Tuesday, June 24, 2008

America For Sale

History, once again, repeats itself. Prior to the crash of the Nikkei in the early 1990s, the acquisition of U.S. real estate and corporations by the Japanese was a source of substantial anxiety and prognostication of future economic dominance. The 1980s might have been the pinnacle of the Japanese economic revolution, but the speculation that propelled stock and real estate prices to lofty heights is similar to the mania that incited the technology and housing bubbles in the United States. Now, with real estate values depressed, the credit markets in turmoil, the dollar progressively weakening, and the stock market teetering on the breach, U.S. assets are attractive to foreign buyers prompting significant capital inflows. While foreign direct investment provides a substantial stabilizing force during a period of capital constriction, it also provokes deep consternation among a populace facing the potential for a deepening recession and extensive job losses.

The media has reported extensively on sovereign wealth funds which are state owned investment pools used to invest reserves and government funds in financial assets such as stocks, bonds, and real estate. The growing debate over sovereign wealth funds follows the 2006 controversy in which Dubai World, a company owned by the government of Dubai of the United Arab Emirates, acquired the Peninsular and Oriental Steam Navigation Company (P&O) of the United Kingdom along with the operating rights to six major U.S. port facilities. Congress expressed their innate protectionist bias and blocked the acquisition of the U.S. ports in the name of national security. The Dubai World controversy culminated a burgeoning trend of protectionism that arose in 2005 when Congress orchestrated the acquisition of Unocal (Union Oil Co. of California) by Chevron after the Chinese National Offshore Oil Corporation (CNOOC) made an aggressive bid for the company. Again, Congress opposed the acquisition based on the guise of national security as they ostensibly feared that China would hoard the oil resources to meet their growing demand.

In response to these failed attempts at foreign direct investment, governments resorted to sovereign wealth funds to invest assets primarily through investment managers and advisors around the globe. The unbridled consumerism in America leads to a persistent trade deficit leaving many trading partners flush with dollars. Additionally, the depreciation in the dollar combined with inflation in energy and commodities has exacerbated our trade deficit with many resource rich countries. As these countries amass stockpiles of dollar reserves and generate “windfall” profits through their state owned companies, government officials must evaluate their relative appetite for American goods and services versus financial and real assets. Historically, many of these countries invested their reserves in U.S. Treasury notes and bonds, but the current negative real interest rates encourage diversification of their portfolios.

Many sovereign wealth funds are deploying their reserves across a diverse set of investment vehicles including hedge funds, separately managed portfolios, private equity, and direct investment. As major banks deleverage by raising capital and selling assets to cope with the effects of the housing implosion, sovereign wealth funds have purchased direct stakes in many banks including a $7.5 billion investment in Citigroup by Abu Dhabi, the largest sovereign wealth fund at over $875bb in assets, and a $5 billion investment in Merrill Lynch by Singapore’s Temasek Holdings. Sovereign wealth funds, with assets totaling an estimated $3 trillion, have made more than $30 billion in direct investments in U.S. financial institutions. Generally, to avoid the ire of protectionists and the associated regulatory scrutiny, these funds have remained under the 5% ownership threshold and have forgone voting rights. Even so, the sovereign wealth funds’ growing direct investment in U.S. corporations and less transparent investment through hedge funds and separately managed accounts has raised public concern and prompted Congressional hearings.

Contrary to the populist movement towards a more insular economy, the United States should embrace the capital infusions provided by sovereign wealth funds during a credit crisis that ultimately claimed one of the largest investment banks in the country, Bear Stearns. The willingness to provide sizable capital infusions to the U.S. financial system in a time of crisis reflects a global confidence in the resilience and attractiveness of the American economy. Populist complaints reflect a desire to change the terms of the game, a common desire amongst a populace accustomed to bailouts and intervention (e.g. the proposed housing bill in Congress). The American people have mortgaged their futures for the sake of current consumption. It can only be expected that claimants, otherwise defined as the holders of dollars, will eventually collect by exchanging their dollars for U.S. goods and services, financial assets, and direct investment in corporations and real estate. America is for sale because the populace has an insatiable appetite for consumption that is checked neither by reason nor by income. Eventually, the risk premium for financing this consumption manifests itself in the form of higher nominal interest rates, inflation, and currency devaluation.

Ultimately, the global economic system relies on the belief that the dollar is readily exchangeable for U.S. goods, services, and assets. It has obtained global preeminence as a reserve currency due to the confidence in the property rights protections, financial stability, and credit of the United States. After decades of borrowing to finance an voracious appetite for consumption, the American debtor society must show restraint by reducing imports and paying down personal debt. Government policies against domestic drilling, nuclear and coal power plants, and refining capacity assure a dependence on foreign oil and the further mortgaging of America. Unless U.S. consumers redirect their income from excessive consumption to investment in domestic infrastructure, the United States will continue to rely on foreign capital and imported commodities to sustain our economy. And rest assured, this debt will eventually come due!

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