Sovereign wealth funds cut exposure to U.S.

Sovereign Wealth Funds (SWFs), which played such a vital role in the recapitalization of U.S. financial institutions during the first go around, are looking to cut their U.S. exposure.

Basically, the U.S. is running an extremely inflationary monetary policy with Fed Funds at 2% and inflation at 5%. The Dollar has therefore lost value relative to currencies like the Australian DOllar, the Euro, the Swiss Franc and so on. The Gulf States like Kuwait and Saudi Arabia have their currencies pegged to the U.S. Dollar. So the expansionary U.S. policy is exporting inflation into the Middle East.

They are experiencing inflation of as much as 25-30%, to the point where expats down in the gulf are finding it difficult to get apartments. There is a building boom going on in places like Dubai the likes of which have never been seen. This is clearly out of control. What to do?

Kenneth Shen, head of the strategic and private equity group at Qatar Investment Authority, another Middle Eastern fund looking to do more deals in Europe than the US, aired such concerns publicly at a conference in Hong Kong late last year. “The outlook for the U.S. dollar is a significant issue for investors contemplating US-related investments,” Mr Shen said.

These money managers are very concerned about the value of their investments. However, more draconian policy shifts are in the offing if the U.S. dollar continues to sink.

Behind the scenes, fund officials are questioning the credibility of the Federal Reserve and U.S. Treasury in defending the dollar and maintaining financial stability. Reacting to last year’s collapse of structured investment vehicles, the head of one Middle East fund said: “I thought the problem of off-balance sheet had gone away with Enron.”

Kuwait last year ended its currency link to the dollar, raising questions about whether other oil-rich Gulf states with similar arrangements would follow.

The largest of the sovereign wealth funds, the Abu Dhabi Investment Authority, is still committed to the dollar. ADIA’s subsidiaries make their investments without taking into account currency risks. A separate ADIA division then decides whether to hedge or not.

As long as the United Arab Emirates – which includes Abu Dhabi – pegs its currency to the dollar, a major departure from the current investment policy is unlikely. Moreover, ADIA staff say they worry that the euro may be at a peak against the dollar.

Still, dissatisfaction with the dollar peg is growing at the Abu Dhabi fund. “We are suffering. We are importing inflation for no reason,” says one ADIA staffer.

It is only a matter of time before other Middle Eastern countries see the benefit of switching to a currency basket. The relative appreciation in their currency from re-pegging some of their basket to Euros and Yen would certainly halt the rise in inflation. This would leave money managers free to invest in Euro-denominated assets and protect their returns.

These moves would cause the dollar to lose value and interest rates in the U.S. to rise irrespective of what the Fed does. This is yet another reason the low interest rate policy of the Fed is not in America’s best interest.

Sovereign funds cut exposure to weak dollar, FT, 17 Jul 2008

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