–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.)

– Neil Unmack and Agnes T. Crane are Reuters columnists. The views expressed are their own —

By Neil Unmack and Agnes T. Crane
When some of the most influential financial thinkers of our time failed to call one of the biggest bubbles since the Great Depression before it burst, a little skepticism about the recent run-up in stocks is a healthy antidote to the cheerleading that typically accompanies big gains.

Given the enormous size of the last bubble, the current round of inflation in financial markets perhaps should be called by another name — maybe “bubblette” would better suit the times.

The hallmarks, though, are similar: Access to cheap credit helps re-inflate depressed prices, but eventually the explanations for extended gains start looking flimsy. Stocks started entering that territory in August when many pointed to better-than-expected earnings to justify the surge in prices that have taken major gauges to their best levels for the year.

The price-to-earnings ratio for the S&P 500 currently stands around 26.5 based on operating earnings for 12 months through June. That’s well above the historical average of 19.26, according to S&P senior index analyst Howard Silverblatt.

To get back to normal, the economic recovery will have to be powerful enough for earnings to meet more optimistic expectations. The price-earnings ratio for the FTSE 100 is still just below its historic average, but nevertheless stands at its highest since July 2004.

There are good reasons to rejoice about the recovery in stocks — for one, they make last year’s losses less painful. But there are also plenty of reasons to think the market will pull back in the near term, and to foresee a rude awakening if the much talked-about V-shaped recovery fails to deliver.

- The consumer is key. Still buried under a mountain of debt and daunted by the prospect of joblessness, consumers aren’t likely to return to their old spending habits. More saving and less spending means low growth, excess capacity, and falling prices, all of which are bad news for equities.

- Unprecedented fiscal and monetary stimulus are distorting reality. While some markets have returned to their levels before Lehman Brothers collapsed a year ago, much of the stimulus behind the recovery is still in place to keep money flowing into even some of the riskier asset classes, such as high-yield debt and stocks.

Start taking the various props away, which will begin to happen this autumn, and investors’ appetite for risk will diminish.

- Ridiculously low government bond rates and rock bottom interest rates in the developed world have pushed investors to look elsewhere for yield. But this can’t last forever. Eventually central banks will raise rates, while increased borrowing needs still lurk as a potential flash point for bond vigilantes who want to be compensated for the risk of future inflation.

- Funding markets, while much improved, still aren’t working properly. While many companies have been able to refinance their short-term debt, borrowers in real estate markets are still facing a funding void left by the collapse of the shadow banking system.

High-yield companies in the United States and Europe face far higher borrowing costs, and must also refinance or pay down a wall of debt falling due in coming years. Commercial real estate, in particular, faces daunting maturing debt.

Unless more sources of alternative funding can be found, the result will be higher borrowing costs, more defaults and bank losses, and more corporate failures. Companies in general will focus on keeping their creditors sweet, rather than doling out cash to shareholders.

Stock buybacks have sunk to their lowest level since 1998, when Standard & Poor’s first started tracking the data.

- Unemployment rates are expected to stay high. Economists view unemployment data as a lagging indicator, but this time may be different. A persistently high unemployment rate will likely keep anxiety high among consumers who stretched themselves thin during the boom years. Even if it steadies, the unemployment rate could keep consumers on the straight and narrow.

- Follow the smart money. Insiders, such as company management, are selling at the highest rate since before the crisis kicked off in 2007. Sure, the sellers may have their own personal reasons for dumping stock, or they may know what is going on better than anyone.

Some of these arguments were equally true in March — since then the FTSE has gained 45 percent. Investors who avoided stocks for sound fundamental reasons back then have been dealt a cruel hand by the recent upswing.

The cheap liquidity and confidence that drove the rally may well persist for some time, or even carry the market higher if third-quarter earnings beat expectations.

Still, investors who missed the equity market party should be doubly wary of joining in now that the good times may be over.

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

If and when China makes its currency convertible and opens its financial system the stage will be set for a bubble that should make the dotcom and housing booms look tame.

China has recently signaled its key aspirations: for a greater international role for the renminbi and for Shanghai to become a great financial capital. Neither is imminent, but both imply, if not require, a series of steps that, taken in combination with China’s legitimately great potential for growth, could lead to a bubble of magnificent and dangerous proportions.

Magnificent in that, like the dotcom bubble or the railroad boom in the U.S. in the 19th century, a bubble in domestic China is directionally right and will build useful things which will change the world. A bubble, after all, needs a good story and China has one of the best ever.

Dangerous because, like the housing bubble, it will inevitably go too far and could take down banks and banking systems globally.

Perhaps rather than dotcom or housing, the most useful template for China is closer to home; namely the Japanese bubble which preceded its ongoing malaise, according to Dylan Grice, a strategist at Societe Generale in London.

“In the medium term we face the mother of all asset bubbles in China. The fundamental story is a good one; there are just lots and lots of people to sell to,” Grice said.

“If you drop a ton of liquidity on people it is possible that they will do rational things with it, but more likely they will do something pretty stupid.”

The parallels are strong. Both China and Japan successfully industrialized and opted for high-savings, low-consumption economies which concentrated on exports, exporting capital and keeping their currencies artificially weak. The result in both cases was a huge stockpile of U.S. Treasuries.

Both, too, scared their western clients and competitors witless. Remember U.S. autoworkers ritually burning Japanese cars? This of course was mingled with admiration and a sense that the global balance of power was changing, giving bubble thinking a strong push.

Japan slowly and over a long period liberalized its capital account; allowing the yen to float freely and deregulating financial markets.

Grice points out that during some of the 1980s the world fell in love with the yen, figuring that Japan’s new ascendancy meant that it would rise and rise. As a result Japan Inc. could in effect borrow in dollars, swap it into yen and get paid for the privilege. Much of the money found its way into the stock market, sending stocks to stratospheric levels and reinforcing the bubble illusion.

The Nikkei index of stocks went to the moon and Tokyo residents ended up needing 100-year mortgages to afford tiny apartments.

GOOD AND BAD BUBBLES

Of course, that is not where it ended with Japan, which had its bust and which is still struggling with deflation, though that is in part a function of a shrinking workforce.

Japan liberalized its financial system and currency arrangements under strong pressure from the United States.

China almost certainly has more relative real power today and there is every sign that it will open up on its own terms and to its own schedule.

But open it probably will.

Chinese officials have expressed a desire for the renminbi to play a great role in world trade, naming 2020 as a date by which it can play the role of a reserve currency.

That is almost certainly going to require deregulation of financial markets, something also needed if Shanghai is to become a global financial capital.

China now buys Treasuries not because it thinks they are good value, but because those purchases maintain a competitive currency, not to mention protecting existing holdings. As that ends, much of the money will seek out high returns, and as the renminbi strengthens international capital will doubtless pile on and pile in.

That kind of liquidity and deregulation, in combination with strong national pride and a legitimately fantastic story, is a step-by-step recipe for a bubble. So it proved in Japan, so it likely will be in China.

A look at recent experience in China only underlines this. Speculation is rife and billions in government mandated loans have leaked into stock market bets.

China’s government undoubtedly understands all of this and is surely determined to maintain control. They may not find it that easy. Getting rich, as we’ve seen in the United States, is a heady business and it is easy to start to believe your own press.

As the momentum builds and the money rolls in it will be easy to see it as a great country meeting its prosperous destiny.

Given the size of the opportunity and the strength of the story, China’s bubble will be huge. Investors would do well to avoid being in the immediate vicinity when it bursts.

–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.–

Financial markets have plenty to be worried about but their latest concern — a trade war between the United States and China — should not be on the list.

Aligned self interest and a knowledge on both sides of the causes of the Great Depression should limit matters to a kind of trade war Kabuki, a highly stylized piece of theatre in which the United States shakes its fist and China responds in kind but no blows land.

The Obama administration on Friday slapped tariffs of 35 percent on the import of auto tires from China, reacting to a surge in imports and complaints from the United Steelworkers union. It also acted on the recommendation of the independent U.S. International Trade Commission.

China duly responded, announcing investigations into subsidies made to U.S. chicken producers and auto products, as well as vowing to take its case to the World Trade Organization.

Shares around the world sold off on Monday at least partly in response to the dispute, which awakened memories of the 1930 Smoot-Hawley tariffs and the trade war that ensued, a key cause of the Great Depression.

What’s worse, the United States is not just spitting into the wind of history but also into the face of its largest creditor. China holds about $1.8 trillion of Treasuries and any decision on their part to lighten up would send the dollar into a steep decline and torpedo U.S. plans to fund its fiscal deficit.

That’s just it. The United States and China need one another, and both sides are big enough and mature enough to understand this. China cannot dump U.S. investments without walloping its own portfolio, nor can either side accomplish any of their economic goals without the other as a client.

It is best to understand the U.S. move not as the first salvo in a war, but as a relatively small sop thrown to a domestic constituency, organized labor, that President Obama needs for other purposes, notably health care. It is also, in an odd way, a sign not of weakness but of the stabilization of the global economy. It is only now that things have calmed down that the United States would dare to appease a domestic special interest in this way. Had they done this in February, financial markets would have fallen over in a dead swoon.

The dollar, tellingly, actually rose as a first reaction to the fuss, hardly the reaction you would expect if the Chinese were preparing to dump dollars. Treasuries lost ground, but nothing extraordinary.

STUPID BUT PROBABLY HARMLESS

Technically, the United States is probably within its rights to impose the duties. WTO rules allow this if a surge in imports threatens a domestic industry, even if the trade is not unfair.

Rights and laws aside, the duties are indefensible. They protect less efficient makers and simply punish China, not for unfair trade practices, but for success. They also punish U.S. consumers, arguably hurting living standards more than the loss of the jobs the tariffs are presumably meant to protect.

Expect China to make a lot of noise about this. They also have domestic audiences, and theirs are rightly aggrieved. Expect too the rest of the G20 leaders who will assemble this week in Pittsburgh to say all the right things in public and to play peacemakers in private.

What I would not expect is for this to accelerate into something damaging and destabilizing. The stakes are too high and the political rewards domestically for a trade war are tiny in comparison.

There are, however, longer-term issues which are unsettling. China’s interests and those of the United States are diverging and over time there will be serious conflicts to be negotiated. The system of China trading goods for Treasuries which did so much to raise living standards in China and fill garages with stuff in the United States is no longer tenable.

The U.S. will consume less of China’s stuff and must even compete with China more effectively for exports, probably in areas like military technology where sales will be doubly unsettling for the Chinese.

China, over time, will not want to subsidize U.S. borrowing rates and will want to diversify its currency holdings. This will not be easy or pleasant for the United States but, broadly speaking, is probably in its own long-term interests.

All of this could blow up, especially if it undermines confidence in Treasuries and the dollar. It has not yet, and I think the two protagonists will put off the serious business of working out their conflicting interests until either the global economy returns to robust growth or things in the United States stay bad long enough to change the political math of a real trade war.

We are not there yet, and for at least another year probably won’t be.

–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 —

Google’s former China head Kai-Fu Lee wants to create China’s next internet giant in a factory. He believes that by combining the smartest entrepreneurs, the shrewdest businesspeople and the brightest business ideas, he will be able to create five highly sellable companies a year. That sounds like an ideal model for venture capital, but is he being realistic?

Lee’s plan, formulated while he spent time in hospital over the summer, follows a battle with Beijing regulators who wanted to censor Google searches that lead to pornographic sites. It has drawn strong support from investors.

Lee has managed to raise $115 million in just one month, winning support from YouTube Inc. co-founder Steve Chen, as well as Foxconn Electronics Inc., Legend Group, New Oriental Education and venture firm WI Harper Group.

They believe that as China embraces a start-up culture, Lee’s business, which is a mix of venture capital and development lab, will be well positioned to capitalize.

Lee’s plan is to hire 100 to 150 young engineers, help nurture their ideas, then spin off 50 to 75 of them a year with funding from his venture, whiling hiring new people to make up for the loss. However, it looks like his company, called Innovation Works, has yet to line up ideas or engineers.

This kind of “incubator” model became popular in the U.S. and Europe during the dot-com boom, but most of them just burned through a lot of money and then folded. Lee and his backers believe that China’s market is more favorable, as it is at a crucial point regarding “cloud computing” and mobile technology, and there is a strong need for early-stage funding.

The new fund is still starting off, but Lee plans to expand from its base in Beijing to places such as Taiwan, the Asian hardware manufacturing base.

Investors are attracted by Lee’s reputation as the single largest magnet for talent in China. Lee, who grew up in the United States, has won a loyal following from Chinese students through his numerous coaching books, public speeches and blogs, although critics say he has spent too much time promoting his personal brand.

An expert in speech recognition technology, he founded Microsoft’s China research lab in the late 1990s. When he left to join Google, Microsoft sued him for violating a promise not to join a competitor.

Nimbler local rival Baidu now dominates China’s search market with 75.7 percent in terms of total search queries, dwarfing Google’s 19.8 percent share, according to iResearch. At Google, Lee was caught between the Beijing authorities who insist that foreign web companies censor the Internet and his U.S. bosses who demanded he drum up more business in China.

He has wanted to break away from his corporate role to start his own company for a decade, but it looks as if he is stuck in the corporate mindset. Lee is adopting an almost a planned economy approach to an industry that has always relied on markets to determine who is the fittest to survive. Indeed, he is even promising to tailor-make companies for interested foreign investors.

A factory model lowers the risk for investors as they will enjoy more control, but that also means less incentive and ownership for entrepreneurs, since their roles are reduced to that of employees. Why would young people take their ideas to Lee rather than make a go of it themselves?

Unlike Silicon Valley, China does not have an ecosystem where start-up companies can easily find angel investors. Even though China is a hotspot for venture capital, with $50 billion chasing mid- to late-stage projects, less than $1 billion in total is earmarked for early-stage projects.

Lee prides himself on his doggedness in chasing after talent. One year while at Google he made offers to graduates, only one of which was initially rejected. He called the student, found out that his girlfriend thought Google was a bit of a start-up, then asked for his girlfriend’s number and called her up. That year he achieved a 100 percent offer acceptance rate.

Nevertheless, it remains to be seen whether Lee can retain his ability to attract and inspire the best young people now that he is no longer at Google. He needs a lot of them to make his dream come true.

– 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 —

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

By most counts, the death toll of U.S. soldiers in America’s wars in Iraq and Afghanistan stood at 5,157 in the second week of September. Add at least 1,360 private contractors working for the U.S. and the number tops 6,500.

Contractor deaths and injuries (around 30,000 so far) are rarely reported but they highlight America’s steadily growing dependence on private enterprise. It’s a dependence some say has slid into incurable addiction. Contractor ranks in Iraq and Afghanistan have swollen to just under a quarter million. They outnumber American troops in Afghanistan and they almost match uniformed soldiers in Iraq.

The present ratio of about one contractor for every uniformed member of the U.S. armed forces is more than double that of every other major conflict in American history, according to the Congressional Budget Office. That means the world’s only superpower cannot fight its war nor protect its civilian officials, diplomats and embassies without support from contractors.

“As the military operations in Iraq and Afghanistan have progressed, the military services, defense agencies and other stakeholder agencies…continue to increase their reliance on contractors. Contractors are now literally in the center of the battlefield in unprecedented numbers,” according to a report to Congress by the bipartisan Commission on Wartime Contracting in Iraq and Afghanistan.

“In previous wars, the military police protected bases and the battle space as other military service members engaged and pursued the enemy,” said the report. In listing the 1,360-plus contractor casualties, it noted that criticism of the present system and suggestions for reforming it “in no way diminish their sacrifices.”

So why are they not routinely added to military casualty counts? And why should they? A full accounting for total casualties is important because both Congress and the public tend to gauge a war’s success or failure by the size of the force deployed and the number of killed and wounded, according to George Washington university scholar Steven Schooner.

In other words: the higher the casualty number, the more difficult it is for political and military leaders to convince a sceptical public that a war is worth fighting, particularly a war that promises to be long, such as the conflict in Afghanistan. Polls show that a majority of Americans already think the Afghan war is not worth fighting.

Figures on deaths and injuries among the vast ranks of civilians in war zones are tracked by the U.S. Department of Labor on the basis of claims under an insurance policy, the Defense Base Act, which all U.S. contracting companies and subcontractors must take out for the civilians they employ outside the United States.

EXPENDABLE PROFITEERS, ROGUES?

The Labor Department compiles the statistics on a quarterly basis but only releases them in response to requests under the Freedom of Information Act. This can take weeks. The Department gives no details of the nationalities of the contractors, saying that doing so would “constitute an unwarranted invasion of personal privacy” under the U.S. Privacy Act.

Writing in last autumn’s Parameters, the quarterly journal of the U.S. Army War College, Schooner said that an accurate tally was critical to any discussion of the costs and benefits of the military’s efforts in the wars. What’s more, the American public needs to know that their government is delegating to the private sector “the responsibility to stand in harm’s way and, if required, die for America.”

Schooner wrote it was troubling that few Americans considered the deaths of contractors relevant or significant even though many of them performed roles carried out by uniformed military only a generation ago. “Many…concede that they perceive contractor personnel as expendable profiteers, adventure seekers, cowboys, or rogue elements not entitled to the same respect or value due to the military.”

That’s not surprising after a series of ugly incidents involving armed security contractors. They make up for a small proportion of the total (about 8 percent) but account for almost all the headlines that have deepened negative perceptions and prompted labels from mercenary and merchant of death to “the coalition of the billing.”

In the most notorious incident, two years ago, employees of the company then known as Blackwater opened fire in a crowded Baghdad square, killing 17 Iraqis. Five of the Blackwater shooters, who were working for the Department of State, have been indicted on manslaughter and weapons charges.

The Pentagon describes private contractors as a “force multiplier” because they let soldiers concentrate on military missions. Some of the actions of private security contractors could be termed a “perception multiplier.” Such as the after-hours antics of contractors from the company ArmorGroup North America guarding the U.S. embassy in Kabul.

Shaking off the image of rogues became even more difficult for private security contractors after a Washington-based watchdog group, the Project on Government Oversight, accompanied a detailed report on misconduct and morale problems among the guard force with photographs showing nearly nude, drunken employees in a variety of obscene poses and fondling each other.

Whether contractors, even rogue elements and cowboys, should not be counted in the toll of American wars is another matter. Doing so would be part of the transparency Barack Obama promised when he ran for president.

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

Rest in peace, Great American Consumer. We will not see your like again.

“Cash-for-clunkers” aside, consumers seem bent on actually paying back debt rather than racking it up, a change that if sustained, as it is likely to be, will dampen economic growth not for months but for years, and not just in the U.S.

Outstanding U.S. consumer borrowing fell by a jaw-dropping $21.6 billion in July, according to data released this week by the Federal Reserve, five times more than analysts expected and the second largest monthly drop since the end of World War II.

June’s borrowing was revised to negative $15.5 billion from what had been an impressive minus $10.3 billion.

Over the past year, the stock of consumer loans outstanding has dropped by 4.2 percent, or nearly $110 billion, leaving the total now lower than it was before the crisis began in 2007.

Over the long term, this is exactly what needs to happen. With household wealth badly hit by the housing and stock market crashes balance sheets are stretched. And with a huge baby boomer cohort hurtling towards retirement age also, spending and borrowing were bound to be curtailed.

The question really becomes how entrenched the trend towards the new frugality becomes.

“Memories of debt are very powerful. The generation that grew up in the 1920s and 1930s, was wary of getting into debt as it - and its parents - had experienced two periods of deflation,” Lombard Street Research economist Gabriel Stein wrote in a note to clients.

“We are now in another period of debt repayment and deflation. The thought that US households will forget 2007-2009 and begin to borrow and spend as they did in the early 2000s, is fanciful at best.”

For years the mantra on Wall Street was “don’t bet against the American consumer,” a creature so fabulously resilient as to be almost super human.

Wars and recessions did little to brook consumption and the debt that grew alongside. Even the September 11 attacks saw healthy month on month growth in borrowing in the aftermath.

Whole industries, some now vanished, were predicated on Americans continuing to borrow and spend. It’s an overstatement, but only a slight one, to say that the global economy was predicated on U.S. consumption, which in turn was predicated on consumers borrowing.

THE NEW FRUGALITY

It is doubtless true that lenders of all stripes are making credit harder to get. But there is a good bit of evidence that individuals are changing their preferences. Much of the cash from stimulus handouts earlier this year was used to pay down debt rather than goosing consumption.

A Gallup poll asking Americans how much they had spent in the past day, not including major purchases or normal household bills hit $63 when most recently measured, down from above $100 a year ago.

Now on the face of it, that reduction must be overstated. If consumption had fallen by that magnitude, we’d be in a depression rather than debating the strength of a recovery.

But of course the Gallup poll is a self reported one, and I would be willing to bet that people are now exaggerating how frugal they are, where once they would have exaggerated how much they were spending. That in itself is an important marker of a social trend. Once you wanted the nice people at Gallup to think you were a big shot leaking money, now you probably want them to see you as a saver.

Gallup also looked at the data by generational group, and found that it was not just those in or approaching retirement who were cutting back on self-reported spending. So-called Generation Xers and Millennials, who followed the boomers into the workforce, are also cutting back in similar scale.

But the issue isn’t the rate of savings but the stock of savings as compared to liabilities. While it is reasonably possible to cut back on spending and so increase your savings rate that is far different from suddenly becoming financially robust.

The other thing to bear in mind is that there is a huge difference between stocks and flows. A person can quite quickly raise her savings rate - as we have seen - but that does not mean that her debts are quickly paid off.

If U.S. consumers cut debt as quickly as Japanese corporations did in the 1990s, it will still take them until 2018 to get their debt down to 100 percent of GDP from recent peaks of 130 percent, according to a study from the San Francisco Federal Reserve.

If the trend in consumer borrowing continues, it will not be long before the conversation will turn back to stimulus, quantitative easing, and a relapse for the U.S. economy.

–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.–