Sovereign Wealth Funds: The New Intersection of Money and Politics

By Christopher Balding | Go to book overview

CHAPTER 2
The Economics of Sovereign
Wealth Funds

There is a recognized but poorly understood fact about sovereign wealth funds (SWFs) and the countries that manage them, and it is that they face unique economic circumstances. The simplest and obvious dividing line is between the commodity-dependent funds and the noncommodity funds. There are divergent economic policy recommendations and investment strategies for commodity-dependent states based upon the source of the wealth. However, there are additional cleavages in economic policy decisions and impact, such as the size of a country, its economic development, and its economic diversification. The major SWF countries, with the exception of midsized Saudi Arabia, come from either the smallest or the largest countries in the world. While the world economy will not be impacted by the Saudi riyal and US dollar exchange-rate peg, the Chinese yuan and US dollar peg has a potentially destabilizing impact on the world economy. Despite a passing recognition of the importance of the underlying economics, little research has been done to study the unique economic situations facing sovereign wealth fund countries.

Here is a more fundamental issue: what would replace SWFs if they were either wound down or did not exist in the first place? Sovereign wealth funds grew out of sustained current account surpluses that will not disappear by wishing away SWFs. Suitable economic policies must replace SWFs for countries with large capital surpluses and accumulated wealth. Little research has considered this alternate factual scenario and even it is qualified with the notation “the applicability of the benefits and the attractiveness of the alternatives depend heavily upon the political and economic context in which the SWF operates” (Blackburn et al. 2008). Sovereign wealth funds are designed to respond to and address three specific economic problems. First, large and persistent surplus inflows create a problem for countries, because they can lead to rapid expansion of the money supply and lead to inflation. This is the monetarist problem by which sovereign wealth funds stabilize the incoming capital surplus by purchasing international assets. Second, large growths in tax revenues create a problem for countries that can lead to excessive and sustained growth in government expenditures. This is the fiscal problem that SWFs seek to ameliorate through fiscal rules designed to prevent rapid public expenditure growth. Third, large and persistent surplus inflows

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