Tidal wave of money coming! Sovereign wealth funds!

May 26th, 2007

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In our previous article, Awash with cash?what to do with it?, we mentioned that with the US printing so much dollars to fund its current account deficit, ?those foreign countries that account for the vast majority of US imports (namely the oil-producing Middle Eastern nations, Russia, China and Japan) are sitting on so much US dollars that they do not know what to do with it.?

Indeed, this is a problem. With each passing day, those freshly printed US dollars will dilute the value of the existing ones, resulting in reduced worth of every dollar. Given that the US dollar still has the status of the world?s reserve currency (albeit a very shaky status), it gives the US the unique power to export inflation overseas (see How does the US export inflation?). It is no coincidence that around the world, central bankers are ?fighting? inflation (the idea that central banker ?fight? inflation is itself a ridiculous concept?see Cause of inflation: Shanghai bubble case study) and that global asset prices are still in a raging bull market.

In recent times, there is a beginning of a new force sweeping the global financial markets?sovereign wealth funds (SWF). Traditionally, central banks hold foreign currency reserves (namely the US dollar) as a form of ?savings? for a rainy day. Usually, these currency reserves are stored in the form of relatively safe and liquid Treasury Bonds.

Now, what if there are so much of them (and growing rapidly) that they far exceed their use as ?savings?? The Singapore Government?s Temasek Holdings is the pioneer in the concept of SWF. It is a government investment company that invests Singapore?s foreign exchange reserves and savings around the world. Now, this concept has spread to countries like Japan, China, Norway and Middle Eastern nations.

According to Morgan Stanley, the SWF may have as much as US$2.5 trillion at its disposal. The global hedge funds industry may be as large as US$1.5 to US$2 trillion. With that amount of new money from SWFs, they are a potent force to be reckoned. However, since they act as an arm of the governments, there will be issues with transparency and political controversy.

What are the implications? Good question. We do not really know the answer, but we are sure this new development will eventually add on to the problems of asset price inflation and general price inflation.