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

If current trends continue, China might swing to a trade deficit in the not-too-distant future. Given that China has enjoyed more than a decade of strong exports, this may sound a bit far-fetched. But even if it happens, this would not necessarily be something for the world to worry about.

Some economists have recently sounded alarm bells about the possibility of a Chinese trade deficit. They argue that if the Chinese current account surplus shrinks, it would leave Beijing with less spare cash to buy U.S. Treasury bonds. Then who would fund the U.S. budget deficit — and, by implication, U.S. consumers?

Those worries are largely misplaced. First, it is unlikely to happen any time soon. In order for China to have a trade deficit next year, imports would have to outgrow — or shrink less than — exports by at least 23 percentage points.

In August, exports fell 23.4 percent while imports fell 17 percent. So while the trade surplus is diminishing, a deficit is not around the corner.

If China’s trade surplus shrinks, it will most likely be caused by a contracting U.S. deficit, in which case Americans will be saving more and the U.S. will be less dependent on overseas investors to finance its government debt. That would be a sign that the long-overdue rebalancing of the global economy was beginning to take place.

It would not be so bad for the Chinese economy either, because China is a lot less dependent on exports than many people assume. Although exports have accounted for a whopping 50 percent of the economy in the past few years, the contribution of net exports to economic growth is actually much smaller, because a lot of what China sells abroad is low value-added assembly work.

In the same way, one cannot just look at China’s large imports number and jump to the conclusion that China is a big end-user of the world’s goods. China’s imports accounted for a third of its gross domestic product last year, versus about 17 percent in the U.S. during the same period. But this is because a lot of what China imports, such as computer parts, eventually finds its way abroad.

On average, net exports contributed 1.4 percentage points to annual GDP growth between 1979 and 2007, according to the Statistics Bureau, much less than the contribution from the other two drivers — consumption and investment.

The transition to a more balanced trade account will take time. In particular, it will need a push from foreign exchange reforms, as the currently undervalued yuan encourages exports and discourages imports. China allowed the yuan to rise gradually for a few years after 2005, but has re-pegged it to the dollar since the start of the credit crisis.

It will take time before Beijing is confident enough to remove some of the export incentives, or at least not pile them up as it has done in response to the crisis. A more equalised trade account will probably not hurt China’s overall growth that much, but will help in making the world economy more balanced.

– 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 —

– Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own –

Twenty-four years ago, major nations called for depreciation of the dollar to rebalance the global economy. Now, as another effort at rebalancing looms, the dollar will again bear the brunt — though officials will try to ensure its fall is less dramatic this time.

That’s the implication of President Barack Obama’s announcement this week that he will push world leaders for a new global “framework” in which the United States would cut its huge trade and budget deficits.

Agreeing on this framework would be politically difficult, since it would require policy changes by many countries — China, for example, would probably have to rein in its explosive export-led growth.

But as the euro’s climb to a new one-year high versus the dollar this morning shows, markets are starting to think the rebalancing process may start as soon as this week’s Pittsburgh summit of leaders from the Group of 20 nations.

The Plaza Accord of 1985 called for “orderly appreciation of the main non-dollar currencies against the dollar”; it was followed by central banks’ coordinated intervention to ensure that happened.

This time, with the world shakily emerging from a financial crisis, policymakers are likely to try to manage the dollar’s drop in a more low-key fashion.

They are unlikely to issue an explicit call for the dollar to fall. In fact, the U.S. Treasury may continue proclaiming its “strong dollar policy” in an attempt to keep the markets calm.

No one in the G20 wants to risk a freefall of the dollar that could disrupt global trade as it recovers from recession. And in contrast to the 1980s, developing nations such as China are now challenging the dollar’s long-term role as the world’s top reserve currency.

The dollar’s premier status helps the United States to obtain foreign capital and in order to keep that access, Washington is likely to encourage central banks around the world to continue holding dollars. This would require slow depreciation of the currency rather than a panicky slide.

So unless policymakers completely lose control of the forex markets — which cannot entirely be ruled out — the dollar’s slide is likely to be slower and smaller than it was after the Plaza Accord, when the currency sank about 50 percent versus the yen between Sept. 22, 1985 and the end of 1987.

The overall direction of the dollar does not look in doubt, however. Top presidential adviser Lawrence Summers has said he wants a U.S. economy that is “more export-oriented and less consumption-oriented”.

A lower dollar is a logical tool to achieve that goal, and letting the currency weaken would probably be faster and easier than most other big policy steps to reshape the U.S. economy, such as tax changes and health reform.

The International Monetary Fund, which is advising G20 nations on economy policy, is hinting heavily at the need for currency realignment.

In a report released this week, it said “current policies and the assumed constellation of exchange rates may not be sufficient for the needed rebalancing of demand.”

It added that policy reforms by the world’s big economies to restore growth “would be more effective if accompanied by a real effective renminbi appreciation, offset by euro and dollar depreciation”.

An international understanding on dollar depreciation may well not be reached in Pittsburgh. A French official said last Friday that Pittsburgh would merely set the stage for future talks on foreign exchange rates.

“At this stage there will not be currency discussions, but the framework that we hope to put in place…is a way of discussing later the question of exchange rates,” said the official, who declined to be named.

But giving China and other developing countries more power in the IMF and the World Bank could be part of an informal quid pro quo in which China quietly undertook to resume appreciating the yuan against the dollar.

The rise of the euro as high as $1.4821, breaking the December 2008 peak of $1.4719, is a technical signal that the market thinks the dollar is increasingly vulnerable.

For many traders, the break suggests a good chance of a rise to at least the psychologically important level of $1.50 in coming weeks or months.

The European Central Bank might seek to limit speculation against the dollar by expressing concern about such a move. But the market does not appear to worry that the ECB could actually intervene to support the dollar.

When the European Union’s Economic and Monetary Affairs Commissioner Joaquin Almunia said last week that excessive appreciation of the euro could hurt Europe’s economy, the euro fell back only marginally and briefly.

The market knows that even at levels just above $1.5000, the euro would remain well below its all-time high against the dollar of $1.6038, hit in July 2008.

And any rise of the euro against the dollar in the current circumstances would probably be seen by policymakers as the result of general dollar weakness, not excessive euro strength. When euro/dollar reached its July 2008 peak, euro/yen hit a similar high; now, euro/yen is a full 35 yen lower.

The Japanese may also be willing to see their currency strengthen. Before new Finance Minister Hirohisa Fujii took office this month, he said a strong yen was generally good as it boosted the purchasing power of Japanese.

Fujii subsequently backed away from that comment, but speculation will remain that after sweeping to power last month, the Democratic Party of Japan may try to shift the country away from its reliance on exports and its opposition to yen strength.

In the context of a G20 drive to rebalance the global economy, this could easily cause the market to think the yen should be trading stronger than 90 to the dollar.

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

The U.S.-China tire dispute threatens to spill into other sectors and squeeze Chinese exporters’ already razor-thin margins further. It might seem mind-boggling to many that Chinese manufacturers are still hanging on to weak overseas markets even though the domestic economy looks much healthier and surely offers more potential.

But there are structural reasons why the grass is greener outside China. The risk of not getting paid, or getting paid late, is significantly lower when dealing with foreign buyers. The cost of international shipping has dropped so much that it can be cheaper to send goods over the Pacific Ocean than across the country.

In addition, selling to large buyers such as Wal-Mart creates volumes large enough to compensate for weak margins. Moreover, Chinese exporters get all sorts of export rebates and local government incentives which help to lower their costs.

But as the tire spat has illustrated, Washington can slap punitive duties on Chinese imports simply by pointing to a significant increase in imports from China. By imposing penalties in this case, President Obama has opened the door for a slew of similar complaints against Chinese goods. It will only be a matter of time before other countries, worried about where those displaced Chinese exports might end up, start to follow suit.

That’s why Chinese policy makers need to get more serious about stimulating domestic spending. It is time for Beijing to revamp a system built over the past three decades that explicitly and implicitly favours exports and to encourage manufacturers to prioritise selling to the domestic market.

A good first step would be to reduce some of the export incentives China offers to certain industries. These effectively subsidise foreign consumers at the expense of domestic customers. For example, Chinese tyre-makers get a tax rebate of about 9 percent on the value of the products they sell abroad. That’s why tyre makers can afford to price exported tyres more cheaply than ones sold at home, according to Xu Qiyuan, a researcher at China’s Social Science Academy.

To date, however, China’s response to the credit crunch has been to boost incentives to prop up export markets. Beijing raised export rebates on 3,802 items from April 1. Textile exporters also got an increase in their rebate to 16 percent from 15 percent. This activity is not illegitimate and many countries subsidise exports. But the U.S. enforcement action shows that this policy may have practical limits.

China needs more than just a change of heart on subsidies. Longer term, Beijing needs to foster the development of a healthy credit culture for suppliers so they can get paid on time, and to improve China’s transportation infrastructure in order to reduce the cost of moving goods around the country, and most importantly, to break down local protectionism that discriminates against suppliers from other provinces. It may seem odd but China needs to create a single internal market.

Despite all the talk about Chinese consumers being unwilling to spend due to a lack of a social safety net, one important reason that they don’t buy much at home is because prices are often too high . When “frugal” Chinese consumers go to Hong Kong or London, they immediately become big spenders, splashing out thousands of dollars on clothing, cosmetics, bags and watches. The irony is that a lot of the things they buy are actually made in China, but are simply not available there, or cost much more.

Moreover, the lack of a single market hampers foreign companies seeking to sell to China. Although foreign executives might fancy China as a giant market with 1.3 billion customers, the reality is that it is extremely fragmented, so economies of scale are hard to achieve. Transporting goods from one province to another can incur hefty tolls levied by local governments keen to raise local revenue and make it harder for companies to break into their local markets.

The credit problem also needs to be addressed. Big Chinese retailers only pay for goods on delivery. An exporter, by contrast, gets a letter of credit when the order is placed, and this can be cashed in to finance production.

China’s rebalancing away from export dependence has barely begun, and it will take a long time to change attitudes. But now would be a good time to make a start. The recent trade disputes over Chinese tyres and toys should serve as warning shots. China’s leaders must start to make the domestic market more friendly to suppliers and consumers.

– 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 —

- Richard Wellings is Deputy Editorial Director at the Institute of Economic Affairs. The opinions expressed are his own.-

Argentina should be an object lesson for the U.S.

A century ago, it was one of the richest countries in the world. Today, it has fallen far behind Europe and North America, after a hundred years marked by long periods of recession.

Faced with economic crisis, for example during World War I and the Great Depression, Argentina’s politicians turned to socialism. Lame-duck industries were subsidised and protected from competition, and policy was often driven by powerful vested interests such as the trade unions.

Profligate government spending was initially financed by borrowing, and then by printing money. The result was rampant inflation, which damaged investment and growth by making it almost impossible for businesses to plan ahead.

A new IEA study, Economic Contractions in the United States: A Failure of Government, suggests that President Obama’s current economic policies could be similarly ruinous - though, to be fair to Obama, the authors point out that these policies were started by George W. Bush.

Despite deep recession and an exploding budget deficit, Obama is embarking on ambitious and hugely expensive socialist reforms, including a subsidised healthcare programme, extra education spending, and a cap and trade policy to reduce carbon emissions. In the long run, these measures will heap yet more misery on taxpayers following the bailout of banks, insurance companies and the car industry. And they come after George W. Bush's period in office, during which he was one of the most profligate presidents in US history.

For the time being, Obama is relying on lenders to fund his spending spree. The Federal Government’s budget deficit is likely to reach $1.6 trillion this year. Shockingly, this means around half the money it spends will be borrowed.

The long-term economic impact is likely to be devastating. Such high levels of borrowing hamper recovery by crowding out investment and will almost certainly lead to much higher taxes and interest rates. Expectations of a less dynamic US economy as a result of greater state intervention and more burdensome taxation also act as a deterrent to business expansion.

Perhaps more worrying still, Obama’s policies will increase the share of the US population directly dependent on government largesse. This will make it far more difficult to cut Federal expenditure if borrowing levels prove unsustainable. The temptation to monetize debt on the grounds of political expediency will be much stronger, even if it risks high inflation.

The President is sowing the seeds of the kind of destructive special interest politics that helped consign many South American countries to a century of economic failure. And while the authors do not argue that the US is likely to become the next Argentina - years of stagnation are more likely - by expanding the role of government so rapidly, Bush and Obama have raised at least the possibility of long-term catastrophic decline

- Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own. -

Is the crisis over yet?

In the last 3 months, the Dow and the FTSE have each risen by about 25 percent, the Standard & Poor's 500 by a third. House prices appear to be stabilising in the UK. Stress-tested and backed by seemingly unlimited government funding, the banks are lending again (if only to each other), so that 1-month libor is down to only 0.3 percent.

In the Far East, the Chinese economy may be growing again, and even Japan may have pulled out of its nosedive. The oil price has recovered from its lows.

Is there any reason to doubt that the worst is past?

No reason whatever, except the following (in ascending order of gravity):

1. As unemployment increases, defaults on credit card debt are certain to rise, reducing the banks’ ability and willingness to lend to consumers.

2. Even if the residential property market has stabilised, commercial property prices appear to be in free fall, leading to further contraction in the construction sector, more bad debts and knock-on effects on employment and investment in the broader economy.

3. The consensus view is that bank stress tests, in the U.S. at least, were based on optimistic assumptions about the depth and duration of the real estate slump.

4. In order to spare U.S. and UK taxpayers, the bailout burden has been piled on to the bond markets, which have so far proved willing to finance the massive increase in the national debt of the two countries at a cost of only 3.75 percent on 10-year Government debt in UK and 3.5 percent in U.S., which is remarkable considering that both countries appear to be heading for a debt-to-GDP ratio of 100 percent or more.

However, in addition to the recent threat by S&P to downgrade UK gilts, the spread on credit default swaps is an even clearer warning: it costs 86 b.p. to insure against a British government default, and 44 b.p. for the U.S. (compared to only about 40 b.p. for France, Germany or Japan). Outright default by Britain or the U.S. is, in my view, highly improbable.

By far the most likely outcome in the medium term is inflation, or default by stealth. This is how Britain paid the bill for World War Two and the U.S. for Vietnam. So far, however, the bond markets appear to trust the politicians to come up with a plan to pay off these debts. But they will not wait forever.

At some point, they could well take fright and try to dump UK or U.S. government debt, forcing yields up to cripplingly high levels, with disastrous consequences for the real economy.

5. Who are these bondholders anyway? A significant proportion are institutions or governments of countries which, unlike Britain and the U.S., save rather than consume, and hence have balance of payments surpluses, notably the Gulf States, Japan and, most important, China. How long will their patience last? They are locked into their massive accumulation of dollar assets, unable to exit without realising enormous capital losses. But if they decide to stop throwing good money after bad, the outcome could be a dramatic rise in interest rates and a calamitous fall in the value of the Dollar, a final convulsion in this long devastating crisis.

None of these disasters is inevitable. But if you think the worst is over, ask yourself: why is the price of gold - traditionally seen as a safe haven in times of economic turmoil - rising again?

-- Neil Collins is a Reuters columnist. The opinions expressed are his own --

LONDON, April 23 (Reuters) - "Practically everyone who follows Latin American events agrees that Castro's end is near." Thus one Laurence W Tuller, writing in 1994 in his manual on high-risk, high-reward investing. Defaulted Cuban government bonds had jumped on hopes of a settlement to allow the country back into the international capital markets.
Today, former leader Fidel Castro's end is 15 years nearer, but he's still there, albeit in semi-retirement, and holders of these pre-Castro bonds with a face value of around $200 billion are still waiting. Castro's regime kept good records, but have paid no interest, and ignored redemption dates since his revolution half a century ago.
Few Americans can remember why their administration has been so beastly to Cuba for so long.
Those who can mostly live in Florida, a key swing state, and many risked everything to get out of Cuba. They do not want to see their investment devalued by hordes of their former compatriots simply walking off the Delta Airlines flight from Havana.
Last week U.S. President Barack Obama eased the squeeze somewhat. Americans can now visit Cuba, but only if they have relatives there.
This gesture has re-ignited the bondholders' old hopes. Past settlements of defaulted sovereign bonds have tended to pay about half the total of accrued interest plus principal, so the buyers see plenty of upside.
Exotix, a specialist trader in "frontier markets", says its price for a typical Cuban bond instrument has risen from around 9 cents on the dollar at the start of this month to 14 cents on April 23.
Mind you, the spread is wide, the market thin and as events crowd in on the President, he might feel there are more pressing problems than to risk upsetting those key-voting Floridian Cubans.

Thirty-first U.S. President Herbert Clark Hoover once said: "Blessed are the young, for they shall inherit the national debt."

Governments around the world are borrowing heavily to finance their fiscal expansion – unprecedented in size and scale – to prevent severe economic downturn.

However, outspoken independent economist Roger Nightingale thinks fiscal stimulus will not work.

He predicts a severe, Japanese-style recession to hit major and developing markets.

"There is no way out of this problem. Fiscal policy won’t help it at all," he told a conference in London.

"It’s taking from one type of people and giving it to another… It’s net zero. It’s taking from non-banks and giving to banks. It’s taking from the innocent and giving to the guilty. It’s Robin Hood in reverse."

– John Kemp is a Reuters columnist. The views expressed are his own –

Even by the standards of a deep-cyclical industry, the “golden age” of oil refining has proved remarkably brief, lasting no more than three years, before giving way to a new dark age.

Particularly in the United States, refiners have returned to the state of chronic unprofitability that plagued the industry before 2005.

U.S. refiners now have too much capacity and produce the wrong products (gasoline) in a fuel economy increasingly dominated by ethanol and diesel. Capacity cuts of as much as 0.5-1.0 million bpd (equivalent to 4-8 average refineries) and expensive investment to reconfigure the system to increase the diesel yield seem inevitable.

EVAPORATING PROFIT MARGINS

In May 2007, U.S. refiners paid an average of about $64 a barrel to acquire high quality West Texas Intermediate (WTI) crude (less for other grades) and sold gasoline for $97 per barrel - a margin of $33 per barrel or 52 percent.

By November 2008, U.S. refiners were paying $62 to acquire WTI but selling gasoline at a loss for just $52 - a negative margin of $10 or 16 percent.

Other outputs are still profitable (notably diesel and heating oil) and many refineries will have acquired lower-quality crudes for less than the WTI price. The overall gross margin was still (just) positive.

But the NYMEX benchmark 3-2-1 crude oil-gasoline-heating oil has shrunk from $30 per barrel to just $3. Once operating costs (including natural gas, electricity, water and catalysts) as well as capital expenditures (building, maintaining and upgrading refineries) are taken into account, the industry is making little or no profit.

DEMAND DESTRUCTION

Demand for gasoline and other refined products has been falling for more than a year, initially in response to high prices and now as a result of a weakening economy, leaving refiners with a huge overhang of unused capacity.

The total volume of refined products supplied to the domestic market averaged just 19.2 million barrels per day (bpd) in the four weeks ending Nov. 21, down 1.7 million bpd (8 percent) from 20.9 million bpd in the same period last year. The volume of motor gasoline supplied (9.0 million bpd) was down 300,000 bpd (3.3 percent) compared with last year (9.3 million bpd).

Refiners have responded with run cuts and record exports of both gasoline and distillates to avoid flooding the domestic market and collapsing prices further.

Operating rates have been below year-ago levels since the start of 2008 (https://customers.reuters.com/d/graphics/US_RFRT1208.gif).

Refineries processed 15.2 million bpd of crude and other inputs in the week ending Nov. 21 - using just 86.2 percent of their 17.6 million bpd maximum capacity, and leaving more than 2 million bpd of crude distillation capacity idle.

Refiners also sent increasing volumes of refined products abroad to avoid flooding the domestic market. Refiners and merchants ramped up gasoline exports from 38 million barrels in Jan-Sep 2007 to 50 million in Jan-Sep 2008 (+32 percent) and distillate exports from 52 million barrels to 146 million (a massive increase of +182 percent).

It has not been enough. By Nov. 21, reported gasoline inventories stood at 200 million barrels (22.3 days of supply) up from 197 million barrels (21.2 days cover) in 2007.

ETHANOL DISPLACEMENT

Refinery gasoline is increasingly squeezed out by ethanol. U.S. ethanol production has tripled from 260,000 bpd in Sep 2005 to 640,000 bpd in Sep 2008, with another 80,000 bpd of ethanol imported. As a result, ethanol is cutting almost 750,000 bpd of demand for fossil-fuel refinery-derived gasoline (https://customers.reuters.com/d/graphics/US_GSETH1208.gif).

In Sep 2005, some 8.9 million bpd of gasoline was supplied to the domestic market, of which 8.7 million bpd came from refineries and just 0.3 million bpd was sourced from ethanol distilleries.

Three years later, in Sep 2008, the volume of gasoline supplied had fallen 400,000 bpd to 8.5 million bpd. But while the volume of ethanol sourced from distilleries had risen by 0.5 million bpd to 0.7 million bpd, the volume of gasoline sourced from refineries was down by a massive 1 million bpd to 7.7 million bpd.

Roughly half the refinery demand lost over the last three years is due to increased ethanol (500,000 bpd), while the remainder is due to cyclical factors (400,000 bpd).

The displacement of refinery gasoline is an explicit objective of federal policy to reduce U.S. oil imports. It has been accelerated by the surge in crude oil prices during 2007-2008, encouraging widespread voluntary blending of cheaper ethanol into the domestic fuel supply.

But increased blending volumes threaten to strand many U.S. oil refineries as white elephants with no long-term future. Refinery utilisation rates have been trending down since the start of the decade, but the loss of demand has accelerated notably since widespread ethanol blending commenced in 2005 (https://customers.reuters.com/d/graphics/US_RFRTA1208.gif).

As a result, there is an increasingly wide gap between system capacity and actual throughput. More than 2.0 million bpd of crude distillation capacity is sitting idle. The last time the refining system had more than 1 million bpd of spare capacity was in the early 1990s, when refiners responded by mothballing facilities and closing plants, cutting capacity by more than 500,000 bpd between 1992 and 1994 (https://customers.reuters.com/d/graphics/US_RFRTB1208.gif).

Even with refinery shutdowns, the long-term outlook is bleak. The Energy Information Administration (EIA) projects gasoline consumption will increase from around 142 billion gallons in 2006 to 151 billion gallons in 2030 (based on an increasing population and rising car use, partly offset by improved fuel efficiency).

But the fossil-fuel content of that gasoline is scheduled to drop from 136 billion gallons to just 125 billion gallons as the ethanol content rises from 5.5 billion gallons to 25.8 billion gallons to comply with Renewable Fuel Standard (RFS) targets.

GASOLINE-DIESEL MIX

As if falling demand and the increasing challenge for ethanol were not enough, U.S. refiners face a deeper structural problem.

Most of the world relies on diesel rather than gasoline for transportation fuel and heating demand. According to the International Energy Agency (IEA) the world consumed just 0.75 gallons of gasoline for every gallon of diesel in 2005, and the refinery system was configured to produce the two fuels in roughly the same proportion (https://customers.reuters.com/d/graphics/FL_CNSP1208.gif).

The U.S. petroleum economy is highly unusual in that it is tilted towards consumption and production of gasoline. The United States consumes almost two gallons of gasoline (1.97) for every gallon of diesel; the European Union consumes only 0.40 gallons and China consumes 0.48 gallons.

Until recently, that led to a mutually beneficial trade, with the United States exporting surplus diesel, while Europe and China exported surplus gasoline (https://customers.reuters.com/d/graphics/REFINEPRDS1208.htm).

But U.S. refiners now face the problem that in the fastest-growing parts of the petroleum economy (China, Asia, the Middle East and Africa) the marginal demand is for diesel, while their marginal supply is gasoline, for which demand is stagnating.

The global economy now faces a structural surplus of gasoline and a structural shortfall of diesel. By implication, the world has too much capacity for producing gasoline (much of it concentrated in the United States) and not enough capacity for producing diesel (especially in Asia).

As a result, U.S. refiners face increased competition in their domestic market from imported gasoline, while they struggle to produce enough diesel to sell abroad. This mismatch explains why U.S. diesel exports have risen much faster in the past year than gasoline, even though it is the domestic gasoline market which is most oversupplied.

The United States now has too many refineries for its increasingly ethanol-based economy, and they produce the wrong product mix for a dieselised global economy.

U.S. refiners have begun to reduce gasoline production (https://customers.reuters.com/d/graphics/EIA_REFGS1208.gif) and prioritise distillates (https://customers.reuters.com/d/graphics/EIA_REF1208.gif). But yield changes have been marginal (1-2 percentage points), reflecting the technical limitations of the existing refinery units.

In the short to medium term (12-24 months), it seems virtually certain U.S. refiners will have to cut total capacity sharply, perhaps as much as 0.5-1.0 million bpd, 4-8 average refineries. In the longer term, they have no choice but to undertake substantial capital expenditures to shift the system towards more diesel.

U.S. military operations crossed another threshold in Pakistan this week when a Predator ‘drone’ aircraft fired missiles into Bannu area in North West Frontier Province (NWFP), away from the seven Federally Administered Tribal Areas where it has conducted raids with impunity.

Attacking the self-governing and semi-autonomous FATA on the Afghan border, considered a haven for al Qaeda and Taliban,  is one thing. Targeting the North West Frontier Province, or settled areas as Pakistanis call it, is quite another.

This is a  province governed by the national assembly - unlike the tribal areas which are not subject to the national assembly - and therefore  represents an expansion of U.S. operating area into Pakistan proper.

Pakistanis are worrying that if the United States can attack deep inside the North West Frontier Province, then what stops them from raining down missiles on Pakistani cities in pursuit of al Qaeda, according to a report in The Hindu. They are wondering just how far will the United States go in its battle against the militants.

At the moment, though, the raid in Bannu in which the five people including an al Qaeda operative were killed, is a signal that there are no limits to targets in Pakistan for the United States.

At this rate and if they are not stopped,  the U.S. military may end up attacking Peshawar, the capital of the North West Frontier Province, the Daily Times said, quoting unnamed government and military officials.

Pakistanis had led themselves to believe that the Predators would remain confined to the unsettled tribal areas and the leave the rest of the country alone, wrote columnist Ayaz Amir in The News. "Our American friends have surprised us once again...,” he wrote.

Amir argued that President Asif Ali Zardari was doing exactly what his predecessor Pervez Musharraf promised to the Americans but didn't deliver. While Musharraf put the army -the only thing he had - at the disposal of the Americans, Zardari, on the other hand, had placed the country, its democratic institutions at the service of the United States.

It was a far cry from the hopes that voters came with at the polling stations in the February election that gave Zardari's party the highest number of seats in parliament.  "The people of Pakistan, chumps as ever, thought they were knocking at the gates of a new redemption. Little could they have realised that they were merely tinkering with the old and giving it a new facelift."

"The people of Pakistan haven't been betrayed. That would be to put too apocalyptic a meaning on current events. They have merely been used to lend the semblance of popular backing to an unpopular cause. Pakistan's democracy is now hitched to America's war chariot which is not quite what the people of Pakistan were expecting when they marched to the polling booths on Feb 18," Amir wrote.

Zardari told CBS earlier this month that the United States should at least inform Pakistan  that it was launching missile strikes. Many people in the gathering gloom of Pakistan took this statement as acquiescence to missile strikes

Where does Pakistan go from here? U.S. cross-border strikes have increased sharply in the past few months and indeed as Rahimullah Yusufzai, the respected resident editor of The News said, the more Pakistan protests, the more are the raids. The Pakistani government really must come clean on the war and reveal the terms of engagement with the United States, he said.
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