Capital Warfare

With Iraq, Afghanistan and the war on terror dominating headlines in Washington these days, there's a real danger that U.S. policymakers will lose sight of the other major war currently being fought around the world -- the war for capital. While other countries are fighting with all they've got, many in the U.S. remain complacent, indifferent or antagonistic. Big mistake. There's a clear relationship between global financial leadership and global influence, and if history is any guide, Americans can't assume that today's financial powerhouse will be tomorrow's.

The war for capital is a three-front battle, encompassing competition among sources, markets and destinations. Already countries like China and oil-rich Middle Eastern states are challenging U.S. predominance as a source for capital, a consequence largely of factors beyond American control. But on the other two fronts - the battle to be the predominant location for exchanging capital and the battle to attract capital - the U.S. is in danger of losing out and significant blame falls on Washington.

China's muscular move into international investing via its newly created investment fund - which some rumors suggest could be as large as $300 billion - is only the latest (albeit the largest) example of a major new source of capital on the global scene. Recent years have seen the creation of large pools of investment capital emanating from governments such as Singapore and Kuwait, as well as from countries awash in petrodollars - many of which are ambivalent or antagonistic to the U.S. as a matter of policy. With alternatives to U.S. markets now readily available, much of this capital is being deployed away from the world's biggest economy.

And little wonder, given the political uproar that has already greeted several prominent attempts to invest in America. China still nurses the raw wounds from the failure in 2005 of CNOOC's bid for Unocal. Meantime, the controversy over the proposed Dubai Ports World deal may have won some politicians short-term gain, but there's a very real danger that it has left a long-term bad taste in many mouths in the Middle East.

Whatever certain lawmakers and commentators think, the problem for the U.S. is not that capital from China and elsewhere will attempt to invest too much in America. The real threat is that these new investors will take their money elsewhere. The risk of that happening will only increase as the negative of political controversy starts to outweigh the benefits of American investment in foreign eyes.

Particularly so given that the U.S. already faces stiff competition as an investment destination from resource-rich developing countries that welcome any investment by offering minimal government hectoring and high returns, not to mention strategic and political advantages. While the embrace of markets and capitalism by countries like China, Russia and even Vietnam represents a long-sought triumph over communism, the U.S. must nevertheless recognize the ancillary consequences of this victory. We now have to compete with them.

As for where capital changes hands between its suppliers and its consumers, competing centers of global finance, not only in London but also in Asia and the Middle East, are increasingly influential. A recent survey of financial professionals found almost two-thirds believed that London would consolidate its position as the global center of finance by 2015, 13% predicted Dubai, 10% pointed to Shanghai and fewer than one in ten gave a nod to New York. The U.S.-led unipolar financial era appears to be slipping away.

This isn't just about maintaining New York City's Wall Street-dependent economy. Access to U.S. markets, either as a final destination for investment capital or as a locus of exchange, has historically provided the U.S. with enormous influence - both carrot and stick - over companies and countries around the world. "If you want access to our capital and markets," the implicit message went, "you have to play by our rules."

This power to influence already is fading rapidly. Consider Russia. In the aftermath of the Kremlin crackdown on Yukos in 2003, investors barely batted an eye and continued to pour money into the Russian markets. The Kremlin realized that its treatment of Yukos' management and shareholders would not negatively impact its economy -- at least not via the capital markets. Thus emboldened, the Kremlin raised over $10 billion by re-selling those same Yukos assets via the IPO of Rosneft and another $9 billion by listing Russian banking behemoth Sberbank shortly thereafter. In each case, they raised enormous sums without directly accessing U.S. markets or investors. They bypassed U.S. lectures on good governance. They could flex muscles, act against political opponents and generally do as they pleased, and suffer no obvious financial penalty as a result.

This shift is evident in other ways as well. Trading floors around the world look to capital flows from China's State Administration on Foreign Exchange for "direction" in bond markets. While global equity markets still look to the open of New York trading for their leadership, the market's recent steep drop was prompted by China's move to limit speculative investment on the Shanghai exchange, not by fears about U.S. earnings growth. Is it only a matter of time until market direction in global equities is determined elsewhere?

If the U.S. is to maintain its leadership in a new multipolar world, policymakers must recognize that there is no guarantee the U.S. will remain the world's center of financial gravity forever and must plan accordingly. American lawmakers, financiers and companies must rise to the occasion and engage in the global war for capital by working together to make certain the U.S. remains an attractive destination and market for capital.

Reforms to Sarbanes-Oxley, shareholder litigation and regulatory fixes are all important pieces of the puzzle. But as long as policymakers still think that this threat to U.S. pre-eminence is "overblown," and as long as politicians think the U.S. can afford to play protectionist politics with the CNOOC's and Dubai Ports World's of the world, then these proposed solutions are unlikely to stem the tide. The first step must be to recognize that there is, in fact, another war being fought.