– 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.–

– Jay R. Pryor is vice president of business development for Chevron. The views expressed are his own. —

The concept of a “green recovery” is a compelling topic of discussion at the World Economic Forum this week in Dailan, China. It stems from the United Nations Environment Program calling for investment of 1% of global GDP (nearly $750 billion) to promote a sustainable economic recovery.

A “green recovery” speaks to two of the most important issues of our time –- the efficient use of energy and the realistic understanding of energy’s role in the global economy. It’s a role that can help lift millions of people out of poverty, while addressing a healthier environment.

We all aspire to a more environmentally sound approach to energy, but to address these aspirations we need to be realistic about energy. Call it “energy realism.”

“Energy realism” is a commitment to a long-term view of the role of all forms of energy in our lives, and the need to be realistic about the true scale and complexity of the energy challenges that confront the global community.

Every day, the world uses, from all energy sources, the equivalent of 245 million barrels of oil. Eighty-five percent of the global economy is powered by oil, natural gas and coal, despite the enormous progress we’ve made toward alternative energy sources.

Worldwide, we use 50 percent more energy than we did only 20 years ago. And 20 years from now, demand will have risen by another 30 percent or so.

Faced with this level of demand growth, energy realism requires that we develop all the energy we can, in every available form. No single source is the only answer. We need it all – oil and gas, nuclear and coal, solar and wind and biofuels.

Alternatives and renewables have strong promise, and over time, they’ll meet a far bigger share of global demand. But it’s unrealistic to suppose that they can replace conventional energy in the short term. Today’s global energy system is enormous and took more than a century to build. We must be realistic in how quickly technology and economics will permit a transition away from fossil fuels.

If one looks at the data, there is no avoiding one simple conclusion: the sheer scale of our energy needs is far beyond the capacity of any one source or technology. So we must balance energy aspirations with energy realism and agree that for the foreseeable future we need to develop it all.

We can do so with a shared goal of managing the transition to lower-carbon energy. But it will require a long-term commitment and, again, a grasp of the true size and scale of the undertaking.

For example, if we were to replace today’s global transportation system with a zero-carbon solution — all cars, trucks, buses, trains, planes and ships — we would reduce greenhouse gas emissions by only 15 percent. If we were to replace the entire global power generation system, we would reduce greenhouse gas emissions by only another 25 percent. So combined, that’s only a 40 percent reduction.

Yet there are serious and systematic ways of reducing carbon emissions for the long term. We need to set carbon reduction goals that are high – but goals that are also realistic. We need to willingly accept the associated costs that we all must bear. And we need to be realistic that an economy entirely free of fossil fuels may be beyond our reach.

But energy realism also holds the promise that we can make meaningful progress, and there are actions we can take today. The most immediate and cost-effective thing we can do is to maximize conservation through energy efficiency.

In the U.S., for example, we’ve made great strides in energy efficiency. In fact, we use half as much energy per unit of GDP as we did a generation ago.

For over a century, innovation, collaboration and partnerships have been the backbone of a global energy infrastructure that interconnects and powers the world.  Our ongoing challenging is to find the common ground we need for that enhanced collaboration.

As we look to the future, we must continue to seek common ground on meeting the world’s long term energy needs while addressing environmental concerns – balancing the energy aspirations with energy realism, for the common good of all.

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

The effort to rein in banking bonuses, outrageous as they may be, is akin to banning glue sniffing because you are worried about the effects of intoxication.

There are, as the kids in the alley behind the high school can tell you, other ways of getting high.

Train your regulatory fire instead on requiring more and better bank capital and you will arguably do a great deal to control excessive compensation as well as doing much more to protect taxpayers and the economy.

Financial leaders from the Group of 20 rich nations agreed the skeletal outlines of a plan to reform banking last weekend in London. Included was the idea of claw backs on bonuses if earnings evaporate, forcing more pay to be deferred for longer, and more disclosure of top pay.

This may have some effect; bankers will have to wait a while for their money and some risky bets may not be made. But the out-sized rewards are the result of people within finance having an informational advantage over their shareholders and regulators and the ability to play with huge amounts of other people’s capital. Combine this with an implied government guarantee for the too-big-to-fail and you end up with a crisis every ten years or so. Just making bankers wait longer for their money does nothing to affect the competition for deals and assets to leverage.

Besides the folks who brought you the CDO squared will be well able to find workarounds to ensure that money leaks out in one way or another.

More promising by far are proposals to force banks to increase the amount and type of capital they hold. Central bankers and regulators from the Basel Committee on Banking Supervision are calling for a host of measures to bolster capital, including saying that common shares and retained earnings must be the mainstay of capital, introducing a leverage ratio and minimum standards for funding liquidity. All three will make banking and the economy more stable. All three will also, in so far as they reduce the amount of borrowed money available for investment, tend to push asset prices lower.

LEVERAGE IN, LEVERAGE OUT

Kansas City Federal Reserve President Thomas Hoenig points out that the largest 20 U.S. banks have equity capital equal to only 3.5 percent of their assets, as against an average of 6 percent for their middle sized competitors.

“They have an implied guarantee, which affords them an enormous advantage in terms of their use of leverage and their ability to accumulate assets to unprecedented levels,” Hoenig said in a speech to bankers made in August but released last week.

The large U.S. banks, it is worth mentioning, in turn face competition from their big trans-Atlantic peers, many of whom have leverage far in excess of theirs.

Forcing large banks around the world to raise enough capital, or dump enough assets, to put them on a level with their smaller peers would do a great deal to put an end to the rolling bubbles and bailouts.

The Basel committee also said it would consider the need for a capital surcharge to “mitigate the risk of systemic banks.” If by this they mean a tax on size above a certain level, this would be a fantastic start to counterbalancing the unfair advantage enjoyed by the too-big-to-fail, not to mention the threat they pose to the public purse. It would make good sense to impose a tax on size and to phase it in over several years, so that banks would have both the time and the incentive to shed assets without resorting to a fire sale.

Control leverage and size and you will do more to control destructive risk taking than any programme can which simply makes bankers wait a few years until they can get their payouts.

If you are really worried about unfair compensation in banking you have to define who is being badly treated by it. Moderating the effect of a taxpayer subsidy by limiting size and controlling risk taking is a start, but there are still shareholders and consumers of financial services to be protected. Both of these groups suffer because they don’t really understand the complex products being produced and sold by the industry. This allows consumers to be overcharged or oversold and shareholders to be chiseled out of part of their portion of the gains generated.

It is strange to say, but bank customers and owners may want to make common cause over the issue of simplicity in financial services. Simple banks with simple products might in the long run generate better outcomes for their owners and clients, just as simple index funds now do for investors. Will regulators be able to accomplish all of this? Probably not, but they would do well to concentrate their limited resources and creativity on the foundations of banking rather than the salaries on the top floor.

–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 —

As exports of manufactured goods slow, China has found a new niche — exporting its construction boom.

With many countries in the world adopting stimulus plans to drive demand, China has been scrambling for these public spending dollars. And it is well placed to do so.

Infrastructure investment has powered Chinese growth in the past three decades. The nation has deep experience in building roads and bridges quickly and cheaply.

Moreover, it isn’t just construction expertise China is offering to clinch the deal. Its state-controlled banks such as the Industrial & Commercial Bank of China (ICBC) and Bank of China are eager to throw in some cheap loans too.

China’s big advantages are the scale of its companies — 51 of the world’s largest 225 contractors hail from China — and its substantial capital reserves, which allow its banks to provide long-term, low-cost credit for projects abroad.

The surge in construction revenue from overseas looks remarkable against a 22 percent drop in total exports during the first half.

Services revenue from overseas amounted to $32.2 billion, up 52 percent from last year, outpacing the average growth of 30 percent over the past few years. Chinese companies signed new contracts worth $64.6 billion, an increase of 38 percent from last year.

Chinese construction companies were the biggest beneficiaries. China Railway Construction said the value of newly entered overseas contracts surged 98 percent in the first half, representing one fifth of the total new contracts signed.

Support from the highest authority in China has helped seal deals abroad. In February, witnessed by President Hu Jintao and King Abdullah, China Railway signed a $1.78 billion contract to build the first phase of a special railway for Muslin pilgrims in Saudi Arabia.

It marks the first time that Saudi Arabia, one of the biggest oil exporters to China, gave the country a major public works agreement, although Huawei, a private Chinese telecommunications company, is already a main supplier there.

The success of Chinese contractors is not limited to emerging countries. China’s Gezhouba Group is involved in Australian mining projects. An aircraft technology company has got a big contract for wind power projects in the United States. And a Chinese contractor won a bid to build the Hamilton Bridge in New York.

Winning the services contract opens the door to other export opportunities. Just as IBM and Hewlett Packard promote system integration services to sell more of their hardware, when a Chinese contractor builds a bridge abroad, it is also likely to source the great majority of the materials from China.

Every dollar increase of contracted work will lead to a 4.9 dollars increase in the gross domestic product, according to the Ministry of Commerce. Taking that into consideration, overseas contracted work and related equipment exports accounted for more than 7 percent of total GDP last year. (Total exports were about a third of GDP)

Services exports have started to move the needle. Without the services jump, China’s export decline during the first half would have been two percentage points more. Service exports have helped create 450,000 jobs domestically during the first half, said the government.

The benefit of exporting migrant workers to lower the unemployment rate might not be big — every year China only exports about 150,000, or less than 1 percent of the new workers it adds — but the habit of importing Chinese labour for projects can cause a lot of friction.

The most recent and serious case was in Algeria, a country where seven out of every 10 adults under 30 are unemployed. About 100 locals and Chinese workers fought with knives and bludgeons. Russia, which has been hit hard by lower oil prices, is coming up with ways which make it harder for Chinese contractors to bid for deals.

Although China likes to stress the complementary nature of its relationship with other emerging countries, the reality is developing countries directly compete against each other because their competitive advantages, namely low wages, are similar.

Beijing has seen some backlash from its largest export markets, namely Europe and America. As China steps up its investment activities overseas, the drive to export more people and services to Africa and Latin America could cause headaches if pursued too aggressively.

– 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. –

– Neil Unmack is a Reuters columnist. The views expressed are his own —

It’s a sign of how bad things are in the private equity industry that some buyout funds are asking their investors for additional capital to prop up ailing portfolio companies.

But such moves can be messy. Investors should be wary of throwing good money after bad, and even more careful of rewarding failed managers.

Private equity portfolio companies will soon have to start refinancing a wall of maturing bank debt. Unless the leveraged loan markets recover, new equity capital will be needed.

The first port of call will be existing investors in the buyout funds. The argument is that raising cash early would allow a troubled portfolio company to tackle the problem early, for example by buying back debt at a discount.

Kohlberg Kravis Roberts & Company has already closed one such vehicle, called annex or top-up funds. Others may follow suit.

But these kinds of funds are laden with tension for both investors and managers. Small wonder then that, according to the Financial Times, the latest attempt to launch one, by Apollo, has failed.

It’s a grim prospect for investors who have to pony up more cash or see their existing investment suffer. They also need to do a lot of work, analyzing each company closely to make sure they are not just throwing good money after bad.

Even if they want to, not all investors will be able to reinvest, which means that existing investments will be diluted by the new equity. That causes friction between private equity investors, something any manager will want to avoid.

The more contentious issue, however, is fees.

Some managers will have precious little to show for their existing deals other than overleveraged companies bought at too high a price. They will probably struggle to raise new funds, and face declining fees on their existing ones as deals go sour or returns dwindle.

The danger is the manager simply uses the annex fund as a way to preserve its own business rather than protect investors’ capital. After all, with an annex fund, you don’t even need to go out and find new companies to buy.

Also, by keeping the original investments alive, the new fund will help managers earn performance fees which they wouldn’t be entitled to otherwise.

There’s a simpler way round this, which is for limited partners to invest directly in ailing companies, rather than buying into an annex fund.

That helps solve the need for new capital more quickly, eliminates additional fees, and ensures fresh capital is targeted at companies with a chance of survival. The downside is that this could require investors get involved in multiple capital raisings. An annex fund might be more flexible.

But in that case investors should push for managers to waive the base management fee for the annex fund, and lower their performance fees. Then again, that’s not really part of the private equity model.