Nigel Lawson was the longest serving as well as the most controversial of Margaret Thatcher’s chancellors. His inaugural Adam Smith Lecture (reprinted in the January issue of Standpoint) shows him true to form. It is entitled "Five Myths and a Menace”. His menace is – or should be to Financial Times readers – the least controversial of his assertions. It is that of a "recrudescence of protectionist sentiment that threatens to repeat the disaster of the 1930s”. The 'myth' on which I wish to concentrate is his fifth – that big current account imbalances are unnatural and dangerous. He is broadly right, but the argument needs to be taken further.
The essential point is that current account imbalances are the mirror image of international investment flows. These move, not always from rich to poor countries, but from high-saving economies such as China to those such as the US with a high propensity to consume. Lawson instances the old Halifax building society, which in its heyday channelled savings from the north of the UK to the more free-spending south. The difficulty with this analogy is that the UK has been for centuries under one political jurisdiction employing a common currency. Internationally, everything depends on what the surplus countries do with their surpluses.
Many commentators have surmised that as countries such as China become richer and develop a consumer culture, their savings surpluses will diminish. But it will take time. The International Monetary Fund estimates total current account surpluses in 2010 at just over 2 per cent of world gross national product, less than often supposed. Nearly 1 percentage point is attributed to a group of east Asian countries in which China preponderates. Another 0.5 percentage points are accounted for by Germany and Japan. The remainder is mostly the oil exporting countries.
These estimates also suggest that 'Asian' countries held official reserves of about $5,000 billion, or more than 60 per cent of the world total. Nearly all of these are held in dollar securities of one kind or another. The wisdom of such a high dependence on what might be a vulnerable currency has often been questioned. A precarious equilibrium has been secured by a financial form of MAD – mutually assured destruction. If China were to indulge in a fire-sale of dollar assets, it would devalue its own reserves and probably precipitate a sharp rise in US interest rates. Knowledge of Chinese firepower in turn discourages US protectionist threats.
But none of this prevents the Chinese authorities from diversifying new reserve accretions. Indeed, China may have ceased purchasing official dollar assets altogether in 2010. Where then are the surpluses going? Into productive assets worldwide, sometimes in direct investment, but increasingly in the form of sovereign wealth funds. These funds – worldwide, not merely Chinese – were said by McKinsey to amount in 2008 to $12,000 billion, much larger than official reserve holdings. They got off the ground much earlier in the Gulf states than in China, which is fast catching up. But one of the earliest sovereign wealth funds was established by oil-rich Norway.
A remarkable amount of piecemeal information on them has been unearthed by the US journalist Eric Weiner in his book The Shadow Market, already published in the US and to be published in the UK next month. Weiner reminds his readers of some familiar facts such as Persian Gulf involvement in the London skyscraper designed to be the tallest building in western Europe and some less familiar ones, such as the estimate that the Middle East accounts for 70 per cent of London high-end property deals.
The author remarks that these funds of diverse national origin are reluctant to work together, but therein lies their saving grace. For it makes it unlikely that they would gang up in a global financial war of the kind 'lost' by the US in an official computer simulation two years ago. Of course it is idle to expect funds owned by authoritarian governments to play by the Queensberry rules. China’s top priority is obviously to secure access to energy sources; and most of these funds have no use for the western pretence of separating commerce from politics. But a remarkable number of their investments make commercial sense and contribute to world development, for instance the Chinese offer to fund infrastructure in south-east Asia or its finance of the African private sector. Beijing’s efforts to save peripheral European economies may be as much a commercial as a political speculation.
Norway nothwithstanding, the rise of sovereign wealth funds is part of the much-analysed transfer of political and economic power away from the old industrial west. The present debate is marred by treating countries as if they were individuals. That China and India are expected to "overtake” the US at some point is mainly a matter of relative population. We should rejoice that their citizens become better off.
Copyright The Financial Times Limited 2011.