Sovereign Wealth Funds for Monetary Sovereigns

When would an American sovereign wealth fund make sense?

Sovereign wealth funds are some of the world’s most important institutional investors, controlling an estimated $13 trillion in global capital. While SWF models vary broadly, around 90 countries have some sort of permanent government-run investment vehicle.¹ But despite being home to the world’s deepest capital markets, America does not.²

That could be set to change, however, due to Trump’s recent executive order calling for the creation of an American SWF. Admittedly, the order has been generally lambasted in the popular press, and Trump hasn’t helped matters by speculating that the fund could buy TikTok. Executed carefully, however, an American SWF may not be such a bad idea.

Of course, the devil is in the details. As a monetary sovereign and issuer of the world’s reserve currency, it’s not enough for America to simply copy & paste another country’s SWF model. With the right structure, however, an American SWF could facilitate both improved economic management and greater national investment.

Lens Shift: Thinking in Terms of Sovereignty

Understanding how to structure an American SWF starts with asking the right questions. Unfortunately, much of the debate so far has focused on operational issues: Where will we get the money? What will be in the fund? Who will run it?

But these questions put the cart before the horse. There is a deeper, more fundamental question that has so far been largely unaddressed: When does it make sense for a monetary sovereign to have a sovereign wealth fund?

Recall that some governments are monetary sovereign; they have floating exchange rates, limited foreign-currency debt, and the power to print their own currency. The ranks of monetary sovereigns include the US, the UK, and Japan.

Other governments, however, are not monetary sovereigns; either they do not have the power to issue their own currency (e.g. France, Italy, and all US states) and/or have obligations that require access to foreign currencies (e.g. the UAE’s fixed exchange rate and Argentina’s dollar debt).

It makes complete sense why a non-monetary sovereign would want an SWF. The classic motivation for an SWF is to increase a government’s spending power by making profitable investments. For governments that lack the ability to freely issue their own currency, an SWF can be a tool to save cash for a rainy day or build wealth for future generations. For monetary sovereigns, however, this logic falls apart.

B-dollars and real dollars

Suppose that I create my own cryptocurrency token dubbed B-dollars and convince the entire world to accept them at a 1-to-1 rate with US dollars. Here’s the question: Would it ever make sense for me to try and ‘build wealth’ in B-dollars by making smart investments and accumulating assets?

Of course not. Doing so would implicitly assume that I am somehow currency constrained in my ability to spend B-dollars. Since I have the power to issue the token at my discretion, however, B-dollars are an unlimited resource for me — I never have to worry about running out, so I never need to save them.³

Now back to the real world. The B-dollar situation may sound fantastical, but it’s not far off the federal government’s relationship with actual US dollars. Just as I don’t need to save B-dollars, America doesn’t need to save US dollars, Japan doesn’t need to save yen, and Britain doesn’t need to save pounds. (Note that there can be valid reasons to save the currencies of other nations — which we discuss below.)

The traditional argument in favor of an SWF is that earning more money allows a government to spend more money. For individuals, households, and non-monetary sovereigns, this argument holds water. But for a monetary sovereign, there is no logical link between making money and spending money. If America wants to spend dollars, the money doesn’t need to come out of a savings account — the government can simply spend it into existence.

Fish on Bikes: Monetary Sovereigns with SWFs

But does this mean that an SWF offers no benefit to a monetary sovereign? Intelligent commentators certainly seem to think so. In a recent piece, Professor Stephanie Kelton argues that the US needs a sovereign wealth fund like a fish needs a bicycle:

“It’s hard to see why anyone who understands how a sovereign currency works would be pushing a sovereign wealth fund. Even if it became ‘one of the biggest funds’ in the world, as Trump envisions, it wouldn’t give the federal government any spending power it doesn’t already have.”

The final sentence is undoubtedly correct. Since monetary sovereigns are not currency constrained, they already have all the spending power they’ll ever need.

But how can we square this argument with the fact that many monetary sovereigns already have SWFs and seem to perceive substantial benefits from operating them? Examples include:

• Norway, which issues the krone and has the world’s largest SWF, the $1.8 trillion Government Pension Fund Global.

• South Korea, which issues the won and has the $189 billion Korea Investment Corporation SWF.

• And China, which issues the yuan and has two SWFs managing at least a trillion dollars (along with a smattering of smaller funds).

Are these governments simply foolish, wasting their time and effort managing SWFs that don’t add any real value for a monetary sovereign?

No. The reality is that while SWFs cannot offer monetary sovereigns increased spending power, they can be useful for other purposes. Specifically, SWFs can be valuable tools to help manage an economy and facilitate strategic investments.

To better understand this argument, we need to explore the cases of Norway, South Korea, and China in greater detail.

Monetary Sovereign Case Studies

Norway’s SWF: Limiting inflation from natural resources

In 1969, Norway discovered oil in the North Sea. Subsequent discoveries made it clear that this wasn’t a one-off — the country was home to substantial oil reserves. But while significant deposits of natural resources are a blessing, they can also be a curse if mismanaged.

International commodity markets are almost universally priced in US dollars. If a huge surge of export dollars is converted into local currency, it can cause the exchange rate to appreciate, making the country’s other exports less competitive. Moreover, increased domestic spending driven by this flood of money can push up inflation.

This ‘Dutch disease’ is named for the Netherlands’ economic experience after discovering natural gas deposits in the 1960s. But any country undergoing a natural resource boom can catch it, as demonstrated by Australia (minerals), Venezuela (oil), and the tiny island nation of Nauru (phosphate).

Like most diseases, however, this one can be avoided with preventative measures. Specifically, earnings from natural resource sales can be parked internationally and only trickled into the domestic economy over time. Doing so prevents both rapid exchange rate appreciation and the risk of spending-fueled inflation. As it turns out, this is exactly the strategy pursued by Norway’s SWF, colloquially known as the ‘oil fund.’

The oil fund was established in 1990 as part of the Norwegian government’s decision “that revenue from oil and gas should be used cautiously in order to avoid imbalances in the economy.” Since oil production began, some 80% of Norway’s oil revenue has gone to the fund, thanks to a 78% industry tax rate and strong state ownership. In line with the mission of protecting Norway from the Dutch disease, 100% of the oil fund’s current $1.8 trillion value is invested internationally, and the government can only spend up to 3% of the fund’s value each year.

Norway’s SWF is often marketed as a savings vehicle to preserve oil wealth for future generations. Given this background, however, the ‘savings’ explanation isn’t the best way to understand the fund. Rather, Norway’s SWF is a sink for the country’s oil earnings, preventing both economic overheating and unwelcome krone appreciation.

Korea’s SWF: Self-insurance against currency crisis

During the 1990s, Korea’s economy became dependent on large amounts of foreign money continually flowing into the country.⁴ When the 1997 Asian financial crisis hit, however, this flow of funds reversed sharply. As international lenders and investors pulled their money out of Korea, they sold the won and scrambled for foreign currencies.

The result was a severe deprecation in the won, with the currency’s dollar exchange rate falling by more than half between 1996 and 1998. In turn, this increased the real value of foreign debt in dollar terms, contributing to a wave of corporate bankruptcies. By mid-1997, eight of Korea’s largest companies were effectively insolvent, with the total number of bankruptcies rising to nearly 3,500 firms a month.

Although the Korean central bank attempted to intervene by using its foreign currency holdings to buy won, it simply didn’t have enough reserves to arrest the decline. By the end of 1997, the government’s reserves were nearly exhausted. The only remaining option was for Korea to accept a $55 billion loan package led by the IMF, which came with painful austerity measures attached.

In the wake of the crisis, it became clear that if Korea had a larger stock of foreign reserves, the country may never have had to turn to the IMF to secure international currency. One strategy to earn more reserves would be to invest the central bank’s foreign currency in higher-yielding assets. Thus, the idea behind the Korea Investment Corporation (KIC) was born, an SWF designed to manage and invest a portion of the central bank’s reserves.

KIC was formally established in 2005 and seeded with $20 billion of foreign reserves. By year-end 2023, that had risen to $189 billion due to a combination of newly earmarked funds and investment gains. As the fund’s assets are counted as part of the country’s official reserves, this figure amounts to 45% of Korea’s total reserves.

Thus, KIC serves as an element in Korea’s “self-insurance” strategy of holding vast amounts of foreign reserves to prevent international capital volatility from destabilizing the country’s economy. Today, Korea is estimated to have the 9^th largest holdings of foreign reserves in the world. In fact, this insurance policy has already been cashed in once — in 2008, the Korean central bank used its stockpile of reserves to support the won, which some have argued helped ameliorate the worst effects of the crisis on the country.

A final point about KIC is worth mentioning. One of the justifications for the SWF, enshrined in the official act establishing the fund, is to help develop Korea’s domestic asset management industry. Therefore, in addition to its role in building foreign reserves, KIC can also be viewed as a strategic investment in a politically favored sector.

China’s SWFs: Conduits for strategic investments

When compared to Norway or Korea, navigating China’s sovereign wealth system is no easy feat. The country has dozens of SWFs, each with varying degrees of transparency and complexity. This system is simpler in one key aspect, however: it appears almost entirely designed around the objective of serving as a conduit to promote the Chinese Communist Party’s strategic goals, both domestically and abroad.

As researcher and author Zongyuan Zoe Liu persuasively argues in her book Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions, China’s SWFs can’t merely be understood as tools for managing the country’s stockpile of foreign reserves. Rather, “[t]hey represent a state-engineered project to leverage capital to solve urgent domestic problems and support the state’s political-economic agenda.”

The evidence for this is ample. China’s first significant foray into deploying an SWF was with Central Huijin, a company established in 2003 to recapitalize the country’s ailing banks. Using foreign reserves endowed by the central bank, Central Huijin injected $77 billion of capital into China’s banks. After restructuring the country’s brokerage industry as well, the firm gradually became the “shareholder in chief” of China’s financial sector.

Central Huijin was eventually rolled into China Investment Corporation (CIC), the country’s $1.3 trillion flagship SWF. Like its subsidiary, CIC was funded with foreign reserves from the central bank (albeit via a complicated swap transaction). CIC’s support for the financial sector hasn’t faded. Via Central Huijin, CIC has purchased both bank shares and broader ETFs to support domestic equity prices.

But CIC’s mission goes beyond just supporting the financial industry. The fund has also been a key capital provider to strategically important companies like Alibaba and SMIC. Finally, CIC has played a role in funding China’s political ambitions abroad. CIC provided a portion of the capital to back the Silk Road Fund, a mini-SWF designed to facilitate international infrastructure projects as part of the Belt & Road Initiative.

China’s other major SWF is the State Administration of Foreign Exchange (SAFE), the agency responsible for managing the central bank’s reserves. Similar to KIC, SAFE invests a portion of these reserves outside of traditional ultra-safe holdings. As such, even though SAFE is not officially acknowledged as an SWF, it functions like one in practice.

SAFE does not disclose its activities as transparently as CIC, but estimates indicate that it invests $1-$1.5 trillion outside of traditional reserve holdings. In fact, SAFE is the majority shareholder in the aforementioned Silk Road Fund. The agency has also capitalized numerous smaller geopolitically focused SWFs, including development funds focused on Africa and Latin America.

Doubtless, some of the motivation behind China’s SWF activity is growing and diversifying foreign exchange reserves to help support the yuan’s exchange rate regime. Overall, however, the evidence strongly indicates that the best way to understand vehicles like SAFE and CIC is in political terms. These funds showcase how a monetary sovereign can benefit from using a sovereign wealth fund as a conduit to finance strategic projects — both domestically and internationally.

Conclusion: Lessons for America

As a monetary sovereign, America will not benefit from an SWF as a savings tool. The very idea of ‘saving’ an unlimited resource is illogical. The examples of Norway, Korea, and China demonstrate, however, that an SWF can still benefit a monetary sovereign when it comes to economic management and/or strategic investing.

In economic terms, America does not have a foreign exchange-dependent regime, nor is the country at risk of Dutch Disease. As a result, an American SWF would need to be designed to support the Federal Reserve’s existing economic management. Moreover, although America has already demonstrated a capacity for industrial policy without an SWF, a permanent vehicle could facilitate strategic investments on an ongoing basis.

In the coming weeks, I’ll describe a novel proposal for an American SWF that uses these two goals to motivate a structure linking both fiscal and monetary policy. Without careful thought, an American SWF risks being an expensive and foolish boondoggle (or worse, a vehicle for open corruption). Properly executed, however, an SWF could come with real benefits for the American public — despite the government’s monetary sovereignty.

Appendix: A Note on the Dollar’s Reserve Status

One final aspect of the relationship between monetary sovereigns and sovereign wealth funds is worth noting.

In the edge case of a monetary sovereign with a trade surplus in a specific sector, a trade deficit for essential goods, and a relatively small economy with shallow capital markets, establishing an SWF can make sense for an additional reason: building up foreign reserves to fund international imports if the surplus sector is exhausted or disrupted. Possible examples include Taiwan (chip exports disrupted in a war) or Nauru (phosphate exports that eventually run out). For such countries, domestic productive capacity may be too limited to meet the country’s needs, motivating a stockpile of dollars, euros, or other major international currency.

It should be clear why this isn’t appropriate for the main section — as the issuer of the world’s reserve currency, this concern does not apply to America. More broadly, however, it doesn’t really apply to countries with the ability to purchase or borrow sufficient volumes of foreign currency on the open market.

1. Technically, not all permanent government-run investment vehicles are SWFs. National pension funds (like Social Security) also fall under this definition, but are almost universally recognized as distinct from SWFs.

2. Also technically not true. 20 US states have their own SWF, although America has never had one at the federal level. Alaska’s SWF, the $81 billion Permanent Fund, is the largest.

3. Obligatory acknowledgment that while I don’t have spending constraints, I do have real resource constraints. I can’t buy things that aren’t for sale and I can potentially push up inflation if I spend too much.

4. In technical terms, Korea was running a fairly persistent current account deficit, essentially meaning that the country was importing more than it was exporting. To get the foreign currency necessary to pay for these imports, Korean firms borrowed a lot of money from abroad. Total foreign debt swelled to $164 billion in 1996, equivalent to about a third of GDP at the time.

Moreover, due to regulatory incentives pushing firms toward short-term borrowing, just under half of Korea’s external debt in 1996 was due in less than one year. This composition exacerbated the risk of currency crisis by making it easier for foreign lenders to pull funds by calling in loans or refusing to roll them over.