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Economic SYNOPSES short essays and reports on the economic issues of the day 2008 ■ Number 11 The Sovereign Wealth Funds of Nations Christopher J. Neely S current budget surpluses for expected liabilities in health care overeign wealth funds (SWFs) are commonly defined as and pensions. investment vehicles created by government entities to invest From a consumption-smoothing perspective, the rationale in income-producing assets. According to the International for the Chinese SWF (China Investment Corporation or CIC) is Monetary Fund (IMF), governments use SWFs to (i) stabilize opaque. China is still a relatively poor but rapidly growing country, revenues from commodity exports; (ii) invest foreign exchange with a large SWF. Essentially, China saves today (reduces conreserves; (iii) fund pension liabilities and development projects; sumption) to consume even more in the future, when China will and (iv) save proceeds from the sale of nonrenewable resources be richer. This is puzzling behavior. (e.g., oil) for future generations. (This last objective is the most From a mechanical point of view, China’s foreign exchange common.) intervention strategy produced the CIC’s assets as a byproduct. SWFs have been around for many years: For example, the To restrain the rise of their currency’s value, the Chinese State Kuwait Investment Office—which manages funds for the Kuwait Administration for Foreign Exchange has long purchased foreign Investment Authority—was created in 1953. However, the recent currency (by selling their own). Ordinarily, this intervention would growth in their assets and numbers—and especially their large raise the Chinese money supply, producing domestic inflation, investments in companies such as Citigroup, Merrill Lynch, and but the People’s Bank of China issues securities (bills) to soak up Union Bank of Switzerland—has attracted much new attention. the excess liquidity created by this foreign exchange intervention. The IMF estimates that SWFs now control $2 to $3 trillion in The ultimate outcome is that the Chinese government exchanges investments and could have $6 to $10 trillion by 2013. In compariits own bonds for foreign assets. son, in 2006, the market capitalization of all the equity markets But this mechanical explanation fails to answer the question in the world was about $50 trillion and world GDP was about why China accumulates foreign assets, rather than consuming $48 trillion. Both the recent hikes in oil prices and the tendency more or even investing more in domestic physical assets? One of nations to accumulate foreign exchange reserves have conmight conjecture that China’s high savings rate reflects what tributed to the growth of SWF assets. economists call “precautionary saving”—saving against a downWhat is the economic logic of SWFs? SWFs permit nations turn—which in turn reflects its relatively recent experience with with temporarily high incomes from nonrenewable resources— poverty. Nevertheless, it seems likely that China will not accusuch as oil exports—to save for the future. That people prefer mulate assets at its present pace forever. ■ relatively smooth levels of consumption—rather than starving one year and gorging the next— is a cornerstone of economic theory. SWFs enable governTop Ten Sovereign Wealth Funds ments to save high current Range of asset holdings ($ billions) income for future spending when income may be lower. Country SWF Lower Upper Year of inception The chart shows that six of UAE Abu Dhabi Investment Authority 250 875 1976 the top ten SWFs, measured by Norway Government Pension Fund–Global 380 380 1990 asset holdings, come from oilSingapore Government Investment Corporation 100 330 1981 exporting nations: United Arab Saudi Arabia No designated name 289 289 No formal start date Kuwait Reserve Fund for Future Generations 213 213 1976 Emirates, Norway, Saudi Arabia, China China Investment Corporation 200 200 2007 Kuwait, Russia, and Libya. SWFs Russia Reserve Fund 125 125 2004 will enable these countries to Singapore Temasek Holdings 108 108 1974 maintain their consumption levels Australia Australian Future Fund 54 54 2004 after the depletion of their oil, just Libya Libyan Investment Corporation 50 50 2006 as 401Ks allow people to save for SOURCE: Monetary and Capital Markets and Policy Development and Review departments of the IMF, “Sovereign consumption during their retireWealth Funds—A Work Agenda,” February 29, 2008; http://www.imf.org/external/np/pp/eng/2008/022908.pdf. ment. Likewise, the Australia Futures Fund is intended to save Views expressed do not necessarily reflect official positions of the Federal Reserve System. research.stlouisfed.org