Little more than a year ago the world – at least one small piece of it – was focused on the new influence of Sovereign Wealth Fund and their potential impact on the financial market, as well as the potential geostrategic implications and real economy implications. Questions included what would the impact be of a large new buyer of riskier assets? What kind of boom would this be for institutional investment managers? What does it mean when many companies were held in large part by semi-political actors? And to what degree would the SWF be political? (note 1).
These was a reasonable question; the pools of money that were large and the expectation of moving into risky assets was not unreasonable. A lot of work went into understanding and predicting the roles that these entities would play. That being said the over focus on SWFs missed the significance of Central banks (maybe because they wasn’t new and exciting) and now that reserves are dropping the the focus has moved away from SWFs but the work was not entirely for nothing. The US government now runs a huge sovereign wealth fund. The dynamics are very very different in that they run it not because of reserve build up but because of a financial crisis and the need to recapitalize the banking system. Additionally the Federal Reserve has moved its portfolio into risk assets in a major way. How much did these actions hold up the market? Where would the market be without them? Admittedly this is more complex than a ’simple’ flow and risky asset elasticity problem because it is not even close to linear; in that without these action the system may have completely collapsed. I’ve gone back to my files on the SWF research and commentary and tried to read them in the context of the Fed and Treasury actions. The questions that burn for me surround how it all unwinds. I expect them to continue holding the system together and I don’t think it is big enough to bring down the dollar reserve currency status (and thus have the economic system collapse). So I’ve focused on what happens when we get through this painful deleveraging process and how will the unwinding work through the political process. I believe that this may have much longer term consequences. Will the financial system be able to go back to trying to capital allocate or will it be prevented from doing so by political decision that try to force capital to go to their specific project. Ear marks for tax spending is bad enough; ear marks for credit (what we saw in china and a number of other state controlled economies in that past) is a long run disaster. The more I learn about the political process the worse my expectations become.
Note 1: I think the answer to that question is almost never but they will when they need (read: want) to be …people use their influence to get what they want; pure profit maximization is very unlikely. Consider the Suez crisis and how the capital flow influence the British response…(admittedly slightly different but it gets at the point).
