We have spent a week preoccupied by our own affairs: by the pre-Budget report and the political fallout from it. But while the decisions of Alistair Darling, assuming they are not changed by next spring, have a practical importance for us, they are hardly earth-shattering as far as the rest of the world is concerned.
From a global perspective, the two huge economic issues have been, first, whether consumer demand from the "new" economies of Asia will take over from the US consumers and keep the global boom going, and second, what the emerging economies will do with their savings. I want to focus on the second, partly because this has attracted less attention but also because it will become a more important issue right across the developed world.
The story is familiar. China, the Middle East and Russia have been running vast current account surpluses, China as a result of its export boom and the Middle East and Russia because of the surge in the price of energy. One way of looking at this phenomenon is to focus on the surpluses and the need for adjustment – for the US (and the UK) to run smaller current account deficits and for China to run a smaller current account surplus. But another is to examine how the creditor countries are using their money.
This is changing. Three years ago, most of the money built up in official accounts went into US government securities. Now it is being diversified in two ways: it is going into a wider group of currencies and a wider group of investments. Some new data, collated by Merrill Lynch, highlights these shifts. The investment bank points out that central banks control more than $5,600bn in reserves and are adding nearly $1,000bn a year to that stock. But central banks, by their nature, hold short-term financial assets and gold; it is not their job to invest long-term.
So countries are forming so-called "sovereign wealth funds" to manage the longer-term portion of their national assets. Some have been around quite a while: the Kuwait Investment Authority was founded in 1953 when it became clear the country would build up huge surpluses that could not realistically be invested at home and so should be held in trust for future generations.
But now there has been a sudden spurt of new funds. The reserves of the central banks have ballooned, putting pressure on governments to invest longer-term. (The size of the top 10 central bank holdings of reserves, excluding gold, is shown in the first chart and the rise of such holdings in different parts of the world each year since 1999 is shown in the second one.) China and Russia have both founded sovereign wealth funds this year and Russia is expected to set up another next year. Merrill Lynch reckons that the present stock of assets held in these funds is somewhere between $1,586bn and $2,228bn and that this will grow to nearly $8,000bn by 2011. "The bathtub," says Merrill Lynch, "is now overflowing."
So where will these funds go: equities, property? To put the numbers into perspective, the total market capitalisation of the world's equity markets is $24,200bn, while non-government debt instruments amount to $13,400bn.
Assume, to keep the numbers simple, that the annual flow of investment funds is some $1,500bn a year. So if all the money from these sovereign funds was invested in shares, this would be equivalent to more than 6 per cent of the stock of equities each year. It seems unlikely that the world's corporations will issue anything like that amount of new securities, even allowing for the privatisation of the major Chinese banks and other institutions. So, other things being equal, that seems a recipe for rising share prices.
Merrill Lynch is more precise in its judgement. It argues that it takes a while for countries to build up the staff and other infrastructure to invest funds broadly and meanwhile the taps are full on. It thinks that, in the short term, it will be mainly Middle East investment funds that go into equities because they have the structure in place to do so. But in the medium term the focus will shift to Russia and China and they will become the big investors in the riskier sorts of investments. Merrill Lynch predicts five big trends:
1) A shift into riskier assets.
2)A shift out of government into private sector assets.
3) A shift out of dollar-denominated assets.
4) A shift out of internally managed assets.
5) A shift in the centre of gravity to Asia and Russia.
If this is right (and it feels rational to me), there will be a number of consequences. Perhaps the biggest losers will be safe assets inside the US, most notably US government bonds; America will have to pay more to finance its deficit. Among the big winners (aside from the global investment industry) will be risky assets outside the US.
What will those non-US risky assets be? Well here I am not sure that we can know. But if we don't know what choices investors in Russia and China will make, we can be absolutely certain that their decisions will shape the world investment scene. And naturally, the world's investment community will craft instruments to suit this new band of investors. This is a huge shift of power.
The most interesting aspect goes beyond the remit of the Merrill Lynch paper. It is how a world will look where decisions are made not by investors in the "old" economies but by investors in the "new" ones – and with a lot of those investors being government agencies rather than private financial institutions. There is a precedent that is encouraging: the Kuwait Investment Office in London has been a skilled and honourable investor over many years.
In Britain we have a long and basically benign experience of such foreign investment. But I wonder whether the US will feel happy about its assets being bought up by the sovereign funds of China, Russia and the Middle East. I rather think not.Reuse content