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The "wolf in sheep's clothing" metaphor may be overused. But
it describes, in a mental picture, a hidden danger, or an enemy putting
on a false display of friendship.
"Sovereign wealth funds"
are foreign-government controlled investment companies. Middle eastern
governments have these funds, filled with oil wealth. The Chinese
government has there funds, filled with trade surplus wealth. They are
buying U.S. productive assets. They should be analyzed through a
foreign policy lens, not market economy lens. The mere fact that
a separately incorporated entity carries out the transactions misleads
only the naive.
The Dubai port deal was killed, and many
"free market" zombies said the reaction was zenophobic. But it
was a national security and foreign policy issue.
The Abu Dhabi government investment corporation recently completed a deal:
Advanced Micro Devices said Friday that an investment arm of Abu
Dhabi’s government had taken an 8 percent stake in the company for $622
million.
China owns much
of its economy, and is buying more. China government controlled
corporations are buying strategic ports around the world, and many
important U.S. companies. But that government does not let either
U.S. private companies, or the U.S. government (assuming our government
tried) to purchase major Chinese companies.
Pat Mulloy was a
member of the United States-China Economic and Security Review
Commission and is now an Advisory Board member of the Coalition for a
Prosperous America. He delivered testimony to the Senate Banking
Committee last Wednesday on sovereign wealth funds. His
Commission has unearthed a trove of troubling data and patterns on the
phenomenon.
After the jump (hit "read more") you will find his whole testimony.
TESTIMONY OF PATRICK A.
MULLOY
BEFORE THE SENATE COMMITTEE
ON BANKING, HOUSING & URBAN AFFAIRS
HEARING ON
“SOVEREIGN WEALTH FUND ACQUISITIONS AND OTHER
FOREIGN GOVERNMENT INVESTMENTS IN THE U.S.:
ASSESSING THE ECONOMIC AND NATIONAL SECURITY IMPLICATIONS”
NOVEMBER 14, 2007
Introduction
Chairman Bayh, let me begin by thanking you,
Chairman Dodd, Ranking Member Shelby and Senator Webb for providing me
the opportunity to speak before you today on the economic and national
security implications of sovereign wealth funds and other foreign
government investments in our nation.
My name is Patrick Mulloy and I served as a member
of the twelve person, bipartisan, bicameral United States-China
Economic and Security Review Commission from its creation in early 2001
through the end of 2006. I presently serve as the Washington
representative of the Alfred P. Sloan Foundation and also teach
International Trade Law and Public International Law as an Adjunct
Professor at the law schools of Catholic University and George Mason
University.
I should note that the views I will present today
are my own and not necessarily those of any of my present employers nor
the U.S.-China Economic and Security Review Commission. I do want to
assure the Committee that I have no client except the public interest
on these matters and have never been paid by any company or any other
entity to advise it on foreign investment matters.
I commend the Committee for holding this important
hearing and I am honored by the invitation to testify. It is a
source of enormous personal satisfaction for me to have served on the
staff of the Committee from 1983 to early 1998 when I left to take a
position as Assistant Secretary in the Commerce Department’s
International Trade Administration. During the period of
1987-1988 when the provisions of the Omnibus Trade Act of 1988 dealing
with “exchange rates” and “foreign investment reviews” were being
formulated by the Committee, I served as the Committee’s General
Counsel and was directly involved in the discussions that led to their
formulation and enactment into law. The sovereign wealth fund and
other foreign investment issues we are discussing today are directly
related to those two sections of the 1988 trade bill.
Prior Oversight Hearings
In October 2005 Chairman Shelby and Ranking
Member Sarbanes invited me to testify before the Committee on the
background of the foreign investment provisions enacted in 1988 and
amended in 1992 and how they were being implemented by the Treasury
Department chaired Committee on Foreign Investment in the United States
or CFIUS. I am delighted that some of the concerns I expressed at
that hearing were taken into account by the Committee in the CFIUS
reform legislation entitled the “Foreign Investment and National
Security Act of 2007” which you formulated on a bipartisan basis and
got enacted into law just a few months ago.
In May of this year, International Finance
Subcommittee Chairman Bayh and Ranking Member Martinez invited me to
testify on the “exchange rate” provisions of the 1988 Omnibus Trade
Bill and the performance of the Treasury Department in carrying out the
statutory obligations given it by that law to identify and report to
Congress the names of countries that were manipulating their currencies
to gain trade advantages with the United States. In my May testimony I
told the Subcommittee that the Treasury Department had failed to carry
out the responsibilities given to it by Congress in that 1988
law. That failure is at least one reason we are here today to
discuss the issue of sovereign wealth funds and increased foreign
ownership of the United States economy. I will explain in my
testimony why I make that direct link.
I am pleased, however, that the Committee subsequent
to the May hearing did formulate and report out for consideration by
the full Senate legislation to address some of the measures that were
advocated by me and others to address exchange rate manipulation by
other nations including China.
Sovereign Wealth Funds
As I begin my discussion of sovereign wealth funds,
and knowing that many officials in the Executive Branch along with some
business leaders will not be sympathetic to the concerns I will raise,
let me remind the Committee that under Article I, Section 8 of the
Constitution it is the Congress, not the Executive Branch, which is
charged with the regulation of foreign trade, foreign investment and
the value of our nation’s currency. Our Founding Fathers knew such
matters directly impacted people’s lives and wanted them under the
control of the branch of Government closest to the people. The
rise of “sovereign wealth funds” and the increased foreign ownership of
our economy are directly related to our mismanaged trade policies which
have failed to take into account the government-directed mercantilist
trade policies of many of our trading partners.
In June of this year, then Acting Under Secretary of
the Treasury Mr. Clay Lowery made a speech in San Francisco on
“sovereign wealth funds”. He said he would use the term to mean:
“a government investment vehicle which is funded by foreign exchange
assets and which manages those assets separately from official reserves”
He said such sovereign wealth funds typically fall into two categories
based on the foreign government’s source of foreign exchange
assets. These are:
1. Commodity funds – which are established through commodity
exports such as oil and gas. The tripling of oil prices since
2002 has created a windfall for oil-exporting nations such as Abu
Dhabi, Kuwait, and Norway. McKinsey and Company in an October
2007 report entitled The New Power Brokers, which examines sovereign
wealth funds, has estimated that investors from oil-exporting nations
collectively owned between $3.4 trillion and $3.8 trillion in foreign
financial assets at the end of 2006. That report also said many
oil exporting nations have now set up state-owned investment funds,
often called sovereign wealth funds, to invest some of the assets they
have acquired through their oil exports. The October 2007 study
done by McKinsey and Company tells us that “sovereign wealth funds”,
unlike “central bank reserves” (also known as “foreign exchange
reserves”), have diversified portfolios that range across equity, fixed
income, real estate, bank deposits, and alternative investments such as
hedge funds and private equity. According to the McKinsey October
2007 study; the largest sovereign wealth fund among oil exporters is
the Abu Dhabi Investment Authority which reportedly has total assets of
up to $875 billion.
2. Non-Commodity Funds – which are typically established through
transfers of assets from official foreign exchange reserves.
Large balance of payment surpluses, according to the McKinsey Study,
have enabled non-commodity exporters to transfer “excess” foreign
exchange reserves to stand alone investment funds to be managed for
higher returns. Most of the non-commodity holdings of foreign
exchange reserves are held by the Asian central banks. The
October 2007 McKinsey study estimates that at the end of 2006 Asian
central banks had $3.1 trillion in foreign reserve assets. The
study then stated:
“to put this in perspective, it is twice as many assets as global hedge
funds manage and twice the size of global private equity”.
China’s central bank had $1.1 trillion in reserves at the end of 2006
and the Bank of Japan had $875 billion. The central banks of Hong
Kong, India, Malaysia, Singapore, South Korea, and Taiwan together have
another $1 trillion.
Now how are these Asian central banks able to
accumulate these vast and fast-growing amounts of “foreign exchange
reserves”? The McKinsey study tells us on page 77 that:
“…exchange rate management has been key. Since the Asian
financial crisis, the region’s economies have benefited from rapidly
growing exports, and apart from Japan, have switched from running
current account deficits to large current account surpluses. The
logical long-run corollary of these surpluses, combined with foreign
capital inflows would be the appreciation of the currencies of the
surplus countries. However to preserve the competitiveness of the
region’s exports, Asian central banks have intervened in the foreign
exchange markets to prevent rapid appreciation, buying foreign
currencies (mainly the dollar) while selling domestic currency.
The McKinsey study on page 78 then explores the pros
and cons of having the Asian central banks manage the value of the
dollar in a system some economists called Bretton Woods II. The
study states:
“For Asia the system has ensured the success of its export-led growth
model and continuous and growing current account surpluses. For
the United States the benefit has been twofold. American
consumers have the advantage of being able to bring in a huge range of
cheap goods manufactured in Asia. But of even more importance is
the fact that the United States has been able to maintain a large and
growing current account deficit while at the same time maintaining
significantly lower interest rates than would normally prevail with a
large deficit position – because Asia has provided low cost funds to
finance the shortfall”.
The McKinsey Report then goes on to note that the Bretton Woods II
system has two distinct disadvantages for the United States. A
higher dollar (propped up by the Asian central banks) hinders our
nation’s ability to export (and harms import sensitive domestic
industries) and there are hazards from an over-reliance on foreign
capital.
Recently Asia’s governments have begun to shift some
of their foreign exchange assets into “sovereign wealth funds”.
The Government of Singapore Investment Corporation has around $150
billion under management. China has taken at least $200 billion
of its foreign reserve assets and put them into its sovereign wealth
fund the China Investment Corporation. It can always transfer
more from its foreign exchange reserves into its sovereign wealth fund
as it is accumulating foreign exchange at a rate of well over $300
billion annually. Its trade surplus with just the United States this
year will be over $250 billion.
Problems for the U.S. with Sovereign Wealth Funds
1. Purchases of Strategic Assets and Technologies
Mr. Gerald Lyons, the Chief Economist of the Standard Chartered Bank,
issued a paper on October 15, 2007 entitled “State Capitalism: The Rise
of Sovereign Wealth Funds”. In that paper he noted that sovereign
wealth funds are presently valued at $2.2 trillion, but could reach
$13.4 trillion in a decade. One concern he identified on page 9
of his paper is that these funds may make purchases (investments) for
strategic, rather than economic purposes. He noted that through
these funds foreign governments could acquire:
“strategic stakes in key industries around the world such as
telecommunications, energy, the financial sector, or even to secure
intellectual property rights in other fields.”
In 1992 the Treasury Department as part of its CFIUS responsibilities
was tasked by law to report to Congress within one year and every four
years thereafter whether any foreign government had a coordinated
strategy to acquire U.S. companies involved in the research and
development or production of critical technologies. In its 1993 report
the Treasury said it could not find credible evidence of such
strategies but said that “should not be viewed as conclusive proof”
such strategies did not exist. It did indicate some governments did
identify “technologies that are critical to national economic
development and thus prime targets for acquisition through
M&A’s.” In its first update to that report submitted to the
Congress in September of 2007, the Treasury again reported it “did not
find strong enough evidence to conclude that any individual company had
a coordinated strategy or was acting on a coordinated strategy on
behalf of its respective government.’ The Treasury report did note,
however, that “there is significant evidence that foreign governments
are involved in other efforts to acquire such technologies.” That was
in the Treasury’s unclassified report. I understand that there is a
classified version and I would urge you to have your staffs peruse that
and brief you on it. It just seems reasonable to me to assume that if
some foreign governments are using illicit means to acquire U.S.
developed critical technologies, that they will probably buy companies
producing them if they can utilize that means to access these critical
technologies.
2. Increasing Foreign Government Ownership of Our Market Economy
Another concern was expressed by SEC
Chairman Christopher Cox in an October 24th speech at the Kennedy
School of Government at Harvard University. In that speech entitled
“The Role of Government in Markets”, Chairman Cox noted that sovereign
wealth funds, which are already enormous in his view, could “grow as
large as $12 trillion over the next eight years”. He then went on
to state:
“The economic rationale for our legislative and regulatory
deference to markets is called into question when the major marketplace
participants are not profit-maximizing individuals but governments with
national interests”.
The SEC Chairman then went on to discuss why in the United States we
have traditionally been against large government ownership of our
economy, noting our emphasis on private ownership is directly tied to
America’s dedication to individual freedom. He stated:
“…the fundamental question presented by state-owned public companies
and sovereign wealth funds does not so much concern the advisability of
foreign ownership, but rather of government ownership”.
He then revisited the issue of foreign ownership later in his speech
and noted that if ownership is held by our own government, we can at
least influence it to use its ownership to “put our nation’s interests
first.” If the owner on the other hand is a foreign government,
he said,
“the national interests a foreign government will advance will presumably be its own”.
So there are, in Chairman Cox’s view, legitimate concerns a nation must
take into account when it considers whether to follow policies giving
foreign owners and particularly foreign governments increasing amounts
of control over its domestic economy.
Foreign Ownership and Trade Deficits
On October 26, 2003, Fortune Magazine carried an
article by Warren Buffett entitled “Why I’m Not Buying the
Dollar: America’s Growing Trade Deficit is Selling the Nation Out
From Under Us”. In that article, Mr. Buffett noted that America’s trade
deficit exceeded 4 percent of GDP (it is closer to 5.5 percent now),
and our nation owed the world $2.5 trillion from the cumulative effect
of past trade deficits. He then wrote:
“In effect our country has been behaving like an extraordinarily rich
family that possesses an immense farm. In order to consume 4
percent more than we produce – that’s the trade deficit – we have day
after day been both selling pieces of the farm and increasing the
mortgage on what we still owe”.
He then said it was imperative that we take “action to halt the outflow
of our national wealth” and advocated a plan to do so. I will discuss
that plan later in my testimony.
In the winter of 2005 Mr. Buffett in his annual
letter to the shareholders of his company Berkshire Hathaway, stated
that our country’s continuing and massive trade deficits are leading us
in the direction of becoming a “sharecropper society”, not an ownership
society. In July of 2005 a debate raged in Washington about
whether the Chinese National Offshore Oil Company (CNOOC), which was 70
percent owned by the Chinese government, should be prohibited from
purchasing UNOCAL, a privately owned American company. During an
interview on CNBC Mr. Buffett was asked to comment on the matter and
stated:
“If we are going to consume more than we produce, we have to expect to give away a little part of the country”.
Associated with the same debate about the CNOOC/UNOCAL merger, the
Washington Post published an editorial which appeared on August 7, 2005
entitled “A Sharecropper Society”. In it the Post expressed concern
that Mr. Buffett’s vision of where the United States was headed was
“distressingly plausible.” The editorial noted that “the country is
living beyond its means, spending more than it earns, and relying on
foreigners to supply the difference.” On October 24th of this year the
Washington Post published an editorial entitled “Countries Buying
Companies” about sovereign wealth funds. The editorial stated:
“Sovereign wealth funds, however, offer governments a way to take over
businesses for political as well as economic purposes. That’s a
benign prospect if the buyer is Norway, a member of NATO. It is
more troubling if the government behind the money is that of China,
Russia, or Venezuela … the accumulation of so many dollars in foreign
hands is the result of years in which the United States has imported
more than it exports.”
The fast-increasing surge of sovereign wealth funds are just another
indicator that the country is living beyond its means, spending more
than it is earning, and relying on foreigners to purchase our assets to
supply the difference. Most of the so-called foreign investment in this
country is not “green field” investment whereby new assets are being
created, but rather the sale of existing assets to new foreign owners.
This is what Warren Buffett means by the “sharecropper economy
reference. In allowing this to happen on our watch we are not doing
well for future generations of our citizens.
What is to Be Done: Immediate Steps
America’s political leaders must realize that the
United States is part of an increasingly competitive global economy in
which many of our trading partners, such as China, Korea, Japan and
Taiwan have national goals and strategies to move their economies
forward. Under pricing their currencies to achieve trade surpluses and
attract investment is just one part of their economic strategies. Our
nation must begin to develop our own national goals and a strategy to
accomplish them to ensure that the Asian countries do not achieve their
economic goals at our expense. Some elements of our own “national
strategy” or if you prefer “business plan” might be:
1. The development of an energy policy that promptly begins to reduce
our reliance on imported oil and gas. Spending on the technologies to
accomplish this, which means investing in America, would create new
high tech jobs in our nation and in time reduce the speed by which oil
and gas exporters are building their sovereign wealth funds with our
own dollars.
2. The development of policies to aggressively address the mercantilist
trade practices (being used by China and many of our other Asian
trading partners) such as currency manipulation, barriers to imports,
illegal export subsidies, forced technology transfers, subsidies to
attract investment ,and the massive theft of intellectual
property. This Committee has already developed and reported to
the Senate legislation to begin to address currency manipulation.
I hope that additional measures can be added to that legislation when
it is taken upon the floor, such as a provision to make an under-priced
currency an illegal export subsidy that can be addressed by our
countervailing duty laws. It would also be good public policy to
include measures to stop the influx of contaminated toys, foods and
other items that threaten the health and welfare of our citizens.
3. A third element of such a strategy is to have in place a CFIUS
process for reviewing foreign acquisitions of U.S. companies that
ensures our Government does not permit the selling off of assets that
are critical to our national security. The CFIUS legislation
enacted this summer goes a long way in doing that. It gives the
intelligence agencies a key role in the review process and ensures
closer scrutiny of purchases made by foreign government-owned
corporations.
Under the new statute, however, the more searching CFIUS review process
for a foreign government acquisition only takes place if the foreign
government acquires “control” over the American assets and it leaves
the word “control” to be defined by agency rulemaking. The
Treasury Department, which will pursuant to the Administrative
Procedures Act engage in “notice and comment” rulemaking, is likely to
receive more comments to be lenient in defining control than
strict. It was thus reassuring to see that Senators Dodd, Shelby,
Bayh and Webb have written to Secretary Paulson on that matter.
Their September 27th letter urged the Treasury in its rulemaking
process to take account of the fact that:
“…in some cases passive foreign ownership interests in assets in
the United States, including through sovereign investment funds may
have national security implications”.
It will be very important for this Committee to continue its recent
close oversight of the CFIUS process to ensure that the Treasury
implements the new statute in the manner intended by its Congressional
authors. You can be sure interests representing foreign
investors, including foreign government investors; will be active
participants in the rulemaking now underway at the Treasury Department.
What is to Be Done: Further Steps
1. Emergency Trade Summit
During the period of August 2006 through January
2007, I had the opportunity to participate as a senior staff member on
the Horizon Project, which was established by the Democratic Policy
Committee to develop proposals to address America’s economic prosperity
and security. At the conclusion of their work the leaders of the
Project briefed both the Democratic and Republican Policy Committees
about their recommendations.
The Horizon Project group of CEOs and policy
experts, which included the President of the Sloan Foundation with whom
I work, was very concerned about our nation’s massive and ongoing trade
deficits and recommended, among other things, that:
“An Emergency National Summit on the Trade Deficit be convened to be
attended by relevant Cabinet officers, the bipartisan leadership of
both Houses of Congress and a small number of top corporate and labor
leaders”.
The Project report stressed that capping the size of the trade deficit
had to be a top national priority. One method the report
advocated was the so-called Buffett proposal which was put forth by
Warren Buffett in the May 2003 edition of Fortune Magazine which I
referred to earlier in my testimony. Under the Buffett plan our
nation’s trade account could be balanced through a system whereby the
Federal Government would issue import certificates to exporters of
goods in the amount equal to the dollar value of their exports. Such a
system could be phased in over a period of time. The Alfred P. Sloan
Foundation has recently funded a proposal submitted by a group of trade
economists and lawyers to examine how the Buffett proposal could
actually be implemented. The Horizon Project noted that Senators
Dorgan and Feingold encapsulated the Buffett proposal in S.3899, a bill
they introduced in the last Congress, which would phase in balanced
trade for regular commerce over five years and for petroleum trade over
ten years.
Another way to reduce the trade deficit considered by the Horizon
Project was to use unilateral emergency tariff increases as President
Nixon did in August of 1971. Either the Buffett proposal or the
tariff increases could be justified under Article XII of the GATT/WTO
agreement which permits parties to take measures to deal with serious
balance of payment difficulties. The fast declines of our currency
against the currencies of nations which do not prop it up are evidence
of our balance of payments problem. Serious discussion in the
Congress of either proposal would give us much needed leverage to deal
with China and the other Asian countries which under-price their
currencies and utilize other mercantilist practices to achieve massive
trade surpluses at our expense.
2. Align Corporate and National Interests
America’s political leaders must understand that
other countries such as China have instituted policies, including
subsidies and an under-priced currency, to give incentives to U.S. and
other multinational corporations to help them grow their own
economies. Our corporations are operating in a system that
compels them to focus on making profits for their shareholders.
Top corporate officials get significant financial rewards for achieving
these objectives. Public officials, who are accountable to
America’s citizens, must develop policies to counter foreign practices
designed to entice our corporations to serve their interests. We
must find the means to align the interests of American based
multinational corporations with the national interest which includes
keeping and creating well-paying high tech jobs in this country and not
transferring huge chunks of our productive capabilities out of the
country.
3. Craft an Omnibus Globalization Bill
Over 20 years ago the joint House and Senate
leadership, acting in a bipartisan manner, decided to craft an omnibus
trade bill to address some of the competitive challenges then facing
the nation. Each relevant Committee of the Congress was charged
to conduct hearings and to elicit ideas and concepts that could be
encapsulated into one Omnibus bill. This process began in 1986
and continued in 1987 and resulted in the Omnibus Trade and
Competitiveness Act of 1988.
As one who participated in that process and found it
exhilarating, I urge the Congress to again institute such a process and
use the year 2008 to lay the groundwork through comprehensive hearings
for an Omnibus Globalization bill. Such a Bill would be designed
to shape our nation’s participation in the globalization process in a
manner that reduces our current account deficits and lifts the living
standards for our citizens. Any new Administration that comes to power
in January 2009, will, I am sure, welcome a cooperative relationship
with the Congress in crafting such a bill.
Conclusion
The rapidly-rising status of sovereign wealth funds,
which the Committee is examining today, are just one more sign that our
nation is not doing well in the global economic competition that will
only intensify as we move forward into the 21st century. While it
is very useful to examine proposals to make such funds more transparent
and to establish behavioral guidelines for them, the real lesson we
should take from their rise is that we must take action now to
forthrightly address our massive trade deficits which are feeding the
growth of these funds.
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