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Sovereign wealth funds: China's potent economic weapon

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Because China has repeatedly demonstrated its willingness to use foreign reserves as an economic and political tool, America has much to lose from the rapidly growing ability of Chinese SWFs to acquire controlling interests in US corporations. One obvious strategic danger is that China may seek to gain control of critical sectors of the US economy – from ports and telecommunications to energy and defense.

Chinese SWFs with controlling interests in US corporations may also try to offshore jobs, managerial best practices, and research and development to China. Even worse, they may also seek to promote technology transfer while nabbing customers in the US. The effect of offshoring jobs and poaching markets hits America's economy immediately – just ask Michigan. Moving America's R&D, managerial elite, and technologies to China significantly reduces future American productivity and growth.

While China poses the most direct SWF threat, Russia and its growing SWF are no strangers to state capitalism and brass-knuckled trade policies either. Exhibit A is Russia's bullying of Europe and Ukraine over access to Russian natural gas reserves at reasonable prices.

Not all SWFs smack of foul play or abuse. As the poster child of a good SWF, Norway's petrodollar-financed fund provides countercyclical "fiscal stabilization." When oil prices are high, Norway adds to its SWF. If oil prices fall, they can draw down their SWF rather than slashing government expenditures.

Norway also knows that its declining oil reserves eventually will cease to be a major revenue source. By growing its SWF now, Norway generates wealth for future generations to continue living in the style that current oil revenues have made them accustomed to. For these reasons, Norway's SWF seeks to maximize its risk-adjusted financial returns – a primary requirement of efficient global markets.

However, the rapid emergence of SWFs calls for a coherent US policy. One major obstacle to swift action is the constructive role SWFs appear to be playing in the current global financial crisis in providing critical liquidity. This should not lull the US into a false sense of security.

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