(James Saft is a Reuters columnist. The opinions expressed are his own)

Emerging markets could be the first to suffer destabilizing inflation, courtesy of a strong economic rebound, a weak dollar and extremely loose monetary policy in the developed world.

Inflation, in faster growing emerging markets, was not high on the list of worries even months ago, but the speed and strength of the rebound and red-hot asset markets in some places show that it may be a rising threat.

“The surprise could be that inflation in emerging markets really takes off,” Amer Bisat of hedge fund Traxis Partners said on Tuesday at a Euromoney foreign exchange conference in New York.

It is not yet a central case, but should price pressures in countries like China, Korea and Brazil take hold, it will leave policy makers in a bind and would roil financial markets.

Interest rate hikes might only attract more hot capital and may be only partially effective. Rising currencies can be self-fulfilling and higher interest rates in emerging markets make carry trades — borrowing in dollars, for example, and reinvesting in something like Korean won — all the more attractive.

Other methods of stemming currency appreciation, which stokes inflation, may also become more popular; Brazil in October imposed a 2 percent tax on foreign inflows into equities and fixed-income instruments designed to keep the real from appreciating too quickly.

Emerging market central bankers can expect no help from colleagues in the developed world any time soon. The Federal Reserve will find it economically and politically difficult to hike with unemployment near 10 percent.

“Inflation in emerging markets will be U.S. inflation exported,” said Maxime Tessier of Canadian state asset manager Caisse de Depot et Placement du Quebec.

This might actually argue for China to acquiesce to U.S. calls for it to increase the value of the yuan, which will fight inflation at home and would win it friends and influence abroad. It would not be a surprise for China to return to a “crawling peg” under which the yuan is allowed to appreciate upward slowly. That won’t happen immediately; a negotiation and wooing period will allow China to extract maximum value from the United States for implementing a policy it may well need anyway.

And of course, with significant spare capacity, the decision will not be easy as inflation in the Chinese economy will not be evenly distributed.

RED HOT

While the data on inflation is still fairly tame, asset markets in many emerging markets are now red hot.

The World Bank this week raised its growth forecast for developing east Asia to 6.7 percent this year from 5.3 percent, but said the strong recovery brought with it new dangers in booming asset prices.

“As liquidity is working its way through the system, and demand is relatively low, the credit is finding its way to stock exchanges and real estate markets. It’s a danger,” said Vikram Nehru, the World Bank’s chief economist for East Asia and the Pacific. The IMF chimed in, citing surging property prices in Hong Kong and “a risk that prices could become driven more by short-term liquidity conditions, divorced from fundamental forces of supply and demand.”

Authorities in South Korea have also reacted to a surge in real estate price in and around Seoul, imposing regulations to tighten access to mortgage finance.

Officials have taken some steps to slow the flood of loans they unleashed via Chinese banks this year, but not entirely effectively. Loans by Chinese banks have disproportionately found their way into property and financial speculation, but moves over the summer to limit lending sent the stock market into a tailspin which may have scared off officials. China’s  four largest banks extended about 136 billion yuan ($20 billion) in yuan-denominated new loans in October, up 23.6 percent from September’s 110.4 billion yuan, the China Securities Journal reported on Tuesday.

And it’s not just property — the MSCI Emerging Markets Index is up more than 60 percent this year and currencies in many emerging markets have recorded strong returns.

All of this comes with one very large caveat; if, as is very possible, the recovery in the United States and Europe falters in the new year, then the risk of actual inflation in emerging markets will recede along with their exports to the West. A relapse lower too might bring with it a recovery in the dollar, which would inflict huge pain on speculators who are running dollar carry trades and investing in emerging markets assets and property.

Taking a very long view, strong emerging markets make good sense. Capital should flow to emerging markets. Returns there over the long run will be better, at least if the rule of law prevails. Unless policies can tread a very narrow path, that growth will bring with it inflation and rising volatility.

(Editing by James Dalgleish)
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

(James Saft is a Reuters columnist. The opinions expressed are his own)

So it can be done after all.

Britain is poised to take tough steps to break up the large banks it rescued, setting it in stark contrast to the United States, which seems set on a policy of shoring up the unfair advantages it grants its too-big-to-fail banks while regulating around the edges.

It is quite a change for Britain, which has a sorry history of self-serving self-regulation in financial services combined with limp and outgunned official control.

Chancellor of the Exchequer Alistair Darling on Sunday told the BBC that Lloyds, RBS and Northern Rock would be partly broken up and assets sold to new entrants into the banking market. Large existing competitors such as HSBC are expected to be blocked from making bids for the assets.

Britain took over Northern Rock after a run on the bank and its rescue of Lloyds and RBS left it with stakes of 43 and 70 percent, respectively.

It is worth noting that if anything Britain is more dependent on its financial services sector than the United States.

Could it be that Britain has determined that a level playing field, strong competition and a lower risk of a crisis might actually make it more competitive internationally? I certainly think so.

It will without doubt improve the situation for the small businesses and individuals that can’t access international capital markets and depend on the banks for access to credit and other financial services.

Before we get all excited and expect the United States to follow suit with Citibank and Bank of America, it is important to recall that Britain’s Labour government is more or less on its death bed and faces an election in 2010 which the bookies and almost everyone else think it is highly unlikely to win.

There is also the matter of the European Union, which has a say over subsidies such as the ones Britain has showered on the banks. RBS said on Monday that it may be forced by the EU to sell more assets than it had planned. Lloyds is also seen likely to raise additional new capital to allow it to stay outside of an asset insurance scheme Britain is running for the banks and which would involve the government taking yet more equity in the participants.

OH WHAT A CONTRAST

The fact remains that Britain and the EU are saying that more competition is needed and taking steps to ensure that the banks which ended up needing state care are broken up. This must have an impact on how other big banks are ultimately treated, even if they did not receive the same level of direct state aid.

The equity buffer that is being required is also remarkable; the banks should end up with core tier one equity of about 10 percent, four times what they were expected to hold before the crisis.

Contrast all of this with the hopefully named Financial Stability Improvement Act of 2009, now wending its way through Congress. As Harvard Business School professor David Moss points out, as currently drafted this bill won’t even allow the systemically important banks it is designed to control be named, a real Monty Python-esque touch.

Think about it: we won’t even be allowed to know the identities of the firms we are potentially on the hook for. Moss points out that this neatly side-steps the idea of taxing too-whatever-to-fail status as a means of encouraging the behemoths to sell up and avoid the costs. The costs remain with the taxpayer, or potentially with a group of big firms after the fact.

The argument the U.S. administration is making, more or less, is that our complex global economy somehow demands that we have complex huge banks. If we don’t allow huge banks to persist, we’ll choke off growth. If we think we can go back to mom and pop banking, we are simply kidding ourselves. And anyway, if the U.S. doesn’t allow it, foreign banks will just scoop up the cream. With Britain and the European Union taking strong steps, that argument is losing traction. And as for complexity, well I’d have to say that the record of complexity in banking is mixed, to be kind, as far as the deal it gives to taxpayers and consumers of banking services. It would be one thing to argue for huge economies of scale for plain vanilla banking processes like clearing, but it is hard to see why that needs to be combined with derivatives and trading.

It would be nice to think the winds are blowing west across the Atlantic, but this is not usually the case.

(Editing by James Dalgleish)

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

(James Saft is a Reuters columnist. The opinions expressed are his own)

Don’t expect the year-long rally in risky assets to be undermined any time soon by the Federal Reserve becoming concerned about inflation.

The old metaphor — that the Fed’s job is to take away the punchbowl just when the party starts getting good — just doesn’t apply in the current circumstances. That’s not to say inflation isn’t a threat in the medium term — it is virtually a promise.

But punchbowl thinking dates from a time when firstly the Fed was presumed to have a degree of control over events we now know is not true and secondly to an era when asset prices were the caboose rather than the engine of the economic train.

Even with an economy that is now growing, the risk of a self-reinforcing de-leveraging spiral is enough to ensure that the Fed will not pull the trigger on tightening any time soon.

“Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up, economies don’t do well, and when they go down, the economy can be horrid,” Pimco bond chief Bill Gross writes in his most recent letter to investors.

Gross argues that leverage inflated the price of assets even as investment in the U.S. real economy flagged. As this happened the U.S. economy became ever more dependent on asset prices and on the sectors, such as finance, which intermediated the borrowing. When the debt and asset bubble is pinched, the whole edifice is threatened, leading to a response like the one we’ve seen: massive and overwhelming aid trained on markets irrespective of the costs.

Pimco data shows that the prices of assets in the United States over the past 50 years have gone up 1.3 percent a year more than would have been expected given nominal growth in the economy, leading to a putative 100 percent overvaluation if you reason that the assets which depend on the economy for income shouldn’t outgrow it.

Unsurprisingly, the real outperformance of asset prices against economic growth has come in the past 30 years, since when debt growth has accelerated.

There are other explanations for why asset prices have outpaced economic growth. For one thing, off-shoring and outsourcing have both suppressed wages in the United States, leading to higher returns on capital, and increased the income that U.S. assets receive from overseas.

It’s obvious that the past 25 years have not been kind to labor, and as its share of GDP has declined the share going to asset owners has increased. In that sense increasing asset prices make economic sense, though there seems to be every chance that workers start to recapture some of what they have lost.

GROWTH, DEFAULT OR INFLATION?

Taxes on capital and profits have also fallen in the United States, and, like wages, this is a trend that could easily be reversed in coming years, especially given the huge amount of public debt that will have to be paid back.

This brings us to the other very strong reason the Fed may have for not pulling away the punchbowl — or water bowl as perhaps we had better see it — even when the party turns inflationary: public debt.

Since the United States have taken a decision to not allow too much of the private debt to default, it has taken on a corresponding increase in public debt which will have to be repaid ultimately. U.S. debt as a percentage of GDP will exceed 60 percent, a level not seen since World War II.

But unlike the post-war period, Europe doesn’t need  rebuilding and though Asia will grow hugely those profits won’t flow to U.S. coffers.

So, if growth doesn’t allow the United States to repay debts, there are two options, neither pretty; default or inflation.

“No policymaker in the developed world — and, by now, few in the developing world — would want to countenance default as an option,” writes economist Spyros Andreopoulos of Morgan Stanley in London in a note to clients.

“This leaves inflation.”

To be sure, the Federal Reserve takes its mandate to control inflation and its independence seriously, but it is going to find itself in a very difficult squeeze, partly of its own making. The debt is high, growth will be poor and the time for private defaults is past. Threats to its independence will only grow.

Given that, and the dependence of the economy on asset prices, it’s not hard to bet that the evil we will be left with is inflation. Whether it is engineered or just kind of happens is less interesting than the reasonably high likelihood that it will happen at all.

For a time at least, that would argue that risky assets, particularly real assets and emerging markets, do well.

Longer term, things get stickier and stickier.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

– Wei Gu is a Reuters columnist. The opinions expressed are her own —

When it comes to protecting intellectual property in China, the United States often feels that its pleas are falling on deaf ears. Its best hope is that China recognizes that copyright protection is in its own interests. To achieve that, Washington needs to push for changes from within.

After a fruitless decade of lobbying China on intellectual property, Washington has reached for the microphone. This week, the U.S. Chamber of Commerce launched a high-profile international forum on intellectual property in Guangzhou, capital of Guangdong Province and best known as both China’s manufacturing hub and the global centre for intellectual property theft.

Guangdong understands it cannot hold on to both titles forever. Its reforming leader Wang Yang has vowed to build an innovative Guangdong, but he and his deputies understandably do not want to be criticized in public. The U.S. delegation included high-ranking officials such as Commerce Secretary Gary Locke, but the very man they hoped to engage with didn’t show up.

Foreign pressure can help, but changes rarely happen in public. First, both parties need to agree on what they are trying to achieve. As a manufacturer for the rest of the world, China has historically seen little upside in protecting copyright. The United States needs to convince Beijing that, if it wants to develop its own products, then protecting copyright is important.

Huawei Technologies, the telecom equipment maker based in Guangdong, could be a good partner in this. In 2003, Cisco sued Huawei for copyright violations, but dropped the suit after Huawei agreed to stop selling some products. Now, Huawei has emerged as a strong protector of copyright. Last year the company filed the largest number of patents in the world.

Song Liuping, Huawei’s chief legal officer, advocates increasing the penalty for IP theft, a view shared by Americans. But he thinks the problem is not the lack of an adequate legal system or even lax enforcement, but the absence of a culture in China that values designs, patents, and copyrights.

China is likely to act when it feels others are trampling on its rights. A Chinese group recently complained that Google’s planned online library of digitised books might violate Chinese authors’ copyrights. The more China feels that its own interests are at stake, the more serious it will get. When every new movie or software program can be copied for nothing, it is impossible to develop a film business or software industry.

It is better to back Chinese movie stars and technology entrepreneurs rather than American politicians to drive this message home in China.

— At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund —

(James Saft is a Reuters columnist. The opinions expressed are his own)

There are encouraging signs that shareholders are becoming more assertive in defending their interests.

The Financial Times reported on Monday that some of Britain’s largest institutional shareholders - including Standard Life, Legal & General and M&G - are working on a plan to bypass investment banks by creating a club to underwrite new issues of equity by small and medium-sized British companies, a move that could save hugely on fees.

What, you may wonder, took them so long?

Second only to taxpayers, investors have been the great patsies of the financial crisis, paying massive costs to a financial services industry which has, to put it mildly, not served them well.

Activist shareholders and investors could be a key force in fixing what is wrong with the financial system. Unleashing their power to act in their own best interests should be a main thrust of new regulation.

The British investor group, reportedly being assisted by mergers and acquisition advisors Lazards, would effectively cut out the middle men by agreeing to take up any unwanted new shares in an offering. This is an idea which if successful could save companies and their owners huge amounts in fees and at the same time deal a blow to investment banking profitability.

Fees charged by banks for equity underwriting in Britain have more or less doubled in the aftermath of the crisis to 3.5-4.0 percent of the amount being raised, with the lions share going to banks rather than to the institutional investors who sub-underwrite.

While banks may argue, and in part be correct, that this is because the past two years have demonstrated the risks of capital market underwriting, it is also patently because there are now fewer banks competing for this business.

To be sure, a club approach is better suited for small and medium sized underwritings and would face huge difficulties for a major share issue involving global investors. But if a test run proves successful it would place pressure on fees for transactions of all sizes.

Even before the crisis hit, fees for investment banking services seemed not to follow with the same fidelity the laws of economics which hold such sway in microchips, steel or even tax preparation.

And it’s not just investors, who consume investment banking products, who have been ill-served. Shareholders in companies, particularly in banks, have provided the capital but have not had their fair share of the fruits.

FOR WHOSE BENEFIT IS THIS ZOO BEING RUN?

That has led to bad decisions, decisions often designed to maximize the benefit to employees at the expense of the shareholders who run disproportionate risk.

Paul Myners, a British Treasury official with special responsibility for financial services, gave an absolutely scathing address last week to the Worshipful Company of International Bankers, assembled for dinner in the Mansion House in the City of London.

Myners, who is reported to be considering holding a competition inquiry into banking fees, took aim at the bonus and compensation culture in the industry.

“It could be argued that some shareholders in banks have been left holding not the ordinary shares they originally purchased, but a new form of subordinated, participating, non-cumulative equity that ranks behind rewards for the senior management, and executives of the firm in which they invested have a prior claim. This cannot be right,” Myners said.

“In case anyone needs reminding, the profits of banks belong to their owners; not their managers and traders.”

I imagine that the bankers were a little less worshipful on their way out then they were on the way in.

I would also argue that what Myners said about banking also holds true - to a lesser extent - in other publicly traded companies, where management is able to extract compensation out of proportion to their likely contribution.

Shareholders, and we are really talking about institutional shareholders, have allowed management to get away with it for years because they thought what they were supposed to be doing was outperforming the market by picking winners.

Much of what passed for skilled investment over the last 20 years has been little more than riding the waves of a debt-fueled economy which seemed capable of providing six to ten percent returns on an unleveraged basis.

Adding value too often meant little more than adding leverage to increase returns. When the current rally ends, as it surely will, investors should take a long look at their long term returns. What they will usually see is that they are poor.

A better strategy for the next 10 years may be to spend as much effort protecting your economic interest in what you own as you do in choosing what to own.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )

– Lance Knobel is a guest columnist. The views expressed are his own. He is an independent strategy advisor and writer based in the United States. His professional site is www.lknobel.com –

The promise was certainly seductive: Lock up your money with me for five years and I’ll give you double-digit annual returns.

For years, that was an accurate equation for venture capital. From 1981 to 1998, there were ups and downs, but the 10-year return generally hovered around 20 percent, well above most other asset classes. That return came at a price of course. It was illiquid and there was no secondary market. And there was a further catch. Most potential investors were excluded: Venture funds were relatively modest in size, there weren’t very many of them and they were picky about whose money they’d take.

The dotcom boom changed all of that. Venture capitalists became business magazine stars, new funds sprouted up all over, and established firms with a decent track record were suddenly able to raise nine- and ten-figure funds. The 20 percent mark began to look pallid. In 1999, the U.S. venture industry was boasting five-year returns of nearly 50 percent, as a flood of IPOs provided swift and lucrative exits. The end-to-end return, net of fees, expenses and carried interest, for the year ended March, 2000, was 310 percent.

Alas, that was then. New York VC Fred Wilson, principal of Union Square Ventures, reckons average returns over the last 10 years are in the range of 6 to 8 percent. Aggregate industry figures are still flattered by the anni mirabili of the dotcom era, and the staggering venture bonanza of the Google IPO for a handful of elite firms. But when 1999 drops out of the 10-year calculation, average returns will slump to the low single figures or negative.

The returns have shrunk, yet the industry hasn’t contracted all that much. According to Thomson Reuters data, in 2008 there were 882 existing venture capital firms with $197.3 billion under management. That represents an increase from the go-go year of 1998, when there were 624 firms with $92 billion under management.

Venture investments have been ticking along at a fairly constant rate as well. There were two astoundingly anomalous years — 1999 and 2000 — when U.S. venture investment was $52 billion and $102 billion. After the dotcom crash, that slumped to $19 billion in 2003. Last year’s $28 billion was down from 2007’s $30 billion, but before 1999 the biggest year in the industry’s history, 1998, had seen just over $20 billion invested.

Returns have slumped and lucrative exits are vanishingly rare. Only six venture-backed companies went public in the U.S. last year. Earlier this year, the National Venture Capital Association launched a plan to increase the number of sub-$50 million IPOs.

Given all this, why do investors continue to back venture funds? After all, $28 billion went into VC funds last year. I asked Wilson, who is one of the more publicly skeptical VCs. “If you get into a good fund, you can still get 30 to 40 percent,” he said. “That’s what keeps the LPs interested.”

Everyone believes they are investing in the children of Lake Wobegon, who are all above average. But institutional investors won’t play the fool for long and the response from potential LPs is bound to get stonier for all but the most accomplished funds. So what, if anything, will save venture capital?

There will need to be fewer, smaller funds, making smaller bets with their investors’ money. Fewer exits won’t be such a problem, because fewer exits will be needed. It will be something that looks, in fact, a lot like the VC world pre-dotcom. That will be a wholly good thing, for venture capital, for investors and for entrepreneurs.

A smaller industry will have fewer hangers’ on who invest with the latest trend, and there will be less dumb money buoying poorly formed, unrealistic dreams.

(Edited by David Evans)

–James Saft is a Reuters columnist. The opinions expressed are his own.–

When the U.S. dollar ultimately loses its status as the world’s premier reserve currency it will be painful for all involved, almost certainly disorganized, and very possibly a very good thing.

World Bank President Robert Zoellick outlined the risks to the dollar’s status in a speech in Washington on Monday.

“The United States would be mistaken to take for granted the dollar’s place as the world’s predominant reserve currency. Looking forward, there will increasingly be other options to the dollar,” he said.

Zoellick went on to emphasize how choices in the United States on inflation, fiscal policy and financial system reform would help to influence the dollar’s fate.

Quite true. The U.S. cannot simply devalue its way to competitiveness, nor can it appear to be inflating away its debts without risking a run on the currency. The Chinese and others would sell dollars or fail to buy up new debt if they felt the U.S. was behaving both cynically and irresponsibly.

China has good reasons not to force a crisis and devalue its holdings of dollars, but not immutable ones. The two nations are like two men trying to swim to shore while dragging a heavy box of gold, the difference being that the U.S. is tethered to the box while China is only holding on. If China decides the water is too rough it can let go, sacrifice its dollar holdings and swim for it. The United States is not so lucky.

“Exorbitant privilege” is a term coined by an understandably embittered French Finance Minister Valery Giscard d’Estaing to describe the fact that under the old Bretton Woods currency system the United States, unlike everyone else, could simply print dollars to cover current account deficits.

Bretton Woods is gone, but the arrangements which replaced it also tended to underwrite U.S. overconsumption, as purchases of U.S. dollars as reserves by other nations kept funding rates lower despite household or government profligacy.

“The United States is incredibly fortunate that the dollar enjoys this special status,” Zoellick said. “When I work with countries struggling to pay for budgets or finance trade deficits, I reflect on how Americans do not spend a moment considering the unique advantages of being able to issue bonds and print money freely.”

My best guess is that Americans will spend quite a few moments in coming years considering that unique advantage, and that while they will miss it, they should also be sorry they ever enjoyed the right to borrow freely and seemingly without consequence.

THERE’S NO “G20″ IN “TEAM”

Of course the U.S. current account deficit has contracted massively, standing at about 3 percent of gross domestic product in the first quarter as compared to 6.5 percent of GDP in 2006. That’s the result of plunging global trade and steep falls in investment in the United States. And while the personal savings rate has jumped in the United States, which after all it had to since credit was no longer easy, the government has stepped up massively as a borrower, overwhelming households’ efforts to save.

Barclays Capital calculates that the United States now needs to attract 46 percent of the world’s net savings, i.e. the sum of all current account surpluses, as opposed to 54 percent before the crisis broke.

That 46 percent figure is an improvement, but it too is ultimately unsustainable. It’s also arguably starving lots of other places of investment that could ultimately produce higher returns.

The newly empowered G20 group of nations has meanwhile resolved to rebalance the global economy, using peer pressure to force the irresponsible to shape up and the overly tight to start spending at home.

The world’s central bankers and politicians just received an object lesson in what a good idea it is to have a bunch of reserves piled up against a bad day. Even putting China aside, responsible leaders in places like India will have a very tough time trusting in an international body to protect their own best interests. And because that body doesn’t have any real power to compel, it will be ignored. That means that there is a good risk, G20 or not, that everyone is trying to simultaneously keep their currencies low and exports high.

The only body seemingly exempt from market discipline, the United States, is not going to be in a position to resume eating up everybody’s exports. This is a recipe for very slow growth and for rising international economic tension. That doesn’t make the changes proposed at the G20 a bad idea, but they are not sufficient and threaten to be a resolve-softening time waster.

So not so much as rebalancing but a re-basing of growth expectations. Look for continuing dollar weakness alongside that, with the real drama being not the decline but the rate of decline.

–At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.–

– Wei Gu is a Reuters columnist. The opinions expressed are her own —

It is hard to be very optimistic about China’s proposed stock market for start-up companies. After all, similar attempts in other countries have a decidedly mixed track record. Why would China, where small private companies face an uphill battle against state-owned firms, be any exception?

Nevertheless, there are reasons to believe that the start-up market, set to debut in October, offers better potential than previous efforts in Singapore, Germany and Hong Kong.

The country has a big reservoir of fast-growing small companies with real profits. In the past, they have opted for listing on foreign exchanges such as the Nasdaq. Though they were attracted by the prestige of a foreign listing, they also faced a home market that favors size over quality.

Indeed, China, home of internet stars such as Baidu and Sina, is the second-largest foreign supplier of companies to the Nasdaq.

But the exodus has almost ground to a halt. Beijing has tightened its grip on foreign listings because it wants to keep the best growth companies at home. Only companies which already have overseas structures can list their shares abroad, but even then they have to jump through a lot of regulatory hoops.

Obtaining a domestic listing will become much easier, as Beijing has ambitious plans to float hundreds of companies on the new market each year. Maintenance fees are lower and disclosure requirements are less stringent when listing at home.

And companies will not necessarily need to compromise on valuations, since Chinese equities routinely trade at a premium to their foreign counterparts because there is a lot of liquidity chasing a limited pool of stocks.

Although institutional participation is likely to be limited because the small size of most start-up companies, the new market is expected to draw in a large amount of retail investors who favor more volatile small-caps.

No wonder that about 150 companies have already lined up to list on the new market. With a potential universe of 50,000 private companies nationwide, there will be no shortage of new supply in the next few years.

Chinese stock market regulators are wary of the lack of success by Western countries in creating markets capable of funding early-stage companies. Easdaq, Europe’s answer to the Nasdaq, rumbled along for years before finally disappearing. Germany’s Neuer Markt, launched during the dot-com boom, soared and then collapsed along with the rest of the stock market bubble.

In an effort to make a good start, the regulator has picked companies with the best track record of sales and profit growth for the first batch of listings. Most of them already qualify to list on the market for small-and medium-size companies, which is also part of the Shenzhen Stock Exchange.

The first 13 companies to go public almost look a bit too old-fashioned, with leading positions in markets such as railway transport electricity systems, lithium batteries, and medical devices. However, being boring is actually better than being too adventurous at this stage.

China has set the standards for listing on the new market much higher than Hong Kong’s growth enterprise market to avoid overly speculative companies. Like the Nasdaq, China requires companies to have a three-year operating record and a history of profitability.

Yet while it is good to set the bar high, it is even more important to keep it there by de-listing companies promptly if they fail to comply with listing rules.

One of the major reasons that the mainland market has a lot of moribund companies is because the regulator does not force de-listing. American exchanges de-list hundreds of companies a year.

Beijing has finally given the green light to the market for start-up companies after 10 years in preparation because it understands that small private companies, the most vibrant sector of the economy, will be the drivers of China’s next stage of growth. It also does not want to wait until the market gets too hot as then will be more speculative behavior.

Most of these markets suffer because they cannot attract a sufficient number of long-term institutional investors, so they end up as either illiquid or relying on much more speculative retail investors. This will be an even bigger problem in the retail-driven Chinese market.

Although the start-up market is necessary to provide some much-needed funding for small enterprises, Beijing should avoid getting too ambitious. There were initial talks about bringing as many as 500 companies public a year. But at that speed, disclosure and approval standards will inevitably be compromised.

The low success rate of markets for start-up companies has underscored the importance of not getting carried away. Early investors will walk away at the first sign of disappointment, and the markets are rarely granted a second chance. China should concentrate on getting off to a good start and build it up its new market slowly.

– At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund —

(Editing by David Evans)

-Bernd Debusmann is a Reuters columnist. The opinions expressed are his own -

When Mexico’s president, Felipe Calderon, ordered 2,500 troops and federal agents into border city Ciudad Juarez 17 months ago to tamp down drug violence, the monthly murder rate ran at an average of 66. In retrospect, those were the days of peace and calm.

Ciudad Juarez has become the most active front in simultaneous and increasingly bloody wars. One is between drug cartels fighting each other for access to the U.S. market. Another is between drug traffickers and Mexican authorities charged with imposing law and order. They have been singularly unsuccessful.

Despite a vastly increased military presence (now about 7,000, plus 2,500 federal agents), the monthly body count this year has averaged more than 180 a month. In August, the body count exceeded 300, a record. According to a study published in August by a Mexican non-profit group, the Citizen Council for Public Security and Justice, Ciudad Juarez (population 1.6 million) has become the world’s most violent city.

Nation-wide, almost 14,000 people have died in drug-related violence since Calderon took office and declared war on the drug business. Casualties on the government side: 725 police and soldiers between the beginning of 2008 and mid-2009 alone.

But body counts tell only part of the story. To hear residents of Ciudad Juarez tell it, there is a third war going on, waged by common criminals against citizens who are fast losing what little faith they had that the state can provide security.

Common crime, from robbery and rape to extortion, auto theft and kidnapping for ransom, is up and Ciudad Juarez, divided from its Texan sister city El Paso by the Rio Grande river, has slid into what one long-time resident calls “a permanent state of criminal anarchy.”

Most killings fall into the category of “bad guys eliminating bad guys” and don’t inspire much, if any, investigative energy. And there is near-absolute impunity for murdering “malandros,” a colloquial term for an underclass of young addicts, small-time drug dealers, homeless people and others at the bottom of the social pile, according to Gustavo de la Rosa, a senior investigator of the Human Rights Commission of the state of Chihuahua, where Ciudad Juarez is the biggest city.

“We estimate that between 300 and 500 malandros have been killed since July of 2008,” de la Rosa said in an interview. “Not a single one of these murders has been solved, which leads one to believe that what is going on is ’social cleansing’ with the tacit permission of the state.” Oscar Maynez Grijalva,  a former state forensics chief, has talked about death squads whose activities should be, but are not, investigated.

In the most brutal act so far of what some suspect is “social cleansing,” gunmen wielding AK-47 assault rifles stormed into a drug rehabilitation center early in September, herded 18 youths outside, lined them up against a wall and shot them. For good measure, they also put a bullet through the head of the center’s dog. It was the fifth mass killing at a rehabilitation center in a year and it took place within sight of the U.S. border fence.

ELIMINATING DISPOSABLE HUMAN BEINGS?

“Social cleansing,” the targeted elimination of groups considered undesirable, worthless or dangerous, has been practiced in a number of countries across Latin America, including Guatemala, El Salvador, Brazil, Honduras, Argentina, and Colombia, where the victims are labelled “the disposable ones.” It has not been a Mexican tradition.

But now, looking too closely into the question “who is killing whom and why” is becoming an increasingly risky business, as is following up on citizens’ complaints about army abuses. Mexico’s National Human Rights Commission has documented rapes, executions, torture and arbitrary detentions in states where the army is fighting the drug cartels.

Since Calderon began using the military to bypass notoriously corrupt police agencies, around 50,000 soldiers and 30,000 federal police officials have been deployed in drug-producing states and border cities. If Ciudad Juarez is a model, they can be part of the problem rather than the solution.

Take the case of de la Rosa, who became an outspoken critic of the military in the course of his job - pressing the army to investigate complaints from victims or their families. That earned him ever more explicit warnings to cool his criticism, from telephoned death threats to the detention and beating of one of his bodyguards.

“I’m convinced my life is at risk and on August 25, I asked the head of the state human rights commission to arrange for protection for myself and my office,” he said.  His request was greeted with silence, until September 20, when he was suspended from his job because the commission saw no way to guarantee his safety.

He then sent a detailed, 3,100-word letter to the Inter-American Human Rights Commission urging it to take measures to protect his life and that of his wife and 21-year-old son. What effect that plea will have remains to be seen.

Meanwhile, “I’ve begun adjusting my life,” said de la Rosa. “I won’t be sleeping in the same place every night. I won’t follow a daily routine.”In other words, he is going into hiding in the city where he has lived for most of his 63 years. Criminal anarchy in action.

(You can contact the author at Debusmann@Reuters.com)

(James Saft is a Reuters columnist. The opinions expressed are his own)

The simplest way to end the imbalances in the world’s economy is also sadly perhaps the most likely: for the Chinese to stop buying U.S. debt.

This is not going to happen anytime soon, for one thing deleveraging in the U.S. will for a time make U.S. Treasuries look good value, but a buyer’s strike is a heck of a lot more likely than the orchestrated rebalancing the U.S. will push at this week’s G-20 meeting of leading nations.

The U.S. plans to advance a plan at the Pittsburgh summit to fundamentally change the balance of the global economy, which over the past 15 years or so has been characterized by over-borrowing and consumption in the West provided and financed by savers and workers in Asia.

That state of play kept going, as is the way of these things, until it stopped, or rather until one of its wheels fell off. It wasn’t that Asians stopped saving or buying U.S. debt but that speculators, usually in Europe, stopped buying securities, often minted in London, which were being created to front run the flow of capital from Asia to the west.

That popped the asset price bubble and the flow of finance to consumers in the U.S. who, with much gnashing of teeth, began to save again and consume more guardedly.

But the debt bubble hasn’t really popped, it has only shifted shape. Before we had private debts which only could be repaid if assets, mostly real estate, continued to go up in value. Now, a new wave of public borrowing is cushioning the downturn. Asians buy some of the debt and some of the money raised buys goods from Asia.

Theoretically, China and other investors in U.S.  Treasuries buy them because they believe that the U.S. will ultimately tax more, spend less and make good. In reality, it is more vendor financing and a good money after bad attempt to protect earlier investments.

The U.S. points out, in a letter to its G20 partners, that if the savings rises in the deficit countries persist and there is no rise in consumption in the savings-bloc, global economic growth will be poor. The idea, it seems, is for IMF-led international coordination to, on the one hand, jawbone the borrowers so they remain credible while at the same time somehow inducing the savers to allow their currencies to appreciate and induce their citizens to spend.

WILL SOVEREIGNS BE THE NEW SUBPRIME?

A new study of global imbalances by economists at the Bank of England points out that Asian savers will only carry on buying western debt so long as they believe it to be high quality.

“In the short run, increased supply of government bonds resulting from the expansionary fiscal policies pursued in deficit countries has provided an ongoing source of asset supply to meet the investment demand from surplus countries,” according to the Bank of England.

“However, to the extent that savers in surplus countries may become more reluctant over time to invest funds in deficit-country government bonds this would tend to raise the cost of borrowing in deficit countries. This shift in the relative cost of borrowing could be an important part of the process by which a rebalancing of demand from deficit to surplus countries is achieved over the medium term.”

In other words, if Asian savers lose faith in Treasuries or gilts, they will stop buying, causing interest rates to spike. This would cause demand to be rebalanced, all right, but mostly by suppressing it in the U.S. and other highly indebted countries like Britain.

This kind of loss of faith in markets can be very sudden. You could draw a parallel to the way in which investors in securitized debt lost faith in the value of a AAA rating, except this time the loss of faith will be in sovereign borrowers and we really will not be able to blame the ratings agencies as enablers.

China and other exporters of course have good reason to want to avoid this. They are stuck with trillions of dollars in Treasuries and they certainly don’t want to kill the U.S. goose while it is still more profitable to sell it goose food.

There may also come a time when the world’s savers calculate that they can earn more by investing at home.

Essentially much of what a controlled rebalancing would do - weaken the dollar and build opportunity for domestic-oriented investment in Asia - creates incentives for a rapid reallocation out of Treasuries.

Ultimately the rebalanceing must happen. The U.S. for very good reasons wants this to happen little by little, but it does not have to happen that way. Past attempts at a controlled rebalancing have failed and it is hard to see what will make this one different.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)