[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
SOVEREIGN WEALTH FUNDS: NEW
CHALLENGES FROM A CHANGING LANDSCAPE
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
DOMESTIC AND INTERNATIONAL
MONETARY POLICY, TRADE, AND TECHNOLOGY
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
SEPTEMBER 10, 2008
__________
Printed for the use of the Committee on Financial Services
Serial No. 110-137
----------
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HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama
MAXINE WATERS, California DEBORAH PRYCE, Ohio
CAROLYN B. MALONEY, New York MICHAEL N. CASTLE, Delaware
LUIS V. GUTIERREZ, Illinois PETER T. KING, New York
NYDIA M. VELAZQUEZ, New York EDWARD R. ROYCE, California
MELVIN L. WATT, North Carolina FRANK D. LUCAS, Oklahoma
GARY L. ACKERMAN, New York RON PAUL, Texas
BRAD SHERMAN, California STEVEN C. LaTOURETTE, Ohio
GREGORY W. MEEKS, New York DONALD A. MANZULLO, Illinois
DENNIS MOORE, Kansas WALTER B. JONES, Jr., North
MICHAEL E. CAPUANO, Massachusetts Carolina
RUBEN HINOJOSA, Texas JUDY BIGGERT, Illinois
WM. LACY CLAY, Missouri CHRISTOPHER SHAYS, Connecticut
CAROLYN McCARTHY, New York GARY G. MILLER, California
JOE BACA, California SHELLEY MOORE CAPITO, West
STEPHEN F. LYNCH, Massachusetts Virginia
BRAD MILLER, North Carolina TOM FEENEY, Florida
DAVID SCOTT, Georgia JEB HENSARLING, Texas
AL GREEN, Texas SCOTT GARRETT, New Jersey
EMANUEL CLEAVER, Missouri GINNY BROWN-WAITE, Florida
MELISSA L. BEAN, Illinois J. GRESHAM BARRETT, South Carolina
GWEN MOORE, Wisconsin, JIM GERLACH, Pennsylvania
LINCOLN DAVIS, Tennessee STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota TOM PRICE, Georgia
RON KLEIN, Florida GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida PATRICK T. McHENRY, North Carolina
CHARLES A. WILSON, Ohio JOHN CAMPBELL, California
ED PERLMUTTER, Colorado ADAM PUTNAM, Florida
CHRISTOPHER S. MURPHY, Connecticut MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana PETER J. ROSKAM, Illinois
BILL FOSTER, Illinois KENNY MARCHANT, Texas
ANDRE CARSON, Indiana THADDEUS G. McCOTTER, Michigan
JACKIE SPEIER, California KEVIN McCARTHY, California
DON CAZAYOUX, Louisiana DEAN HELLER, Nevada
TRAVIS CHILDERS, Mississippi
Jeanne M. Roslanowick, Staff Director and Chief Counsel
Subcommittee on Domestic and International Monetary Policy, Trade, and
Technology
LUIS V. GUTIERREZ, Illinois, Chairman
CAROLYN B. MALONEY, New York RON PAUL, Texas
MAXINE WATERS, California MICHAEL N. CASTLE, Delaware
PAUL E. KANJORSKI, Pennsylvania FRANK D. LUCAS, Oklahoma
GWEN MOORE, Wisconsin DONALD A. MANZULLO, Illinois
GREGORY W. MEEKS, New York WALTER B. JONES, Jr., North
DENNIS MOORE, Kansas Carolina
WM. LACY CLAY, Missouri JEB HENSARLING, Texas
BILL FOSTER, Illinois TOM PRICE, Georgia
ANDRE CARSON, Indiana PATRICK T. McHENRY, North Carolina
MELVIN L. WATT, North Carolina MICHELE BACHMANN, Minnesota
BRAD SHERMAN, California PETER J. ROSKAM, Illinois
KEITH ELLISON, Minnesota KENNY MARCHANT, Texas
TRAVIS CHILDERS, Mississippi DEAN HELLER, Nevada
C O N T E N T S
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Page
Hearing held on:
September 10, 2008........................................... 1
Appendix:
September 10, 2008........................................... 29
WITNESSES
Wednesday, September 10, 2008
Drezner, Dr. Daniel W., Professor of International Politics, The
Fletcher School, Tufts University.............................. 11
Setser, Dr. Brad W., Fellow for Geoeconomics, Council on Foreign
Relations...................................................... 9
Truman, Dr. Edwin M., Senior Fellow, the Peterson Institute for
International Economics; Visiting Lecturer, Amherst College;
and Visiting Professor, Williams College....................... 7
APPENDIX
Prepared statements:
Manzullo, Hon. Donald A. and Marchant, Hon. Kenny............ 30
Drezner, Dr. Daniel W........................................ 32
Setser, Dr. Brad W........................................... 44
Truman, Dr. Edwin M.......................................... 62
SOVEREIGN WEALTH FUNDS:
NEW CHALLENGES FROM A
CHANGING LANDSCAPE
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Wednesday, September 10, 2008
U.S. House of Representatives,
Subcommittee on Domestic and
International Monetary Policy,
Trade, and Technology
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2:05 p.m., in
room 2128, Rayburn House Office Building, Hon. Luis V.
Gutierrez [chairman of the subcommittee] presiding.
Members present: Representatives Gutierrez, Maloney, Moore
of Wisconsin, Meeks, Moore of Kansas, Watt, Sherman, Ellison;
Paul and Manzullo.
Ex officio: Representative Bachus.
Chairman Gutierrez. This hearing of the Subcommittee on
Domestic and International Monetary Policy, Trade, and
Technology will come to order. The subject of today's hearing
is, ``Sovereign Wealth Funds: New Challenges from a Changing
Landscape.''
Good afternoon, and thank you to the witnesses for agreeing
to appear before the subcommittee. I look forward to hearing
from you.
This hearing is a follow-up to the joint hearing we held
with the Capital Markets Subcommittee in March of this year,
when we focused on some of the sovereign wealth funds that we
considered to be good actors. I view them as such because they
seem more transparent and/or they tend to follow good
governance practices.
But the sovereign wealth fund landscape is constantly
changing. New players continue to enter the field, and new and
different types of investments are being made. And
international organizations such as the International Monetary
Fund (IMF) and the Organisation for Economic Co-Operation and
Development (OECD) are more involved in seeking a universal
regulatory or best practices framework.
Just last week, the International Working Group of
Sovereign Wealth Funds (IWG) announced preliminary agreement on
a set of voluntary principles and practices that is intended to
guide appropriate governance and accountability arrangements,
as well as conduct of investment practices by sovereign wealth
funds. The IWG, which is comprised of 26 funds, will present
the guidelines for the IMF's policy-setting committee next
month.
Sovereign wealth funds are not a new source of funding.
They have existed for over 25 years. What is remarkable is the
recent growth in their number and size. In the last 2 years,
Saudi Arabia, Russia, and China created large funds. According
to the 2007 estimates from Morgan Stanley, the largest
sovereign wealth fund, the Abu Dhabi Investment Authority,
controls around $875 billion in assets.
Although size estimates of sovereign wealth funds are
hindered by the fact that they are often not transparent, the
IMF estimates that sovereign wealth assets worldwide are
somewhere between $1.9 trillion and $3 trillion. And private
financial institutions have estimated that sovereign wealth
fund assets will reach $10 trillion to $15 trillion by 2015.
Whether these are considered large or small figures depends
on the metric used. The $3 trillion estimate surpasses the $1.5
trillion managed by hedge funds worldwide, but it's dwarfed by
the $53 trillion managed by institution investors like pension
funds and endowments. Regardless of how they are measured,
sovereign wealth funds are already large enough to be
systemically significant. I expect them to grow larger over
time in both absolute and relative terms, especially with the
increasing worldwide demand for commodities.
In my opinion, a discussion that the impact of this growth
may have on the U.S. and global financial system is required.
Obviously, sovereign funds represent a growing percentage of
foreign investment in the United States, especially in the
financial services industry.
Over the past year, sovereign funds have invested more than
$40 billion in Wall Street's biggest players, including: the
Abu Dhabi Investment Authority's $7.5 trillion in Citicorp in
November; Merrill Lynch's $4.4 billion investment; the China
Investment Corporation's $5 billion investment in Morgan
Stanley in December of 2007; its investment in Visa's IPO in
March of 2008; and lately, the Abu Dhabi Authority's $800
million purchase of a 75 percent stake in ownership of the
Chrysler Building in New York City.
The purpose of today's hearing will be to discuss recent
changes, both approved and proposed, in the regulation of
sovereign wealth fund investment and practices--in particular,
changes Congress made to the CFIUS process in 2007 and the IWG
agreement I mentioned.
After the issues raised at the joint subcommittee hearing
in March, and during the congressional delegation I led to the
United Arab Emirates in May to meet with leadership of several
funds, we now need to focus on transparency and good governance
with respect to specific funds. I have particular concerns
about the lack of transparency because of the sheer size of
these investment vehicles.
By definition, these funds are extensions of the state, and
should always be viewed as maximizing their nation's strategic
interests, in addition to maximizing profits. Without a clear
understanding of the intention of these funds, some of them
hold the potential to create chaos in the marketplace. These
concerns are particularly relevant when discussing countries
like Russia and China, whose security and economic interests
are not always consistent with our own.
For this reason, I welcome our witnesses' take on the
potential financial impact some of the largest funds can have
on the United States based on the investment decisions and
sheer size of the fund.
I also want to focus on sovereign wealth funds that take
more active approaches to investment, seeking not just to be a
passive investor, but to control U.S. companies. I look forward
to hearing from our witnesses, and I yield 5 minutes to the
ranking member, Dr. Paul.
Dr. Paul. Thank you, Mr. Chairman. Thank you for holding
this hearing.
Once again, we confront the issue of sovereign wealth
funds, an issue which has become quite important due to the
large amount of dollars and dollar-denominated bonds held by
foreign governments, and the fears of these governments, given
the dollar's precipitous decline over the past few years.
The past few days have been quite interesting, with
speculation that one of the reasons for the government takeover
of Fannie Mae and Freddie Mac was the more than $1 trillion in
Fannie and Freddie debt held by foreign governments. The threat
of default on this debt would have undoubtedly had massive
repercussions on the value of the dollar, and might have
unleashed the so-called nuclear threat of a massive
international sell-off of U.S. Government and agency debt.
The United States Government now finds itself between a
rock and a hard place. The massive amounts of debt that we have
allowed to accumulate are hanging over us like Damocles's
sword. Foreign governments such as Russia and China hold large
amounts of government and agency bonds, and there are fears
that, as our creditors, they will exert leverage on us.
At the same time as the dollar weakens, the desire to sell
bonds and purchase better performing assets increases, leading
to fears from others that foreign governments will attempt to
purchase American national champion companies, or invest in
strategic industries to gain sensitive technologies.
In either case, most politicians overlook the fact that we
are in this situation because of our loose monetary and fiscal
policy. Actions that would stifle the operations of foreign
sovereign wealth funds would likely result in corresponding
retaliatory action by foreign countries against American
pension funds, and could have the same detrimental effect on
the economy, as the trade wars begun after passage of the
Smoot-Hawley Tariff Act.
Rather than limiting or prohibiting investment by sovereign
wealth funds, we should be concerned with striking at the root
of the problem, and addressing inflationary monetary and fiscal
policy. Debtors cannot continue building debt forever, and we
now face strong indications that our creditors are eager to
begin collecting what is owed them.
It is not too late to correct our mistakes, but we must act
now, and cannot dally. We must drastically reduce government
spending and wasteful and disastrous interventions into
financial markets, and reign in the Federal Reserve's
inflationary monetary policy. Failing to do so will ensure a
descent into financial catastrophe. I yield back.
Chairman Gutierrez. Thank you. Congressman Sherman, you are
recognized for an opening statement.
Mr. Sherman. Thank you. First, I should observe that the
United States has sovereign wealth funds, not at the Federal
level, but at the State level, where CalPERS and CalSTRS are
among the biggest players in securities markets, investors in
private equity, and, with the support of this Congressman, are
taking into account not just narrow investment criteria, but
also the political effect and international effect, and effect
on the Nation of what they do.
Not only should we be concerned about sovereign wealth
funds, but we should not assume that non-sovereign foreign
investors are completely unmoved by political or governmental
considerations. With a sovereign wealth fund, it is obvious
that the government of the entity may control the investment.
But we in the United States operate under our legal system
to the point where we believe--since so many of us are
lawyers--that other people operate under the same legal system.
Under our legal system, everything is published. Every
governmental effect on investors is ascertainable by looking at
regulations and laws.
In most societies, a telephone call from a government
official can influence investors and private business in a way
that is so strange to those of us who went to law school, that
our economists and free trade advocates must insist that it
could never happen, because it doesn't fit any of their models.
And where the model differs from the reality, obviously, the
reality is wrong.
As Mr. Paul points out, we have a growing debt to
foreigners. This is best seen in our trade deficit. This trade
deficit is a direct result of our failed trade policies, and
our failed trade policies are a direct result of the obtuseness
caused by a belief that if we change our laws and regulations
to allow foreign products in, and they change their laws and
regulations, that they, therefore, have let our products in,
that if we change our laws and regulations, that means
government is no longer influencing private sector actors. And
therefore, if they change their laws and regulations, they have
also eliminated governmental influence on their private sector
actors, which is absolutely absurd.
And therefore, it should not surprise us that there is big
money in imports. There is big power where there is big money.
And with that big power, the lie can constantly be repeated
that if we get other countries to change their laws and
regulations, that we have accomplished as much as the other--as
it would be if we changed our published laws and regulations.
So, I look forward to these hearings and many others. I
think, ultimately, we are going to see a much further decline
in the U.S. dollar, because a country with a government this
bad is not going to retain a currency that is regarded as good.
I yield back.
Chairman Gutierrez. The gentleman yields back. I have the
ranking member of the full Committee on Financial Services, Mr.
Bachus, who honored me with co-leading the delegation when we
went out to look at the sovereign wealth funds. Mr. Bachus?
Mr. Bachus. Thank you, Chairman Gutierrez. As the chairman
mentioned, we visited Abu Dhabi and Dubai. And I am convinced,
as a result of that visit and my study of that region of the
world, that the enlightened leadership and the people of Abu
Dhabi and Dubai are a really stabilizing and positive influence
on the Middle East, a very necessary thing.
And they are also committed to, I believe, some of the same
freedoms we enjoy. There is a tremendous amount of freedom of
the press there. We were in a meeting where a young student
brought up a pollution problem there, in front of one of the
leading sheiks. And I thought, ``Well, that was pretty daring
of her.'' And then, in the paper the next day it mentioned that
problem, and that she had mentioned it. I was very encouraged
at their commitment to having a free press.
As for the U.S. economy, we have entered our second year of
a significant credit crunch. As we all know, growth has slowed
from its peak, and there remain risks to the economy and
financial markets. Many individuals and families are suffering
through difficult times. And last weekend, action to place
Fannie and Freddie under government control underscores the
systemic risks that have been created by the unwinding of the
housing bubble and the subprime lending debacle.
During this challenging time, sovereign wealth funds have
played a constructive role in the U.S. economy by injecting
billions of dollars of needed capital into some of the
country's largest financial institutions. This has allowed
those institutions to shore up their reserves, helping to
soften the blow from the massive write-downs of mortgage-
related securities that have destabilized the banking sector,
and continue to do so.
Banks with strong capital are in a much better position to
make loans to American consumers and businesses, and to help
get our economy going again. In addition to benefitting the
U.S. economy, these capital infusions have given sovereign
wealth funds and the countries that administer them a vested
interest in the continued health of the U.S. financial services
industry, and the U.S. economy as a whole.
Like any other investor, sovereign wealth funds expect
their investments to succeed. It is in their economic self-
interest, therefore, that the United States businesses in which
they invest billions continue to prosper.
Nonetheless, I am aware there are important questions we
should ask about the growth of these investments, especially
since some of the most recently established sovereign wealth
funds are controlled by countries with whom the United States
has struggled to forge positive economic and strategic
relations. As I said, Abu Dhabi and Dubai certainly don't fall
in that group.
We must, of course, remain vigilant to the national
security implications whenever countries that do not have our
best interests at heart seek to invest in our companies. But we
must also not lose sight of the great benefits that foreign
direct investment produces for our citizens. What we need is a
process that is uniform and fair for all investors seeking a
stake in the U.S. economy, the same way that investments by
U.S. citizens domestically must be treated uniformly and
fairly, and the way we expect U.S. investments overseas to be
treated.
What would create a more effective investment framework is
greater transparency on the part of sovereign wealth funds. To
that end, the preliminary agreement reached last week by the
IMF and the International Working Group of Sovereign Wealth
Funds is an encouraging development. While the final details
are still being worked out, these generally accepted principles
and practices for sovereign wealth funds should bring about a
greater degree of transparency and foster a better
understanding of governance and operations of these entities.
In conclusion, Mr. Chairman, capital is more mobile than it
has ever been in the history of the world. And that capital can
and will travel anywhere. While remaining vigilant to potential
threats to our national security and our economy and our
economic interest, our country must act responsibly to maintain
an environment that is free and open to international
investment so that all Americans continue to benefit from in-
flows of foreign capital that creates jobs for American workers
and fuels economic growth here in the United States.
With that, Mr. Chairman, I again thank you for holding this
hearing.
Chairman Gutierrez. Would the gentleman care to be
recognized? No? Thank you. Well then, I am going to introduce
the witnesses. First, we have--I'm sorry, the gentleman from
New York?
Mr. Meeks. I have a quick statement.
Chairman Gutierrez. The gentleman from New York is
recognized.
Mr. Meeks. Thank you, Mr. Chairman, and good afternoon. I
want to thank the chairman, my colleague, Mr. Gutierrez, and
the ranking member, Dr. Paul, for holding today's critically
important hearing on sovereign wealth funds, the new challenges
for a changing landscape.
The rise of sovereign wealth funds as the new power brokers
in the world economy should not be looked at as a singular
phenomenon, but rather as part of what can be defined as a new
economic world landscape. And, as such, it requires careful
analysis in order to appropriately address any issues that
arise from the growing prominence of sovereign wealth funds.
On March 5, 2008, two subcommittees of the U.S. House
Financial Services Committee held a joint hearing on the
subject of foreign government investment and the U.S. economy
and financial sector. The hearing was attended by
representatives of the U.S. Treasury Department, the Securities
and Exchange Commission, the Federal Reserve Board, Norway's
ministry of finance, and the Canadian Pension Plan Investment
Fund.
On May 21, 2008, the House Committee on Foreign Affairs had
a full committee hearing on sovereign wealth funds, the rise of
sovereign wealth funds, and impacts on U.S. foreign policy and
economic interests.
Assets under management of sovereign wealth funds increased
18 percent in 2007 to reach $3.3 trillion. And most of this
growth stemmed from an increase in official foreign exchange
reserves in some Asian countries, and rising revenue from oil
exports.
Now, we--as we look at what is taking place here, it is
clear that Congress has to look at sovereign wealth funds, see
how it has and can be a help to--I know it has--to some
municipalities, and see how we can continue to move forward in
the global economy which we now live in. And I think that we
have demonstrated a commitment to the issues raised by the
sovereign wealth funds, and that this committee in particular,
under the leadership, of course, of Chairman Frank, along with
the efforts of my colleagues on both sides of the aisle, and I
expect we will continue to engage in constructive efforts to
shape our Nation with policies with respect to sovereign wealth
funds.
I look forward to visiting nations where we see a lot of--
we went to Norway, and we will be going to others, so that we
can make sure that sovereign wealth funds is a mechanism to
help us in the global economy, and not hurt us. I would love to
hear the testimony of the witnesses this afternoon. Thank you.
Chairman Gutierrez. I thank my colleague for his comments.
I will introduce the witnesses now.
First, we have Dr. Ted Truman, a senior fellow at the
Peterson Institute for International Economics. Dr. Truman
previously served as the Assistant Secretary of Treasury for
International Affairs from 1998 to 2001. Prior to that, he was
Staff Director for the Division of International Finance at the
Federal Reserve Board, and before that, an economist on the
Federal open market committee.
Dr. Truman has written extensively in the area of sovereign
wealth funds, including a blueprint for sovereign wealth fund
best practices, published this year as a Peterson Institute
Policy brief in international economics. He has also written,
``The Management of China's International Reserves: China and a
Sovereign Wealth Fund Scoreboard,'' also in 2008. And,
``Sovereign Wealth Funds, the Need for Greater Transparency and
Accountability,'' a 2007 Peterson Institute Policy brief. He
received his B.A. from Amherst College, and his M.A. and Ph.D.
in economics from Yale University.
Dr. Truman, please?
STATEMENT OF DR. EDWIN M. TRUMAN, SENIOR FELLOW, THE PETERSON
INSTITUTE FOR INTERNATIONAL ECONOMICS; VISITING LECTURER,
AMHERST COLLEGE; AND VISITING PROFESSOR, WILLIAMS COLLEGE
Mr. Truman. Thank you very much, Chairman Gutierrez,
Ranking Member Paul, and other members of the subcommittee. It
is a pleasure to testify before you today on the challenges
posed by sovereign wealth funds.
By way of further introduction, the accountability of such
funds has been the focus of my research and analysis for the
past 18 months, as you indicated in your introduction. I use
``sovereign wealth fund'' as a descriptive term for a separate
pool of government-owned or government-controlled assets that
includes some international assets. I include all government
pension funds, as well as non-pension funds, to the extent that
they manage marketable assets.
Sovereign wealth funds may be funded from foreign exchange
reserves, earnings from commodity exports, receipts from
privatizations, other fiscal revenues, or pension
contributions. Table 1, attached to my full testimony, lists 56
funds of 38 countries.
No two funds are the same. They have a wide range of
structures, mandates, and economic, financial, and political
(primarily domestic, but in some cases international)
objectives--normally, a mixture. Consequently, it is perilous
to generalize about sovereign wealth funds and any associated
threats to the U.S. economic and financial interests.
With that important qualification, my six summary
conclusions are:
First, sovereign wealth funds are here to stay, and likely
to grow in their relative importance, in particular as
financial globalization continues.
Second, the U.S. economy is thoroughly intertwined with the
global financial system through both the private and public
sectors here and abroad. The United States, as Congressman
Sherman indicated, is the number two player in the sovereign
wealth fund game, in terms of international assets of our
sovereign wealth funds. It follows that advocates of formally
regulating sovereign wealth funds should be careful what they
wish for. Any regulations or other restrictions that are
applied to foreign sovereign wealth funds properly should be
applied to our own funds, and would be applied to them by other
countries.
Third, the most promising approach to dealing with the
sovereign wealth fund phenomena is via what I call ``reciprocal
responsibility.'' Countries with such funds should embrace a
voluntary set of best practices, along the lines of my
sovereign wealth fund scoreboard. I hope it has been largely
incorporated into the Santiago ``generally accepted principles
and practices'' of sovereign wealth funds that is in the
process of being adopted. That was referred to earlier. It is
associated with the IMF. We don't know yet.
On the other hand, countries receiving sovereign wealth
fund investments should strengthen the openness of their
financial systems. At present, more progress is being made by
countries making sovereign wealth fund investments than by
recipient countries. My fear is that the financial hurricane
that would result from an outbreak of financial protectionism
over sovereign wealth funds would make the recent events look
like a mere squall.
Fourth, it is fundamentally impossible to distinguish
sovereign wealth funds by the degree of political motivation in
their investment decisions. They are governmental entities, as
has been pointed out, and governments are political.
Fifth, sovereign wealth funds do not pose a significant new
threat to U.S. economic and financial interests. As long as we
put in place and maintain sound economic and financial
policies, we control our own destiny. In my view, we have
adequate mechanisms to address any potential national security
concerns posed by such funds, or, of much more relevance, other
forms of foreign government investment in this country.
Sixth, I am a bit uneasy about the possibility that such
funds may exercise what I call ``undue influence'' in
connection with the investments in our financial institutions.
It is my hope that our existing processes can deal with the
more heavily regulated portions of our financial system, and
improvements in the accountability of large hedge funds and
private equity firms, which I also favor, could help elsewhere.
Finally, a few words about the sovereign wealth fund
scoreboard that I have constructed for 46 funds. It is
summarized in table 2, attached to my full testimony. All
sovereign wealth funds are not the same. Nor is there one
cluster of ``good'' funds and another cluster of ``bad'' funds.
The overall scores in my scoreboard range from 95 to 9 out of a
possible 100. The simple average score is 56; the weighted
average score is 51, weighing the funds by their estimated
foreign assets.
The funds are in three broad groups: 22 funds with scores
above 60; 14 with scores below 30; and 10 funds in the middle.
The top group includes funds of a number of developing
countries, the middle group includes funds of non-industrial
countries as diverse as Russia, Mexico, Kuwait, and Singapore.
The bottom group includes two funds from Abu Dhabi which,
nevertheless, reportedly have excellent reputations in the
financial markets, as well as having made a favorable
impression on Mr. Bachus. Eleven non-pension sovereign wealth
funds have estimated assets of more than $60 billion. We scored
nine of these funds. Two are in the top group and two are in
the bottom group.
Thank you. I will be pleased to answer your questions.
[The prepared statement of Dr. Truman can be found on page
62 of the appendix.]
Chairman Gutierrez. Thank you, Mr. Truman, so much. Next,
we have Dr. Brad Setser. Dr. Setser is currently a fellow for
geoeconomics at the Council on Foreign Relations. He is an
economist with expertise in finance, global capital flows, and
emerging economies, and works in CFR's Maurice R. Greenberg
Center for Geoeconomic Studies, focusing on foreign policy
consequences of capital surpluses in East Asia and oil
exporting states.
Dr. Setser most recently was a senior economist for RGE
Monitor, an online financial and economic informational
company. In 2003, he was an international affairs fellow for
CFR, where he coauthored, ``Bailouts or Bail-ins? Responding to
Financial Crises in Emerging Economies,'' a book examining
international monetary policy toward crisis in emerging market
economies.
Dr. Setser served in the U.S. Treasury from 1997 to 2001,
where he worked extensively on the reform of the international
financial architecture, sovereign debt restructuring, and U.S.
policy toward the IMF. He ended his time at the Treasury as the
acting Director of the Office of International Monetary and
Financial Policy.
Dr. Setser earned his B.A. from Harvard University, his DEA
from Institut d'Etudes Politiques de Paris--last word in
Spanish, not French--and his master's and doctorate's degrees
from Oxford University.
Please, Doctor, proceed.
STATEMENT OF DR. BRAD W. SETSER, FELLOW FOR GEOECONOMICS,
COUNCIL ON FOREIGN RELATIONS
Mr. Setser. I want to thank Chairman Gutierrez, Ranking
Member Paul, and the members of the subcommittee for inviting
me to testify today. It is a particular honor to be on the same
panel as Ted Truman--my biography, which you read, sort of left
out that during that entire period when I had those long
titles, I was basically working for Ted. And it is an equal
honor to be on the same panel as Dr. Drezner, who was a
colleague at roughly my level at the Treasury at that time. So
you have somehow managed to acquire an all-Treasury panel.
I think over the last few years, capital has flowed in a
rather unusual way. It has flowed, broadly speaking, from poor
countries to rich countries, from fast-growing countries to
slow-growing countries, from countries with appreciating
currencies that often offered high returns on their financial
assets to a country with a depreciating currency that provided
a low return, and often from countries that would be more
autocratic to countries like the United States, which are
highly democratic.
This pattern of global capital flows does not stem, in my
judgement, from private investment decisions. Private demand
for the assets of emerging economies has actually been quite
strong over most of this period. Rather, it reflects an
unprecedented growth in the foreign assets of many emerging
economies' governments.
Now, the U.S. slowdown and the rise in oil prices initially
intensified this pattern, leading to basically a doubling of
the pace, in my judgement, of official asset growth from maybe
$800 billion a year to maybe $1.5 to $1.6 trillion a year. That
pace has clearly slowed over the last month, as oil prices have
fallen, and as some of the private capital flows, which I
mentioned earlier, have reversed. Yet so long as oil exporters
and countries like China continue to run very large current
account surpluses, it is reasonable to think this basic pattern
will continue.
A sharp fall in central bank purchases of U.S. debt, absent
an increase in private demand for U.S. debt, leaves U.S.
interest rates to rise, possibly significantly. Consequently,
it would not be in the United States's interest.
On the other hand, the goal of U.S. policy, in my
judgement, should not be to sustain large deficits through the
ongoing growth of the funds of central banks and sovereign
wealth funds. A world where China's government continues to add
roughly $700 billion a year to its foreign assets, at a time
when the oil exporting economies are adding a roughly
equivalent sum, is unlikely to be a world that evolves in ways
favorable to U.S. interests.
The debate over sovereign wealth funds should not be
limited to a debate over where the CFIUS process strikes the
right balance between protecting U.S. security interests and
encouraging capital inflows. That leaves out questions about
whether the same policies--exchange rate intervention,
stockpiling oil surpluses in government hands--that have fueled
the growth in sovereign funds also hinder necessary adjustments
in the global economy. It also ignores the potential shifts in
geopolitical influence associated with a world that relies
heavily on other governments for financing.
And here I would note that the national security
implications of relying so heavily on central bank demand for
Treasury and agency bonds to fund the agencies in the U.S.
deficit warrant at least as much consideration as the national
security implications of sovereign wealth funds.
I want to emphasize three specific points. First, the
majority of the growth in official assets continues to come
from the growth in central bank reserves, not the growth in
sovereign funds. And, best that I can tell, the increase, the
general pattern of global capital flows that flows into the
U.S. market has not been one which has been going towards risky
U.S. assets, but rather, one that has been concentrated in the
least risky of U.S. assets, and that is probably where the
greatest distortions lie in the U.S. market.
The $35 billion that sovereign wealth funds invested in
U.S. banks is less than the average monthly increase in central
bank holdings of treasuries and agencies at the Federal Reserve
Bank of New York's custodial accounts.
Second, it's getting harder, not easier, to evaluate how
central banks and sovereign funds are influencing U.S. markets.
More of the growth in central bank reserves is coming from
countries that do not disclose data about the currency
composition of their reserves to the IMF. More countries are
channeling some of their reserve growth through state banks,
and not reporting that transparently. And many sovereign funds
report significantly less data--many, not all, there are some
important exceptions--than central banks.
And finally, both the set of countries with sovereign funds
and the investment styles of those sovereign funds are evolving
rapidly. In the future, the large sovereign funds, if current
patterns of growth continue, will likely come from Russia,
China, and Saudi Arabia, not from Abu Dhabi, Dubai, and
Singapore. I think that's a significant change that warrants
consideration, as well as the evolution in the individual
investing styles of some of these countries, and I would be
happy to take your questions.
[The prepared statement of Dr. Setser can be found on page
44 of the appendix.]
Chairman Gutierrez. Thank you so much. The last panelist is
Dr. Daniel W. Drezner. Dr. Drezner is a professor of
international politics at Fletcher School of Law and Diplomacy
at Tufts University, and a senior editor at the National
Interest.
Dr. Drezner has served as International Economist at the
Treasury Department's Office of International Banking and
Securities Markets. He also held a research position at the
Rand Corporation.
Dr. Drezner has published articles in numerous scholarly
journals, as well as The New York Times, The Wall Street
Journal, and The Washington Post on foreign policy and foreign
affairs. He has provided expert commentary on U.S. foreign
policy and global political economy for C-SPAN, CNNfn, CNN
International, and ABC World News Tonight, and is currently a
regular commentator for Newsweek International and NPR's
Marketplace.
He received his B.A. in political economy from Williams
College, and an M.A. in economics and a Ph.D. in political
science from Stanford University. We welcome him and his
testimony. Thank you.
STATEMENT OF DR. DANIEL W. DREZNER, PROFESSOR OF INTERNATIONAL
POLITICS, THE FLETCHER SCHOOL, TUFTS UNIVERSITY
Mr. Drezner. Chairman Gutierrez, Ranking Member Paul, thank
you very much for the invitation to testify. It's also a
privilege to be on the same panel with Dr. Setser and Dr.
Truman. I would add that Brad, I think, is being generous in
saying we were on an equal level when I was at Treasury. As
memory serves, he was a few pay grades above me. So it's good
to know that I can potentially catch up.
I have submitted my complete written testimony, so I will
just try to quickly make five points.
The first is--and again, I agree with Dr. Setser on this--
sovereign wealth funds, in particular, are a symptom, rather
than a cause of the current macro-imbalances we are
experiencing. The underlying drivers of what's going on are the
combination of a low U.S. savings rate; an inelastic demand for
energy, and imported energy in particular; in some cases
undervalued currencies, which are leading to persistent trade
deficits. And, therefore, the primary focus should be on those
underlying problems, rather than this symptom of sovereign
wealth funds.
The second point I would make is that, as symptoms go,
sovereign wealth funds are relatively benign in their effects.
In my opinion, most of the concerns about their ability to act
geostrategically in the United States have been overstated. I
am not saying these concerns are completely unfounded. I just
think, as current commentary exists, they have mostly been
exaggerated, and I would be happy to talk about that further in
Q&A.
Furthermore, the increase in sovereign wealth fund
investment in the United States is leading to more
interdependence, not so much asymmetric dependence, on the
United States from the sovereign wealth funds investors. So,
while there is some constraint in terms of U.S. foreign policy,
which I will go to in a second, the extent of sovereign wealth
fund investment in the United States also gives these other
countries a direct incentive in the stake in our economy.
And finally, it should be pointed out on this that not all
sovereign wealth funds see eye to eye. As Dr. Truman said,
there is a heterogenous group of sovereign wealth funds. The
largest ones currently are relatively close allies of the
United States, or at least housing countries that are allies of
the United States.
And I think, if anything, we saw from the recent IMF
meeting in Santiago that there might be a bit of a schism
between the more mature sovereign wealth funds, such as the
Kuwait Investment Authority, and, for lack of a better way of
putting it, the ``arriviste'' sovereign wealth funds coming
from Russia and China. The older, more mature market funds who
have operated in Western markets largely uninterrupted and
largely undisturbed for several decades, are probably upset at,
suddenly, all the renewed focus of attention.
Third, I would say the current structures to deal with
official sovereign investment in the United States are largely
adequate to the task. The CFIUS and FINSA guards against
national security concerns were put in place, in some ways,
anticipating this problem as a result of the Dubai Ports World
incident. And we, right now, see other OECD countries looking
to adopt CFIUS-style procedures. So, in that sense, we are the
template, rather than having to push further on.
It is too soon to tell whether or not the IMF/IWG process
for developing the Santiago principles will actually lead to
improved behavior by sovereign wealth funds. I will say,
however, that if you are going to articulate a set of
transparency standards, it is relatively easy for private
actors to determine whether those transparency standards are
actually being adhered to. It is always good to have more
information about these sovereign wealth funds, and so I
certainly encourage active monitoring and intelligence about
them. But that is different from more regulation.
Fourth, Russia and China, in particular, do not have an
advantage, in terms of their sovereign wealth funds, because
they are so-called authoritarian capital powers. There is a
claim sometimes that authoritarian capitalist states can use
``patient capital.'' They can invest with the idea of thinking
about the long term, rather than worrying about short-term
losses.
I think looking at the behavior of both Chinese and Russian
investors in the past year flatly contradicts that. There has
been a significant amount of blowback in China because of the
CIC's investment purchase of Blackstone last year. You now have
conspiracy theories among mid-ranking Chinese banking officials
that the United States has somehow tricked China into buying
large amounts of debt, with an idea that they are, therefore,
trapped into holding them. There has been significant blowback
in Russia over the fact that Russian official investors have
large amounts of Fannie Mae and Freddie Mac debt, as well.
Authoritarian countries have short-term political problems,
just like democratic countries. And so the notion that
authoritarian countries have an advantage, I think, is
incorrect.
Finally, there are undoubtedly some negative effects that
come from growing sovereign wealth fund investment, and I talk
about this in my written testimony. First, there is no question
that U.S. democracy promotion efforts will be hindered. And,
second, financial globalization looks more and more like a game
of mutually assured destruction, in that, as Larry Summers put
it most famously, ``There is now a financial balance of terror
between capital importing countries and capital exporting
countries.''
Now, fortunately, mutually assured destruction can lead to
a more peaceful coexistence, but it's a relatively nervous
coexistence, and I would certainly acknowledge that. Thank you
very much.
[The prepared statement of Dr. Drezner can be found on page
32 of the appendix.]
Chairman Gutierrez. Thank you. The new Cold War. Thank you
very much. We will now go to questions.
Dr. Drezner, let me just follow up, since you finished on
your last point. You wanted to get them all, so you were trying
to be very disciplined about the clock. I appreciate that.
Please elaborate just a little bit on the financial
industries and mutual destruction, and the banking industry and
their mutual terrors.
Mr. Drezner. The financial balance of terror, as it were,
is that, you know, there is that old line that if you owe the
bank $1,000, that's your problem. If you owe the bank $1
billion, that's the bank's problem. Something that plays is
similar here, which is we are the ones that are borrowing from
sovereign wealth funds, but we have now borrowed so much that
the countries that are holding our debt also do have a stake in
our country succeeding.
We can debate about this. There is no question that these
countries could pursue what's called the nuclear option, which
is to sell all of their debt, and to sell all of, you know,
their equity in U.S. markets. There is no question they can do
that. But in the same way, during the Cold War, the Soviet
Union could have launched all of their ICBMs in a first strike
against the United States. The reason they didn't do that is
because it would have destroyed them, just as much as it would
have destroyed us.
So, in that sense, there are high degrees of
interdependence between the United States and capital exporting
companies to the United States. This degree of interdependence,
as I said, will constrain U.S. foreign policy in some ways.
There are ways in which we do need to please our foreign
creditors.
At the same time, there are limits on what foreign
creditors can do to influence us, precisely because they can't
see all of their assets wiped away with the blink of an eye.
They would be equally devastated.
Chairman Gutierrez. Thank you. Thank you very much. Dr.
Setser, in your testimony you indicated that many foreign
governments clearly expected the U.S. Government to protect
their central banks from taking losses on their holdings of
Fannie Mae and Freddie Mac bonds. What makes you so sure that
foreign government investors expected to be protected, and do
you think we got ourselves in such a bad situation, in terms of
GSEs and foreign investment, where we are so leveraged to these
foreign central banks that we had to make certain promises to
them?
Mr. Setser. Well, I read the press statements coming from
China quite closely, and I know some of the names that were
associated with those statements. And when a former member of
the monetary policy of the Central People's Bank of China
indicates that this would be devastating to the global
financial system, I think that indicates a level of concern.
And having spoken with some Chinese bankers, and discussed
with them various options, and seen the deeply concerned
reaction at any suggestion that some type of restructuring
might be extended to the bonds, not just a change in the equity
structure of the companies, I think it was quite clear there
was a very high level of concern.
And then, finally, I watch, as I'm sure others do, the
custodial holdings of the New York Fed quite closely. Foreign
central banks' total holdings of agencies peaked in late July.
And after average purchases of, say, $20 billion a month of
U.S. agency bonds over the course of this year, in the month of
August their holdings fell by about $12 billion, which I think
is indicative of more than just expressions of concern, but a
desire to see much greater clarity before they were willing to
add to their existing holdings.
Chairman Gutierrez. Are they going to lose a lot of money
in China, given the GSE's debacle?
Mr. Setser. They will not lose money because of GSE's
debacle, because the U.S. Government, I think, has made it
clear that the debt of the bonds that the GSEs have issued will
be honored in full. China will take losses, but those losses
will come from having very large exposure to the U.S. dollar,
and having, as a by-product of its currency policy, in some
sense, overpaid for U.S. dollars on a consistent basis. And
that will produce very significant losses.
And I think that's what worries me a little bit about the
interdependence, is this interdependence where one party is
going to take financial losses. And, as a byproduct of that,
they have clearly gained an advantage for their exports, or for
its encouraged production of U.S. companies as well, in China.
But it's not clear to me that the Chinese public is on board
fully with the losses that will likely be incurred.
And there is a complicated set of issues about how the
economic meaning of losses at a central bank, that I am sure
Ted Truman will be more than happy to comment on and explain.
But I do think that the political reaction inside China is
important.
Chairman Gutierrez. I want to go to Dr. Truman. So,
following up on your colleagues now, right--your former almost
students, using their words--so, could you just elaborate a
little bit on the currency issue? How do you feel about the
Chinese government and their transparency, lack of manipulation
of their own currency, and the inter-relationship between the
dollar and what's going on there in our government?
Mr. Truman. They weren't students; they were colleagues. I
learned as much from them as they learned from me.
It is a complicated question. And, in fact, you will find--
I think--the three of us probably agree on some things, and
then we disagree on some others. But those others are probably
deeply into the economist weeds, so I apologize for this,
because I do disagree a little bit.
You do have this problem, that--to simply answer your
question--the Chinese buy dollars. The Chinese currency goes
up. So value of the dollars in Chinese currency, the renminbi
or the yuan, goes down. Their dollars are worth fewer yuan. And
if you were a citizen of China, you would turn around and say,
``Why did we waste our money buying this currency that is going
down?'' I think that is the political problem.
Now, of course, the dollar is still worth a dollar, if you
want to put it that way. So, in terms of the value of
purchasing power in the United States, it is the same amount
today as it was worth--approximately, even aside from
inflation, but presumably interest covers inflation, mostly.
So there is a sense in which they could have been doing
better if they had bought something else, or they kept the
money at home. On the other hand, the currency reserves, the
dollars they accumulated, because they didn't want their
currency to appreciate versus our currency were going down in
yuan. If you want to be crude about it, that's the price they
paid for resisting the currency appreciation.
So, I don't feel too sorry for them, though I agree with
Dan and Brad that in some sense it is a political issue in
China and in several other countries who have set up sovereign
wealth funds. They have woken up one morning with lots of
foreign exchange reserves and said, ``No, how come we have this
pile, and now we have to justify to our citizens what we are
doing.''
So, rather than just parking it in Treasury securities, and
so forth and so on, the way they did before, they have gone out
and said, ``Well, we are going to buy equities,'' or, ``We are
going to to invest in hedge funds or private equity firms, in
order to generate at least more return than just holding
Treasuries.'' But it's a response to, in some sense the by-
product, of the foreign exchange policy.
Chairman Gutierrez. I will try to see if we have time to
follow up. Dr. Paul, 5 minutes.
Dr. Paul. I want to direct a question to Dr. Drezner. You
said in your opening statement that we are looking at more of a
symptom than a cause, and I wanted to follow up on that,
because I agree with you on that. Just the fact that these
funds exist is not a problem, and may be just symbolic of a
different problem.
First off, how do other countries react to this problem?
What do other countries and other governments think about it?
Are they having this same discussion, or is the only discussion
a concern with us here? Do you have a feel for that?
Mr. Drezner. To be technical to that question, I would say
other countries are freaking out even more than this one.
Dr. Paul. Other countries are concerned about this?
Mr. Drezner. Yes.
Dr. Paul. And what are they worrying about?
Mr. Drezner. They are worried--in some ways, again, because
the United States has the CFIUS procedure in place already, and
because FINSA was passed last year in response to what happened
in 2006, in some ways the United States was out in front,
because it already had, in many ways, a regulatory
infrastructure in place. The European Union does not have
similar infrastructure. Other countries are only now just
beginning to get this stuff online.
And it also should be pointed out that many of the
countries that house sovereign wealth funds are also even more
protectionist when it comes to foreign direct investment. So,
as a result, Germany just recently passed a law, I believe, to
guard against sovereign wealth fund investment that will
probably be declared illegal by the European court, because
it's so restrictive. Australia also passed a law in the
beginning of this year. You are also seeing moves by other
countries, as well.
Again, I think the United States was actually ahead of the
curve, in terms of already having pre-existing structures. And,
as a result, it's probably not done as much, as a result.
Dr. Paul. Would you say, then, they are treating a symptom,
or are they looking at the basic cause of the problem?
Mr. Drezner. No, I think they are still treating the
symptom.
Dr. Paul. Still--okay. Let's talk about the real cause. Is
there an imbalance in the distribution of our currencies and
values because the United States issues the reserve currency of
the world? Is that related to this problem?
Mr. Drezner. I would say it's partially related, but I
would actually probably defer to Dr. Truman on this, who has
slightly more expertise on the dollars of the reserve currency
than I would.
There is no question that, if anything, the dollar, having
the reserve currency, actually allows the United States to run
a balanced payments deficit that no other country in the world
would be allowed to do. So that's certainly true.
On the other hand, the magnitude of the deficit we are
talking about now dwarfs the sort of comfort level I think most
economists would have, in terms of running a deficit just
because the--our currency is the reserve currency.
Dr. Paul. Okay. I will, then, ask Dr. Truman. What I am
thinking about along this line is, if we can issue the reserve
currency of the world, and there is no substance to it because
we have license to issue it, we are likely to issue a lot of
it. And as long as there is a trust, whether it's a worthy
trust or not, other countries are going to take our dollars,
which encourages us to print more dollars, and we get to export
our inflation, so to speak, causing some of these problems.
Do you agree that there is something to this, that because
we have a reserve currency we contribute this significantly to
the imbalance because we get away with something maybe that we
shouldn't be getting away with?
Mr. Truman. I agree with you 35 percent, if I may put it
that way, that because we--as Dan said--issue a reserve
currency, it means that we can more easily finance our deficit.
And that leads us to both internal and external deficits and,
perhaps, to be less concerned about them than we should be.
On the other hand, as you said in your very statement, in
some sense it also gives the opportunity to the rest of the
world to vote with their feet, or vote with their pocketbooks,
or vote with their balance sheets. So it's another
manifestation of this sort of mutually assured destruction, if
you want to use that term.
So, if we go too far, they can walk away from the dollar.
There will be some consequences for them financially, but there
are other things that they can walk away into: commodities, on
the one hand, if you're really worried about inflation, or into
other currencies.
And so, the financial leaders of the United States, if I
can put it that way, and you guys in Congress too, for that
matter, every time something happens--and you see it today in
the newspapers, talking about Fannie and Freddie, ``We are
going to put this on the budget, and it's going to count as
part of the debt,'' and that is going to drive up interest
rates.
So that, in some sense, is the market, including the
international market, voting at least a level of concern about
how we are running our affairs. And they can do that more
easily for the United States than they can do it for Zimbabwe.
Dr. Paul. Well, it seems like there will be a limit to how
long we can maintain this balance. And, eventually, we can't
come up with bailing out Fannie Mae and Freddie Mac, which
would have really disturbed this balance, because the dollar
would have continued down, and it gave a tremendous boost to
the dollar. But that's hardly seen as curing the problem. It
is, once again, treating the symptoms.
But I appreciate your testimony, and I yield back.
Chairman Gutierrez. Thank you. Congresswoman Gwen Moore
from Wisconsin, you are recognized for 5 minutes.
Ms. Moore of Wisconsin. Thank you, Mr. Chairman. This has
been very helpful testimony this afternoon, and I don't know
exactly who to direct my questions to.
But I--one of the things that I am very curious about is
that since I have joined this committee there has been a
tremendous urging on the part of Europeans and even Americans
for China to not manipulate its currency, so to speak. And,
really, listening to your testimony today, I am curious.
If they were, in fact, to allow their currency to rise
based on market forces, wouldn't that be less of an incentive
to hold on to our American exchange reserves? And you know,
what if they were to say, ``Okay, everybody--the Europeans, the
Americans--wants our currency to rise. Let is rise.'' What do
you think could be those consequences?
Mr. Setser. I think it depends on whether China lets its
currency rise to the market clearing rate, or makes a much more
incremental adjustment. If China makes an incremental
adjustment, I think the basic dynamics that we see now would
continue. That is to say China will continue to run a
meaningful trade surplus, because it will take time for the
trade surplus to--China's trade surplus--to come down, even
with something of an appreciation.
And Chinese residents and foreign investors will believe
that there is still more adjustment to come, and that will lead
to ongoing growth in China's reserves. We sort of have seen
this. This is sort of more or less what happened after China
allowed its currency to adjust by a small amount in 2005, and
is also, broadly speaking, the pattern that we have seen in the
past year when, until the past 3 months, China allowed a
faster-paced appreciation.
Here I would also note that it is important to
differentiate between movements against the dollar, which have
been present, and movements, in China's case, against a broad
basket of its currencies. If China is going up against the
dollar, and the dollar is going down even faster, China's
currency isn't really going up. And that, more or less, has
been the case. So I think that's sort of a big gap that has to
be made up.
In the unlikely event that China moved all the way to a
market clearing rate, and private outflows had to balance its
trade surplus, there would be a very significant adjustment in
the pattern of capital flows out of China, which might have
significant market implications. But I think the probability of
that is fairly low.
Ms. Moore of Wisconsin. Okay.
Mr. Truman. But--
Ms. Moore of Wisconsin. Okay, go on.
Mr. Truman. I am going to add just one point, which is
that, meanwhile, China has accumulated $2 trillion. So even if
they stopped buying dollars tomorrow, or 5 years from tomorrow,
they still would have to worry about investing those dollars in
the United States, or somewhere else.
So, in that sense, the problem is still with us. The legacy
of the problems of the past would still be with us. That was
the only thing I would add.
Ms. Moore of Wisconsin. Okay. Let me ask this. I am really
relieved to hear from this panel that there is--it's really
doubtful that there could be any really politically motivated
funds management of these sovereign wealth funds, that they are
really looking for the best rate of return.
What would happen, in your estimation--a couple of things.
What if, for example, the Chinese people were to decide that
they--they were to prevail on, say, that the great level of
poverty in the country is intolerable, and that they needed
greater liquidity, and they needed to cash in some of these
foreign exchange reserves? And of course, you know, they have
this basket of currencies, and perhaps if the U.S. dollar
continues to plummet, that's a political motivation that's not
nefarious, but it's something that could really happen.
If they needed a great influx of liquidity, and decided
that they needed to cash it in to take care of domestic issues,
is that a scenario that we can hedge against?
Mr. Setser. If I can, I don't think it's a scenario we need
to hedge against, because I think the way that scenario would
play out is that China would, in some sense, borrow money
domestically, which it is currently doing. The China Investment
Corporation is issuing bonds domestically inside China to buy
foreign assets.
It could change from issuing bonds domestically to buy
foreign assets to using that money to make domestic investments
inside China. I personally think that would probably be a good
trade. It would be in China's interests to do more of that.
In a macroeconomic sense, that would mean that China would
run a larger fiscal deficit, and that would tend to reduce the
size of China's current account surplus. So, rather than
thinking--
Ms. Moore of Wisconsin. That would help us? That would--
Mr. Setser. There would be more--
Ms. Moore of Wisconsin. Would that bring us more into--
Mr. Setser. We are in a--it depends on who the ``us'' is.
It would help anyone in the--
Ms. Moore of Wisconsin. ``Us,'' the United States.
Mr. Setser. Well, it would help exporters, who would--there
would be more demand inside China, so there would be more sales
of goods to China. It might mean somewhat smaller Chinese
purchases of U.S. financial assets, but that would be just sort
of a rebalancing away from the situation we have had over the
past several years, where exporters have not sold as much as
they otherwise would have, and financial players have had
access to funds at a lower rate than they otherwise would have.
I think if you want to have the global economy adjust, you
need to have China invest more in China, and China invest a
little bit less in U.S. treasuries.
Mr. Truman. We stop exporting paper to them, and we start
exporting goods to them.
Ms. Moore of Wisconsin. Okay.
Mr. Drezner. Could I just add one thing?
Ms. Moore of Wisconsin. Yes, with the indulgence of the
Chair. May he answer?
Chairman Gutierrez. Yes.
Ms. Moore of Wisconsin. Thank you.
Mr. Drezner. Just one other thing, which is this is one of
the problems with sovereign wealth funds, in terms of
relationship to U.S. democracy promotion, which is the scenario
you just outlined is not an inconceivable one.
Furthermore, if you were to have some kind of
democratization, let's say, in the Gulf countries as well, this
could also lead to unpredictable effects. There is a paradox,
in terms of sovereign wealth funds particularly emerging in
countries that have relatively low per capita income, because
the political perception is, ``Why are we holding trillions of
dollars, or hundreds of billions of dollars in U.S. dollars,
and not investing it domestically?''
Furthermore, if you marry that in some cases in countries
with relatively rampant anti-Americanism, if you have a
democratic regime, they could actually then decide to act
politically. And it should be noted that it's actually
sovereign wealth funds based in democratic countries that are
most likely to attach political conditions to their investment.
And I am thinking here of CalPERS in the United States and
Norway's fund, as well.
Mr. Meeks. [presiding] Mr. Manzullo?
Mr. Manzullo. Pass.
Mr. Meeks. Take a pass? I will recognize myself then,
before I go to Mr. Watt.
Let me follow up with Dr. Setser really quick. I know that
you just said that investment from China, Russia, and Saudi
Arabia should be the ones that concern us. Can you elaborate on
that a little bit further?
Mr. Setser. Sure. Right now, China is adding roughly $700
billion to its foreign assets. So, you know, that's why I was
not concerned if China had a bigger fiscal deficit. I think it
would just mean that they would add $600 billion or $500
billion or $400 billion to their foreign assets. But that is,
by far, the biggest source of foreign assets around, and that
has generally been invested in fairly safe treasuries, some in
agencies.
If that were to change, that would have a much bigger
impact, in my judgement, than the shift of a smaller country.
And China, obviously, has a somewhat different political
relationship with the United States than does a country like
Norway or a country like Singapore.
The second biggest source of foreign asset growth in the
global economy right now is probably Saudi Arabia. They are
certainly going to add over $100 billion to their foreign
assets. And, again, that has been invested very conservatively,
as best we can tell. There is extremely little reliable
information.
And then, until the events in Georgia led to a significant
outflow of money from Russia, Russia was the third largest
source of foreign asset growth in the global economy. Combine
those pools of money and you're looking at an increase. The
annual increase in their foreign assets was approaching about
$1 trillion. The annual influx of new money into the Gulf
funds, into the Norway fund, was about $150 billion.
So, when I look at the magnitudes, and look at how those
flows could change, and who would--what the impact would be, it
strikes me that the biggest changes potentially would come from
these sets of countries.
And then, as Dan alluded to quite accurately, these
countries are much poorer than the existing countries. And even
in the existing countries with big funds, I think there is
pressure. You know, if you look at some of the stuff that Abu
Dhabi is doing, it's designed to spur their own economic
development to buy--you know, ``Let's put some money in
Ferrari, and then Ferrari should put a theme park in Abu Dhabi,
because we want to compete with Dubai.'' Is that commercial? Is
that political? Is it prestige? It's all kind of rolled
together.
And I think you could possibly see some of those same
complicated political pressures emerging amongst these other
countries, and I think that might change the way sovereign
funds invest.
Mr. Meeks. Thank you. Let me ask you this question. And I
think everyone agrees, when we are talking about that, that
it's the symptom and not the cause of some of the economic
problems. But here we have had several hearings, as I indicated
in my opening statement, on the questions of transparency, etc.
I know in Chile, for example, that recently the
International Monetary Fund just broke a preliminary agreement
with the world's largest sovereign wealth funds about a code of
conduct that covers issues of transparency, governance, and
accountability of sovereign wealth funds.
I heard Dr. Truman say we have to be careful in how we
regulate, because it could boomerang back to us, because as
quiet as it's kept, a lot of our pension funds, etc., that is
sovereign wealth dollars that we use overseas.
The question that I have is should we--you know, in trying
to settle some of this issue of transparency, should we, the
United States, be one of the leaders in trying to set this code
of conduct, and call for--in pursuing a policy of transparency
and rules that can be enforced by all the countries across the
board?
Mr. Truman. Let me answer, with your permission. Actually,
we have been involved. I think it is useful to you to
understand; it was not the Fund who did this; it was actually
the countries with the sovereign wealth funds.
Because the United States has sovereign wealth funds in
addition to the State pension funds--as was mentioned, Alaska
has a fund, and Wyoming has a fund, and so forth and so on. So
we were in the room with Abu Dhabi and with Singapore. And
also, Australia was in the room, and also Canada was in the
room, because they are the same--and Norway was in the room.
So, this is an agreement that involves all the countries
who were in the room, the 23 or 26--23, actually, the number
is; there were 3 observers, so they--23 countries who were in
the room, and that whatever the agreement is, they all agreed
to apply it, all the large funds, with the exception of Hong
Kong and Saudi Arabia--if you think it has a sovereign wealth
fund, but Saudi Arabia said they don't have one--also was
participating in this.
So on the assumption that they all have agreed, which is
the assumption I am making, and on the assumption that it's a
strong agreement, in terms of increased accountability and
transparency, then you actually have had a useful document to
get people to come together. It's not an imposed regulation.
It's an agreement about how they are going to try to conduct
their own business, going forward.
And that, I think, is actually encouraging, because it is
an international agreement about how to approach this matter,
which is, I think--I don't want to offend anybody here in
Congress--is probably preferable to doing it unilaterally by
our own action.
Mr. Meeks. Thank you. Let me ask one other question, then
I'm going to yield to Mr. Watt and Mr. Manzullo is--or to the
chairman.
Different area. Trying to figure out how to, you know,
maybe you can do some good for poor countries. And Bob Zoellick
of the World Bank had said not too long ago, and urged some of
the sovereign wealth funds to invest 1 percent of their assets
in equity in Africa. And you know, I sit on the Foreign Affairs
Committee also, and look at the condition of Africa and the
infrastructure and things.
I was just wondering. What would your opinion be that we
would--to set--in Chile, all the countries got together and
said, ``We are going to put together 1 percent, we are going to
set aside 1 percent for investment and infrastructure and other
things in the continent of Africa,'' what would you--what's
your opinion of something of that nature, as Mr. Zoellick had
put it?
Mr. Truman. You have heard from me on this subject, so I
will let someone else answer.
Mr. Drezner. I will give a quick answer. I would say, first
of all, as I said before, there is a political tension in some
of these countries that host sovereign wealth funds about the
fact that they are holding trillions of dollars of assets, but
within their own country are relatively poor.
So there might be--that tension might still exist. If China
was suddenly to say, ``We are going to dedicate 1 percent of
our sovereign wealth fund to helping Africa,'' I could see
citizens in Chengdu asking, ``Well, what about us?'' So that
could be one problem.
The second thing that should be pointed out is that the
foreign policy effects of this we are already seeing in Africa
in the form of official Chinese investment, in terms of aid
flow, which is--on the one hand, this would undoubtedly help,
in terms of African economic growth. On the other hand, it
would also cause these countries to be far less willing to make
policy reforms advocated by the United States and by the bank
and fund, because they would be less dependent upon the bank
and fund for development capital.
Mr. Meeks. Mr. Manzullo? Thank you.
Mr. Manzullo. Well, thank you. I am sorry I'm late, but in
this great world of automation, I was trying to make a car
payment on the Internet, and then on the telephone. And so I
finally had to call the government office of the car
manufacturer to say, ``Why don't you have somebody answer the
telephone?''
So, I guess maybe my question to each of you would be,
``When someone calls your office, do you have a live person who
answers the telephone,'' but I don't want to do that.
I am just throwing that out. In fact, when I was with
Secretary Gutierrez several months ago, and people wanted to
know how to grow business and succeed, he said, ``The first
thing that you never do is have an 800 number or an automated
answering machine.''
I don't know why I brought that up, but the level of
frustration is high, and it's the same time that somebody cut
the telephone line in front of our house back home, and my wife
was on the cell phone waiting for the telephone people to pick
up her phone.
The--when CFIUS was amended last year, I offered the
amendment that called for the elevated level of review, in the
event that there was a sovereign wealth fund involved. It
probably came out of the Dubai transaction.
And when I look at these sovereign wealth funds--I mean,
for example, in the United States, a State teacher's pension
union--I'm sorry, a State--yes, a State teacher's union pension
fund, that would be called a sovereign wealth fund, is that
correct? Because--
Mr. Truman. I would, but not everybody would.
Mr. Drezner. There is some debate on this issue.
Mr. Manzullo. Well, that's like the telephone company. I
mean, you know, tell me--because I see in--go ahead.
Mr. Truman. Well, if it is a foreign government pension
fund, it would be subject under CFIUS to the same kind of
government restrictions. I am sure that I don't speak for the
United States Treasury, but it would fall under the government
category of CFIUS regulations today.
Mr. Manzullo. Right.
Mr. Truman. If it is a foreign government pension fund.
Mr. Manzullo. Right.
Mr. Truman. So, if it was Canada, or it was Canada's
pension fund, it would fall under the government regulations.
Now, whether it was, strictly speaking, a sovereign wealth
fund is another matter. The Canadians--as they probably told
you in that hearing--said, ``No.'' They think they are not. I
think they are--it quacks like a duck. The Canadian pension
fund, as far as its being a sovereign wealth fund, in my view,
because it quacks like a duck, therefore it is a duck, and I
would consider it that. But the Canadian pension fund does not
consider itself a sovereign wealth fund.
Mr. Manzullo. All right. The reason I ask that is that I
know there was a lot of angst--and, in some cases, rightly so--
but according to the stats that I look at here from Dr. Truman,
it says that governments in the United States own or control
more than $3 trillion, or 20 percent of the global government
total of sovereign wealth funds.
And so, you have made the statement. I guess I was just
asking you to--
Mr. Truman. Okay. Sorry. We have U.S. State and local
government pension funds that are approximately $3 trillion in
value.
Mr. Manzullo. Okay.
Mr. Truman. And approximately a quarter of those funds are
invested abroad. That's an estimate, since I haven't counted
all of them. But that's how much CalPERS, which is one of the
biggest ones--
Mr. Manzullo. Okay. Let me stop you right there, then.
Mr. Truman. Okay.
Mr. Manzullo. State and local pension funds would be
considered to other countries SWFs.
Mr. Truman. Well, think about it this way. Certainly,
Alaska's fund is. And, in the case of Abu Dhabi and Dubai,
those are states within the United Arab Emirates.
Mr. Manzullo. Okay.
Mr. Truman. So you're dealing with subnational units in the
case of Abu Dhabi and Dubai.
Mr. Manzullo. Okay.
Mr. Truman. And so you only have a question of whether you
want to think of a pension fund as a sovereign wealth fund.
And, in terms of political issues, as Dan pointed out when he
cited the example of CalPERS, many people would argue that
CalPERS has a political agenda in its investment strategy. I
don't think it has been political in the past.
Mr. Manzullo. You mean that California wants to secede from
the union?
Mr. Truman. Yes, or the rest of us want to throw them out.
Mr. Manzullo. Okay.
Chairman Gutierrez. The time of the gentleman is--
[Laughter]
Mr. Manzullo. Chairman, thank you. I know that--I was
just--the point of my inquiry was to try to define and lower
the expectations of many that there is something innately wrong
with SWFs. And you answered the question. Thank you.
Chairman Gutierrez. Congressman Watt.
Mr. Watt. Thank you, Mr. Chairman. Let me just say first I
was privileged to accompany the chair of this subcommittee to
Abu Dhabi and various places to look and understand more about
sovereign wealth funds, and came away with less of a concern,
probably, than--coming back, than I had when I left the United
States going there, partially because those sovereign wealth
funds that we looked at were controlled by people who were
friendly to us, as has been indicated.
The larger problem, as I saw it, was that you can't set up
a set of rules in what is theoretically a free world market for
one set of people who are your friends that is different than
the set of rules that you set up for those who are not your
friends.
And I think either Mr. Setser or Mr. Drezner--I didn't hear
Mr. Truman's testimony, so I know it wasn't him--but one of you
talked about this tension between the old funds and the new
funds. The problem is that you can't have a different set of
rules. Or can you have a different set of rules for those
people who are your friends? In the economic free market, can
you have a set of rules that is different for your friends than
for your enemies?
Can you have two sets of rules, first of all? I guess
that's the--and I would welcome a yes or no answer to that,
because I--
Mr. Drezner. I am an academic, sir, so I would have to say,
``It depends.'' I can't give you just yes or no.
I mean, my understanding of the CFIUS procedures is that
the--
Mr. Watt. Don't talk to me about CFIUS. I am talking about
rules in general, transparency, because I am going on to CFIUS.
Do you accept the general proposition that you, in a free
economic world market, have to have a set of rules that are
consistent, across the board?
Mr. Drezner. I would say yes.
Mr. Watt. Okay. All three of you--
Mr. Truman. And I would say, you can do it--have the same
rules--but I--
Mr. Watt. Yes, you can. But--
Mr. Truman. You end up--
Mr. Watt. But the general proposition is that you have to
have--
Mr. Truman. It's unwise, yes.
Mr. Watt. All right. If that is the case, then I guess my
next question, then, becomes is CFIUS adequate to--actually, it
could set up a different set of rules, as far as CFIUS is
concerned, because it's about national interests. And I
understand that we could set up a different set of rules
related to national interest, based on who our friends are and
who our enemies are.
I haven't been all that enamored, historically, with the
choices that we have made across the board about who our
friends and who our enemies are, in terms of dictators, you
know. They serve our interest, even though they don't promote,
necessarily, our values. But that's a different question.
I accept that notion. Okay. The 20 or so countries got
together and they made up these transparency rules. What
happens if our enemies say, ``We don't abide by those
transparency rules?'' They really have no enforceable effect at
this point. That's where governments step in, I guess. The
private market can set up some rules, but it can't enforce the
rules, I take it.
Are the rules sufficiently enforceable, and equally
applicable to both our friends and enemies, other than CFIUS,
that you're satisfied where we are at this point, I guess is
the bottom line question that I am asking.
Mr. Truman. Let me try this.
Mr. Watt. Okay.
Mr. Truman. The first part of the answer is that we don't
know yet, because we don't know what the rules are. But let's
assume that the rules are ones that you and I would agree on
were sensible rules.
I am now going to give you a hypothetical answer. That
group got together and wrote rules. There were various
countries, including Russia and China, to use those two
examples, who participated in the process. They now have a lot
of peer pressure--
Chairman Gutierrez. Dr. Truman, I ask you to--we have a
vote on the House Floor.
Mr. Truman. They will have a lot of peer pressure to obey
those rules. And there is no assurance of that, but I think
there will be a lot of pressure on them, as sovereign wealth
funds, to abide by the common rules that were agreed.
Chairman Gutierrez. Thank you very much. Congressman Keith
Ellison, from Minnesota.
Mr. Ellison. Professor Drezner, in your submitted testimony
for today's hearing, you mentioned a comment made by former
Treasury Secretary Larry Summers about the geopolitical
concerns caused by ``the financial balance of terror.''
Could you extrapolate on that thought a little bit, and
share what you had in mind when you made those comments?
Mr. Drezner. Certainly, Congressman. Traditionally, if you
study international relations, you tend to observe that there
is a lot more cooperation out there on economic issues than
there are on security issues.
And one of the reasons this has been hypothesized to be the
case is that if countries defect from the rules of the game on
trade, or if they defect the rules of the game on finance, the
implications aren't immediate. Whereas, if a country defects on
the rules of the game in security, you have a war, and it's
suddenly a very instantaneous shift in the distribution of
power.
One of the things that is happening as a result of the
deepening financial interdependence we are seeing now is that
the game in economics is beginning to shift from one where if
there is a defection there are costs, but the costs play out
over a long period of time, to the point where if the People's
Bank of China were to decide not to buy agencies, or sovereign
wealth funds were to decide not to buy dollars, the effects
could be potentially much more drastic and much more immediate.
Now, does this mean, therefore, that will happen? No. Just
as in the case of where you had countries with large numbers of
nuclear weapons, mutually assured destruction means you don't
have an incentive to strike first.
So, as a result, my tendency is to think that there is a
financial balance of terror. And, really, the question is how
comfortable are you with that? Mutually assured destruction led
to 40 years of peace during the Cold War, but it also led to a
fair amount of anxiety, as well. And I am just trying to be
balanced in saying there is some good and there is some bad, as
a result of this.
Mr. Ellison. Thank you. This is one for all of the
panelists. What do you believe is the key to preventing the
politicization of sovereign wealth funds? Is the solution for
the recipient country to control which funds are allowed to
invest in that country, or is it more effective to establish
transparency guidelines for all sovereign wealth funds to be
held within their countries of origin?
Mr. Setser. If I can begin, I mean, I think all sovereign
funds are created as a result of a political decision of one
kind or another.
The decision to take oil export revenues and to channel
that to a sovereign fund, rather than to use it to finance
domestic investment is a political decision. The decision to
intervene in the foreign currency market, to keep your currency
from going up, is a political decision. The act of accumulating
foreign assets, if you're a government, is a political
decision.
The question then becomes--and you know, we in the United
States have a limited capacity to directly stop that, and we
pay a good dollar for imported oil. Once we paid the dollar,
it's someone else's decision about how they want to use that
dollar. They can use it to buy more goods, or they can use it
to buy more financial assets.
Once, though, they have made a decision to not spend the
dollar, to invest the dollar, then they have a series of
choices about how to invest. And many countries have a national
interest in making money. They save the dollar, and they would
like to make more money.
Other countries may have another kind of national interest.
They may say, ``Well, we, as a country, are under-represented
in the global ownership of oil or minerals, so we would like to
invest in ways that would increase the share of global mineral
supply that is owned by our nationals. And, as a government, we
have the foreign exchange, we can help channel some of that
foreign exchange to state companies that are expanding
abroad.''
That is a decision, it's a political decision. It may not
fall under the rubric of an investment by a sovereign wealth
fund, and I think that's one of the points of agreement amongst
our testimony, that focusing solely on sovereign wealth funds
is too narrow. There is a much broader rubric of sort of state
capitalism, state enterprise, all of which can draw indirectly
on some of the foreign exchange.
You can also make an investment that is designed to
enhance--support your own economic development. Now, that's
kind of an awkward thing to do because, remember, the beginning
point is a decision that you didn't want to spend the money at
home, and you were shipping the money abroad. So there is sort
of a tension there.
But you could buy assets which you think will have positive
spillovers for your own plans for economic development. Maybe
you will invest in a company and then they will make an
investment back in you, which kind of undoes some of the
initial decision to invest abroad.
Or, you think that you can buy some intellectual property
which has some value to you, and that is why there is a process
of review. And I think that is sort of a sensible way of trying
to balance the reality of money that is under control of
governments can be invested for a range of purposes, probably
primarily to make money, but not necessarily exclusively. And
you have to evaluate it on a case-by-case basis.
Mr. Truman. I think that was a good answer. A clear answer
to a complicated question.
Mr. Ellison. Yes, right. Are we done?
Chairman Gutierrez. Thank you. Yes, the time of the
gentleman has expired. We have about 7 minutes before we have a
vote on the House Floor.
First, I want to thank you all. I wish we didn't have to go
vote, so we could, I am sure, have members continue to engage
in this conversation, this dialogue that we are having. We are
going to have more hearings on sovereign wealth funds. I think
it's important that this panel understand it, and that the
Financial Services Committee take issue with it.
But it seems to me that what I come away with, more and
more--whatever panel--is that: China undervalues their
currency, which leads me to believe that the only way you can
do that is to manipulate your currency; that they are a growing
economic force; they are changing the world, not just because
of the Beijing Olympics and how many gold medals they won,
though that's an indication of what they are investing in; and
their prestige, internationally.
It's not something I am particularly afraid of, I just want
to make sure we are strong, and that we have--and that there is
some balance and fairness, and that we are not--you know, they
are not getting some--and I think that when you bring--we look
at--and I am going to continue to look, and I thank you for all
stressing sovereign wealth funds is a symptom.
But when you have Russia controlling all of the gas,
attempting to control all of these new gas pipelines, and all
of these new--how would I say it--energy pools, when you see
the way they are acting in Georgia, when we know we have not
transparent governments with not transparent billions of
dollars, I think I am not quite as unworried as all of you are,
or appear to be, as you testified today before this committee.
Things have a way of changing. I have seen China. We have
seen how China acts in Africa when it wants raw materials, and
the kind of governments that it will support, in spite of our
best efforts. That is a scary situation, what they are going to
be doing with their sovereign--and I understand it.
I really--and, Dr. Truman, I thank you for putting these
sovereign wealth funds in the categories, because I like the
fact that you actually give them points. And, I mean, for
transparency, and the way--and I think that is a huge
difference in something that my colleague Mr. Watt, and
others--you know, what is the--they are not all the same. They
are not all the same.
And I just want to end with this. I went to Abu Dhabi. I
went to Dubai. I came back, much like Mr. Watt, less worried
about them. I mean, they surround themselves with these--they
are either Brits or Australians or Americans. It's hard to tell
that they were actually a sovereign wealth fund.
But what's curious is when you ask them who controls the
money, they try to act as though they were equity traded on
the, you know, S&P 500 or the U.S. Stock Exchange. They won't
give you the name of the sheik, they won't give you the name of
the crown prince who actually controls the money. And in that,
there is a distinct difference. And with Russia, there are
other kinds of differences.
So, I thank you all for coming. I want to thank the
witnesses and the members for their participation.
The Chair notes that some members may have additional
questions for the witnesses which they may wish to submit in
writing. Therefore, without objection, the hearing record will
remain open for 30 days for members to submit written questions
to the witnesses and to place those responses in the record,
and also to submit written statements for the record.
This subcommittee hearing is now adjourned. Thank you.
[Whereupon, at 3:35 p.m., the hearing was adjourned.]
A P P E N D I X
September 10, 2008
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