Foreigners Buying the US: Should We Worry?

Mark Thoma quotes a Washington Post op-ed piece by Daniel Gross that gets worried about the current and prospective level of foreign ownership of US businesses:

…In countries that are resource-rich or export powerhouses, governments and government-controlled entities have amassed huge pools of capital. A report issued last month by Morgan Stanley economist Stephen Jen estimated that funds such as the United Arab Emirates ADIA ($875 billion), Russia’s stabilization fund ($32 billion) and Singapore’s Temasek Holdings ($100 billion) collectively hold $2.5 trillion in assets — a sum equal to about 18 percent of the value of the S&P 500.

The funds’ managers have generally been content to invest in safe assets such as bonds. But in recent weeks, … General Electric … sold its plastics unit to Saudi Basic Industries Corp. (SABIC), which is 70 percent government owned… On May 20, the private equity firm Blackstone Group announced that China’s State Investment Co. is buying a 10 percent stake for $3 billion.

This phenomenon isn’t entirely new. In 1996, Norway’s government, planning for a day when its North Sea petroleum bounty would slow to a trickle, began plowing oil revenue into a mutual fund, which is now worth about $311 billion — or about $67,000 per Norwegian.

China, which has a whopping $1.2 trillion burning a hole in its coffers, has thus far been content to invest in U.S. government bonds and bonds issued by quasi-government agencies such as Fannie Mae. But like any smart investor, it is looking to diversify…

But there are complications. Many of the governments starting such funds have shown a propensity to intervene in their domestic economies and capital markets. And when governments own companies, that creates the potential for geopolitical mischief. Hugo Chavez has used the Venezuelan government’s shares of Citgo … to poke his fingers in the eyes of the U.S. government. In Russia, Vladimir Putin has used state control of energy companies as a political tool against domestic enemies and a diplomatic tool against Russia’s neighbors. …

Americans don’t seem to mind that foreigners own 45 percent of U.S. publicly held debt, in the form of low-yield government bonds. After all, as long as we pay the interest, the debt doesn’t entitle the foreigners to any say in how we run our business. But stock investors have a say in how the corporations they own are run….

Thoma isn’t concerned:

The purchase of U.S. companies is due to the potential for profit relative to risk, i.e. these companies are the best investments available to the purchasers, not because of the potential geopolitical leverage ownership might give. If there are better deals elsewhere, that’s where the money will flow.

In one sense, he is correct. The key issue is Gross’s mistaken view, “[S]tock investors have a say in how the corporations they own are run.” That’s theory, not reality. Only if you own a controlling stake do you have a say. That’s why takeover artists pay a “control premium.” The fact that investors are demonstrably unhappy with burgeoning CEO pay and can do nothing about it (except now vote on non-binding resolutions to perhaps embarrass the board into doing something) reveals how little practical power shareholders have.

However, what Thoma misses is that these investors are putting most if not all of their money into tradeable assets. If you are going to be dependent on foreign capital, it’s best to have it be illiquid, meaning real estate, venture capital, and other forms of what is counted as “foreign direct investment,” such as locating subsidiaries or operations here (think of all those Japanese car plants). You don’t want them to be able to pull it out suddenly and wreak havoc on your economy. That’s what happened to the Asian tigers in the emerging markets crisis of 1997-1998, and it was devastating to some players (Thailand and Indonesia were particularly hard hit).

Now I am sure some of you are thinking that the US isn’t Indonesia. If growth trends continue, various analysts (here and here are examples) say it will take 40+ years for China to surpass the US (although if the yuan appreciates, it could happen sooner). But China isn’t the only player growing faster than the US. India, the Gulf states, and other developing countries have higher growth rates. The US is now about 25% of world GDP and its share is falling.

And even at our present level, we are terribly dependent on foreign capital. A Fed study using 2004 data found that US long-term interest rates would be 1.5% higher in the absence of foreign inflows. Since the trade deficit has increased, that figure is likely to underestimate our current standing. And that merely assumes no foreign inflows. What if there was a net outflow? As we have noted repeatedly before, some of our biggest funding sources, namely China and the Gulf States, are getting tired of taking losses on their dollar positions and are diversifying away from the dollar. If the dollar slide continues, overseas investors may decide to stand on the sidelines (or worse, stem losses by lightening their dollar holdings) and wait for the dollar to bottom. But their failure to buy dollars in the face of our massive trade deficits would push the dollar downward.

As Nobel Prize winner Joseph Stiglitz summed up our status relative to China: “We are in a mutual hostage situation, and China may hold the better cards.” That statement applies to other substantial funders of our trade deficit, uh, investors.