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By William Patalon III
Money Morning/The Money Map Report
Both the United States and the European governments are pushing for global codes that will make sure that sovereign wealth funds aren't transforming the billions they're investing in Western companies into positions of influence for the foreign governments that operate the funds.
Asian countries such as China, Singapore and Korea are using the funds to invest portions of their soaring trade surpluses with Europe and the United States, while such Middle East nations as Abu Dhabi, Dubai and Kuwait are using the funds to invest their spiraling oil profits from record oil prices.
European Commission President Jose Manuel Barroso said there were "real concerns" about some foreign state-run funds, without naming any countries. He said the Eurozone would be pushing for more disclosure from these funds.
"We cannot allow non-European funds to be run in an opaque manner or used as an implement of geopolitical strategy," Barroso said.
Sovereign funds currently control between $3 trillion and $3.5 trillion, experts estimate. But it's the accelerated activity and potential size that has the European and U.S. governments so concerned. The International Monetary Fund (IMF) and other experts predict the state-run venture funds could control $12 trillion by 2015. But Money Morning Investment Director KeithFitz-Gerald thinks the ultimate total is likely to reach $20 trillion by the middle of the next decade.
The growth rate is certainly accelerating. The U.S. Treasury says that 20 new funds have been created since 2000 – more than half of them since 2005 – bringing the total to nearly 40. In the last 12 months alone, sovereign funds have invested roughly $70 billion in financial institutions worldwide, most of them in the West.
Citigroup Inc. (C), Merrill Lynch & Co. Inc. (MER), UBS AG (UBS), and Morgan Stanley (MS) are among the financial-sector heavyweights that have received major capital infusions from sovereign wealth funds after their balance sheets were eviscerated by the subprime-spawned credit crisis.
Barroso said the European Commission would adopt "a set of principles for transparency, predictability and accountability" for the funds themselves – and for both the donor and recipient nations – that will be reviewed and discussed by European Union leaders at a March 13-14 summit.
Barroso said the EU will push the International Monetary Fund (IMF) to set up a global code of conduct for sovereign wealth funds and their owners by the end of this year. The Organization for Economic Cooperation and Development (OECD) also is coming up with recommendations for recipient countries. The EU president said the commission will not introduce laws to regulate sovereign wealth funds unless efforts to create a worldwide voluntary code end in failure.
In the United States,that a delegation from the U.S. Treasury Department has met with executives from the Abu Dhabi Investment Authority and from the Government Investment Corp., to discuss their embracing a set of promises to not use their wealth for political advantage. The talks are part of global negotiations to draft rules to oversee the behavior of such funds without discouraging them from investing in the United States at a time when the capital is badly needed because of a credit crunch and accelerating global financial turmoil.
"They are not a big bad wolf at the door," the European Commission's Barroso said. "We want to maintain an open investment environment, in Europe and worldwide."
[Editor's Note: For Money Morning's investment research report on profit opportunities created by sovereign wealth funds, please click here. The report – part of our ongoing "Outlook 2008" series on investing opportunities in the global economy – is free of charge. It will also be part of our "Global Investing Playbook" for the next 12 months, an in-depth investment guide that will debut within the next several weeks].
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So is globalization always a good thing? As the virtual "Who's Who" of investment giants continued to report record write-downs due to the subprime debacle and subsequent credit crisis, many turned to global "partners" for infusions of capital. Enter the Abu Dhabi Investment Authority (ADIA), the Government Investment Corporation of Singapore, and a host of other government-controlled sovereign-wealth funds to the rescue. But, what's in it for them [besides some healthy returns once the dark clouds clear and companies such as Merrill Lynch & Co. Inc. (MER), Citigroup Inc. (C) and UBS AG (UBS) get back to the business of printing money]?
Could the billions these funds are laying out buy them power and influence? Could these foreign governments – some of which are in relatively "unstable" regions — be seeking some control over the U.S. financial system [and through that, control over the world financial system]?
Last week, the U.S. Treasury Department initiated dialogue with representatives of these funds to outline ground rules and discourage them from currying political favor in return for their investments [i.e. bailout money].
But the reality – unfortunately – is that some strings are always attached.
Oil inventories rose for the seventh consecutive week so consumers should be giving each other high fives, figuring that energy supplies now appear more than ample to cover future demand, right? Apparently, investors didn't think so. Crude-oil prices surged to record levels above $103 per barrel as the weak U.S. dollar and ongoing geopolitical turmoil – in the same "unstable" regions we referred to earlier – which served to negate the positive supply news. While some analysts claim that investors fear future rate cuts will serve to drive up energy demand, others believe that speculative forces will always carry the day and that once oil prices are nudged into record territory, the sky is the limit. In the meantime, Exxon-Mobil Corp. (XOM) and others can expect additional record-setting quarters.
Fannie Mae (FNM) and Freddie Mac (FRE) highlighted the financial-service-sector news last week as the two mortgage giants reported significant quarterly losses: Delinquencies and defaults continued to mount and many of their related investments losing value by the day.
So how do the regulators remedy this situation? By increasing the limits on the mortgages these government-sponsored enterprises can hold onto their books. Haven't these entities run into accounting irregularities over mortgage valuations on their books in the past?
In earnings news, Lowe's Companies Inc. (LOW) and The Home Depot Inc. (HD) struggled last quarter as the housing market continued to slide, while Dell Inc. (DELL) and insurer American International Group Inc. (AIG) reported lower-than-expected results.
In other financial news, Microsoft Corp. (MSFT) was fined yet again by the European Union; International Business Machines Corp. (IBM) announced a $15 billion stock buyback plan; and Visa may be headed for the largest domestic IPO in history.
The equity indexes rose early in the week as investors reacted favorably to the news that Fannie Mae and Freddie Mac can now buy more mortgages, thus adding liquidity to the system. And they did it without accepting money from any of the sovereign wealth funds. The $15 billion IBM buyback was a huge bright spot of the week.
Unfortunately, late in the week, some poorer-than-expected earnings announcements and weak economic reports roused the bears from their ultra-short hibernation, which sent U.S. stocks into a nosedive.
Record oil prices and a plummeting dollar surely didn't help. Bonds benefited as investors rushed to the perceived safe haven of U.S. Treasuries. Foreign investors – especially foreign governments – continue to be big purchasers of U.S. government bonds, a potential trouble spot if the U.S. greenback and U.S. economy lose credibility in the global financial markets.
With an extremely hectic economic calendar, analysts and investors barely had time to catch their collective breaths to listen to U.S. President George W. Bush and U.S. Federal Reserve Chairman Ben S. Bernanke make their latest prognostications.
Here's a bit of business trivia; see if you can guess which of these two made which of these two statements:
- "The economic situation has become distinctly less favorable since the summer…the situation is not anywhere near the dangerous stagflation situation that prevailed in the 1970s and I don't anticipate stagflation."
- "I believe that our economy has got the fundamentals in place for us to grow and continue growing, more robustly hopefully than we're growing now…I don't think we're headed to recession. But no question, we're in a slowdown."
Bernanke made the first statement. President Bush made the second. Perhaps he has aspirations of becoming a Fed governor once his presidential terms ends.
Last week's news on the economic front was far from stellar. Here's an overview:
- Inflation – as measured by the Producer Price Index (PPI) – was higher.
- The overall U.S. economy, as measured by gross domestic product (GDP) growth, was weaker than expected.
- Housing, as measured by new and existing home sales, continues to struggle.
- Consumers, as measured by the consumer confidence index (CCI), are growing more fearful.
But all hope isn't lost. At least for now, neither of these two noted economists are expecting a recession or stagflation anytime soon. [For a story that offers a complete analysis of last week's economic reports – and that appears elsewhere in today's issue – please click here].
Weekly Economic Calendar
Existing Home Sales (01/08)
Slowest pace of sales since 1999
Double the rate expected by analysts
Consumer Confidence (02/08)
Worst showing since November 1993
Durable Goods Orders (01/08)
Largest decline in orders in 5 months
New Home Sales (01/08)
Slowest pace of sales in 13 years
Initial Jobless Claims (02/23/08)
Greater than expected claims for benefits
GDP (4th quarter 2007)
Slowed to 0.6% as reported in its initial estimate
Personal Income/Spending (01/08)
Increase in spending reflective of higher prices
The Week Ahead
ISM – Manu (02/08)
Factory Orders (01/08)
ISM- Services (02/08)
Fed Beige Book
Initial Jobless Claims (03/01/08)
Unemployment Rate (02/08)
Non-Farm Payroll (02/08)
Consumer Credit (01/08)
News and Related Story Links:
- European Commission:
- ABC News:
- FT.com: .
European Union seeks sovereign fund rules: report.
- Money Morning Economic Forecast Report:
Outlook 2008: Three Ways to Profit From Sovereign Wealth Funds – the "Next Wall Street"
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.