now, what are some of the problems? Senator Webb talked 
about strategic--that they can invest for strategic purposes. 
Mr. Lyons, who is here today, wrote a paper on that called 
``State Capitalism: The Rise of Sovereign Wealth Funds,'' and 
talked about strategic investments in telecommunications, 
energy, the financial sector, or even to get intellectual 
property rights that they do not develop but that they can 
buy--that we develop or others develop.
    Two, what is another problem? And, Senator Bayh, you talked 
about this. Chairman Cox of the SEC made a major speech up at 
Harvard at the Kennedy School a couple of weeks ago, and he 
made the point you made. We have not wanted to have our own 
Government owning large chunks of our economy, and the road 
that we are on now, we are going to have foreign governments 
owning large chunks of our economy.
    Now, Mr. Cox said at least if our own Government owned 
portions of our economy we could presumably try to influence 
our own Government to carry out our wishes. Here is what he 
said about the foreign governments. If the owner, on the other 
hand, is a foreign government, ``the national interests a 
foreign government will advance will presumably be its own.'' 
OK. That is so clear.
    Now, Warren Buffett, who I like very much--I follow him and 
I pay attention to what he tells me. He wrote an article in 
Fortune magazine in October of 2003 entitled, ``Why I'm Not 
Buying the Dollar: America's Growing Trade Deficit is Selling 
the Nation Out From Under Us.'' Selling the Nation out from 
under us. He says we are behaving like a rich family that has a 
farm and we are no longer earning our way in the world and we 
sell off portions of the farm to foreigners every year to 
maintain a lifestyle we are no longer earning. That, he said, 
is the trade deficit. He said it was imperative that we take 
``action to halt the outflow of our national wealth.''
    In 2005, he writes a letter to his shareholders, and he 
refers to the United States as moving toward ``sharecropper 
society.'' In other words, we are going to be working for other 
people because they are going to own us.
    The Washington Post then put out an editorial in August of 
2005 at about the same tine CNOOC was trying to buy Unocal, and 
the Post said Buffett's vision of where we are headed was 
``distressingly plausible.'' And the editorial then went on to 
say ``the country is living beyond its means, spending more 
than it earns, and relying on foreigners to supply the 
difference.''
    Senator Bayh. Mr. Mulloy, I am loath to interrupt, because 
I like you and I like Warren Buffett, we are a little bit over, 
and I would like to explore this with you in response to 
questions.
    Mr. Mulloy. OK. I will make three key points.
    One, we need an energy policy to reduce the outflow there.
    Two, we have to understand these other Asian countries in 
particular are following mercantilist trade practices, and we 
need to address those. The bill reported by this Committee on 
exchange rates was very important. And in the provision that 
you have talked about, making these underpriced currencies and 
illegal export subsidy that should be countervailed, that is 
very important to get in that bill that you reported out of 
this Committee.
    The third thing is, Senator Webb, keep an eye on that CFIUS 
process at the Treasury. There is going to be rulemaking, 
notice and comment rulemaking. The interests of the foreign 
governments and foreign investors are going to be all over that 
process, and I think a countervailing effort has to be made by 
this Committee to stay on top of that process, because Treasury 
in the past did not operate CFIUS the way you intended, and you 
had to amend it.
    So those are my key points, and I thank you very much 
again, Senator, for the opportunity.
    Senator Bayh. Mr. Mulloy, thank you very much.
    Again, Mr. Mulloy, I apologize for intervening but I have 
some--part of having the gavel means trying to keep things more 
or less on schedule.
    Mr. Mulloy. I understand.
    Senator Bayh. Although, as you know, it is the Senate and 
we do tend to fall beyond. So thank you very much.
    Yes, Dr. Lyons.

 STATEMENT OF DR. GERARD LYONS, CHIEF ECONOMIST AND GROUP HEAD 
          OF GLOBAL RESEARCH, STANDARD CHARTERED BANK

    Mr. Lyons. Good afternoon, Senator Bayh, Senator Webb, 
members of the Committee. It is my pleasure and honor to appear 
before you today and offer views on sovereign wealth funds. 
Thank you for inviting me here to Washington to participate. I 
commend the Committee for devoting time to this examination of 
this issue.
    I am going to offer brief oral testimony but I have, 
respectfully would request my written statement that covers the 
biggest 22 sovereign wealth funds be entered into the record.
    I would like to talk about three areas. But before I do 
that, I should stress that sovereign wealth funds are both 
stakeholders and shareholders of Standard Chartered. Indeed, I 
met and sat with some last week when I was in the Middle East, 
so hopefully I'll give you some fresh thoughts.
    But there are three areas I would like to talk about. 
First, the composition. Second, their possible impact on 
financial markets. And third, the strategic aspects of 
sovereign wealth funds that I think stresses the need for 
common ground rules.
    First, in terms of composition, really I just want to 
reinforce the points already made. They are in the written 
paper. It is not just the size of these funds, which are $2.2 
trillion and possibly more, in our view. It is difficult to 
contemplate fully how much or how big these funds will plump. 
In qualitative terms, they clearly are going to grow and 
therefore become far more important.
    It is not just the size, as I say. Chairman Bayh listed 
what I call the super seven funds in his opening statement. But 
there is also the openness and transparency of these funds. One 
can differentiate between the funds. Some of them appear to be 
very transparent. They include Norway, Singapore's Temasek, 
Alaska, Malaysia and Canada's Alberta. Those funds provide 
detailed information on their size, returns achieved, and their 
portfolio composition. And many companies have seen these as 
investors without any apparent issues to date. One has to ask 
if these funds find it possible to provide such information and 
continue to perform as sovereign wealth funds, why cannot 
others?
    In contrast, there are other, secretive, funds. They 
include the UAE funds, China, Qatar, Brunei, Venezuela, Taiwan, 
Oman, and Kuwait. And while secrecy in itself does not mean the 
funds will be a bad investor, in the global investor 
environment where transparency and accountability are seen as 
important positives, such opaqueness should be discouraged and 
openness clearly encouraged.
    Second is their possible impact on the financial markets. I 
would stress that the source of these funds comes from four 
different areas. One has already been stressed, namely the 
movement in commodity prices. Second is the growth in foreign 
exchange reserves. And just to put that in perspective, a 
decade ago Asia held one-third of global currency reserves. Now 
it holds two-thirds. The bulk are still in dollars, although I 
would stress that, in my view, passive diversification from the 
dollar is already underway.
    In addition to commodities and FX reserves, the third is 
clearly the investment performance. And fourth is what I would 
call the discretionary factor, how much a government wants to 
put into these funds. That is particularly important when one 
considers the new Chinese fund where, whilst in my view foreign 
exchange reserves in China will grow significantly--probably to 
$2 trillion by early 2009--it is not yet clear how much of that 
increase in reserves will be allocated to new funds.
    Senator Bayh. What was your third factor, Dr. Lyons?
    Mr. Lyons. Sorry, the investment performance of the funds. 
Basically how much money they are making.
    They also will grow relative to other types of investors, 
as has already been stressed. I think it is important to 
appreciate that in other parts of the world sovereign wealth 
funds are viewed as a force for good, particularly in emerging 
markets. And that is partly because of where I believe 
sovereign wealth funds are expected to invest their money. I 
would stress four particular areas, two of which come into the 
category of state capitalism, as Senator Webb mentioned in his 
opening statements.
    In terms of where I expect the funds to invest their money: 
one, I do expect them to take bigger stakes in equity and bond 
markets across the emerging world. That makes sense in economic 
and financial terms. Second, I do expect them to feed more 
money into alternative investments such as hedge funds and 
private equity. And the third and fourth area which I would 
include under state capitalism, I believe that they will boost 
strategic links with countries that have not fully shared in 
globalization's success or, indeed, regions that have been 
shunned by the West. Africa comes immediately to mind. Although 
I would stress if a country wants to take a stake in such 
regions or areas, they do not have to just do it through 
sovereign wealth funds. And finally, I think they will take 
strategic stakes in sensitive areas within developed countries 
if, clearly, they are allowed to.
    That leads on to the third and final aspect, which is the 
strategic aspect of these funds. I think this is very much in 
the case of trying to head off future problems rather than 
addressing the issue that is really big at the moment. In the 
paper I submitted, I said that my big concern is that these 
funds will see an opportunity to acquire strategic stakes in 
key industries around the globe, whether it be 
telecommunications, energy, the media, the financial sector, or 
indeed to secure intellectual property rights in other fields.
    Whilst that can be viewed in a sinister way, I would also 
stress that it makes a lot of economic sense. If one is a low 
value-added country like China, then it makes sense to try and 
leap a few years by acquiring strategic assets that give access 
to intellectual property rights. Basically, countries will want 
to move up the value curve quickly. Of course, there may be 
other non-economic factors at play there. Also, buying into 
overseas firms will make sense for countries which are not 
thinking possibly of setting up sovereign wealth funds.
    Reverse nationalism is an area that I think is already big, 
and that is basically the need to acquire strategic commodities 
and resources around the world. Not just energy but maybe hard 
metals and, indeed, soft commodities.
    Despite that, I would argue a protectionist backlash 
against sovereign wealth funds would be damaging for global 
trade. I would reinforce some of the points already made about 
the need for sovereign wealth funds to be encouraged to adopt 
the best practice of open funds like Norway. I would also 
stress countries in the West to press for what I call the level 
playing field approach, to encourage the opening up of markets 
from which sovereign wealth funds emanate.
    I think this is a particularly important point when we look 
at sovereign wealth funds. One of the reasons why I think they 
have become such a big issue is because of the imbalance to the 
global economy. For the global economy to become more balanced, 
it is not just a case of currency adjustment that is needed. 
One needs to see high savings regions like Asia and like the 
Middle East move away from export-led to domestic-led growth. 
Indeed, that is in their best interest as well, given their 
demographic profiles.
    As they move toward domestic driven growth, part and parcel 
that process will be the opening up and deepening and 
broadening of their financial sectors. I think that is 
something that needs to be stressed. And that is a multi-year 
process which I think will address many of the issues here.
    And of course, I would say and reinforce the point made 
that we need to try and improve the governance and transparency 
of sovereign wealth funds and to promote an investment 
framework that is fair and commercial driven.
    So finally, I would say the sovereign wealth funds debate 
is a further sign of the shift in the global economy, the shift 
in economic and financial terms. In recent years, there has 
been much talk about the need for global policy form to change. 
Whether they will change remains to be seen, but even if they 
do change, whether they will be effective again remains to be 
seen. But in this particular area, it is an opportunity for 
countries in the West to work with emerging economies, 
particularly those from where the big funds come, to basically 
get some ground rules and a common code of practice.
    I would stress that the more sovereign wealth funds invest 
strategically, that would be a concern. Yet, as long as the 
investments by these funds are for commercial reasons and not 
for political purposes, then these funds should be accepted. 
But as clearly stated, there is lots of issues within that.
    Senator Bayh. Thank you very much, Dr. Lyons.
    Perhaps I should pick up where you left off. As I said at 
the beginning, and Mr. Mulloy was going on--I think 
appropriately so--and you mentioned as well, some of the forces 
that are leading to the reserves that enabled these funds to be 
created. It seems as if the macroeconomic factors are not going 
to be changing any time soon. So this phenomena is likely to 
continue.
    So we want to see these dollars recycled into our economy. 
That is beneficial to us. But we want to insulate ourselves 
from any political agenda on the part of countries that have 
the sovereign wealth funds. So I would like to focus with all 
of you on that, perhaps, Mr. Larson, starting with you, and 
then Dr. Truman, and then Dr. Lyons. I am not leaving you out, 
Mr. Mulloy. I had another question for you, but my first two 
questions to you three gentlemen--maybe we can just go in 
order.
    No. 1, should the best practices that we envision for these 
funds be entirely voluntary? And if they are, I think, Dr. 
Truman, you emphasized--and I think appropriately so--the 
notion of accountability. So if the best practices are 
voluntary, what should the accountability be if the best 
practices are not followed?
    Mr. Larson. Thank you very much.
    I do think that the international effort to develop best 
practices and get them adopted is an important one. My 
government career over 32 years was negotiation and I know that 
some of these can take a while. And I think that I would not 
want to offer undue hope that this will be quick and easy.
    Having said that, I want to come back to the ``what if'' 
because I think that insofar as these entities are making 
acquisitions in the United States that have security 
implications, national security implications, that the law that 
Congress has put in place and the process that the CFIUS 
agencies run allows them to demand information with respect to 
a specific transaction, about the reasons why the investment is 
being made, whether it is political, whether it is----
    Senator Bayh. Will the CFIUS process serves as a backstop 
to the voluntary nature of the best practices?
    Mr. Larson. I think it is a safety net, sir, yes.
    Senator Bayh. Is there any inconsistency in your mind about 
why we would not insist upon adherence to best practices from 
global investors when, for publicly held companies in our 
country, we would probably not countenance such a thing, 
voluntary standards?
    Mr. Larson. Well, I think there is a difference.
    Senator Bayh. In other words, if the SEC just said you 
know, the reporting requirements and that kind of thing, that 
is just best practices and you can follow it if you want to. 
And if you do not, the marketplace will do with you what it 
will?
    Mr. Larson. I am glad you asked that question, because let 
me zero in on some of the things that Chairman Cox said. I 
agree with the requirements that the SEC levies, and I do think 
that they protect investors and give confidence to investors. I 
agree with his comments that we have had, as Americans, a 
strong and correct desire to make sure that government is not 
conflicted as between its role as an owner of a company and its 
role as a regulator of an industry. And that was one of the 
things, I think, that was at the core of some of the remarks 
that the Chairman made in his speech at Harvard.
    It is, in my judgment, a different set of issues that we 
face when we have foreign companies or entities and possibly 
government-owned entities making investments in the United 
States. And that is why the structure of the Foreign Investment 
National Security Act, I believe, took the form that it did. 
And it gave the executive branch tremendous authority to 
scrutinize, review, and if necessary prevent those acquisitions 
that would jeopardize national security.
    Senator Bayh. I have only got 56 seconds left before I turn 
to Senator Webb, so I apologize. But I think you put your 
finger on an important point I wanted to make, which is I hope 
that the--and I was very grateful for the Under Secretary's 
comments and presence today. A lot of this will depend upon the 
zeal with which they enforce the new law.
    In the past, it has been the perception of some that it has 
been largely a laissez faire interpretation of the regime that 
was in place. And perhaps they will have a bit more rigor going 
forward which, I think, would give a lot of people confidence 
in the fact that the appropriate framework may already be in 
place. But it is going to be dependant upon how they choose to 
enforce it. I guess that is what I--and some of us are going to 
be looking to see do they mean business here or is it going to 
be just kind of an anything goes attitude yet again.
    And I apologize, Dr. Truman--thank you. I hated to 
interject, but I want to get to Senator Webb.
    Dr. Truman, should it be voluntary? If not, how is 
accountability provided?
    Mr. Truman. Well, I would--let me turn on the microphone, 
excuse me.
    I would go the same place where Al Larson started from. In 
some sense, in terms of the national security dimension, we 
have a mechanism that--I would come at it the other way.
    From the national security dimension, you have things that 
prevent--whether or not you have best practices. Right? Some 
foreign government comes in, buys something, does not tell us, 
we can throw them out of the country after the transaction is 
made, right, and have mitigation agreements and so forth and so 
on.
    So the best practices, in some sense, has to do with the 
other things we are concerned about, right? The citizenship 
elements. Do we know what they are doing? Do we--what kind of 
things they are buying, whether they are passive investments, 
whether they--and so I think that is a--I would it the other 
way around.
    You have the first line of defense, in some sense, is for 
government's own investments, is the CFIUS, whatever 
abbreviation you now call it.
    And the second would be a set of best practices. I think to 
be successful the principle should be--as it is often called--
comply or explain. If you have a significant number of 
countries who are following essentially the best practices, 
then the system--right--public opinion has a lot of leverage, a 
lot of leverage over countries and entities that are not 
following those best practices.
    You can do it, if I may put it that way. You and your 
colleagues can do it. The newspapers can do it. And public 
opinion, since this is also in the interest of the people in 
the countries themselves, can do it.
    Senator Bayh. If I could just interject, please go ahead 
and then I want to get to Dr. Lyons. But I am going to need to 
get to Senator Webb. Two of the reasons that we are here 
today----
    Senator Webb. Mr. Chairman, it is not a problem. I am 
interested in hearing this, as well.
    Senator Bayh. Thank you, Senator.
    Two of the reasons we are here today, Doctor. No. 1, the 
line between what constitutes a national security interest and 
what constitutes an economic or financial interest may not be 
quite as clear and bright as we would all like it to be. Part 
of that is a process of interpretation.
    Dr. Lyons alluded to other countries perhaps having a 
strategic interest in acquiring our intellectual property, 
which if our national economic comparative advantage is going 
to be by being a more highly innovative economy and our 
intellectual property is bought for a few cents on the dollar, 
that has some potentially pretty significant ramifications for 
our country.
    So that is just one example.
    Mr. Truman. I accept fully that these lines are not easy to 
draw.
    Senator Bayh. The second thing was what some of us would 
call the relaxed attitude of the administration on enforcing 
the previous regime.
    Mr. Truman. We can discuss it. I favor a narrow approach 
personally. My judgment, and it is a matter of judgment and I 
understand it is a matter of judgment for a narrow definition 
of national security. But I recognize that there are other 
issues involved. There are issues involved whether you are a 
government-owned corporation or entity or not, about 
proprietary information and so forth and so on. Those are 
issues which extend, it seems to me, in the continuum extend 
from government to non-government and it is a very complicated 
issue.
    I think it is appropriate that we have laws and rules and 
regulations in this area. I would note that, just to come back 
on the publicly held corporations, I mean it is true that 
outside of CFIUS itself, there are rules and regulations in 
terms of publicly owned entities that require certain 
disclosures when large--or even relatively small stakes--are 
accumulating, including your friend the Prince, the Saudi 
Arabian Prince. That had to be disclosed.
    So it is not as if we do not--but on the other hand, I 
think it is in the interest of the countries involved, right, 
as well as our own, right, that there be more disclosure and 
accountability, including to the countries involved.
    I say in my testimony that, in some sense, if this money is 
wasted, right, the biggest--which is one risk, right? You 
pursue non-economic objectives, right? And even if they are 
overall national security objectives and it is wasted, in some 
sense you get nothing on either dimension, right? Then the 
people who really pay are the citizens of the country involved.
    And there are a lot of examples where that has happened 
already, whether it is Nigeria or Ecuador or appearing to be 
happening in Venezuela. So in that sense, accountability, in 
some sense, the biggest risk, in some sense, is to the 
countries' wasting their money. You can have issues about where 
the money came from in terms of the foreign exchange reserves. 
But at least as far as the commodity funds, it was dug out of 
the ground, right? And then the wealth became below ground, 
became above ground, and if it ended completely wasted, in some 
sense, the country in a longer term sense is much worse off.
    And that also can have national economic and security 
implications for the United States if Venezuela, for example, 
implodes as a consequence of this process.
    Thank you.
    Senator Bayh. Dr. Truman, thank you. Dr. Lyons, I would 
love to hear from you, but I have run substantially over. 
Senator Webb has been very courteous, but I would like to turn 
to him and then maybe in a second round get back to you.
    And I have not forgotten you, Mr. Mulloy. Do not worry.
    Senator Webb.
    Senator Webb. Senator Bayh, I would actually like to hear 
from Dr. Lyons on your question, if you do not mind. I did not 
anticipate we were going to get that long of an answer from Dr. 
Truman when I yielded a few minutes, but I would like to hear a 
little more if Dr. Lyons would care----
    Senator Bayh. You were almost Senatorial in your response, 
Dr. Truman.
    Mr. Lyons. Rather than repeat the comments that have 
already been made, and which I agree with, maybe just three 
different perspectives or three perspectives that reinforce.
    One is, obviously this Committee is looking at things from 
a U.S. perspective. I would very much certainly encourage the 
Committee to try and view this in the multilateral basis and 
try and export best practice. If it is seen that the U.S. is 
putting up some blockages, justified or whatever, then the 
money from sovereign wealth funds will simply go elsewhere. I 
think it is therefore important to work with these funds to 
basically have best practice.
    And best practice is only going to be adopted if the funds 
see it as being in their best interest, as well.
    Senator Bayh. Well, we want the money and we would 
encourage them to follow best practices. The question is what 
do we do when they do not?
    Mr. Lyons. Which leads on to China. It is interesting, I 
agree with the points about China's currency. When I go to 
China, it is very clear that financialism is how they approach 
all aspects of policy, including the currency. China, although 
it is one country, is a multitude of different economies, some 
of which are booming, some of which--Western Central China, 
Northeast part of China--have clearly been held back.
    And Hu Jintao, the President, when he gave his policy 
speech earlier this year, was saying that even though China was 
growing strongly--indeed rapidly--it is not generating enough 
jobs at the moment for urban workers. It needs 25 million a 
year and it is currently generating 9 million to 11 million a 
year.
    So when one looks at it from a Chinese perspective, they 
are almost very fearful of allowing their currency to 
appreciate more aggressively. And therefore, they approach 
financialism.
    But what I find interesting is, in my view, the way the 
U.S. approach changed in recent years, rather than just 
focusing on the currency debate with China, but trying to 
package it as part of the need for China to open up and deepen 
its financial markets. I think that met with more reception in 
China, and I think that is the right way to proceed.
    But I think it is inevitable that China will not allows its 
currency to appreciate too aggressively, but certainly one 
should encourage them to try and appreciate it further. But the 
point is that they will continue to accumulate reserves. We can 
all debate the speed at which they do so.
    And the final point I would make about security, I think 
there is widespread global agreement about protecting areas of 
defense security. As you pointed out, it is very difficult 
beyond that. And indeed, in the U.K., in the Enterprise Act, 
the U.K. Chancellor, the Finance Minister, talked about areas 
of sensitivity, again far more vague.
    But I think the important point is that for any investors, 
they need to know where the line in the sand is. And if one is 
to protect areas outside the defense, then that is in any 
country's--clearly in any countries' interest if they wish to 
do that--or agreement rather to do that. But I think it is 
important to actually know where those lines in the sand are.
    But ultimately, I think we should be working closely to try 
and get best practice. But I think it will take time, actually, 
because many of these funds have only really come under 
scrutiny and under public domain in the last year. The more 
they are in the public domain, under public scrutiny, then 
hopefully the more progress there will be.
    Senator Webb. Thank you, Mr. Chairman.
    I would like to request the Chair reset the clock, since 
that was not in response to my question. I would like to have a 
few minutes here.
    Senator Bayh. The clock has been reset.
    Senator Webb. Again, I would like to thank you for holding 
the hearing and to all the witnesses, I was very interested in 
all your testimony. I found it to be very illuminating. I took 
a lot of notes, a lot of things to think about.
    From my perspective, I would just like to make it clear 
that the concern that I have, and I think a lot of people who 
see this the way that I do, is not foreign investment. It is 
foreign government investment. And that is something that is 
quite different.
    And when we are talking about the individual transactions 
or the individual direct business activities that are going to 
be examined, there is another piece of that. And that is 
whether, in the aggregate, we might reach a tipping point with 
respect to one nation or another. It is a different kind of 
thing. In some cases, the economic and the non-economic factors 
tend to merge, just as the commercial and the political can 
tend to merge.
    As I was listening to the testimony, one thought was going 
through my mind. And that is I do not think we have really yet 
come to grips philosophically with what is going on here. Dr. 
Lyons, you created a couple of terms here that I think are 
applicable. Mr. Mulloy, you talked about a sharecropper society 
in which that is basically the definition of colonialism, quite 
frankly, that somebody else owns the assets and somebody--
another group of people does the work. One group gets the labor 
and the other group gets the profit.
    But somewhere in here with this notion of state capitalism, 
we are emerging, in some cases, to a new form of national 
power. Very clearly, with the countries that are our 
competitors. It is a very unique situation to be in. It is 
almost--we went through colonialism and then we had socialism 
and then we had fascism with the government sort of 
accommodating large scale industry. And now we have state 
capitalism, and I think that is a very good term.
    When it comes to nations that are in competition with us on 
a number of other fronts that affect a clear definition 
national strategy, we have to look at that. And we have to look 
at that not only in terms of individual transactions but the 
vulnerabilities that they are bringing to our ability to 
articulate our policy around the world. We can understand how 
this began. We can understand the inception of this, with the 
nations--particularly in Asia--having accumulated so much 
capital--or excuse me, so much money--that they want to invest 
and that is healthy when it is properly designed, that they do 
so in our country.
    But I am just sort of curious. I would like to hear Dr. 
Lyons and Mr. Mulloy particularly, in the time that I have 
address this philosophical environment that we are moving into.
    Mr. Lyons. I completely agree with the comments of Senator 
Webb. I think it is not just foreign investment. It is a 
differentiation between private foreign investment and state 
investment.
    One phrase used in the U.K. is the Wimbledon effect, which 
relates to the first point about private investment. Basically, 
the feeling in England or Britain is that we have the best 
tennis tournament in the world. But Britain rarely ever wins 
it. But that is not the point. The important point is that the 
tournament takes place in London with all of the associated 
benefits.
    The phrase is used, the Wimbledon effect, not so much for 
tennis but more because of the city of London. The city of 
London is seen as one of the world's major financial centers. 
But the ownership, a very small part of it, is in British 
hands. Lots of it is international hands. And the important 
point is that that is the right thing. As long as you have the 
right legal framework, you have the right environment, then it 
does not really matter who owns the companies, who owns the 
business, as long as it takes place in London.
    And I think that is the right approach. But as you say in 
your comment, it refers to the private sector part of the 
foreign investment.
    When it comes to government involvement, it is a very 
difficult ball game for all the reasons we mentioned before. 
Governments approach things not just in terms of maximum short-
term, maximum long-term return, it is maybe not to maximize 
returns for investors. It is very much a different set of 
criteria.
    The interesting aspect is that this does not really just 
mean sovereign wealth funds. If one looks--let's take China as 
an example. China is investing heavily in Africa, not through 
China's sovereign wealth fund but through CMOOC or Petrol 
China. Indeed, one can argue China's Development Bank, Chen 
Yuan, the president there, have taken stakes overseas in 
Barclay's, et cetera.
    Now all of this is justifiable in economic terms but all 
these different parts of China's ink, you could say, link back 
to the government. So when one starts to look at it in a 
government perspective, whether at different incentives 
structures, than it does actually have a profoundly different 
aspect. And therefore, it becomes very difficult to get the 
common ground rules to apply in that flavor.
    The important point, I would argue, is maybe to try and 
step back and encourage China to open up its financial sector 
even further, one of the points I was making, and try and work 
with them so they see it as in their best interests to adopt 
the principles that we in the West see as in our best interest, 
as well.
    Mr. Mulloy. Senator, thank you for the question.
    Being on that China Commission for 6 years and reading the 
press clips that the staff would prepare for us every weekend--
magazine articles, newspapers, everything--you begin to form 
some impressions of what you think is happening here. China was 
a great society, a great economy. They had a bad 200 years. 
They want it back. They tried communism and a collectivist 
economic approach. It did not work. Deng Xiaoping came in, in 
1978, and he said, ``We need to have the Westerners, the 
foreign investors help us build our economy.'' And they 
provided all kinds of incentives and strategies to make that 
happen. And we have gone along, and many other foreign 
corporations have done so as well.
    So there has been tremendous technology transfer, 
tremendous knowledge transfer. We have not fully grasped what 
is happening here, and we have no counter strategy. I am not 
out to demonize the Chinese. I mean, what the heck? If you were 
them, you would be doing the same thing. But they have a 
strategy, and we do not have any counter strategy.
    This is an article by Peter Navarro that appeared March 
13th. He is a business professor at the University of 
California, and he has written some books on China. He said, 
``China may invest its equity funds strategically to 
established controlling interests in U.S. companies and thereby 
gain influence over decisions ranging from the offshoring of 
production and technology transfers to lobbying against U.S. 
legislation to promote fair trade with China.''
    Now, let me just give you another one. This is from Inside 
U.S.-China Trade, September 12, 2007. There is an article here 
called ``Multinational Firms Begin Campaign to Derail China 
Trade Legislation.'' That is your bill, Senator. He said all 
the major exporters, importers, and firms with investments in 
China are all meeting to figure out--and they are being put 
together by the U.S.-China Business Council, the Retail Leaders 
Association, ECAT, Chamber of Commerce, Business Roundtable. It 
is a lobby. It is a lobby----
    Senator Bayh. It is always nice to be taken seriously.
    Mr. Mulloy. I mean, really, it is an amazing situation.
    So this is what I think we need to understand. There is a 
strategy. The U.S. Government, we need to really think and do 
some serious effort to have the committees of the Congress look 
into some of these things and begin to put together, just like 
we put together the 1988 competitiveness and trade bill, a new 
globalization bill to prepare us for this different kind of 
international economic competition that we are now in. And I 
think that is very important for the country to be doing, 
Senator, and thank you for the question.
    Senator Webb. Well, thank you both for your responses. I am 
not one who is attempting to demonize China, either. I think 
that what we have seen over the past 36 years with China, being 
able to aggressively pursue relations with them, it has been 
very healthy. It is something that we probably should be 
thinking about with Iran. We have been able to bring them into 
the international community. At the same time, we have to 
recognize their size and the potential and the fact that they 
are a competitor, and we need to address those situations in a 
way that prevents us from further vulnerability, and that was 
my motivation--one of my motivations in asking for the hearing, 
and, Mr. Chairman, I thank you very much for having held it.
    Senator Bayh. Thank you very much, Senator.
    Mr. Mulloy, I think you addressed it. I was going to ask 
you about--oh, as long as we have the energy situation that we 
do and the trade situation that we have, and as I think Dr. 
Lyons pointed out, even the conscious currency policies that 
some countries have designed to promote domestic stability, we 
are going to continue to face the phenomenon that we are 
dealing with here today, and the question is: How do we 
responsibly deal with that? As I said at the outset, how do we 
get the advantages of the investment, but insulate ourselves 
from political pressure or an agenda on the part of other 
countries that may have interests other than our own.
    And so with regard to the piece of legislation you 
mentioned, I would much prefer to have global currency markets 
establishing the value of respective currencies. But as long as 
some countries choose to pursue industrial policies, we have to 
think carefully about what the consequences of those are, and 
then act in accordance with our own interests.
    Dr. Truman, you look like you are volunteering an answer.
    Mr. Truman. If you will permit, Mr. Chairman, I just wanted 
to say on the record I agree 100 percent about this issue of 
the Government role, and I have said in my own writings--and I 
think the issue, if I may turn Gerard Lyons' phrase on its end, 
is state capitalism, the question is how much of it is state 
and how much of it is capitalism. That is essentially the issue 
that we have to try to sort out.
    I would like to make one point on the question of the 
linkage of this to the imbalances. I agree with are living 
beyond our means, and that is a big problem. But let's say we 
magically went back to a current account deficit or a small--
balance or small surplus or deficit. There actually still would 
be a case for a lot of cross-border investment because it is 
diversification. And it may not be so important for the United 
States, which actually has a lot more in terms of Government-
owned, Government-managed--I mean, CalPERS and so forth and so 
on, and various Government-owned pension funds. We actually do 
have a lot of that, though it is structured in a way which is 
transparent and accountable and so forth and so on.
    And that makes sense, even for the United States, which has 
a lot--we can diversify a lot within the country. It makes a 
lot more sense for Singapore to have a lot of diversification 
outside.
    So even if we were in current account balance, in some 
sense, given the different governmental structures of the world 
we have, even if we had current account balance and then built 
up an extra $10 trillion worth of--or net of $3 to $5 trillion 
worth--$2.5 trillion worth of debt over the last 24 years. The 
existing say $14 trillion on both sides would still be there, 
and in some sense raise all the same questions, right? Because 
we have different--because we would have our $14 trillion 
abroad, most of which was managed by private investors, right? 
And they would have their $14 trillion in the United States, a 
lot of which--of which a much more significant fraction was 
managed by governments. And that is the issue that you are 
raising, and I think it is a profound issue, and we cannot go 
remaking their governments. We can try to persuade them that 
our system works better, and my guess is that is what is going 
to happen over the next 25 years in some sense, just as with 
central planning. But the diversification motivation is still 
there, and we in some sense still have the same problem even in 
the absence--I agree with you entirely--of this overhang of 
living beyond our means that we have been living with for the 
last whatever number of years you want to pick.
    Senator Bayh. Well, a lot of good issues have been raised 
here today, and, gentlemen--yes, Mr. Mulloy, you raised your 
hand.
    Mr. Mulloy. I agree that we are in a bind now, that we need 
to get these best practices, and I agree probably the best way 
is to have a good CFIUS process that is quite aggressive and 
what we think the best practices are. And I do not think that 
will happen, Senator, without strong oversight from this 
Committee on the rulemaking and other things that go on in 
Treasury.
    Senator Bayh. This Committee with the assistance of Senator 
Webb.
    Mr. Mulloy. Yes.
    Senator Bayh. Well, I think that is a good point, and, 
again, I want to thank all of you. I think there were some 
excellent points raised here today, and the first one being 
that there is a difference between foreign investment on the 
part of individuals or private entities and government-
sponsored entities. That is No. 1.
    No. 2, a good CFIUS process can backstop voluntary best 
practices. One of the hard parts about that is when is it a 
national security interest and when is it a financial or an 
economic interest and how do you differentiate one from the 
other and so forth.
    I suspect that these imbalances will last for a while. You 
are right, it would make sense from a portfolio theory 
standpoint to diversify investments in any event, but I suspect 
what is happening today--and Mr. Mulloy would probably agree--
is that we are at least temporarily maintaining a higher 
standard of living for us at the expense of our children and 
grandchildren, is what is happening here. And I do not think a 
great nation does that for long.
    But that is a topic for another day and another panel, and 
until then I want to thank all of you for your time. Dr. Lyons, 
you have come a long way. We are grateful to you. And, again, 
thank you for your service to our country through your presence 
here today.
    We stand adjourned.
    [Whereupon, at 4:10 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM ALAN P. 
                             LARSON

Q.1. Please discuss the potential, if any, for systemic risk 
when Sovereign Wealth Funds invest in private equity, hedge 
funds, or regulated financial institutions.

A.1. Sovereign Wealth Funds (``SWFs'') invest capital that has 
accumulated in countries with financial surpluses. Their 
investments in financial institutions in the United States put 
that capital to work in our country. As a general matter, such 
investments reduce the systemic risk that would otherwise arise 
if capital surplus countries hoarded their surpluses.
    Periodically, the international financial system comes 
under stress as a result of an excess of ill-considered 
investments in particular sectors, countries or instruments. 
The latest example of this phenomenon is the international 
financial disruption resulting from ill-considered investments 
in poorly understood sub-prime mortgage securities.
    The sub-prime crisis resulted from, by and large, decisions 
by financial institutions in the United States. The sub-prime 
crisis elevated international systemic financial risk. 
Fortunately, the stability of the international financial 
system has been bolstered, and systemic risk has been reduced, 
by investments of ``patient capital'' from SWFs. The 
investments made by SWFs in financial institutions whose 
capital base had been badly eroded by investments in sub-prime 
investment vehicles have been stabilizing.

Q.2. Beyond choosing to invest through Sovereign Wealth Funds, 
what other means could countries with large current account 
surpluses employ? Are such other means more or less desirable 
than using Sovereign Wealth Funds?

A.2. Countries that accumulate current account surpluses could 
dispose of those surpluses in a variety of ways. The citizens 
of these countries are, of course, the persons in a position to 
decide which approach best serves their goals and objectives.
    Most countries with large surpluses choose to devote part 
of those surpluses to the modernization of public 
infrastructure, including roads, ports and airports as well as 
social infrastructure such as health and education. Such 
investments make sense so long as they are well-targeted and 
subjected to rigorous cost-benefit analyses.
    Countries with surpluses could choose to distribute a 
portion of those surpluses to their citizens in the form of 
grants or reduced taxes. Putting a larger share of the 
surpluses into the hands of the private sector is appealing.
    At the same time, the citizens of some countries take the 
view that at least a portion of government surpluses should be 
invested in a way that creates returns for future generations. 
They believe that, after a certain level, the benefits of 
public sector investments or direct grants to citizens can be 
diminishing. These countries have chosen to invest part of 
their surpluses in funds or investment companies.

Q.3. Federal Reserve Chairman Bernanke has stated that he 
believes inflows of foreign capital into our markets, 
particularly to purchase Treasury bills and other dollar-
denominated assets, have helped to keep interest rates low. In 
other words, the globalization of capital flows has benefited 
our economy by suppressing interest rates and maintaining the 
value of the dollar. Do you believe that Sovereign Wealth Funds 
can affect the value of the dollar or our domestic interest 
rates?

A.3. Chairman Bernanke is correct in asserting that foreign 
investment in the United States tends to lower interest rates 
and to support the value of the dollar in relation to other 
currencies. SWF investments in the United States have had this 
positive effect on our economy. Recent SWF investments in U.S. 
financial institutions have supported the capital base of these 
institutions, indirectly bolstering credit, growth and job 
creation.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM ALAN P. 
                             LARSON

Q.1. Do you have any evidence or reason to believe that 
sovereign wealth funds have invested based on, or shared, 
inside government information?

A.1. When sovereign wealth funds invest in the U.S. economy, 
the most important information relates to the firm or industry 
sector that is the target of the investment. In the 
transactions with which I am familiar, the foreign investors 
relied on investment banks and industry experts to assist the 
due diligence that guided their investment decisions. In my 
experience, SWFs and the governments whose money they invest do 
not have inside government information on U.S. firms or on the 
industries in which those firms operate.

Q.2. Do you have any evidence or reason to believe that 
countries have manipulated markets for gain in their sovereign 
wealth funds? For example, using the regulatory powers of the 
state to move market prices.

A.2. In the transactions I know about, sovereign wealth fund 
investors have not benefited from market manipulation. The SWF 
investors I know seek to comply with U.S. laws and regulations. 
Their home governments have not manipulated--nor do those 
governments have the power to manipulate--the international or 
U.S. markets in which the SWF invests.

Q.3. Do you have any evidence or reason to believe that 
sovereign wealth funds have used or had access to national 
intelligence or other state assets for their investment 
decisions?

A.3. I have not encountered instances when SWFs have used 
national intelligence to guide their investment decisions.
    Under the new Foreign Investment and National Security Act 
of 2007, the CFIUS process will benefit from analyses by the 
Director of National Intelligence. I would encourage DNI to 
include in its analyses an assessment of whether a foreign 
investor has had access to national intelligence in making 
their investment decisions.

Q.4. Do you have any evidence or reason to believe that 
sovereign wealth funds have been used as a policy tool similar 
to how some state-run companies have been, most prominently in 
Russia?

A.4. SWFs differ significantly one from another. The ones with 
which I am most familiar operate commercially and are 
independent from government policy and government direction of 
their investment decisions. The SWF investments in the United 
States with which I am familiar have been used to advance 
commercial objectives, not the home government's policy 
objectives. The Foreign Investment and National Security Act of 
2007 provides the U.S. Government with tools, which it should 
use, to investigate any proposed SWF acquisition when there is 
reason to believe that a foreign government might try to use 
that acquisition, to the detriment of the national security of 
the United States, to advance a national policy objective.

Q.5. Have there been any destabilizing effects of sovereign 
wealth funds, such as shifts of large amounts of capital?

A.5. Investments by SWFs have, on balance, promoted financial 
stability. They have recycled capital to the United States. In 
2007, SWF investments bolstered the capital stock of fragile 
U.S. financial institutions.
    Most SWFs have a track record of being long-term commercial 
investors. Most SWFs have made diversified, minority 
investments. I am not aware of any instances where SWFs have 
shifted large amounts of capital in a manner that is 
destabilizing.

Q.6. We have CFIUS to look at foreign control for national 
security reasons. What do we have to look at political and 
economic security concerns of sovereign wealth (or other 
foreign) investments?

A.6. Congress was correct, in my judgment, in writing the 
Foreign Investment and National Security Act of 2007 in a way 
that keeps the focus of CFIUS investigations on possible 
threats to national security. Consistent with the President's 
broad responsibilities to protect national security, CFIUS has 
the flexibility to investigate potential national security 
threats that might arise from economic or political factors.
    Some countries have engaged in screening of foreign 
investment based explicitly on economic criteria such as a 
``net economic benefits.'' Congress was wise, in my view, to 
shun this approach. Markets rather than government policymakers 
are best placed to determine whether investments have a sound 
economic basis. The United States correctly has refrained from 
``picking winners and losers'' and from designating ``national 
champions.'' The same American philosophy lies behind our 
decision not to have the Government decide, on economic or 
political grounds, which foreign investments to permit to take 
place.

Q.7. What tools do we have to monitor these investments?

A.7. I believe that the government's intelligence capabilities 
and its oversight of mitigation agreements provide the 
executive branch with tools it needs to monitor these 
investments. Congress has increased funding for agencies to 
monitor compliance with the mitigation agreements. The 
Executive Branch is obligated to report to the Congress on its 
oversight of mitigation agreements and should promptly inform 
the Congress if additional tools or resources are needed.

Q.8. China has been very active in traditional and economic 
espionage in this country. Are you worried they are using that 
information either to make investments or to pass information 
to companies they invest in?

A.8. The U.S. Government should actively use its counter-
intelligence capabilities to defend against traditional or 
economic espionage. If there is reason to believe that a 
proposed acquisition by a foreign investor could be used to 
engage in espionage, that concern would be grounds for a 
rigorous CFIUS investigation. If the investigation confirms 
that a serious threat exists, CFIUS should take appropriate 
action to address the threat.

Q.9. The IMF is looking into voluntary best practices for 
sovereign funds. What other options do we have to learn more 
about what the funds are doing?

A.9. The IMF's work to develop a code of best practices is 
likely to expand information about the governance of SWFs, 
increase the transparency of their operations, provide a better 
understanding of the differences among SWFs, and offer greater 
clarity as to their investment strategies and methodologies.
    When an SWF makes an acquisition that falls under the 
jurisdiction of the laws of the United States, our laws and 
regulations give the United States adequate tools to learn what 
we need to know about what the fund is doing. I recommend that 
we place primary reliance on U.S. law to address the policy 
needs of the U.S. government.

Q.10. How can we leverage these investments in U.S. markets to 
get other countries to open their markets to U.S. private 
investment?

A.10. The Government of the United States should, and does, 
actively work to open foreign markets to U.S. private 
investment. The government uses a number of tools, including 
the negotiation of Bilateral Investment Treaties, to accomplish 
this. In addition, the World Bank has been an effective 
advocate in persuading foreign countries to reduce barriers to 
foreign investment. Country after country has come to see that 
private foreign investment brings a great boost for economic 
development and that barriers to such investment should be 
reduced or eliminated.
    Using specific investment transactions as leverage to 
promote reciprocity in the provision of investment 
opportunities to foreign countries is neither necessary to 
encourage liberalization abroad, nor is it in the interest of 
the United States. We have adopted an open investment policy in 
the United States because it is in our own economic self-
interest.

Q.11. Do countries with sovereign funds investing in the U.S. 
allow similar investments from U.S. private or government 
investment?

A.11. Each country that has established an SWF maintains a 
somewhat different policy towards foreign investment. In many 
cases, countries whose SWFs seek to invest in the United States 
have been quite open to foreign investments. Singapore, for 
example, has negotiated a Free Trade Agreement with the United 
States that has an investment chapter providing significant 
investment opportunities for U.S. firms. There also are 
substantial U.S. investments in Norway, Canada and those Middle 
Eastern countries which have government-owned investment 
companies.
    In other cases, of course, U.S. companies still face 
significant investment restrictions in countries that are the 
home of sovereign wealth funds. The U.S. Government should make 
strong efforts to persuade these countries to open their 
investment markets.

Q.12. Are there any sovereign wealth funds being used to 
enhance the lives of the wealthy elites, while the general 
population suffers?

A.12. The SWFs with which I am familiar are directed to make 
investments that will provide broadly shared benefits for the 
citizens of their countries. Some government-owned investment 
funds are investing in order to finance pension benefits of 
their citizens. In other cases, SWFs have been accumulating 
assets for future generations, but the governments have not yet 
distributed the earnings of SWFs.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM PATRICK 
                           A. MULLOY

Q.1. Do you have any evidence or reason to believe that 
sovereign wealth funds have invested based on, or shared, 
inside or government information?

A.1. No. However, Chairman Cox of the FCC raised concerns about 
such issues in his Oct. 24th speech at the Kennedy School of 
Government at Harvard University.

Q.2. Do you have any evidence or reason to believe that 
countries have manipulated markets for gain in their sovereign 
wealth funds? For example, using the regulatory powers of the 
state to move market prices.

A.2. No.

Q.3. Do you have any evidence or reason to believe that 
sovereign wealth funds have used or had access to national 
intelligence or other state assets for their investment 
decisions?

A.3. No. I have no evidence, although it would not surprise me 
if they did.

Q.4. Do you have any evidence or reason to believe that 
sovereign wealth funds have been used as a policy tool similar 
to how some state-run companies have been, most prominently in 
Russia?

A.4. No. I have no evidence of that.

Q.5. Have there been any destabilizing effects of sovereign 
wealth funds, such as shifts or large amounts of capital?

A.5. Not that I am aware of.

Q.6. We have CFIUS to look at foreign control for national 
security reasons. What do we have to look at political and 
economic security concerns of sovereign wealth (or other 
foreign) investments?

A.6. You are correct. The CFIUS process currently examines the 
national security concerns of foreign acquisitions of 
controlling influence of U.S. companies. I think the Executive 
Branch interprets ``national security'' in the law governing 
the CFIUS process too narrowly. I believe that political and 
economic security concerns could be addressed in the CFIUS 
process if the Executive Branch carried out its CFIUS 
responsibilities in the manner intended by the Congress.

Q.7. What tools do we have to monitor these investments?

A.7. I am not aware that the U.S. government monitors foreign 
sovereign wealth fund investments or other foreign government 
investments in the United States. I believe the sole exception 
would be if such monitoring was agreed to as part of a CFIUS 
review of a foreign acquisition. Congress should enact 
legislation making the activities of foreign government 
controlled investment in the United States more transparent.

Q.8. China has been very active in traditional and economic 
espionage in this country. Are you worried they are using that 
information either to make investments or to pass information 
to companies they invest in?

A.8. The recently released Defense Department Annual Report to 
Congress entitled ``Military Power of the People's Republic of 
China 2008'' states on page 8 that, ``Officials from the FBI 
have identified China as running an aggressive and wide-ranging 
effort aimed at acquiring advanced technology from the United 
States.'' Thus, it would not surprise me if China targeted 
gaining access to key technologies as part of their government 
investment decisions in the United States.

Q.9. The IMF is looking into voluntary best practices for 
sovereign funds. What other options do we have to learn more 
about what the funds are doing?

A.9. The IMF codes, if developed and agreed upon, would not be 
binding on IMF member nations. Member nations of the OECD are 
also using that organization to examine and discuss the 
national security concerns raised by sovereign wealth fund 
investments. While I believe these multilateral efforts can be 
helpful in highlighting key issues and recommending best 
practices for such funds, I believe that the United States 
Government, perhaps after evaluating the IMF and OECD work 
products, should pass legislation imposing what it considers 
``best practices'' on sovereign wealth funds. That way we would 
know what we think are the best practices could be enforced.

Q.10. How can we leverage these investments in U.S. markets to 
get other countries to open their markets to U.S. private 
investment?

A.10. China is desirous of making investments in the U.S., but 
as the February 2008 report by GAO entitled ``Foreign 
Investment: Laws and Policies Regulating Foreign Investment in 
Ten Countries'' makes clear, China prohibits foreign 
acquisitions in key industries and sectors of its economy. For 
example, CNOOC, which wished to purchase Unocal in the summer 
of 2005, could not itself be purchased by an American investor. 
We might with China enter into some kind of reciprocal 
investment agreement to gain leverage to open China's market to 
U.S. investment. We should not, however, waive our own national 
security concerns just in the interest of ensuring more open 
investment opportunities for U.S. firms abroad.

Q.11. Do countries with sovereign funds investing in the U.S. 
allow similar investments from U.S. private or government 
investment?

A.11. I refer you to the GAO report, ``Foreign Investment: Laws 
and Policies Regulating Foreign Investment in Ten Countries'', 
dated February 2008. GAO did this report at the request of 
Senator Richard Shelby, the ranking member on the U.S. Senate 
Banking Committee. It is a very good review of the foreign 
investment policies followed by a number of key nations.

Q.12. Are there any sovereign wealth funds being used to 
enhance the lives of the wealthy and elites, while the general 
population suffers?

A.12. While I have heard allegations along these lines, I have 
not studied the matter thoroughly. I do think that many of the 
trade policies being followed in the WTO and other bodies tend 
to focus on benefits for small groups within many societies and 
not for the populace of the countries as a whole. That is why 
within the U.S. and many other nations there is a growing 
resistance to ``globalization'' as it is now proceeding.

Q.13. Mr. Mulloy, I understand there is a relationship between 
China's accumulation of dollar-denominated assets--its $1.4 
trillion war chest--and its efforts to keep the Yuan 
undervalued against the dollar. According to a recent survey of 
18 exchange-rate studies by the Peterson Institute, the Yuan 
remains 40% undervalued, in spite of the dollar's recent fall 
against other currencies whose exchange rates are more market 
determined. China's accumulation of reserves and its 
deliberate, trade distorting policy to keep the Yuan 
undervalued are two sides of the same coin. I applaud Chairman 
Dodd and Senator Shelby for moving legislation out of this 
Committee to address the problem, and I hope they are able to 
persuade our Majority Leader to give it the priority it 
deserves. My question to you, Mr. Mulloy, is what effect would 
this legislation have on sovereign wealth funds, and what is 
the danger of Congress failing to use the tools it has 
available to address currency?

A.13. On pages 4 and 5 of the prepared testimony I submitted to 
the Committee when I testified on November the 14th. I quoted 
from a McKinsey and Company report entitled, ``The New Power 
Brokers'', which examines sovereign wealth funds. That McKinsey 
Report tells us, on pages 77 and 78, that China and other Asian 
countries have accumulated huge dollar reserves through trade 
surpluses with the United States. It further tells us that 
exchange rate management, i.e. keeping the dollar overvalued by 
intervention in foreign exchange markets, has been part of 
their trade strategy, and has permitted them to acquire the 
dollars they have put in their sovereign wealth funds. As I 
noted on page 11 of my prepared testimony, the United States 
must craft trade policies to address the mercantilist trade 
practices being used by China and/or other Asian partners. I 
mentioned the Banking Committee bill to address currency 
manipulation in my testimony and strongly supported its 
passage. I also made other recommendations on pages 13 through 
15 of my prepared testimony that we consider other legislation 
to combat China's IMF illegal currency practices. Their 
underpriced currency, as Chairman Bernanke noted in a December 
2006 speech in Beijing, acts as an export subsidy. We should 
have a law to permit our industries to be able to bring 
countervailing duty cases against such a subsidy as you, 
Senator Bunning, along with many other of your colleagues have 
proposed.

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