A New Global Force?

Since an LBO is by definition predicated on easy access to cheap credit, it is hardly surprising such activity has been curtailed sharply since mid-2007, when the environment of tighter credit set in. Increasingly, deals are being postponed because private equity firms are failing to find funding. Even blue chips, such as Blackstone, have been impacted. Blackstone, for example, has not been able to finance its $1.7 billion buyout of PHH, a mortgage lender. Even worse, a jittery stock market has made exit strategies for private investors more problematic. Last year, the number of buyout-backed IPOs fell to 32 from 59 in 2006. Worse, rising interest rates and bad loans have made carrying massive amounts of debt ruinous. The shares of Blackstone Group, which went public in mid-2007, traded at less than half of their IPO value by mid-January.

Volatile and declining stock prices have created opportunities for cash-rich sovereign funds to get a foot in the door in some key strategic sectors. In particular, they have been piling into the global financial services industry, which has begun to totter under the weight of the subprime mortgage crisis in the United States. The ADIA invested $7.5 billion into Citibank, while China Investment Corp plowed $5 billion into Morgan Stanley. Temasek, the Singapore fund, has been looking to invest in UBS and Merrill Lynch. U.S. regulators, grappling with the need to bolster the U.S. banking system and to steady investors’ nerves, welcome the infusion of funds, never mind their source.

Humble OriginsBut could fears of sovereign funds be overblown? Not only political fears, such as concerns that the governments of China, Russia or Persian Gulf states could use their accumulated cash to buy into vital industries in the West and to advance their own murky national or religious agendas, but economic fears as well?

For all their financial muscle, sovereign funds are creatures of necessity, not tools of aggressive M&A policies. Norway’s fund was set up because the government realized that its oil reserves will start running out some time after 2020 and decided to put money aside for future generations. More immediately, the inflow of petrodollars was stoking domestic inflation and pushing up industrial wages. Norway risked contracting the so-called Dutch disease, i.e., losing competitiveness and suffering deindustrialization because of its commodity exports.

When Norway started its stabilization fund in 1996, other oil producers were not in the picture. Oil prices were on their way down, bottoming near $10 per barrel late in the decade, and commodity exporters, including Persian Gulf oil producers and even mighty Saudi Arabia, were going through major difficulties. Far from flexing their financial muscle, they were scouring international capital markets for loans. Nor was China in such a great financial state. In 1997-1998, it suffered a speculative attack on its currency. Russia went through a debt default and devaluation in 1998. Its hard currency reserves, which now measure over $400 billion, tumbled below $10 billion.

Less than a decade ago no one could suppose that the world would soon start to worry about those countries flexing their formidable financial muscle. This means that sovereign wealth funds, despite their huge cash holdings, may not prove to be such lasting players in global financial markets. They may disappear as swiftly as they burst onto the stage. Oil exporters live and die by the price of oil, and China, Singapore and other exporters of consumer goods rely on consumer demand in the United States and other rich markets. Countries such as Russia and China, which have to support very large populations, may be forced to liquidate their sovereign fund holdings quickly, and even low-absorption nations in the Persian Gulf may suffer considerable reversals.

In the late 1980s, Japan Inc., a secretive national business empire, was loathed and feared around the world. Conspiracy theorists suspected that Japanese conglomerates were buying up the rest of the world, using the dollars they amassed from their enormous trade surpluses. Japanese investors did buy some U.S. movie studios, golf courses and office towers. But most of those investments went sour and Japanese investors had to withdraw ignominiously. Sovereign wealth funds may prove to be another such non-threat.

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Alexei Bayer runs KAFAN FX Information Services, an economic consulting firm in New York; reach him at [email protected]. His monthly “Global Economy” column in Research has received an excellence award from the New York State Society of Certified Public Accountants for the past four years, 2004-2007.