The Shadow Market

1. The Shadow Market: A New Global Economic Force

The shadow market isn't a physical entity. It has no headquarters, bourse, or formal leadership. It isn't even a single zone of exchange in the way that we typically define a financial market. Rather, it's the invisible and ever-shifting global nexus where money mixes with geopolitical power.

Unregulated financial behemoth. The shadow market is a collection of wealthy nations and investors that effectively run the international economy through their prodigious holdings of stocks, bonds, real estate, currencies, and other financial instruments. These are held in largely unregulated investment vehicles such as hedge funds, private equity funds, and government-run sovereign wealth funds.

Unprecedented financial power. As of late 2008, more than $12 trillion in assets was controlled by petrodollar states like Saudi Arabia, Kuwait, and Abu Dhabi; the wealthy Asian nations of China, Japan, and South Korea; and hedge funds and private equity funds. This pile of capital is the basis for the shadow market's power, as liquidity is the key to a functioning market.

Reshaping global economics. The shadow market has largely supplanted the United States as the pacesetter for the global economy. It has the ability to stave off global economic calamities but is reluctant to work together to solve global problems, preferring to protect their own interests and zones of influence first.

2. China's Economic Ascendancy and Strategic Investments

China showed that she could be very sophisticated in the financial markets and use them to her advantage.

Economic powerhouse. China's economy has grown faster and more aggressively than any other major country in the world. From 2003 to 2008, China's gross domestic product rose nearly 11 percent per year, by far the fastest growth rate of any country in the G20.

Strategic resource acquisition. China has launched an unprecedented scramble to buy the world's resources while they're still available. The country has been insuring itself future access to oil, minerals, food, and anything else it cannot supply for itself through strategic investments and deals around the globe.

Global influence through investment. China is using its vast holdings of currency and debt reserves as a powerful cudgel against the rest of the world, particularly the United States. It has become a significant player in global finance, with the ability to influence markets and economies through its investment decisions.

3. Oil-Rich Nations Wield Unprecedented Financial Power

When you accounted for the savings on taxes and shipping costs (tankers from the Mideast had to travel more than ten thousand miles around the horn of Africa to reach Europe or the United States), North Sea crude still was a cheaper alternative for Western nations than Middle Eastern oil.

Petrodollar power. Oil-rich nations, particularly in the Middle East, have amassed enormous wealth through their control of valuable natural resources. This wealth has been channeled into sovereign wealth funds and other investment vehicles, giving these nations significant influence in global finance.

Strategic investments. These nations are using their wealth to make strategic investments around the world, often in sectors critical to their long-term economic and geopolitical interests. For example:

• Abu Dhabi's investments in global real estate and financial institutions
• Kuwait's diversification of its economy through its sovereign wealth fund
• Saudi Arabia's investments in farmland across multiple countries

Geopolitical leverage. The financial power of these oil-rich nations gives them leverage in geopolitical negotiations and allows them to pursue their national interests on the global stage.

4. The Decline of Western Economic Dominance

To many observers of the global steel industry, these developments were too coincidental not to be related.

Shifting economic balance. The traditional economic dominance of Western nations, particularly the United States and European countries, is waning. This is evident in:

• The rise of emerging economies like China and India
• The financial struggles of once-dominant economies like the United States and Europe
• The increasing influence of non-Western nations in global economic decision-making

Loss of manufacturing base. Many Western countries have seen their manufacturing bases erode, with production shifting to countries with lower labor costs. This has led to job losses and economic instability in many Western industrial regions.

Debt burden. Western nations have accumulated significant debt, much of which is held by emerging economies. This has created a power dynamic where debtor nations are increasingly beholden to their creditors, shifting the balance of economic influence.

5. Sovereign Wealth Funds: The New Power Players

Sovereign wealth funds (SWFs) are now a global phenomenon. These government-owned investment vehicles are managed separately from a country's debt and currency reserves.

Massive financial resources. As of July 2010, roughly $3.5 trillion in global capital was managed through different SWFs, up from $1 trillion in 1999. The largest funds belong to oil-rich nations and industrial powerhouses such as Abu Dhabi, Saudi Arabia, China, Singapore, Kuwait, Russia, and Norway.

Strategic investments. SWFs are making significant investments in various sectors and countries, often with strategic long-term goals. These investments can have both economic and geopolitical implications. Examples include:

• China's investments in natural resources and technology companies
• Middle Eastern SWFs' investments in Western financial institutions and real estate

Influence beyond size. While SWFs control less capital than some other investment vehicles, their government backing and long-term investment horizons give them outsized influence in the global financial markets.

6. America's Debt and Dependence on Foreign Capital

Since 2007, more than 60 percent of our debt has been owned by nonresident foreign investors and independent governments—primarily rich Asian nations such as China, Japan, and Singapore.

Massive foreign ownership of debt. The United States has become increasingly reliant on foreign capital to finance its government operations and economic activities. This has led to a situation where a significant portion of U.S. debt is held by foreign entities, particularly China and Japan.

Vulnerability to foreign influence. This dependence on foreign capital creates potential vulnerabilities for the United States:

• Susceptibility to economic pressure from creditor nations
• Potential for sudden economic shocks if foreign investors rapidly sell U.S. assets
• Constraints on policy options due to the need to maintain foreign investor confidence

Shift in global power dynamics. The United States' position as a debtor nation represents a significant shift in global economic power dynamics, potentially limiting its ability to exert economic and geopolitical influence.

7. The Global Shift of Economic Power from West to East

In stark terms, here is what has happened: While our economy tanked, nations like China and the small oil-rich states of the Persian Gulf, which still had plenty of wealth on hand, suddenly discovered that they were really rich compared to the rest of the world.

Economic center of gravity moving east. The global economic center of gravity is shifting from Western nations to Eastern countries, particularly China and other Asian economies. This shift is driven by:

• Rapid economic growth in Asian countries
• Accumulation of vast financial reserves by Eastern nations
• Relative economic stagnation in many Western countries

New economic powerhouses. Countries that were once considered developing economies are now major players in the global economic system. The BRIC countries (Brazil, Russia, India, and China) are expected to account for a whopping 40 percent of the world's economic growth between now and 2020.

Implications for global governance. This shift in economic power is leading to changes in global economic governance, such as the increased prominence of the G20 over the G7 in addressing global economic issues.

8. Ethical Investing and Norway's Unique Approach

Norway is consciously pursuing state policy indirectly through its funds. Investment is clearly meant to project Norway's political power by other means, and to move policy in particular directions.

Ethical investment guidelines. Norway's Government Pension Fund Global, also known as the Oil Fund, operates under strict ethical guidelines. These guidelines prevent the fund from investing in companies involved in activities deemed unethical, such as the production of certain weapons or severe environmental damage.

Active ownership. The fund uses its significant investments to influence corporate behavior, pushing for improved corporate governance, environmental responsibility, and social responsibility. This approach includes:

• Voting at shareholder meetings
• Engaging directly with companies on ethical issues
• Divesting from companies that fail to meet ethical standards

Balancing ethics and returns. Norway's approach raises questions about the relationship between ethical investing and financial returns. While the fund has generally performed well, there are ongoing debates about whether its ethical approach enhances or limits its financial performance.

9. Europe's Economic Struggles and Uncertain Future

Suddenly the Greek mess threatened U.S. businesses and workers in other, less direct ways as well.

Debt crisis. Europe has faced significant economic challenges, particularly evident in the debt crises of countries like Greece, Spain, and Portugal. These crises have exposed structural weaknesses in the European Union's economic system and raised questions about the long-term viability of the euro as a common currency.

Economic stagnation. Many European countries have experienced prolonged periods of low growth and high unemployment, particularly following the 2008 global financial crisis. This has led to:

• Political instability in several countries
• Debates about the future of the European Union
• Concerns about Europe's ability to compete in the global economy

Loss of global influence. Europe's economic struggles have contributed to a decline in its global economic and political influence, with emerging economies increasingly taking center stage in global affairs.

10. Emerging Markets: The New Frontier for Investors

Right now, money is flowing east, and there's no sign of that abating any time soon.

Shift in investment focus. Global investors are increasingly turning their attention to emerging markets, attracted by their high growth rates and potential for strong returns. Key emerging markets include:

• BRIC countries (Brazil, Russia, India, China)
• ASEAN countries (Indonesia, Malaysia, Philippines, etc.)
• African economies (South Africa, Nigeria, Kenya, etc.)

Diversification opportunities. Emerging markets offer investors opportunities to diversify their portfolios beyond traditional Western markets. This can potentially lead to higher returns and reduced overall portfolio risk.

Challenges and risks. While offering significant potential, investing in emerging markets also comes with unique challenges and risks:

• Political instability in some countries
• Less developed regulatory environments
• Currency fluctuations
• Potential for rapid market shifts

Last updated: August 19, 2024