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Sovereign wealth funds: China's potent economic weapon

SWFs can act as a nation's fiscal stabilizer, but can also be used to achievemore nefarious economic goals.

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Sovereign wealth funds are neither good nor bad, but governments make them so. While the SWF of a country such as Norway may be cheered, those of China and Russia should rightly be feared by the United States.

SWFs are government-run investments financed by excess foreign reserves fueled by chronic trade surpluses. A SWF often acts as a nation's fiscal stabilizer. But China uses its excess foreign reserves in other ways – as a "loss leader" to achieve more nefarious economic goals. A perfect example is China's currency manipulation to boost its exports and create jobs – at the expense of American workers.

To keep the Chinese yuan pegged and undervalued, China first "sterilizes" its export dollars by issuing bonds to Chinese citizens at high interest rates. China's central bank then maintains the dollar-yuan peg by buying US bonds at substantially lower interest rates. While China earns a negative return, its financial loss is more than offset by China's boost in exports and Gross Domestic Product.

China also uses its foreign reserves as a political weapon. Whenever pressure builds in the US to curb China's currency manipulation or other unfair trade practices, Chinese government officials threaten to dump their vast US dollar reserves and stop buying US bonds. This "financial nuclear strike," which would cause interest and mortgage rates to soar and probably trigger a US recession, has effectively cowed US politicians.

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