The Next Globalization Backlash

By Sebastian Mallaby
Monday, June 25, 2007

The next globalization battle lurks over the horizon, but you can already guess its contours. It will be shaped by two revolutions in finance and business: the growth of vast government-controlled investment funds abroad and the muddled progress toward shareholder democracy in this country. Taken together, these changes will give foreign governments a say in how corporate America is run. Lou Dobbs is going to love this one.

The rise of government investment funds suddenly preoccupies financiers. Treasury officials who never before gave a thought to these outfits now want them on their speed dials. Five years ago, governments were sitting on $1.9 trillion in foreign currency reserves, which was roughly what they needed to stave off financial crises. Now they have $5.4 trillion, way beyond their prudential needs and more than triple the amount in the world's hedge funds. Increasingly, this cash is being moved into "sovereign wealth funds," which have come from obscurity to manage assets worth an additional $1.6 trillion.

These reserves are likely to keep growing. A big chunk of the expansion has occurred in energy-exporting states, and the prices of oil and natural gas show no signs of falling. High energy prices explain why Russia's government, which had negative assets at the time of its default in 1998, now has reserves worth $315 billion, plus an investment fund worth $90 billion. They explain why Nigeria, which pleaded poverty and secured debt relief as recently as 2006, is now sitting on reserves of $80 billion. The Kuwait Investment Office is rumored to manage $500 billion, and the United Arab Emirates has an investment fund worth perhaps $1 trillion (the Arabs won't disclose the real numbers).

The second motor behind sovereign funds is the global trade imbalance. East Asia's exporters rake in dollars that they convert into domestic currency, and the dollars wind up in the region's central banks: China has accumulated an astonishing $1.2 trillion in foreign currency reserves and Japan around $900 billion. Even though the U.S. trade deficit is starting to shrink, it remains huge by historical standards. The flip side is that East Asia's trade surpluses will persist, and the region's central banks will bulge with yet more money.

When central banks amass reserves, they park them in U.S. Treasury bills and risk-free bonds issued by other rich governments. But the buzz about sovereign wealth funds signals that this is changing. The newly wealthy governments are following forebears that grew rich a generation back -- the Gulf states, Singapore, Norway. They want a better return on their savings than they can get from Treasury bills, so they are going to invest in companies.

This need not be sinister. As former Treasury secretary Lawrence Summers argues in the new book "Sovereign Wealth Management," a government that fails to invest excess reserves in corporate assets is irresponsible. Sovereign wealth funds can professionalize the management of national wealth, argues the book's editor, Jennifer Johnson-Calari of the World Bank. A generation ago, the government of Sao Tome might have hidden its oil revenue in Swiss accounts. Today it is consulting the state government of Alaska about sound and transparent management.

But the political backlash is already beginning. China just bought a $3 billion stake in Blackstone Group, the American private-equity firm that sold a chunk of itself to outside investors last week. Blackstone's IPO was controversial even without the China connection -- private-equity firms are already viewed as the engines of ruthlessly competitive global capital, and now they are allied with the engine of ruthlessly competitive global labor. Sen. Jim Webb (D-Va.) raised the predictable red flag. Blackstone may own firms with sensitive national-security information, the senator maintained; therefore, the Chinese investment in Blackstone should have been delayed by regulators.

Imagine Webb's protests if the Chinese do what they say they will do: emulate one of Singapore's national wealth funds, Temasek Holdings, which buys direct stakes in foreign companies without going through a middleman such as Blackstone. Chunks of corporate America could be bought by Beijing's government -- or, for that matter, by the Kremlin. Given the Chinese and Russian tendency to treat corporations as tools of government policy, you don't have to be paranoid to ask whether these would be purely commercial holdings.

But the final straw may be that even the least threatening form of investment -- the purchase of publicly traded equities -- will not escape controversy. This is because of that second upheaval: the advent in the United States of something approaching shareholder democracy. As Alan Murray writes in his new book, " Revolt in the Boardroom," companies are no longer controlled by all-powerful CEOs. Instead, chief executives increasingly live in fear of activist shareholders and directors. Bosses from Harry Stonecipher of Boeing to Carly Fiorina of Hewlett-Packard have been ejected from the corporate suite in a manner that would not have been conceivable a generation earlier.

What if the Chinese are seen to have a hand in the firing of some future Fiorina? The more shareholders exercise power, the surer the backlash against governments that buy up chunks of the stock market.

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