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18 Jan 08
The greatest shift of capital in world history, now washing across Asia, poses a dilemma for policymakers
What is Asia going to do with its money? Because of the astonishing profligacy of the western economies, primarily the United States, the region’s 11 biggest economies have amassed the biggest transfer of financial resources in the history of the world. Although most of the focus has been on China, with its US$1.5 trillion in reserves, the region as a whole holds more than double that amount, nearly US$3.9 trillion. And, by one estimate, the figure appears set to soar upward even further, to US$5.1 trillion by the end of 2009.
It is questionable how long this can go on at the present pace, however. Ultimately it would probably collapse the global monetary system. Debt of that magnitude is not repayable and thus the trust basis of the reserve system would simply collapse. Nonetheless, the way the region manages this massive amount of money can be expected to dominate global economics and financial markets for decades to come. But with few really sophisticated financial markets, and lots of barriers remaining to regional flows of capital, how will this be handled?
For perhaps the last two to three decades, the global trade system has functioned as a kind of perpetual motion machine in which the United States in particular exported a vast amount of its industrial plant to Asia in search of cheap labor. Asia’s mercantilist economies, primarily Japan and China, made cheap goods and sent them to the west, driving trade balances deep into negative territory. The profits from those goods were then recycled back into US stock markets, treasury and corporate bonds, money market funds and other financial instruments used to keep the west, particularly the US economy, going.
But perpetual motion machines work for only so long. Successive US governments, fearing rejection at the ballot box, did nothing to stimulate domestic savings to prompt domestic investment or to cut consumption. Even in areas where the US had a real advantage, including information technology, biotechnology and aerospace, the country began to lose its lead. Services, which it long dominated, also began to slip into the red. The US has thus become Asia’s biggest debtor by far, its international deficit in goods and services now having reached US$63.1 billion for the month of November alone, the biggest total in 14 months.
This wasn’t supposed to happen. The falling dollar and slowing US economy were supposed to begin to reverse that trade balance. But it doesn’t appear to be working yet. Asia’s central bankers and policymakers are beginning have major concerns about the capital inflows, especially to financial markets, pressuring currencies to rise and creating the conditions for inflation.
“The resulting huge accumulation of foreign exchange reserves leaves these economies far better able to deal with potential financial shocks than in 1997,” according to the Asian Development Bank in its July, 2007 Asian Economic Monitor. But, the ADB says, “Surging capital inflows… impose a significant challenge to the region, as inflationary pressures build and world interest rates continue to rise. Given that financial market stability is critical to macroeconomic management, capital flows have become a significant factor affecting policy decisions in these emerging East Asian economies. Policy options are limited because of the increasing conflicts between domestic and external objectives.”
Beyond China, India is perhaps the best example. Although not as big as those of China or Japan, India’s foreign exchange reserves soared from US$192 billion in 2006 to US$284 billion in 2007 – a 47.9 percent jump in a single year. But even tiny Brunei, with a population of about 380,000, holds between US$40 billion and US$60 billion (the exact amount is a state secret). Singapore, with only 4.5 million citizens, holds US$261 billion. Hong Kong, with 7.5 million, holds US$149 billion.
The holders of these reserves, denominated in US dollars, are obviously hostage to their debtors. China alone holds US$1.499 trillion in reserves. According to Qu Hongbin, HSBC’s chief economist for China, “China’s position is just too long in the dollar. If they are going to make any significant reallocation or shift, it would be almost suicidal. Once the market smells that China would sell down dollars, the dollar would go into free fall.”
Although the latest data indicate that China’s trade surplus growth may have peaked, with import growth exceeding export growth over the final three months of 2007, the country has vast resources that Beijing is delicately seeking to manage in a way that would preserve their dollar value. But, Qu says, “It’s just like a bank. If you lend too much money, the last thing you want to see is this guy go bankrupt. When poor Asia lends too much money to rich America, it becomes a hostage.”
In 2006, gross capital inflows into Asia reached a record US$269 billion, spurring the ADB’s concern. But in 2007, that amount soared to US$740 billion, increasing the pressure to drive up asset prices and putting pressure on exchange rates. It has driven the spectacular growth of sovereign wealth funds funds controlled by governments to buy and manage foreign assets. So far few sovereign funds have covered themselves with much glory. The US$200 billion China Investment Corporation bought US$3 billion worth of the investment company Blackstone only to see its shares collapse by US$600 million. A similar US$5 billion investment in the troubled investment bank Morgan Stanley came just as the extent of the subprime crisis was starting to hit financial markets.
Nonetheless, today, according to a study by Joshua Aizenman for the Federal Reserve Bank of San Francisco, sovereign wealth funds hold assets ranging from US$1.5 to US$2.5 trillion, an amount that is expected go grow seven-fold over the next decade. This is “an amount larger than the current global stock of foreign reserves of about $5 trillion.” Sovereign wealth funds, Aizenman writes, “‘have stirred debate about the extent to which their size may allow them to destabilize financial markets and their policies may be driven by political, rather than economic and financial, considerations.”
The two most visible – and oldest – sovereign wealth funds are in Singapore, the Government Investment Corporation and Temasek, which have combined assets of US$200 billion and have long faced questions over lackluster investments. The latest was Temasek’s US$6.2 billion purchase of 9.4 percent of the US investment bank Merrill Lynch on January 3, only to have Merrill announce on January 11 that it was taking a US$15 billion writedown because of the subprime crisis. Another is the Korea Investment Company, with US$20 billion in assets. The bulk of sovereign fund assets, however, are held in the petro-oligarchies of the Middle East, which have combined assets of more than US$1 trillion between them.
Where is this money going to be invested? Up to six months ago, western powers were humiliating Asia’s attempts to buy western assets – see China’s attempts to acquire Unocal and the white goods manufacturer Maytag. Even attempts by Hong Kong tycoon Li Ka-shing, to take over the infrastructure of the Panama Canal were rebuffed on suspicion that he might be too close to the communists in Beijing.
But today, given the growing desperation of American investment banks in particular, the sovereign wealth funds’ money is considerably more appreciated – just ask Merrill and Morgan Stanley.