– 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.

– Eric Auchard is a Reuters columnist. The opinions expressed are his own —

When Oracle agreed to buy Sun Microsystems for $7.4 billion in April, the headlines made much of the software maker’s decision to enter the computer business 30 years late. At less than 10 per cent of sales, Sun’s software business seemed an afterthought.

But Sun’s software is now center stage after European competition regulators said on Thursday that they would withhold approval for the deal until they finish probing the impact of the Oracle-Sun merger on the database software market. The decision means the transaction faces at least a four-month delay, pushing it into early next year.

Any delay is costly for Oracle. Sun’s sales have plunged as key financial, government and communications customers have held back purchases of computers and storage until Oracle is able to clarify its long-run commitment to Sun hardware and software products.

The commission is debating whether, or under what conditions, to allow Oracle to acquire Sun’s MySQL database software. Given that the business brings in only $100 million in quarterly revenue, less than 1/25th of Sun sales, the easy way out would be for Oracle to jettison MySQL. However, that would be a mistake.

MySQL is a free, or low-cost, database that powers the vast majority of the world’s hottest Web sites, blogs and open-source businesses, including Facebook, Google, YouTube and Wikipedia. At issue is the fact that Oracle is already the world’s biggest supplier of database software, the underpinning for many of the world’s biggest information storehouses.

MySQL is the alternative to Oracle and its main rivals, IBM and Microsoft, which between them generate most of the world’s database sales.

There is a valid argument that MySQL is vastly more trouble than it is worth, and that Oracle should sell or give the software code away. This is in part because MySQL customers tend to be fiercely independent grassroots developers, completely unlike Oracle’s traditional customers in corporate and government information management.

Critics claim that Oracle has no interest in seeing MySQL survive and that it is only interested in converting its customers into paying Oracle database users.

Nevertheless, MySQL represents an innovation pipeline of inestimable value to Oracle over the next five to 10 years, assuming Oracle can adapt its dressed-down business practices to court Web developers, the most independent-minded wing of the software world.

It would also help Oracle compete more effectively against old rival Microsoft Corp <MSFT.O>, a goal the EU authorities should embrace.

Java, the programming language invented by Sun, forms the basis of most of the world’s modern software built outside of Microsoft.

Combined with Sun’s software for managing the identities of network users and its Open Office suite of productivity software applications, Oracle could launch a far broader attack on classic Microsoft strongholds in desktop applications and messaging, especially as these markets move onto the Web.

Far from being a stub business, Sun’s software arm could hold the key to a vast new round of industry competition.

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

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

There are times when silence can be as eloquent as words. Take the case of Washington’s reaction to announcements, in quick succession, from Mexico and Argentina of changes in their drug policies that run counter to America’s own rigidly prohibitionist federal laws. No U.S. expressions of dismay or alarm.

Contrast that with three years ago, when Mexico was close to enacting timid reforms almost identical to those that became effective on August 21. In 2006, shouts of shock and horror from the administration of George W. Bush reached such a pitch that the then Mexican president, Vicente Fox, abruptly vetoed a bill his own party had written and he had supported.

What has changed? Was it a matter of something happening in August, when most of official Washington is on holiday? Or was it a sign of greater American readiness to rethink a war on drugs that has, in almost four decades, failed to curb production and stifle consumption of illicit drugs? And that despite law enforcement efforts that resulted in an average of around 4,700 arrests for drug offences every single day since the beginning of the millennium. (Just under 40 percent of those arrests are for possession of marijuana).

Or was it a matter of more countries realising that, as drug reform advocate Ethan Nadelmann puts it, “looking to the United States as a role model for drug control is like looking to apartheid-era South Africa for how to deal with race.” Nadelmann heads the Drug Policy Alliance, one of several groups lobbying for reform of U.S. drug policies.

Under the Mexican law that took effect in August, it is legal to possess small, precisely specified amounts, for personal use, of  marijuana, heroin, opium, cocaine, methamphetamine and LSD. In Argentina, the Supreme Court declared unconstitutional criminal sanctions for the possession of small quantities of marijuana for personal use. The ruling opened the door to legislation similar to Mexico’s.

Brazil decriminalised drug possession in 2006; Ecuador is likely to follow suit this year. In much of Europe, drug use (as opposed to drug trafficking) is treated as an administrative offence rather than a criminal act. America’s hard-line approach has helped to make the United States the country with the world’s largest prison population.

Advocates of more flexible policies say they feel the winds of change beginning to rise in the administration of  Barack Obama, a president who has admitted that in his youth, he smoked marijuana frequently and used “a little blow”(of cocaine) when he could afford it. But hopes for a break from long-standing orthodoxy might be premature, even though a recent Zogby poll showed 52 percent support for treating marijuana as a legal, taxed and regulated drug.

AMSTERDAM’S SCHIZOPHRENIC PRAGMATISM

“As regards to legalization, it is not in the president’s vocabulary and it is not in mine,” Obama’s drug czar, former Seattle police chief Gil Kerlikowske said in July. “Marijuana is dangerous and has no medicinal benefits.”

Oddly, he made the statement in California, where an estimated 250,000 people can legally buy marijuana with a letter of recommendation from their physician. The drug is used for a variety of illnesses, from chronic pain to insomnia and depression. There is extensive academic literature on the medical benefits of marijuana.

Medical opinion, however, conflicts with the congressionally-mandated job description Kerlikowske inherited when he took up the post. It says that the director of the Office of National Drug Policy, the White House group in charge of drug war strategy, must “oppose any attempt to legalize the use of a substance listed in schedule I of section 202 of the Controlled Substances Act.”

Schedule I of the act, which took force in 1970 during the administration of Richard Nixon, the president who formally declared “war on drugs”, places marijuana alongside powerfully addictive drugs such as heroin. The wrong-headed classification matches that of an international treaty, the 1961 United Nations Single Convention of Narcotics Drugs. The convention is a major obstacle for signatory countries that want to legalize drugs.

No country has actually done that. Even the Netherlands, the Mecca of marijuana aficionados, operates on a system best described as schizophrenic pragmatism. Amsterdam’s “coffee shops” are allowed to have 500 grams of marijuana on the premises and sell no more than 5 grams per person to people over 18. The runners who re-supply the shops routinely carry more than the legal quantity and violate the law. So do importers.

While the failure of the drug war and the prohibitionist ideology that drives it have been analysed in great detail in scores of sober assessments by academics and government commissions, there have been few studies of the “how to” of legalization. What, for example, would happen to the criminal mafias that are now running a violent illicit business with a turnover estimated at more than $300 billion a year?

Some drug traffickers would switch to other criminal activities and it is realistic to expect increases in such areas as cyber crime and extortion, according to Steve Rolles, Head of Research of the Transform Drug Policy Foundation, a British think tank. “But the big picture will undoubtedly show a significant net fall in overall criminal activity in the longer term,” he said in an interview. “Getting rid of illegal drug markets is about reducing opportunities for crime.”

Rolles is author of the optimistically titled “After the war on drugs: Blueprint for Regulation,” a book scheduled for publication in November and meant to kickstart a debate on what he sees as something of a blank slate - the specifics of regulation for currently illegal drugs.

On a global scale, nothing much can happen unless there are changes in the world’s largest and most lucrative market for drugs, the United States. If they happen, they won’t happen fast. “I see this as a multi-generational effort, with incremental changes,” said Nadelmann, who has been involved in drug policy since he taught at Princeton University in the late 1980s. “But for the first time, I feel I have the wind in my back and not in my face.”

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

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

Just as Chinese stocks often rise without fundamental support, they are now tanking even though companies just had a better-than-expected earnings season.

Fears about a policy shift towards tighter liquidity are blamed for the 22 percent decline in the Shanghai market from its August peak. But those fears are largely overblown. Beijing might be talking about boosting domestic consumption, but structural reforms take time and there is little the authorities can do other than continuing to reinflate the economy in the short run.

There are encouraging signs that corporate profits — the fundamental basis for share prices — are on the turn.

Chinese companies’ earnings for the past quarter rose 36 percent compared with the previous three months, helped by strong results from banks and property firms. Companies also offered a more optimistic outlook, propelling a string of earnings upgrades.

The purchasing managers’ index, released on Tuesday, confirms that China’s manufacturing sector is keeping up its steady recovery.

Stocks are now trading at about 20 times forecast profits for next year. This is higher than the rest of the region, but Chinese companies enjoy higher growth rates: earnings are projected to grow by 20 per cent this year.

And compared with historical valuations, which range from the low teens to as much as 50 times earnings, current prices do not look excessive.

Premier Wen Jiabao this week tried to ease concerns when he said China’s economy was at a crucial juncture in its recovery and the government would not change its policy direction. But investors are taking their cue from the rising chorus of alarm sent by lower-level government officials, academics, and law-makers.

China’s parliament, usually a rubber-stamp organization, was unusually vocal in its late August session about the need to balance short-term relief with long-term development and structural reforms.

Meanwhile, the banking supervision commission has been cracking down on bank loans that make their way into stocks and property. In an effort to rein in excessive lending, it has also made it harder for banks to pass capital adequacy tests.

But even if Chinese banks stop lending in the second half — China’s largest bank ICBC even reduced its loan book in August — the swath of loans made in the first half will continue to work their way through the system during the rest of the year.

New lending in the first half amounted to an eye-popping 50 percent of gross domestic product on an annualized basis. Even if the ratio slumps to 10 percent in the second half, on average new loans as a percentage of GDP this year will still be double the 15 percent annual growth rate of the past three years.

In addition, as the flood of short-term bills — which banks accepted from companies to boost their lending volumes — start to mature, banks are diverting the cash into long-term loans tied to real projects that should help the economy in the coming months.

China’s monetary fine-tuning still looks marginal, even with July’s abrupt credit slowdown and a similarly subdued number expected for August. That’s because rising foreign capital inflows will offset some of the drop in bank credit.

Technical indicators also suggest the stock market has fallen too far. Chinese stocks had more than doubled between October and August and were ripe for a correction. Trading volumes have fallen substantially since the recent peak.

It is hard to call the bottom. But one thing that looks certain is that China’s companies and economy have proven to be stronger than many expected.

Lou Jiwei, chairman of China’s sovereign fund, said over the weekend that both China and America are dealing with past bubbles by creating new ones. Given how growth-minded Chinese policymakers are, it would be a mistake to bet on Beijing undermining the economy and the stock market by tightening too early.

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

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

There is a long list of outfits which have done well out of the banking bailout, but the U.S. Treasury and Federal Reserve are not among them.

According to calculations made for the New York Times, the Treasury’s Troubled Asset Relief Program (TARP) has reaped profits of about $4 billion, or 15 percent annualized, as eight of the largest banks to participate have fully repaid what they owe.

Meanwhile unnamed Federal Reserve officials told the Financial Times that the central bank’s liquidity facilities have generated a “gain” of $14 billion since August of 2007.

The notion of TARP profits is only true if looked at in the narrowest sense, and even then may prove to be a return as real as those of the Florida condo flippers in the summer of 2007.

The Fed, on the other hand, incontrovertibly has earned more by buying and lending against poorer quality paper, but they did it by taking on more risk - a leaf out of the book of the industry they were helping to rescue.

Wait until the Fed starts making payday loans or gets into the reconditioned small appliance finance business, then you will see what kind of “gains” a bank with a printing press and the power to create money can really generate.

I suppose the idea is to make taxpayers and voters grateful that they had the opportunity to participate in such profitable ventures - doing well by doing good, or some similar fluff.

A number of leading banks have repaid their loans made under TARP, and the government has profited by warrants it held under the deals, but this is really only a bit of runoff from the great jet of liquidity that the government has concentrated on the industry as a whole.

“What this is more appropriately described as is a return of capital; to call this a profit is to ignore trillions of dollars in taxpayer monies that have been spent, lent, guaranteed, drawn against and otherwise consumed in what will likely be the greatest transfer of wealth in the planet’s history,” Barry Ritholz, of research firm Fusion IQ, wrote on his blog.

It is one thing to justify an enormous outlay and subsidy - and make no mistake this is what the bailouts were - on the basis that it was a needed evil, but it borders on the offensive to sell it as a successful investment.

DOING WELL FROM DOING LESS

The first to repay within any loan portfolio are by definition the strongest; it is only later that the laggards show the losses. We do not know how the TARP and other programs of support will look in three or four years time, but it is likely to be worse than they look today.

Moreover, the whole idea of rigging the game and then declaring a profit is wrong. Governments can ever and always create the conditions under which their financial sectors can turn nominal profits.

They do this in a number of ways; through lax regulation, by engineering low interest rates with a sharply sloping yield curve, by limiting competition, or by providing term financing when the markets won’t do so.

These profits though are effectively a tax on the rest of the economy, and I am betting that the taxpayer and government are not getting their fair share, which is virtually all of it.

Billions and billions of dollars are flowing elsewhere - to investors, to borrowers and to employees.

There is also the bald fact that, given that there were no effective funding markets at the time that many of the loans and investments were made, the government could have extracted far higher compensation for its support.

And what about opportunity cost? How would the government and taxpayer have fared if instead of rescuing the banks, and thereby privatizing much of the profit, it seized them and sold them off in the normal fashion? Or what about if the trillions of dollars in support were used in different ways, for different purposes, or even, heaven forfend, not spent at all?

As for the Fed and its gains, the key point is that this money, which represents the extra earned above what three-month Treasury bills would have generated, is not risk adjusted.

The Fed isn’t, and shouldn’t be, a hedge fund — leveraging up and going out the risk curve to generate profits.

It too, conceivably, can allocate credit to a particular part of the economy, say housing, and thereby make the loans it makes to that sector perform and generate “profits.” But this begs two questions; is it right for them to allocate credit in this way and are the profits real or symptoms of a bubble?

This will work for a while, but as we have seen, not forever.

(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.)

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

By making the war in Afghanistan his own, declaring it a war of necessity and sending more troops, President Barack Obama has entered a race against time. The outcome is far from certain.

To win it, the new strategy being put into place has to show convincing results before public disenchantment with the war saps Obama’s credibility and throws question marks over his judgment. Already, according to public opinion polls in August, a majority of Americans say the war is not worth fighting. Almost two thirds think the United States will eventually withdraw without winning.

There are similar feelings in Britain, which fields the second-largest contingent of combat troops in Afghanistan after the United States. A poll published in London this week showed that 69 percent of those questioned thought British troops should not be fighting in Afghanistan.

In the United States, almost inevitably in a country that never forgot the trauma of the only war it ever lost, 36 years ago, pundits are conjuring up the ghost of Vietnam. A lengthy analysis in the New York Times wondered whether Obama was fated to be another Lyndon B. Johnson, the president who kept escalating the Vietnam war.

The war in Afghanistan is drawing into its ninth year and chances are it will still be going badly when Obama is gearing up for his campaign for re-election in 2012. According to a study by the RAND institute, a think tank working for the military, counter-insurgency campaigns won by the government have averaged 14 years.

“The insurgent wins if he does not lose,” according to the U.S. Army’s counter-insurgency manual, “while the counterinsurgent loses if he does not win. Insurgents are strengthened by the common perception that a few casualties or a few years will cause the United States to abandon (the effort).” A key to winning: “firm political will and extreme patience.”

Patience is not an American virtue. The first call for Obama to set a “flexible timetable” for the withdrawal of American troops came this month, from Senator Russell Feingold, a Democrat and member of the Senate Foreign Relations Committee. Not exactly a reflection of firm political will and extreme patience.

In Afghanistan, the Taliban insurgents not only have been winning by not losing, they have actually been gaining ground. In the words of the top U.S. military officer, Joint Chiefs of Staff Chairman Mike Mullen, the situation in Afghanistan “is serious and is deteriorating.”

What does that mean? According to Anthony Cordesman of the Center for Strategic and International Studies, the Taliban have expanded their area of influence from 30 of Afghanistan’s 364 districts in 2003 to some 160 districts by the end of 2008. But, says Cordesman, a widely-respected authority on military affairs, “the military dimension is only part of the story.”

CORRUPTION AND INCOMPETENCE

The other part is a corrupt, incompetent government and an equally corrupt and inefficient system of disbursing international aid. In his war-of-necessity speech, Obama obliquely referred to that aspect of the Afghan war by saying it could not be won by military force alone. “We also need … development and good governance.”

Both have been in very short supply. “The Afghan government lost legitimacy over the past five years,” says Bruce Riedel of the Brookings Institution, a Washington think tank. Whether, and how quickly, it can regain it is open to doubt, no matter who emerges as the winner of the August 20 election in which President Hamid Karzai was running for a second five-year term. (Full results are due on September 3. Both Karzai’s camp and his main challenger, former foreign minister Abdullah Abdullah, have claimed victory on the basis of partial results.)

The extent of corruption and the lack of good governance are reflected by two international gauges - the Failed States Index compiled by the The Fund for Peace and Foreign Policy magazine and the annual Corruption Perceptions Index issued by Transparency International, a Berlin-based watchdog group. Afghanistan ranks 7th on the failed states list and 176th (out of 180) on the corruption scale.

This is not an environment that lends itself to swift solutions. There are powerful vested interests in maintaining what Cordesman calls a dishonest system of power-brokering and corruption. Jean MacKenzie, a Kabul-based reporter, said in a recent guest column for Reuters that foreign assistance coming into Afghanistan was one of the richest sources of funding for the Taliban.

“It is the open secret no one wants to talk about … Virtually every major project includes a healthy cut for the insurgents,” MacKenzie wrote. “International donors, primarily the United States, are to a large extent financing their own enemy.”

Until recently, most experts thought that the Taliban was financed largely from taxes the insurgents levied on the production of opium, the raw material for heroin. Richard Holbrooke, Obama’s special envoy for Afghanistan and Pakistan, said last year (when he was not in government service) that “breaking the narco-state in Afghanistan is essential or all else will fail.”

He no longer thinks that the insurgency is mostly funded by the opium trade. Instead, he says that the volume of money flowing into the Taliban coffers from sympathizers in Gulf states and elsewhere exceeds that of the drug trade.

“Obama inherited a disaster,” according to Riedel, “a war which has been under-funded and under-resourced for six of the past seven years.”  And what would happen if the Obama’s war of necessity went wrong and the United States pulled out of Afghanistan? In the Muslim world, it would be seen as “a triumph on a par with the withdrawal of Soviet forces” from Afghanistan after their disastrous nine-year war and occupation.

Not to mention the impact it would have on Obama’s political standing.

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

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

The People’s Bank of China’s ambitious plan to settle foreign trades in yuan has been given the cold shoulder by companies both at home and abroad. The failure of this experiment shows the difficulties China faces in internationalising its currency.

Launched by the PBOC with a fanfare almost two months ago, the pilot scheme has so far seen only thin volumes of yuan trade settlement. Guangdong province, the country’s export hub, was supposed to be the cornerstone of the plan, but local officials said they found few willing counterparties.

This should not have come as a surprise. Foreign importers either have little access to the yuan, are reluctant to part with it, or do not want to commit future payment in a currency that is expected to appreciate. More surprisingly, domestic exporters, who would benefit from lower currency risks, are put off by the logistical headache of receiving domestic currency for their exports.

These concerns aside, there is a more fundamental reason why the yuan is not catching on. The Triffin Dilemma, named after the Belgian-American economist who rose to prominence in the 1960s, stipulates that it is hard for a country running a large trade surplus to demand that others buy goods using its own currency.

The world now suffers from an oversupply of the manufactured goods that are China’s specialty. Thus it is hard for China’s millions of small exporters to demand that Wal-Mart pays them in yuan, or for thousands of small Chinese steel mills to persuade Rio Tinto and BHP Billiton to accept the Chinese currency.

Only exporters in countries such as Indonesia, which has a limited amount of foreign reserves, have an incentive to sell goods such as timber to China in exchange for yuan, which can be used to buy imports from China later. But given the lack of convertibility of the yuan, it is probably not worth going through the hassle.

It is understandable that the PBOC, which counts fighting inflation as a main task, wants to push some yuan offshore in order to address the problem of domestic oversupply of the currency. But others may have different ideas. China’s Ministry of Finance, for example, has championed for the use of a pan-Asia currency. The Ministry of Commerce may not deem now the best time for struggling Chinese exporters to demand that buyers take on their currency risks.

It also appears that the PBOC had not worked out some of the logistics before launching the pilot scheme. Exporters had problems navigating customs under the new scheme, as well as claiming export tax rebates if they didn’t have foreign currency receipts.

The PBOC this week hosted a web conference with the bureaus of finance, commerce, customs, tax and banking regulation to iron out the kinks and unveil some new incentives. One of them is allowing yuan earned from exports to stay abroad to encourage more use of it outside China, instead of it having to be repatriated immediately. But by loosening capital controls on trade settled in yuan, the PBOC faces heightened risks of money laundering as exporters can overstate the value of their goods to get the Chinese currency offshore.

As China’s economy rebalances over time, the prospects of currency appreciation subside, and Chinese companies start to have more negotiating power, there might be more interest in using yuan as a settlement currency. But this remains a long shot for the PBOC.

Japan, which has fewer capital controls as well as a more developed domestic bond market than China, has been pushing the yen abroad for 20 years. Even so, the currency is still rarely used to settle international trade. The PBOC is facing a long struggle to realise its master plan.

– 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 —