A speech given at the House of Literaturhus, Oslo, recently
I have been invited to visit Oslo to provide an international perspective on the management philosophy guiding Norway’s $500+ billion Oil Fund. In particular, I’ve been asked to compare it to other sovereign wealth funds. With regard to the nation’s economic development over the long run, how does Norway’s approach compare with those of China, Singapore and other countries that have accumulated enormous amounts in financial form?
Despite the large size of Norway’s fund (second only to that of Abu Dhabi), its managers treat it in much the same way that a Norwegian family would treat its own personal savings account. The money is consigned to fund managers to invest in a wide array of stocks and bonds so as to minimize risk. In effect, Norway has a big set of mutual funds. The aim is to avoid converting oil export proceeds into domestic currency and thus pushing up the exchange rate (the Dutch Disease), while using the revenue for future generations to use as best they can.
To my mind, the problem is the limited scope of how to go about doing this. Mutual funds invest in minority shares of companies. Spreading their money around is a widespread strategy for families and small investors to avoid risk. Their basic question is simply one of which stocks and bonds will yield the highest rate of return or rise most quickly in price. This is basically a short-term decision, given the ebb and flow of financial markets. And because stock pickers own only marginal amounts, their actions have no effect on the existing economic and political environment, productivity, employment and economic structures.
China and Singapore pursue a different strategy. Being concerned mainly with their national development, they start by asking what their economies will need to import over the next half-century, and how foreign investment can best serve their long-term diplomatic aims. Singapore invests heavily in Australia, partly to help political as well as economic reciprocity. China has bought up majority shares of mineral resources (including silica mines in Norway and Iceland) and bought into the partnerships of major U.S. hedge funds. Both countries use their sovereign wealth funds to upgrade their long-term economic productivity, living standards, technology and educational levels.
So here is quite a contrast. Norway is using its savings to buy minority stock ownership abroad, without linking its purchases to its own future development – except by receiving foreign exchange returns. It also is selling off ownership of its minerals and other natural resources, bringing in more foreign exchange on top of its oil exports. Most notably, it is selling these resources to nations that are seeking to dispose of their surplus dollars like a hot potato.
I do not mean this figure of speech as a joke. The financial climate has changed radically from when Norway’s Oil Fund was established in 1990. Norway has built up its savings since then by selling enormous quantities of oil and gas, and employing many thousands of workers. By coincidence, an even larger sum of $600 billion recently has been created overnight – electronically on computer keyboards, by the U.S. Federal Reserve Board as part of Chairman Ben Bernanke’s Quantitative Easing policy (QE2). This money has been provided to spur bank liquidity, in hope that they can earn their way out of the losses they suffer from their bad mortgage loans and other gambles.
The aim of these banks is the same as that of Norway’s Oil Fund: to make money. As the financial press has noticed, nearly the entire $600 billion has been sent abroad – to the BRIC countries and raw materials exporters in strong balance-of-payments positions, whose economies are not as “loaned up” as those of the United States and Europe, where Norway invests most of its money. So while Norway is putting its money into these countries, their financial managers are jumping ship – sending electronic dollars and euros to the economies that use their own sovereign wealth funds in the opposite way from what Norway is doing.
Here is the real problem: Money is not what it used to be back when it was backed by gold bullion or anything tangible, earned by labor and enterprise. Banks create credit almost freely on computer keyboards, and entail little cost in making huge gambles on derivatives based on which way foreign exchange rates, interest rates, bond prices and even defaults will move. This cost-free credit is flooding the global economy. This makes Norway’s foreign exchange savings (i.e., the Oil Fund) much less valuable in terms of how much it actually costs to buy $600 billion worth of stocks and bonds. The cost is almost zero for the U.S. banking system. And that is what Norway’s Oil Fund is competing with when it puts its money into the U.S. and European financial markets.
Matters also have changed radically in another respect. The stock market no longer serves mainly as a vehicle to raise funds for tangible capital investment. Since the 1980s it has become a vehicle for debt-leveraged buyouts (LBOs), financed by corporate raiders or ambitious financial empire-builders using high-interest “junk” bonds to “take companies private” by debt-for-equity swaps. Corporate managers at the remaining companies have gone into debt increasingly to finance stock buy-backs simply to bid up their price (and hence, the value of stock options that managers and venture capitalists give themselves), and even just to pay out as dividends.
This is not how textbooks describe stock markets as working. It was not what was expected half a century ago when Peter Drucker coined the term “pension-fund socialism.” He expected the stock market to mediate these inflows to finance new investment and hiring, so the economy would expand. But instead, the stock market has been loading companies down with debt for the past thirty years. Many are threatening bankruptcy – ironically, as a way to wipe out their pension obligations, so as to leave more for the large financial backers of the debt leveraging largely responsible for their insolvency.
Asian economists view the West as entering a dead end – one of corporate as well as individual debt peonage. They see Iceland, Ireland and Greece as a normal result of current policies, not as anomalies. From their perspective – and from that of many of my economic colleagues at UMKC – the world has entered an era of “debt pollution.” Tax reform has favored debt leveraging and speculation (e.g., low capital gains taxes, and a tax shift off finance and property onto labor). The upshot is that savings and credit have not been invested in expanding the means of production or to alleviate the global economy’s debt overhead, but simply to bid up real estate and stock prices on credit.
This is not a formula for long-term growth. It is a financial distortion of real development. I believe that it is as serious as that of the environmental pollution associated with global warming and other problems. I have spoken to Asian officials and can attest to the fact that this is their perspective. They do not see stock or bond markets offering the same promise that existed back in 1990, when the most recent takeoff got underway – and coincidentally, when Norway’s Oil Fund took its present form.
The long stock market rise may be over. Markets are shrinking as economies buckle under their debt overhead. Families and companies, cities and states, and even national governments now find themselves obliged to divert their spending away from the purchase of goods and services to pay down debts, effectively reducing investment and growth.
Governments of mixed economies such as China and Singapore are engaged in long-term planning to improve economic well-being. Toward this end they are investing in themselves, specifically in core resources that future generations will need to control and import in decades to come. They therefore are converting their holdings of currency and financial securities into long-term control over natural resources and technology.
Norway’s best choice also is to invest in its own economy. That means improving domestic infrastructure such as roads, communications, health, research and education. And to elevate its international position and destiny, this calls for direct investment in Norway’s neighbors, starting with the closest, Iceland and Scandinavia.