Bush’s China policy may outlast his presidency

By Philip Stephens

The Bushes are heading for Beijing. By the busload. Visiting the Chinese capital last week, I was told that President Hu Jintao hopes to greet three generations of America’s first family at the opening ceremony for the Olympics. That must be some kind of record – and a nightmare for the secret service.

They are fond of George W. Bush in China. There are not many capitals around the world where foreign policy practitioners say hand on heart that they will miss the US president. Beijing is an important exception. Sino-American relations, I heard several times during my trip, have been consistently steadier than at any time since the door to dialogue was opened by the ping-pong diplomacy of the early 1970s.

The Chinese, of course, still have plenty of differences with the US, and vice versa. But Mr Bush is credited with delivering the thing that matters most in Beijing: an essentially stable process of engagement.

It might have been otherwise. Before the 2000 election Mr Bush decried the so-called strategic partnership with Beijing promoted by the Clinton administration. Instead, he would treat China as a “competitor”. A collision between a Chinese interceptor and a US reconnaissance aircraft over the island of Hainan in the early months of the Bush presidency looked likely to confirm him on that course. But the attacks of September 11 2001 changed all the calculations. The US had enemies enough. In east Asia, at least, Mr Bush’s foreign policy would embrace the hard-headed realism of his father, George H.W. Bush.

Not everyone, of course, thinks being pals with the Chinese regime is something to be worn as a badge of honour. Powerful voices on the right of US politics want a tougher stance against China’s military spending. Some realist scholars see a clash as inevitable as China challenges US primacy. On the left, Beijing’s repression in Tibet and its support for pariah regimes in places such as Sudan and Burma prompt charges of appeasement.

So supporters of John McCain, the Republican candidate for the presidency, say he would be more robust in defending US security interests in the region; those of Barack Obama, the Democratic contender, that he would give sharper focus to human rights.

From a strategic perspective, though, and amid the wreckage of Mr Bush’s foreign policy elsewhere, the sustained stability has been reassuring. Sino-American ties are likely to be the most important, and potentially combustible, component of international relations for the next several decades.

At its crudest, the question is whether China’s re-emergence after two centuries in the geopolitical twilight can be managed without a conflict with today’s sole superpower. History is not comforting. The cautionary precedent frequently cited is that of Germany’s rise at the end of the 19th century.

On a slightly subtler level, the condition of the relationship between Beijing and Washington will be pivotal to the nature of the global order. Competition would herald a revival of great power rivalries, a return to a world of balancing, hedging and competing alliances. Co-operation could pave the way for an overhaul of the existing multilateral system to accommodate China and other rising powers.

The geopolitical case for engagement is reinforced by the economics. The US is China’s market place; China is America’s largest creditor. There is no clearer expression of the interdependence that comes with globalisation.

The big doubts are about China’s intentions: does it want to be a responsible stakeholder in the system, or is it playing for time until it can confront the US on its own terms? We do not know the answer, and the US, quite sensibly, is combining a policy of engagement with one of hedging.

My sense is that Chinese policymakers have not made up their minds. The western instinct is to assume that Beijing has worked out precisely how the world will look in 10, 15 even 50 years hence. If that is the case, it is a plan well hidden.

During my visit I sat in on a seminar co-sponsored by the US National Intelligence Council, the Graduate Institute of International Studies in Geneva, and the China Institute of Contemporary International Relations. The purpose was to peer into the future ahead of the publication early next year of the NIC’s Global Trends in 2025. CICIR, diplomats told me, is the think-tank most closely associated with the Chinese intelligence community. So the simple fact of the seminar, with a high-ranking presence from both sides, spoke to the easy nature of the bilateral relationship.

The hosts certainly seemed fully conscious of China’s new-found power – and unapologetic about its expanding reach in the quest to feed a voracious appetite for resources.

But China’s international presence takes a distant second place to domestic concerns. The mantra of the policymaking elite is the need to safeguard economic growth, social stability and national unity. The neuroses about Taiwan and Tibet merge into a broader anxiety about the cohesion of this vast, multi-ethnic state. Foreign policy matters mostly to the extent that it has an impact – positive or negative – on a fragile domestic order.

With the US, stability now rests on a panoply of institutional dialogues – economic and political – in which differences can be addressed. The system seems to work. Sharp disagreements over China’s exchange rate policy have been managed, although not resolved, within the economic dialogue. The six-party talks with North Korea about Pyongyang’s nuclear weapons on Thursday claimed another, albeit modest, advance towards disarmament. Chinese foreign policy experts see the forum as a possible model for a more permanent east Asian security system.

Nothing is perfect. China is secretive about its military and dismissive of any intrusion into its domestic affairs. It professes support for the international system, but shows great reluctance to accept any constraint on national sovereignty. Taiwan is a permanent source of tension; relations with Japan, much better now than two years ago, always hold the potential for conflict.

But as Mr Bush enjoys the Olympics, he can reflect that here at least is a foreign policy that may outlive his presidency. The case for applying more pressure on China to uphold human rights at home and international law abroad is unanswerable. The best context, though, is engagement.

American candidates ignore Asia at their peril

By Victor Mallet

Barack Obama and John McCain, the US presidential candidates, should understand better than most why Asia is important to any incumbent of the White House. Unlike former president George H. W. Bush, neither has been an envoy to Beijing, but each has at least spent time on Asian soil, Mr Obama as a schoolboy in Indonesia and Mr McCain as a prisoner of war in Vietnam.

Those experiences will stand them in good stead. As home to more than half the world’s people and a large share of its conflicts, Asia has a way of mugging unwary US presidents.

Asia’s historical impact on the US has been more calamitous and bloody by far than anything Middle Eastern; think of the conflict with Japan during the second world war, the Korean war and Vietnam. Even today, the US is fighting one of its two big wars in Afghanistan in central Asia.

George W. Bush is only the latest president to start by underestimating Asia’s importance and taking a confrontational stance towards China. Like Bill Clinton, he later changed his tune and courted Beijing.

There is a danger that this pattern of early hostility and belated bridge-building will be repeated. It is no help that the Beijing Olympics, along with possible human rights protests and ugly displays of nationalism, are to be staged in August, shortly before the Democratic and Republican national conventions.

Whatever happens at the Olympics, neither Mr Obama nor Mr McCain can escape the significance of Asia’s rise for US voters. The Asia-Pacific region exerts more economic and strategic influence each time the US goes to the polls.

In the age of globalisation, it is of no use for US politicians to focus on the “domestic economy” as though it can be isolated from foreign influences. The mocking campaign statement by Hillary Clinton, Mr Obama’s Democratic former rival, that “we borrow money from the Chinese to buy oil from the Saudis” was a truism. The Chinese, after all, have money and the Saudis have oil.

In the midst of the credit crunch, the importance of Asia’s robust economic growth is particularly visible in the finance sector. Mergers, acquisitions and share offerings by companies in China, India and Australia have boosted the incomes of investment banks struggling in the US and Europe. Asian sovereign wealth funds have injected capital into western financial institutions.

Asia’s economic importance, however, goes deeper than that. With his eye on the US electoral calendar, Joseph Quinlan,chief market strategist for Bank of America, this month begged US politicians to recognise how interdependent the US economy is with the rest of the world and urged them not to turn to trade protectionism. “America’s dependence on such critical inputs as foreign labour, resources, capital and markets has never been greater,” he wrote.

As for security, there is no doubt that China in particular is rapidly increasing the power of its armed forces. Lieutenant-General Ma Xiaotian, deputy chief of the general staff of the People’s Liberation Army, was evidently dreaming of a balance of superpowers when he told the annual Asian security meeting of the International Institute for Strategic Studies: “Peace is a product of parity, an equivalence of power and a balance of offensive and defensive strength.” For all his diplomatic fumbling, the second President Bush was right to call China a “strategic competitor”.

Even those who doubt China’s ability to match US military strength before decades have passed understand the risks of conflict and need for co-operation. Both Condoleeza Rice and Robert Gates, US secretaries of state and defence respectively, have gone on the record in recent days to defend close US engagement with China and the rest of Asia. “Asia has become the centre of gravity in a rapidly globalising world,” Mr Gates told the IISS meeting.

So far neither of the two main candidates has said much about Asia policy in a campaign dominated by the economy and Iraq. US business leaders, fearing the populist anti-China rhetoric that marked the early phase of the Democratic contest, hope it stays that way. But it has not escaped them that Mr Obama is the worst offender. He has accused China of currency manipulation and opposes a trade deal with South Korea.

The free-trader Mr McCain, by contrast, noted in an opinion piece with Senator Joseph Lieberman for The Wall Street Journal that the tripling of US trade with Asia in 15 years had created American jobs as well as Asian wealth. The US, they wrote, had common interests with China that could be the basis of a “strong partnership” on climate change, trade and nuclear proliferation.

US presidential hopefuls should openly celebrate the US relationship with Asia, not hide behind a screen of spurious economic nationalism for the sake of a few blue-collar votes. Since the 1970s, Asia and the US have contributed immeasurably to each other’s well-being. Only a foolish president would put that at risk.

Global markets reel after first-half carnage

By Michael Mackenzie in New York, Javier Blas in London and Andrew Wood in Hong Kong

Global equities were on Friday heading for their worst first-half performance in 26 years after a week in which oil surged to a record and there were renewed worries about the health of the financial system and ­global growth.

A high of $142.99 a barrel for oil sparked a tumble in Asian markets and selling in Europe and New York. The Dow Jones Industrial Average on Friday closed just shy of 20 per cent below its record high set in October and is on cusp of entering an official bear market.

Fears of inflation and slower growth caused by higher energy costs are weighing on equities. Yet as stocks suffer, the surge in oil and other commodities during 2008 has the Reuters-Jefferies CRB spot index on track for its largest gain in 35 years. The index has risen 30.1 per cent since January, the largest increase since the 30.2 per cent gain in the first half of 1973.

Evidence of renewed financial stress as banks prepare to close out the second quarter and report earnings next month is also fanning fears.

On Friday the MSCI world equity index had fallen 11.7 per cent since the start of the year, its worst first-half run since a decline of 13.8 per cent during the first six months of 1982.

The S&P 500 closed below 1,300 this week and on Friday tested its mid-March closing low when the collapse of Bear Stearns briefly threatened to spark a systemic financial crisis. The index fell 3 per cent this week.

In Europe, the FTSE Eurofirst was 21 per cent lower for the year, its worst first-half performance since the index was configured in 1986.

The FTSE 100 has fallen 14.4 per cent in 2008, its worst start since a decline of 14.6 per cent in 1994. The S&P 500 has lost 12.5 per cent, its poorest first half since it fell 13.8 per cent in 2002.

Worries about the health of the US economy, a vital market for many of Asia’s export-led economies hammered regional equity markets on Friday.

In Japan, the Nikkei 225 Average fell more than 2 per cent to a two-month low. Shanghai shares plunged 5.2 per cent and the market is in danger of losing all of the gains made during last year’s eight-month rally of 141 per cent.

Fed Board Nominee Duke Gets Confirmed by U.S. Senate (Update3)

June 27 (Bloomberg) -- Elizabeth Duke, a Virginia banker, was confirmed today by the Senate to a seat on the Federal Reserve Board of Governors, breaking a yearlong impasse between the Bush administration and Congress.

The Senate confirmed Duke for a term ending in 2012 as the chamber adjourned for its July 4 recess. Senate Democrats and the White House were in talks over the past day about having at least one nominee join the Fed board. Today's decision leaves one Fed board vacancy and sets the stage for the next president to pick as many as three new governors.

Duke, 55, will become the only governor with commercial- banking experience, providing expertise as the Fed completes rules to curb lax mortgage-lending practices in the aftermath of the housing bust. As a board member, she will be a permanent voter on interest rates at the Fed, at a time when officials are expressing increasing concern about inflation. The Senate didn't vote on two other nominees.

``You are looking at the board that will be in place through the end of the year,'' said Brian Sack, senior economist at Macroeconomic Advisers LLC in Washington and a former Fed research manager. ``This situation still gives the incoming president considerable power to shape the board next year.''

Duke will also become, once sworn in, the first woman on the board since another former bank executive, Susan Bies, departed in March 2007. President George W. Bush in May 2007 nominated Duke, chief operating officer of Portsmouth, Virginia-based TowneBank, and Larry Klane, former president of global financial services at Capital One Financial Corp., for the Fed posts.

Awaiting Confirmation

The administration also nominated Randall Kroszner, a Fed governor whose term expired on Jan. 31, for a new 14-year term. He has continued to serve while awaiting confirmation, as allowed under Fed rules. Kroszner, on leave from the University of Chicago business faculty, heads the Fed board's banking supervision committee.

Today's approval of Duke ``will probably be it'' for additions to the board this year, Sack said. Fed Governor Frederic Mishkin resigned last month, effective Aug. 31.

That means the next U.S. president, to be elected in November, would be able to choose as many as three new candidates to the central bank that steers the world's largest economy.

In confirming Duke, ``we are ensuring the Fed can function during these difficult economic times,'' Senate Majority Leader Harry Reid, a Nevada Democrat, said in a statement.

Keep Pressing

The Bush administration will keep pressing the Senate to confirm Klane and Kroszner, White House spokeswoman Emily Lawrimore said.

Bringing Duke on will prevent a majority of the Fed's interest-rate setting Open Market Committee from shifting to the heads of the central bank's regional branches. That may have affected the panel's votes, as the district-bank presidents tend to dissent from rate decisions more often than governors.

The FOMC voted 9-1 this week to leave the benchmark interest rate at 2 percent, pausing after seven straight reductions. In its post-meeting statement, officials said inflation risks had increased. At the same time, they stopped short of committing to raising interest rates.

``Putting another Fed governor back in at the FOMC meetings could undercut the move in the committee to a full inflation- risks tilt,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. ``Fed governors normally vote more in line with the consensus being forged by the chairman.''

Debates Legislation

Duke will also be involved in the Fed decision on whether to extend the emergency authority to lend to investment banks past September, a move made as part of the central bank's March rescue of Bear Stearns Cos. She'll be in a position to help craft the Fed's position on regulating such firms as Congress debates legislation next year.

Democrats, the majority party in both houses of Congress, are aiming to win the White House in November, gaining power to change leadership at the central bank and federal agencies. Bush's term ends Jan. 20.

Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat who has faulted the Fed for lax oversight of mortgage-lending practices during the housing boom, had refrained from scheduling a vote for the nominees. Today's action bypassed Dodd's panel.

Association Leader

Duke, who has been a banker for more than 30 years, was the first woman to chair the American Bankers Association, the industry's Washington trade group, since its founding in 1875. She served as chairman from 2004 to 2005 and was on its board of directors from 1999 to 2006.

Duke served on the Richmond Fed bank's board from 1998 to 2000. ``She made great contributions then, and I know she'll make tremendous contributions to the system now,'' said Jeffrey Lacker, the bank's president, who was research director at the time.

Duke returned to community banking after the small Virginia lender she headed from 1991 to 2001 eventually became part of Wachovia Corp., now the fourth-biggest U.S. bank by assets.

She formerly served as executive vice president of Wachovia. TowneBank, her current employer, had $2.6 billion in assets as of March. Duke holds a master of business administration degree from Old Dominion University in Norfolk, Virginia, and majored in drama at the University of North Carolina at Chapel Hill. She acted in a Norfolk dinner theater before starting in banking.

Duke would be eligible for reappointment to a full 14-year term after her partial term expires. Governors earn $172,200 this year, while Chairman Ben S. Bernanke has a salary of $191,300.

Duke held at least $8.2 million in assets, including more than $5 million of stock in Wachovia, according to a financial- disclosure filing last year. Fed officials are required to divest themselves of bank shares.

U.S. Stocks Slump, Pushing Dow Average to Brink of Bear Market

June 27 (Bloomberg) -- U.S. stocks fell a second day, pushing the Dow Jones Industrial Average to the brink of a bear market, on concern subprime-related writedowns at banks will worsen and record oil and a slowing economy will prolong the worst profit decline since 2002.

The Dow extended its retreat from an all-time high in October to almost 20 percent, the threshold for a so-called bear market. American International Group Inc. and Merrill Lynch & Co. sent the Standard & Poor's 500 Financials Index to a five-year low on speculation of mounting losses. Hasbro Inc. and KB Home helped lead consumer stocks in the S&P 500 to the lowest level since 2003 as oil topped $142 a barrel.

The Dow average lost 106.91 points, or 0.9 percent, to 11,346.51, leaving it within 0.1 percent of a bear market. The 30-stock measure fell 10 percent this month for the worst June since 1930. The S&P 500 slid 4.77, or 0.4 percent, to 1,278.38 today. The Nasdaq Composite Index slipped 5.74, or 0.3 percent, to 2,315.63. Eight stocks declined for every five that rose on the New York Stock Exchange.

``The news on earnings is that the second quarter is probably going to be worse than we thought,'' said Ron Sweet, vice president of equity investments at USAA Investment Management Co., which oversees $100 billion in San Antonio. ``The old news keeps sticking around: it's energy prices, it's writeoffs at banks, it's the slow economy.''

The S&P 500 slumped 3 percent this week, the Dow slid 4.2 percent and the Nasdaq tumbled 3.8 percent. The S&P 500's 8.7 percent decline in June is the worst monthly performance since the 11 percent plunge in September 2002.

Earnings Slump

Analysts forecast earnings for companies in the S&P 500 will slump 11 percent on average, according to a Bloomberg survey today, compared with a projected decline of 8.9 percent a week ago. Goldman Sachs Group Inc. strategist David Kostin said in a report today that expectations for 2008 and 2009 profits are ``too optimistic'' and are likely to be reduced.

AIG decreased 34 cents to an 11-year low of $27.75. The world's biggest insurer plans to absorb losses for a dozen insurance units after their securities-lending accounts suffered $13 billion of writedowns tied to the subprime-mortgage collapse.

Merrill fell 35 cents to $32.70, the lowest price since March 2003. Lehman Brothers Holdings Inc. analyst Roger Freeman increased his second-quarter loss estimate on expectations subprime-related writedowns will be more than twice as big as previously projected.

`Tenuous Situation'

MBIA Inc. lost 22 cents to a 20-year low of $4.17. The world's largest bond insurer faces a ``tenuous situation'' as it seeks to cover payments and collateral calls on $7.4 billion of securities triggered by a credit-rating downgrade, Fitch Ratings analyst Thomas Abruzzo said.

MBIA may need to tap assets pledged to back other commitments as it comes up with the money, potentially opening the company up for further downgrades, said Abruzzo, who yesterday withdrew his rating on MBIA and Ambac Financial Group Inc. after the companies refused to give him information.

Ambac slid 19 cents to $1.61, a record low.

The S&P 500 Consumer Discretionary Index lost 0.7 percent, falling to the lowest since October 2003, after crude oil gained as much as 2.4 percent to $142.99 a barrel. Hasbro, the world's second-largest toymaker, lost $1.60 to $35.14.

KB Home, the homebuilder founded by Eli Broad, slumped 41 cents to $17.72. The company reported its fifth straight quarterly loss as rising mortgage rates and falling prices reduced demand for homes.

Worst Ahead?

Homebuilders in S&P indexes lost 1 percent as a group. Lennar Corp. fell 72 cents to $12.62, the lowest price since September 2000. The second-largest builder said yesterday that the housing market has yet to see the worst of the slump.

Micron Technology Inc. retreated the most since October 2006, falling 89 cents, or 13 percent, to $6.10. The largest U.S. producer of memory chips reported a wider third-quarter loss on weaker pricing for semiconductors used to store pictures and music in portable devices.

``June has been difficult,'' Matthieu Bordeaux-Groult, who helps oversee about $6.2 billion as fund manager at Richelieu Finance in Paris, said in a Bloomberg Television interview. ``There are a lot of negative elements in the market such as high raw materials prices, but valuations are low and offer buying opportunities.''

The S&P 500 gained as much as 0.5 percent earlier after U.S. consumer spending rose 0.8 percent in May, exceeding forecasts. Tax rebates drove the biggest gain in incomes in almost three years, enabling households to at least temporarily overcome soaring fuel bills.

Bristol-Myers Squibb Co. climbed the most since May 1, rising 63 cents, or 3.2 percent, to $20.30. The drugmaker selling a unit for $4.1 billion to finance acquisitions may itself be a takeover target, Sanford C. Bernstein & Co. analyst Timothy Anderson said.

Should the World Bank Still Lend to China?

Should the World Bank Still Lend to China?

Setting aside the issue of the efficacy of World Bank lending, shouldn't the priority of Bank lending go to countries that have fared nowhere near as well as China in recent years? Unfortunately, there are far too many countries which have been economically stagnant and whose performance pales in comparison to the emerging giant. Late last year, I featured a Wall Street Journal story on how World Bank lending in fiscal year 2007 was topped by India, followed by China in third place. From a social justice standpoint, aren't there other countries where poverty alleviation is a more pressing matter and should therefore get more lending priority?

Current World Bank President Robert Zoellick offered a good reply to that question. Zoellick invoked the potential benefits of these countries participating more in global governance matters. That is, as a prominent international organization, the World Bank can use its clout to engage China with projects such as green ones whose benefits may accrue not only China but the entire world:

There are some 70% of the poor in middle-income countries. If we are going to deal with the poverty agenda, we need to be engaged with these countries.

[Also] if you look at what's happening in the fields of diplomacy and political and security affairs, one of the big challenges is how we integrate the Indias, the Chinas and the Brazils [of the world] in the multilateral system? It strikes me as illogical that you would be trying to engage them in creating a new multilateral order, and not do it in the multilateral economic system.

The third point [is], let's think of the other big issues of the day, like climate change. Well, China and India and Brazil and others have huge energy needs, so if we are going to be able to contribute to the big economic environmental challenges of the day, we've got to be partners with these countries. I can put skin into the financial game to help make this happen.

While visiting the China Daily website, I came across the following article that reiterates Zoellick's basic points. (BTW, lending to China by the World Bank is marginally down to $1.51B in FY 2008 as compared to $1.64B in 2007). Insofar as projects have environmental and social benefits, there is perceived value in the World Bank funding such projects in China:

The World Bank's lending to China reached $1.51 billion in the 2008 fiscal year dating from June 30, 2007 to June 30, 2008, said the WB Beijing office on Wednesday. The WB's Board of Executive Directors approved four new projects in China on Tuesday, the last four for the fiscal year of 2008, said the WB Beijing office.

These four projects were excellent examples of how the WB could help China with its environmental and social challenges, said David Dollar, World Bank Country Director for China. The new rural health project, getting [a] WB loan of $50 million, sought to support and extend the rural health reforms carried out by the Chinese government by testing a series of new innovations in financing, delivery of services and basic public health.

The WB would lend $50 million to the new rural migrant skills development and employment project. The project would support China to deal with the human skills challenge rising from its huge rural migration during urbanization. The WB would work with local governments of northwestern Ningxia Hui Autonomous Region, East China's Shandong and Anhui provinces, and the Ministry of Human Resources and Social Security to improve skills development programs for migrants.

Through the new Xi'an sustainable urban transport project, with a WB loan of $150 million, bus prioritization, bicycle routes, traffic calming and speed-reducing strategies would be introduced in an effort to foster better road use and access to cultural sites in the northwestern city renowned for Terracotta Army and other cultural relics.

The WB would also lend $300 million to help construct a new 355-km dedicated high-speed passenger rail line between Shijiazhuang, capital of north China's Hebei Province and Zhengzhou, capital of central Henan Province. The rail line is part of the new 2,100-km dedicated high-speed passenger rail line linking Beijing with Guangzhou, capital of South China's Guangdong Province. Upon completion in 2010, the rail line is expected to provide a major boost in rail transport capacity while reducing the travel time for passengers from present 24 hours to less than 10 hours.

China continues to be one of the largest borrowers with the World Bank during the fiscal year 2008. Most WB projects approved this year aim to address environmental challenges through improvement of public transport systems, expansion of urban wastewater treatment and pollution control, and strengthened approaches to energy efficiency, said the WB Beijing office.

In the aftermath of the May 12 earthquake in southwest China, the WB offered China a 1.5-million-dollar grant to support technical assistance for recovery and reconstruction efforts as well as expertise assistance.

Credit Rating Agencies: The New Jesters of Capital

Credit Rating Agencies: The New Jesters of Capital

I've already voiced my doubts over Tim Sinclair's book The New Masters of Capital in which he depicts credit ratings agencies such as Standard and Poor's, Moody's, and Fitch's as globetrotting institutions which enforce an Americanized neoliberal order on a hapless world. For you IPE junkies, these agencies purportedly conduct sovereignty at bay. I'll tell you what: if the calendar showed 1998 instead of 2008, I would be inclined to agree with him. However, in a global political economy in which LDCs have boatloads of reserves to guard against the recurrence of another Asian Crisis, their opinions on sovereign debt are greatly diminished in value and efficacy. Moreover, in the wake of the subprime mess, their reputations have been brutalized to the point of no return. Incensed investors and regulators have them by the balls. Masters of Capital? It's more like the Jesters of Capital. The original case for the overwhelming might of credit rating agencies always seemed overblown. From the book, for instance:

The agencies’ output influences the global distribution of money, jobs, and economic opportunity. Hence, they are highly consequential actors in the global economy (p. 63).

The position taken here is that, in the first instance, rating is a US phenomenon. But rating becomes transnational in character as the agencies acquire both allies and opponent in new territories. The transnational view affirms the agencies’ US origins, norms, and practices. Even if rating is increasingly transitional the mental framework of rating remains largely American (p. 120).

It seems that the US government in the form of the Securities and Exchange Commission (SEC) is now busy undermining the already sodden of these credit rating agencies. Whereas the massive market for institutional investment relied much on the agencies' ratings in the past, the SEC appears keen on returning to a more caveat emptor-like approach that predominated before the ascendance of these agencies. That is, due diligence is to once again become more the province of the purchaser than the (potentially biased agencies as) assessor. If these credit rating agencies were so powerful to begin with, then why is it that mere regulators can set into motion changes which will likely result in these agencies becoming even punier than they are now? From the Wall Street Journal:

The Securities and Exchange Commission plans to propose rules that may diminish the longstanding importance of credit ratings across various markets, including the $3.4 trillion money-market industry, in the latest blow to the rating business stemming from the credit crunch.

The most significant portion of the rules, to be proposed Wednesday, would make it possible for U.S. money-market funds to invest in short-term debt without regard to ratings put on those securities by firms such as Moody's Investors Service and Standard & Poor's, people familiar with the matter said. Currently, SEC rules generally require that money-market funds purchase only short-term debt with high investment-grade ratings. The new rule would put more discretion in the hands of money managers to determine whether the debt is investment grade.

The SEC also will propose rules that may diminish the importance of credit ratings in determining the amount of capital that investment banks are required to hold. In all, the proposal will put about a dozen changes on the table that could touch on the role of credit ratings for investors and banks. An SEC spokesman couldn't be reached for comment.

The renewed effort is part of a wide-ranging regulatory push in the U.S. and Europe amid the credit crunch that has devastated many banks and investors. Major rating services -- Moody's Corp.'s Moody's Investors Service, McGraw-Hill Cos.' Standard & Poor's and Fimalac SA's Fitch Ratings -- have been blamed by some for underestimating the risk of default on hundreds of billions of dollars of mortgage debt.

The dirty secret of some bond investors is that they simply bought securities with the highest yield for a given rating, which is why they snapped up complicated securities tied to subprime mortgages. Those securities often got high ratings but yielded more than other, more standard securities with the same rating.

In 2003, the SEC asked the industry and investors for comment on similar changes to money-market funds and capital rules, but the ideas never went anywhere and were shelved amid mixed reviews.

As the current credit crisis has unfolded, regulators have grown concerned that the reliance on ratings in various market rules gives investors a sense of false comfort, discouraging them from doing their own research when assessing the riskiness of bonds in their portfolios. By diminishing the role of ratings, they hope to reverse that. S&P, Moody's and Fitch declined to comment on the pending proposal. The proposals are expected to generate divided comments from investors and also may affect a range of other SEC provisions.

"My initial reaction is, what's the alternative?" to using rating firms for the rules, said Hal Scott, a Harvard University law professor specializing in capital-markets regulation. "What we need to do is have more assurance that these ratings will be accurate."

SEC Chairman Christopher Cox said at a recent hearing on rating firms that their role in the regulatory apparatus "may have played a role in encouraging investors' over-reliance on ratings."

Despite the backlash against rating firms, their assessments of bonds still play a central role in decisions made by banks and investors. Last week offered the latest example, when Moody's downgraded the debt of bond insurers MBIA Inc. and Ambac Financial Group, triggering a selloff in the companies' stocks and fears of forced sales of bonds insured by the two companies.

Regulators also depend on them. The Federal Reserve, after it arranged a sale of Bear Stearns Cos. to J.P. Morgan Chase & Co., said the Federal Reserve Bank of New York would take as collateral some illiquid, beaten-down assets from investment banks, but only if the assets were rated highly by rating firms. Other international codes such as Basel II also use ratings to determine how global banks manage their balance sheets.

Investors have had similar rules on their books for decades that require they only buy bonds the major rating firms grade at a certain level or above. Some may now expand the list of rating firms they can use for such rules to include new firms. In an effort to create more competition in the rating industry, on Monday the SEC recognized a 10th bond-rating firm, Realpoint LLC, a former unit of GMAC.

Institutional investors such as pension funds are looking to make changes in their ratings-based rules. The Illinois State Board of Investment, for example, recently requested more information from its money managers about their approach to buying bonds such as mortgage-backed securities. William Atwood, executive director of the $12 billion fund, said he would be reluctant to give new money to those managers who rely heavily on the ratings firms.

"We've got to pay closer attention," said Richard Metcalf, director of corporate affairs at the Laborers' International Union of North America, which advises pension funds. "If that means creating additional levels of scrutiny of the process, we will do that."

If regulatory changes succeed, ratings would become more of a guide, but not a quasi-regulation from the government on what investors can or cannot hold. Rating firms haven't protested this line of thinking, saying that they don't want their ratings to be misinterpreted as a catch-all recommendation to buy a security.

While many investors and large institutions say they don't rely on ratings, recent lawsuits from holders of battered mortgage-related debt show that at least some used them extensively. In a lawsuit filed this month against Deutsche Bank AG, Buffalo, N.Y.-based M&T Bank Corp. said it had written down the value of two collateralized debt obligations by more than 90%.

"The AAA and AA ratings were major considerations in M&T's determination to invest," the bank argued in its suit, "because they indicated that the notes were safe, stable, and nearly risk-free investments." M&T didn't sue the rating firms, saying they were misled. Deutsche Bank declined to comment.

Capital inflows to China

Hot and bothered

Despite strict capital controls, China is being flooded by the biggest wave of speculative capital ever to hit an emerging economy

A POPULAR game this summer among watchers of the Chinese economy is to guess the size of speculative capital or “hot money” flowing into the country. One clue is that although China’s trade surplus has started to shrink this year, its foreign-exchange reserves are growing at an ever faster pace. The bulk of its net foreign-currency receipts now comes from capital inflows, not the current-account surplus.

According to leaked official figures, China’s foreign-exchange reserves jumped by $115 billion during April and May, to $1.8 trillion. In the five months to May, reported reserves swelled by $269 billion, 20% more than in the same period of last year. But even this understates the true rate at which the People’s Bank of China (PBOC) has been piling up foreign exchange.

Logan Wright, a Beijing-based analyst at Stone & McCarthy, an economic-research firm, has done some statistical detective work to make sense of the figures. The first problem is that reported reserves exclude the transfer of foreign exchange from the PBOC to the China Investment Corporation, the country’s sovereign-wealth fund. The reserve figures have also been reduced in book-keeping terms this year by the PBOC “asking” banks to use dollars to pay for the extra reserves that they are now required to hold at the central bank. Adding these two items to reported reserves, Mr Wright reckons that total foreign-exchange assets rose by an astonishing $393 billion in the first five months of 2008 (see chart), more than double the increase in the same period last year.

China’s trade surplus and foreign direct investment (FDI) explain only 30% of this. Deducting investment income and the increase in the value of non-dollar reserves as the dollar has fallen still leaves an unexplained residual of $214 billion, equivalent to over $500 billion at an annual rate. Some economists use this as a proxy for hot-money inflows. But some of it may reflect non-speculative transactions, such as foreign borrowing by Chinese firms. Mr Wright therefore estimates that China received up to $170 billion in hot money in the first five months of 2008. This far exceeds anything previously experienced by any emerging economy.

Michael Pettis, an economist at Peking University’s Guanghua School of Management, reckons that speculative inflows during that period were perhaps well over $200 billion, because hot money also comes into China through companies overstating FDI and over-invoicing exports. Foreign firms are bringing in more capital than they need for investment: the net inflow of FDI is 60% higher than a year ago, yet the actual use of this money for fixed investment has fallen by 6%. Some of it has been diverted elsewhere.

It is one thing to deduce how much money is coming in. It is another to work out where it is going and how it gets past China’s strict capital controls. The stockmarket, which continues to plunge (see article), is no home for hot money. Some has gone into property. The lion’s share is in bog-standard bank deposits. An interest rate of just over 4% on yuan deposits compared with 2% on dollars, combined with an expected appreciation in the yuan, offers a seemingly risk-free profit for those who can get money into China.

It comes in via various circuitous routes. Big Western investment funds which care about liquidity would find it hard to move money into China, although rumours abound of hedge funds that are investing money through Chinese partners. Trade and investment offers a big loophole for Chinese and foreign firms. Resident individuals can use the $50,000 annual limit for bringing money into China from abroad—many also use their friends’ and relatives’ quotas. Another big loophole lets Hong Kong residents transfer 80,000 yuan ($11,600) a day into mainland bank deposits.

The government is trying to crack down, but that risks shifting the activity towards underground money exchangers. And if the government were to increase its monitoring of FDI and trade flows, the extra bureaucracy could harm the real economy. China needs to reduce the incentive for destabilising capital inflows, rather than block the channels.

Massive hot-money inflows present two dangers to China’s economy. One is that capital could suddenly flow out, as it did from other East Asian countries during the financial crisis a decade ago and Vietnam this year. China’s economy is protected by its current-account surplus and vast reserves, but its banking system would be hurt by an abrupt withdrawal.

A more immediate concern is that capital inflows will fuel inflation. The more foreign capital that flows in, the more dollars the central bank must buy to hold down the yuan, which, in effect, means printing money. It then mops up this excess liquidity by issuing bills (as “sterilisation”) or by lifting banks’ reserve requirements. But all this complicates monetary policy. China’s interest rates are below the inflation rate, but the PBOC fears that higher rates would attract yet more hot money and so end up adding to inflationary pressures. The central bank has instead tried to curb inflation by allowing the yuan to rise at a faster pace against the dollar—by an annual rate of 18% in the first quarter of this year. But this encouraged investors to bet on future appreciation, exacerbating capital inflows. Since April the pace of appreciation has been much reduced, in a vain effort to discourage speculators.

Mass sterilisation

Some economists argue that the problems caused by hot money have been exaggerated. After all, the PBOC has so far succeeded in sterilising most of the increase in reserves. Inflation, at an annual rate of 7.7% in May, has also started to decline, and the impact of last week’s rise in fuel prices is likely to be offset over the next couple of months by falling food-price inflation.

The snag is that money-supply growth would explode without sterilisation, which is now close to its limit. It is becoming very costly for the central bank to mop up liquidity by selling bills, so it is now relying more heavily on raising banks’ reserve requirements (the PBOC pays banks only 1.9% on their reserves, against over 4% on bills). Since January 2007 the minimum reserve ratio has been raised 16 times, from 9% to 17.5%. But it cannot climb much higher without hurting banks’ profits. To curb future inflation, China therefore needs to stem the flood of capital.

One solution would be a large one-off appreciation of the yuan so that investors no longer see it as a one-way bet. This, in turn, would give the PBOC room to raise interest rates. The snag is that the yuan would probably have to be wrenched perhaps 20% higher to alter investors’ expectations, and this is unacceptable to Chinese leaders, especially when global demand has slowed and some exporters are already being squeezed.

This implies that monetary policy will remain too loose. The longer that the torrent of hot money continues and interest rates remain too low, the bigger the risk that underlying inflation will creep up.

Microsoft

The meaning of Bill Gates

As his reign at Microsoft comes to an end, so does the era he dominated

WHEN Bill Gates helped to found Microsoft 33 years ago there was a company rule that no employees should work for a boss who wrote worse computer code than they did. Just five years later, with Microsoft choking on its own growth, Mr Gates hired a business manager, Steve Ballmer, who had cut his teeth at Procter & Gamble, which sells soap. The founder had chucked his coding rule out of the window.

In becoming the world’s richest man, Mr Gates’s unswerving self-belief has repeatedly been punctuated by that sort of pragmatism. But those qualities have never been on such public display as they were this week, when the outstanding businessman of his age stepped back from a life’s work.

As Microsoft’s non-executive chairman, Mr Gates will devote most of his efforts to his charitable foundation, where he will pit himself against malaria and poverty, rather than Google and the Department of Justice. To choose such formidable new foes in the middle of your life takes bags of self-belief, but it is also pragmatic—and a little poignant. Mr Gates has revelled in the day-to-day details of running his firm. To let it all go is to acknowledge that his best work at Microsoft is behind him. It is to accept that the innovator’s curse is to be transitory.

MS DOS and don’ts

As with many great innovations, Mr Gates’s vision has come to seem so obvious that it is hard to imagine the world any other way. Yet, early on, he grasped two things that were far from obvious at the time, and he grasped them more clearly and pursued them more fiercely than his rivals did at Commodore, MITS or even Apple.

The first was that computing could be a high-volume, low-margin business. Until Microsoft came along, the big money was in maintaining a select family of very grand mainframes. Mr Gates realised that falling hardware costs, combined with the negligible expense of making extra copies of standard software, would turn the computer business on its head. Personal computers could be “on every desk and in every home”. Profit would come from selling a lot of them cheaply, not servicing a few at a great price. And the company that won a large market share at the start would prevail later on.

Mr Gates also realised that making hardware and writing software could be stronger as separate businesses. Even as firms like Apple clung on to both the computer operating system and the hardware—just as mainframe companies had—Microsoft and Intel, which designed the PC’s microprocessors, blew computing’s business model apart. Hardware and software companies innovated in an ecosystem that the Wintel duopoly tightly controlled and—in spite of the bugs and crashes—used to reap vast economies of scale and profits. When mighty IBM unwittingly granted Microsoft the right to sell its PC operating system to other hardware firms, it did not see that it was creating legions of rivals for itself. Mr Gates did.

The technology industry likes to sneer at Microsoft as a follower. And it is true that the company has time and again bought in or imitated the technology of others. That very first PC operating system was based on someone else’s code. But Mr Gates’s invention was as a businessman. His genius was to understand what he needed and work out how to obtain it, however long it took. In an industry in which visionaries are often sniffy about anyone else’s ideas, the readiness to go elsewhere proved a devastating advantage.

And look at what happened when Mr Gates’s pragmatism failed him. Within Microsoft, they feared Bill for his relentless intellect, his grasp of detail and his brutal intolerance of anyone whom he thought “dumb”. But the legal system doesn’t do fear, and in a filmed deposition, when Microsoft was had up for being anti-competitive, the hectoring, irascible Mr Gates, rocking slightly in his chair, came across as spoilt and arrogant. It was a rare public airing of the sense of brainy entitlement that emboldened Mr Gates to get the world to yield to his will. On those rare occasions when Microsoft’s fortunes depended upon Mr Gates yielding to the world instead, the pragmatic circuit-breaker would kick in. In the antitrust case it did not, and, as this newspaper argued at the time (see article), he was lucky that it did not lead to the break-up of his company.

Inevitability and temperament are two hallmarks of Gates the innovator. The third is the transience of all pioneers. The argument was brilliantly laid out by Clayton Christensen, of Harvard Business School. The perfecting of a technology by a well managed company catering to its best customers leaves it vulnerable to “disruption” by a cheaper, scrappier alternative that is good enough for everyone else. That could be a description of Microsoft’s Office, which now does more than almost anybody could wish for—even as Google and others are offering free basic word-processors and spreadsheets online.

Mr Gates was haunted by Mr Christensen’s insight—he even asked for his help to keep back the tide. Microsoft successfully extended Windows as an operating system for servers; it has moved into new areas, such as mobile devices and video games; and it has lavished billions of dollars on all sorts of research—without much to show for it. Despite all those efforts, the PC, Mr Gates’s obsession, has ended up as an internet terminal. The company still has everything to prove online (see article). Watching Microsoft in the company of Google and Facebook is a bit like watching your dad trying to be cool.

Business is good for you

Mr Gates had the good fortune to be perfectly suited for his time—but he is less well-equipped for the collaborative and fragmented era of internet computing. This does not diminish his achievement. Nor, as some would have it, does his philanthropy necessarily magnify it. Whatever the corporate-social-responsibility gurus say, business is a force for good in itself: its most useful contribution to society is making profits and products. Philanthropy no more canonises the good businessman than it exculpates the bad. In spite of his flaws, Mr Gates is one of the good kind. Some great industrialists, like Henry Ford, stick around even as the world moves on and their powers fail. Mr Gates, pragmatic to the end, is leaving at the top.

Harvard, Buffett Have Bad News for Asia Bulls: William Pesek

Commentary by William Pesek

June 27 (Bloomberg) -- ``The worst is over.'' One hears some variation of this view constantly when traveling around Asia.

It's a comforting one, predicated on the idea that the U.S. economy will avoid the recession that markets have priced in for some time. It's also a view that could be in for some serious revision as the year unfolds, and not in a good way.

The latest sign comes from a Harvard University report. Growing foreclosures and tighter lending standards are creating an environment that ``is shaping up to be the worst in a generation,'' Harvard's Joint Center for Housing Studies said on June 23.

``The slump in housing markets has not yet run its full course,'' said Nicolas Retsinas, director of the center.

The U.S. market seems likely to remain mired in a recession. And as Retsinas pointed out, housing markets historically recover only after an economy contracts and prices fall enough to improve affordability.

That's a bigger problem for Asia than many investors may want to admit.

There's much relief that Asia is holding its ground as the U.S. economy slows and credit-market woes humble Wall Street's biggest names. While asset markets are heading lower from Tokyo to Jakarta and Shanghai to Mumbai, healthy economic growth has confounded the pessimists -- so far.

Knock-On Effects

The knock-on effects are coming, just more stealthily than many expect. Asia is unlikely to get off easy even if the U.S. skirts a recession. The region hasn't decoupled from America as much as some would say.

The worst-case scenario -- a prolonged U.S. decline -- could be devastating, particularly at a time when record oil and food prices are hurting Asian households. Billionaire investor Warren Buffett laid it out in a June 25 Bloomberg interview. He's unsure when the U.S. will recover.

``It's not going to be tomorrow, it's not going to be next month, and it may not even be next year,'' said the chairman of Omaha, Nebraska-based Berkshire Hathaway Inc.

The idea that Asia will continue to display an impressive immunity to U.S. events ignores how dependent China is on the American economy. It also ignores how reliant Asia is on China's 10 percent growth. Slowing U.S. demand will chip away at that country's export-driven expansion exponentially.

China's Limits

China is one of several Asian economies with negative real interest rates. With its annual inflation above the central bank's benchmark lending rate, China would be hard-pressed to stimulate growth with lower borrowing costs or increased government spending.

Monetary quandaries abound in Asia. Bank of Japan officials, for example, are making it clear interest-rate deliberations have become increasingly challenging over the last two months.

``At the time of the June meeting, both downside and upside risks had risen compared with when we met in May,'' BOJ policy board member Seiji Nakamura said yesterday in Asahikawa, Japan.

The credit crisis that began with U.S. subprime loans is just one force crimping U.S. spending. A new Bloomberg/Los Angeles Times survey shows most Americans are feeling the pain from rising gasoline prices and many are tightening their belts. Seven in 10 of those surveyed said higher gas prices have caused them ``financial hardship.''

Export Woes

That may mean less spending on cars, flat-screen televisions, cellular phones, name-brand clothing items and other goods manufactured in Asia. With U.S. consumers accounting for 70 percent of gross domestic product, any pullback would have an outsized impact on global economies. Housing is arguably the key to all of this.

The U.S. will expand 1.4 percent in 2008, the weakest performance since 2001, according to a Bloomberg survey. U.S. growth may be cut by a half to a full percentage point if consumers spend less and save more, according to Deutsche Bank AG economists. For Asia, that is decidedly bad news.

So is Harvard's housing report and Buffett's concern that the U.S. is heading for stagflation. Rising home prices and easy access to credit have been the major drivers of U.S. growth in recent years. If U.S. housing remains weak, Asia's export- dependent economies are particularly vulnerable.

Here, recent comments by Federal Reserve officials are both good and bad for Asia.

The Fed this week left its benchmark rate at 2 percent, saying ``uncertainty about the inflation outlook remains high.'' Further rate cuts seem unlikely, something that could disappoint some investors. The specter of continued rate moves supported optimism about Asia's export markets.

Yet easy Fed policies also cause problems in Asia. Much of the liquidity that U.S. officials create ends up in Asian markets, increasing so-called hot-money flows. That has made it harder for Asian central banks to control money supply and inflation. Taking a longer-term view, an end to Fed rate cuts isn't a bad thing.

The catch is that with Asia's most important customer in trouble, the region's growth outlook is dimming. Here, the U.S. housing market is more of a linchpin than many in Asia think.

Obama, McCain Likely to Step Up Government Role in U.S. Economy

June 27 (Bloomberg) -- An era of active government may be approaching -- no matter who wins the presidency.

In a variety of areas -- from oil-futures trading and investment banking to climate change and home mortgages -- Republican John McCain and Democrat Barack Obama both see a bigger government role in the economy. So, too, do many Democrats in Congress, whose numbers are likely to grow after November's elections. Put it all together and a shift away from President George W. Bush's anti-regulation ideology is in store.

``We're going to see more regulation and more government intervention in the economy,'' said William Niskanen, chairman of the Cato Institute, a libertarian research group in Washington that supports limited government.

Behind the shift: Americans' growing disenchantment with where the country is headed. Almost 8 out of 10 people questioned in the latest Bloomberg/Los Angeles Times poll said the country is on the wrong track.

``There's a certain amount of disillusionment with free trade and globalization, and the deregulation movement,'' said Martin Baily, senior fellow at the Brookings Institution in Washington and a former chief White House economist under President Bill Clinton. ``It's a genuine shift in sentiment toward a more active role for government.''

That worries Michael Tanner, a Cato senior fellow. ``Regulation is not cost-free,'' Tanner said. ``It's a form of an indirect tax.''

More Regulation

To be sure, government's reach would probably expand more with Obama in the White House than it would under McCain. The Illinois senator has proposed greater regulation of everything from credit cards, where he has talked of a cardholder bill of rights, to the Internet, where he backs rules to bar broadband providers from giving favorable treatment to some Web content and services.

``If Obama is elected, there will be strong pressures from the Congress and executive to regulate more,'' said Robert Hahn, executive director of the American Enterprise Institute's Center for Regulatory and Market Studies in Washington.

Yet even a President McCain would be more inclined to government intervention than Bush, Hahn said.

``He's clearly more populist than Bush,'' J.D. Foster, senior fellow at the Heritage Foundation in Washington, said of the Arizona senator. ``And often times, that means calling for more regulation.''

Similar Rhetoric

McCain and Obama have responded to voters' concerns with rhetoric that, at times, sounds similar. Both have blamed speculators for driving up oil prices and have promised new regulations of futures trading.

Both candidates have proposed a bigger government role in stemming home foreclosures in the continuing housing bust. McCain, 71, wants the Federal Housing Administration to help subprime borrowers refinance into lower-cost, government-backed mortgages. Obama, 46, would go further, creating a $10 billion government fund to prevent foreclosures.

Obama and McCain say they favor increased regulation of Wall Street in the wake of turmoil that forced the Federal Reserve in March to help arrange JPMorgan Chase & Co.'s proposed takeover of Bear Stearns Cos.

``We saw not enough capital backing loans that were made, not enough capital for people who were involved in investments,'' Douglas Holtz-Eakin, McCain's top economic policy adviser, told Bloomberg Television on June 6. ``We need to establish a regulation system that has those kinds of incentives.''

Watching Wall Street

Americans favor more aggressive regulation of Wall Street by a margin of about 3-2, according to the Bloomberg/Los Angeles Times poll. The survey interviewed 1,233 adults from June 19-23.

On the environment, both McCain and Obama back mandatory limits on greenhouse-gas emissions and proposed a cap-and-trade system to help bring that about.

Eric Toder, of the Urban Institute, said no matter how the cap-and-trade system is set up, it will mean more government bureaucracy. ``One way of the other, it's going to be adding complexity,'' he said. ``There's going to be a lot of special pleading by companies looking for exceptions.''

Obama, with potential backing from a Democratic-led Congress, has proposed programs that would extend the reach of government, including a major revamp of the health-care system and a $10 billion plan to promote early-childhood education.

``For eight long years, our president sacrificed investments in health care, and education, and energy, and infrastructure on the altar of tax breaks for big corporations and wealthy CEOs,'' Obama said in a June 9 speech in Raleigh, North Carolina.

Reversing Reagan

Niskanen, of the Cato Institute, said Obama effectively wants to extend U.S. regulation abroad by insisting that trade agreements contain added protections for workers and the environment. ``It would be exporting regulation,'' he said.

Tom Gallagher, managing director in Washington for ISI Group, a money management and research firm, likens this year's election to a mirror image of the 1980 race. Republican Ronald Reagan's victory that year cemented a swing toward deregulation that began under Democrat Jimmy Carter, who, among other steps, removed most government regulation of airlines.

This year's election may mark a turning point in the opposite direction, building on such regulatory actions as the Sarbanes- Oxley law that increased oversight of corporate governance, according to Gallagher.

``'08 may be the opposite of '80,'' he said.

Natural Gas 75% Gain Speeds Horizontal Drilling at Devon, Range

June 27 (Bloomberg) -- U.S. natural-gas producers are drilling wells previously deemed too costly and resurrecting abandoned fields from Appalachia to the Rockies, spurred by the biggest rally in fuel prices in eight years.

Devon Energy Corp. and Range Resources Corp. are drilling horizontal wells that cost three times as much as traditional vertical shafts to unlock gas from rock formations that were unprofitable to exploit before this year's 75 percent gain by gas futures. The number of active U.S. gas rigs rose to a nine- month high last week, according to a survey by Baker Hughes Inc.

``As prices are better you want to drill more wells to get more production on line as quick as possible,'' said Larry Pinkston, chief executive officer at Unit Corp., a Tulsa, Oklahoma-based gas producer and drilling-rig operator. ``So we definitely are drilling more wells.''

The rise in gas futures in New York this year exceeded the 45 percent surge in oil and all commodities besides coal. U.S. gas demand probably will grow 4 percent this year, double the rate of new supply, said Roger Read, an analyst at Natixis Bleichroeder Inc. in Houston.

Gas gained the most since prices more than doubled in the first half of 2000. This month, futures rose above $13 per million British thermal units for the first time since 2005, when Hurricanes Katrina and Rita idled wells in the Gulf of Mexico. Read attributed the gain to ``unrelenting growth in electric power demand,'' lower-than-expected imports and increasing demand for alternatives to coal and oil.

Producer Shares Rise

An index of independent energy producers in the Standard & Poor's 500 climbed 29 percent this year, led by gains of more than 60 percent at Southwestern Energy Co. and Chesapeake Energy Corp. All 10 index members get most of their output from gas. Unit Corp., which isn't in the index, jumped 75 percent. The S&P index of integrated producers such as Exxon Mobil Corp., driven more by oil wells and refining, has fallen 1.7 percent.

New drilling projects will boost U.S. gas supplies in 2009 by 3.6 percent, the biggest increase since 1994, Read said. Gas is the most widely used U.S. furnace fuel and the third-largest source of power generation, according to the Energy Department.

The U.S. Bureau of Land Management, which oversees energy exploration on federal property, issued 7,124 permits to drill in the fiscal year ended Oct. 1, 5.7 percent more than fiscal 2006. Nine out of 10 of those permits were issued for projects in Wyoming, New Mexico, Utah and Colorado.

Drilling Accelerates

Range Resources, based in Fort Worth, Texas, increased its capital budget 40 percent this year to $1.27 billion to sink more wells in the Barnett Shale in Texas and the Marcellus Shale in Pennsylvania and West Virginia.

Range Resources, which gets most of its production from the Barnett Shale, expects to begin pumping commercial volumes of gas from the Marcellus in early 2009.

Drilling horizontal wells in deep, hard deposits such as the Barnett Shale costs about $3 million each, compared with $1 million to $1.5 million for a vertical well, Range Resources President Jeffrey Ventura said in a telephone interview.

Horizontal drilling is costlier because it requires more sophisticated rigs with more powerful motors, said Michael McMahon, managing director of New York-based leveraged buyout firm Pine Brook Road Partners LLC, which bankrolled three new gas producers in the past 15 months.

Horizontal Wells

Horizontal drilling is the only way to tap formations that otherwise won't give up their gas, Ventura said.

``There some areas of the Barnett Shale that didn't work at all as vertical developments but are very commercial as horizontals,'' Ventura said. ``Rock formations that people thought were non-prospective are now prospective.''

Unit Corp.'s Pinkston plans to drill at least 280 wells this year, up 11 percent from 2007. The program will let the company replace at least 150 percent of the gas and oil it pumps for the next several years, he said.

The company, which also owns 131 onshore rigs and a pipeline business, built two new rigs this year and plans to add another two in the fourth quarter, Pinkston said. Unit will decide in the next few weeks whether to order more rigs for 2009 delivery, he said.

Competition for drilling equipment and rig crews is escalating costs for producers, said Pine Brook's McMahon.

Pine Brook, founded in 2006 by former Warburg Pincus Vice Chairman Howard Newman, is stockpiling about 20 miles of pipe, enough to excavate six wells, in response to delivery delays from pipe makers because of soaring demand, McMahon said.

Most U.S. Stocks Decline as Oil Surges; AT&T, KB Home Retreat

June 27 (Bloomberg) -- Most U.S. stocks fell, extending the Dow Jones Industrial Average's worst monthly drop in almost six years, as record oil prices dragged down consumer shares and mobile-phone companies declined on concern demand is waning.

AT&T Inc. and Verizon Communications Inc. dropped after London-based Sony Ericsson Mobile Communications Ltd. said demand for more expensive phones is weakening. KB Home tumbled after the real-estate developer reported its fifth straight quarterly loss. American International Group Inc., the world's largest insurer, slid on plans to absorb as much as $5 billion of losses for a dozen units hit by writedowns.

More than four stocks declined for every three that rose on the New York Stock Exchange. The Standard & Poor's 500 Index added 0.68 points to 1,283.83 at 12:26 p.m. in New York. The index dropped 2.9 percent yesterday, the steepest decline since June 6. The Dow lost 41.69, or 0.4 percent, to 11,411.73, down 9.7 percent this month in its worst June since 1930. The Nasdaq Composite Index slipped 6.39 to 2,314.98.

``This week the news on earnings is that the second quarter is probably going to be worse than we thought,'' said Ron Sweet, vice president of equity investments at USAA Investment Management Co., which oversees $100 billion in San Antonio. ``The old news keeps sticking around: it's energy prices, it's writeoffs at banks, it's the slow economy.''

The S&P 500 has fallen 2.5 percent this week, while the Dow has slid 3.6 percent and the Nasdaq tumbled 3.7 percent. The four consecutive weeks of declines for the S&P 500 is the index's longest losing streak since January. The S&P 500's 8.3 percent decline so far in June is the worst monthly performance since the 11 percent plunge in September 2002.

Earnings Slump

Analysts forecast earnings for companies in the S&P 500 will slump 11 percent on average, according to a Bloomberg survey today, compared with a projected decline of 8.9 percent a week ago. Goldman Sachs Group Inc. strategist David Kostin said in a report today that expectations for 2008 and 2009 profits are ``too optimistic'' and are likely to be reduced.

AT&T decreased 34 cents, or 1 percent, to $33.13. Verizon lost 12 cents to $34.19.

Palm Inc. dropped 61 cents to $5.93. The maker of the Treo e-mail phone reported a wider fourth-quarter loss than analysts estimated.

AIG Slides

American International Group Inc. decreased 37 cents to $27.73. The world's largest insurer plans to absorb as much as $5 billion of losses for a dozen insurance units after their securities-lending accounts suffered $13 billion of writedowns tied to the subprime-mortgage collapse during the past year.

Micron Technology Inc., the largest U.S. producer of memory chips, tumbled 63 cents to $6.36 after posting a wider third- quarter loss as prices plunged for semiconductors used to store pictures and music in portable devices.

U.S. stocks tumbled yesterday as oil's $5-a-barrel surge, forecasts of more credit-market writedowns and a slowing economy threatened to extend a yearlong profit slump.

``The month of June has been difficult,'' Matthieu Bordeaux- Groult, who helps oversee about $6.2 billion as fund manager at Richelieu Finance in Paris, said in a Bloomberg Television interview. ``There are a lot of negative elements in the market such as high raw materials prices, but valuations are low and offer buying opportunities.''

The S&P 500, which has fallen 13 percent this year, is valued at 21.3 times earnings, near the lowest in two months.