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What Sovereign Wealth? Part 2

Imagine you are walking down the street and you see a guy drive past in a really nice car. You think to yourself "gee I should have one of those." Guess what? He earns more than you do.

There almost seems to be a kind of sovereign envy. People look at sovereign wealth funds (SWF) and figure "we should have one of those." The basis for this, apart from the outright envy, seems to be that Australia is experiencing a mining boom and generating windfall cash flows. But as I have written previously, a sovereign wealth fund has to be funded from sovereign wealth. Unlike countries with SWFs such as Norway, Australia is a sovereign debtor, it runs persistent current account deficits, as we can see in the chart below.

The chart also shows that a resources boom is not a prerequisite to running a current account surplus. Also one could consider that for a country with persistent surpluses, creating a SWF by "quarantining" money in an investment fund might actually be required as a way of controlling inflows of money and possible inflation resulting from those inflows.

The chart shows that Norway has had surpluses for an extended period of time, reflecting the life of its North Sea oilfields. For Australia the mining boom is shorter and more transitory but Chile, another country benefiting from mining, is also mentioned as a SWF model for Australia. But Chile has also run current account surpluses as we can see below:

Chile is the worlds largest copper producer. We can see from the chart that as the mining boom took off, and copper prices rose, Chile went into surplus. For the year ending 2008 it went into deficit as copper prices fell when the global markets collapsed but returned to surplus when copper prices recovered. The charts shows an extrapolation through to the end of 2012 in which the IMF appears to be forecasting a return to deficit, perhaps due to an expectation of a correction in commodity markets.

The performance of Chile during the mining boom is in stark contrast to that of Australia over the same period. Why should there be such a difference? Well we could ask ourselves whether Chilean banks borrowed large amounts of money offshore to fund a housing bubble. Australian banks did, and interest payments to service those loans represent outflows that contribute to Australia's ongoing CAD at a time when Chile was able to generate sovereign wealth during a commodities boom.

To have a sovereign wealth fund you need to be generating sovereign wealth. Discussions about the creation of a SWF in Australia should begin by focusing on how first to generate current account surpluses.

Related articles:

An Australian Sovereign Wealth Fund. What Sovereign Wealth?

What sovereign wealth?

What sovereign wealth? Continued...

Current account deficits and house prices