The ratings agencies may have been slow to react to economic data that showed many currencies slipping into a debt-deflationary spiral, but Moody’s really had no choice but to downgrade Portugal four notches to junk status. Buying time was never going to fix the sovereign debt crisis, especially given Merkel’s determination to scare off the pension funds. However, by insisting on “burden sharing” for private holders of Greek debt, EU leaders have made a wider restructuring of debt in peripheral countries like Portugal inevitable.

Financial contagion, which spread to Italy last week, now threatens to spiral out of control. But instead of acknowledging their mistakes, the euro-zone’s panicked leaders are conforming to type and falling back on populist anti-capitalist rhetoric – perhaps to deflect blame from themselves for the eventual demise of the euro.

Past form suggests they are not be bluffing when they talk of banning the ratings agencies outright, or “breaking their oligopoly” to prevent them “fanning the flames of speculation.” After the banking crisis was blamed on “locust” hedge funds – rather than excessive debt – it didn’t take long for the EU to produce legislation to rein them in.

So when Michel Barnier, the EU commissioner for financial regulation, warns credit ratings agencies to be “extremely careful to fully respect” EU regulations, the markets should take him deadly seriously. His pan-EU oversight body already has binding powers to breathe down the ratings agencies’ necks. The EU’s landmark regulation on credit rating agencies came into force as recently as December 2010 (EC/1060/2009), and hands the bloc’s new markets regulator, the European Securities & Markets Authority, supervisory powers.

Manuel Barroso, the European Commission president, says the EU is planning stricter oversight of Moody’s, Standard and Poor’s, and Fitch. Brussels will examine issues of “civil liability” for inappropriate assessments by the agencies on the credit worthiness of sovereign European countries, and draft restrictive legislation by the end of the year.

“It seems strange that there is not a single rating agency in Europe. It shows that there may be some bias in the markets when it comes to the evaluation of the specific issues of Europe,” says Barosso. MEPs agree. In a non-legislative report by German MEP Wolf Klinz, they have recommended the setting up of an EU-wide ratings agency, funded temporarily from the public purse, in a bid to avoid the conflicts of interest they say are endemic where banks pay for their own ratings.

Anyone who is economically literate knows that imposing official EU credit ratings on the bond market would plunge them into chaos, because scared investors would dump European debt. But then Europe’s leaders, who know how to play to the far left – because so many have roots in it – have never really understood how markets work. They may actually believe that muzzling free speech will fool the bond markets.

Meanwhile, the European Parliament is also attempting to rid the EU of the speculators betting on Greece going bankrupt, by voting for a ban on the practice of naked short-selling of credit default swaps. This would, of course, cause the trading in sovereign bonds to dry up, leaving governments short of cash. But in the present economic and political climate it would be unwise to bet against the EU cutting off its nose to spite its face.

Related: Choices For Greece, All Daunting [New York Times]

The Department of Justice has ramped up its pursuit of companies and individuals under the act and has extracted big penalties. It’s now one of the highest law enforcement priorities in the US and nearly $2 billion was forfeited by US firms in 2009 and 2010.

Its recent probe of Avon cosmetics has demonstrated its reliance on companies to self examine and then volunteer the results. Companies have an incentive to settle, if they are not to lose everything. In 2010 the Department of Justice required one privately-held company that violated the FCPA, to end operations and be dissolved.

The prospect of News International’s acquisition of British Sky Broadcasting being approved has added several dollars to News Corp’s share price. Since the phone hacking scandal broke, its shares have only fallen back to $17, from $18. News Corp’s shareholders would be well advised to dump their stock next week, as there appears to be a lot more potential downside than investors realize. As Philip Stephens points out in the Financial Times, the British prime minister, David Cameron must now find a way to block Murdoch from securing full ownership of BSkyB. Otherwise, “the prime minister might just as well sign his own letter of resignation.”

However, the BSkyB deal might be the least of News Corporation’s worries. Renault‘s announcement that it is suspending advertising in all of News International’s newspapers, suggests that the damage to its brands extends much further than The News of the World.

Related: James Murdoch Could Face Criminal Charges on Both Sides of the Atlantic [The Guardian], James Murdoch Could Face Corporate Legal Charges [The Telegraph]

“News Corporation should be investigated by the US department of justice over allegations of bribery, illegal wiretapping, interference in a murder investigation, political blackmail, and rampant disregard for both the truth and basic decency”. Elliot Spitzer

Global temperatures are far below levels that IPCC climate models predicted we’d have even if we “stabilised” CO2 emissions at levels for the year 2000 (orange curve), confirming how worthless climate models are

The actual temperatures (bright blue curve for HadCRUT) show temperatures falling back to 2000 level, while  the darker blue, green and red curves show how much temperatures should have risen, if climate models had any validity.

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Last week France, which has made tackling food price volatility a priority, led efforts at the G20 meeting of agricultural ministers to crack down on speculation in commodities markets – which it blames for rising food prices. Though France did not target biofuels in its G20 agenda, a report it commissioned from the World Bank, the WTO, and other international agencies did.

It calls for a policy rethink; recommending that measures that “subsidize or mandate biofuels production or consumption” are cut in countries like Europe, Canada, India, the United States, and Brazil. Like the United Nations Food and Agriculture Organisation, these organisations are worried that rising cereals prices will cause ever greater levels of political instability.

By raising food prices, biofuel production will make maters worse. The real harm is caused by subsidies to first-generation biofuel production. By lowering biofuel production costs, subsidies increase the link between crop prices and the price of oil.

When oil prices are high, as they are now, food crops have even more value as energy – which is why we’re seeing a rising proportion of crops being diverted to biofuels production, such as corn in the US. Next year, 38% of the corn grown will be turned into ethanol, according to the Department of Agriculture.

Brazil’s land is also increasingly being used to grow sugar cane for ethanol. With the government vowing to stimulate even more ethanol investment, Brazil’s potential as an agricultural superpower is being diminished. But what will make headlines is the inevitable destruction of protected rainforests. It’s this consequence that may finally wake public opinion to the folly of renewable fuel targets and subsidies.

Encouraging deforestation is only one reason though, why renewable fuels have a bigger carbon footprint than fossil fuels. Environmentalists support for ethanol is evaporating because years of study have shown that corn-based ethanol, over its full life cycle, does little to reduce carbon emissions and may actually increase them.

In this context the air transport industry’s plan to increase the use of aviation biofuels – to 2 million tons annually by 2020 – seems rather crass. So too is Boeing’s commitment to biofuels. At the Paris air-show it was showing off its new 747, powered by a blend of 15% biofuel mixed with 85% traditional jet fuel. But it will soon get approval to use a 50-50 fuel blend for commercial flights.

Unless there’s an international agreement to end biofuels subsidies we could see military aircraft being used to deal with the geopolitical consequences of the market distortions that produced the 50-50 blend of ethanol powering them. As always, it’s the poorest who pay for dumb economics.

Related: How Shifting Political Winds Could Finally Kill Ethanol Subsidies [Business Insider], Airlines Cleared for Biofuels [Bloomberg Businessweek]

China had already announced its intention to deploy countermeasures against European aviation, if the EU goes ahead and makes all airlines flying into Europe pay to ‘pollute’ from Jan 2012. But only weeks after the head of Airbus and the International Air Transport Associate warned Brussels it faces a trade war with China and other powerful nations, China’s move shows that it really does mean business.

But it’s not only China that the EU is squaring up against, it is also the US. US airlines have mounted a legal challenge, which will be heard by the European Court of Justice on 5 July – though a judgment is not expected for some months. If they fail, the US is likely to mount retaliatory measures with European airlines and Airbus as targets.

Washington has warned the EU that it expects US airlines to be exempted from the EU’s emissions trading scheme. But it now fears that if the EU accepts that China’s announcement of an aviation emissions plan is an “equivalent measure” then US airlines could be penalized.

The EU’s climate commissioner, Connie Hedegaard talks tough, and is warning that caving into the Chinese or the US would set a worrying precedent. However, with 4.5 million jobs at risk, the EU can’t afford a loose cannon like Hedegaard. The question, therefore, is whether French, British, and German governments will take action to reign her in – before rising aviation costs cause serious damage to the global economy.

Pleas by worried European airlines  - who are struggling with a wafer thin 0.7% profit margin – have so far fallen on deaf ears. But perhaps Europe will start listening when China blocks the other deals Airbus has made with Chinese carriers; or if retaliatory sanctions push an industry – whose net profits are already expected to nosedive to $4 billion from $18 billion in 2010 – over the edge.

With the Indian government and others declaring that the forced inclusion of global airlines in the EU’s scheme is illegal, it looks like it will never fly, unless Europe wants to see another industry take wing.

Business groups across the developed world are becoming increasingly vocal, as industries protest the soaring costs that are being imposed on them and forcing plant closures. TATA recently announced the loss of 1500 jobs in the steel industry in the UK, with the explanation that this was in part because EU carbon legislation threatens to impose huge additional costs, and the “uncertainty about the level of further unilateral carbon cost rises that the UK government is planning.” These are the hard economics of the real world, where new unilateral carbon taxes to be introduced in the UK – tougher even than in the EU – will force industries to simply relocate abroad taking their CO2 emissions with them.

Heavy manufacturing has, of course, to compete internationally with countries which don’t have carbon trading systems. So the result of green policies is simply to move the CO2 emissions abroad to places like China. Already the world’s biggest CO2 emitter and largest energy user, China increases the world’s CO2 emissions by more than the total that Britain emits annually.

Britain’s determination to lead on climate will make our industry so uncompetitive that, it will lead to mass plant closures unless policy is changed, says the CBI. The European Metals Association warns that the EU’s “anti-carbon” policies are becoming so costly that they are already forcing steel, aluminium and other producers in their energy-intensive industry to relocate outside Europe, losing hundreds of thousands more jobs. And in the US, new rules – that are already leading to the closure of coal fired power stations – will cost electric utilities $184 billion by 2030 and kill 1.4 million jobs, according to a study the economic consulting firm National Economic Research Associates conducted for the coal industry.

Similar fears are voiced by  Jürgen Grossmann, head of energy giant RWE, in an interview with Süddeutsche Zeitung. He accuses Chancellor Merkel of creating an “eco-dictatorship” and promoting de-industrialization, warning that her  phase out plan will result in large companies like BASF and Thyssen-Krupp abandoning Germany .

In a display of either breathtaking dishonesty or economic illiteracy, Merkel’s government in Germany has been claiming though, that switching off nuclear power from 2022 will lead to falling electricity prices over the long term (besides actually worsening Germany’s CO2 emissions).  But Rainer Brüderle the leader of her coalition partner, the FDP, has said that it’s time to be honest with the electorate and tell them that renewable energy will be significantly more expensive than nuclear power – and that’s not including the cost of building a new grid and gas fired power stations to provide power when renewables can’t.

In the US, where green energy has become politically toxic, the Republicans are now trying to end federal funding for renewable energy research, describing it as an “anti-energy boondoggle” that fails to live up to its supposed potential. But in the UK there are few signs that the government realizes that its environmental policies are at odds with its primary objective, cutting the national debt and reviving manufacturing.

Following the mad rush by “hot money and speculators” to take advantage of the government’s solar subsidies and build large-scale photovoltaic “farms” all over the countryside, the British government slashed them by 70% last week, as they threatened to soak up a £360m pot of subsidies intended for households. However, the Department of Energy & Climate Change may yet support large solar farms by including them in the Renewable Obligation project – another environmental subsidy scheme which will use a different mechanism to encourage energy companies to buy more solar-generated electricity.

Ultimately, rising household energy bills – to be doubled in the UK by the £100 billion to be invested in a further 10,000 useless, windmills, plus £40 billion to connect them to the National Grid – will become increasingly indefensible for politicians, at a time when incomes are already being squeezed by the loss of jobs to countries which are not being burdened by daft environmental policies. Merkel supposedly has a nose for populism, but it’s Brüderle who can see that the political winds are veering. As household energy bills drive millions more people into “fuel poverty” – already a big issue in the UK – there is bound to be a backlash. All the more so now that one of the main arguments for switching to renwable energy – the depletion of fossil fuels – is no longer plausible following advances that mean there is at least six times as much recoverable natural gas today as there was a decade ago.

Related: Everything You’ve Heard About Fossil Fuels is Wrong [Salon.com], UK Faces Job Losses As Businesses Threaten To Move Abroad To Flee Abroad To Escape Green Energy Levies [The Sunday Telegraph]

The overall lack of transparency in Chinese companies and the Chinese economy is now a major liability. China is “the new dot-com” of the investment world, says Martin Wheatley, Hong Kong’s former securities regulator.

The sell-off has turned into a rout following a belated warning from the US Securities and Exchange Commission urging investors to review company filings for foreign companies that have listed in America through reverse mergers. Today, there are more than 500 such Chinese companies in the United States, collectively worth billions of dollars.

Institutional investors with reputations on the line simply cannot afford to stay in China stocks, hoping that they won’t become the victims of fraud. Even Sina.com, a Chinese internet stock which was supposed to be one of the most credible Chinese companies has been hit, as shareholders like Wells Fargo, UBS, T Row Price, and dozens of hedge funds review their stakes.

Understandably, questions are now being asked about the real level of bad and doubtful loans in Chinese banking, and the undisclosed ownership of some of China’s largest companies.

As China’s property bubble threatens to burst, economists like Nouriel Roubini are predicting that China will soon face a massive non-performing loan problem in the banking system and a massive amount of overcapacity that is going to lead to a hard landing. Guaging these risks is made all the harder when investors don’t know the actual pace of credit growth, because of the scale of off-balance sheet lending.

Already, the gains from labour arbitrage are starting to shrink, and China could have lost its cost advantage over US factories producing for the domestic market by 2015, argues the Boston Consulting Group. China is being forced to let its currency, the renminbi, effectively appreciate at a real rate of about 14% a year in the face of inflationary pressures, estimates Fred Bergsten’s Peterson Institute think-tank .

The recent demographic shift in China from rural labour surplus to rural labour deficit seems to be playing a part. China is now reaching the so-called Lewis turning point, where industrial wages rise very quickly once the supply of excess rural labour is exhausted, according to China’s Center for Economic Research at Peking University. Slower growth, higher inflation, increased consumption, and a deteriorating external balance, are possible consequences.

Such is the upward pressure on wages – as demonstrated by Apple supplier Foxconn’s doubling of wages following a spate of worker suicides – that China is introducing collective wage negotiations in all enterprises over the next 3 years in a bid to reduce labour disputes. It is also thinking about replacing labour with capital as a labour arbitrage, as China starts to move up the industrial ladder and produces higher value-added goods.

But cheap labour is, after all, a major reason foreign manufacturers produce in China. Some manufacturers are already switching to cheaper countries like India and Vietnam. Minimum wages in Shanghai are $141 a month, compared with $77 in Mumbai and $74 in Hanoi, according to Morgan Stanley. However, China’s loss of international competitiveness is benefitting countries even further afield – ones whose industries have previously been undermined by China.

Anecdotal evidence suggests Chinese semiconductor suppliers have been faced with a shortage of workers, because construction jobs pay way more. Some higher quality Taiwanese electronic products are now apparently almost the same price as Chinese ones. While Chinese wages were only about 30% of Mexican wages ten years ago, they are now nearly the same – making Mexican steel makers competitive again.

Perhaps we will enter an entirely new era where we will see a reversal of the trend in which manufacturing jobs have moved offshore from the US to China. Some predict that industry will consequently set the pace for the American stock market in the next decade, as technology did in the 1990s. Others point out though, that onshoring is a myth perpetuated by multinationals fearing a consumer backlash from offshoring jobs.

But as the Japanese Tsunami demonstrated, long complex supply chains are very risky. Moreover, they force companies to hold too much costly inventory. Rising transport costs are also eating into margins..

A sign of the times, is the decision by a manufacturer of wooden ice creams sticks, Global Sticks, to move from Dalian, China to Thunder Bay, Ontario. Canada has lots of cheap wood. But rising oil prices were the critical factor. As oil prices soar, “the distance between your factory in Dalian and North American kids lining up at their neighborhood ice cream store becomes more expensive every day,” writes Jeff Rubin in the Globe & Mail. And then there are the factory restrictions that China has mandated to deal with power shortages, and the problem of wage growth in China.

If even a basic product like this is cheaper to make closer to home, it helps to explain why companies like Caterpillar and Sauder, an American furniture-maker, are shifting production back home. Labour is a small fraction of total costs in capital intensive manufacturing, which is why Swedish and German engineering companies continue to prosper; and why NCR is now producing cash machines in Georgia again, while Frisbees and Hula Hoops are once again made in America.

Of course, China was always over-hyped. Wall Street investment banks played a big role in moving American jobs overseas, financing the wholesale export of the American manufacturing sector by lending money to the Chinese to build the sophisticated industrial infrastructure it needed to take full advantage of its ‘inexhaustible’ supply of cheap labour.

That the reality has been very different for Western manufacturers, who have difficulty operating and making any profits there has been common knowledge for some time. As the China financial-market bubble bursts, Robert Green at Forbes magazine asks whether Goldman Sachs won’t make a fortune on the sell-off, having previously “pumped up China for great profit, without any regard for doing business with the CCP communists and corrupt parties.” Goldman may be arranging its big-China short now to get “closer to home” – just like some disillusioned manufacturers.

Last week Muddy Waters, which likes to “expose substantial frauds before they suck up more money from investors”, caused a storm when it released a damning report on Chinese forest operator, Sino-Forest, comparing it to Madoff’s ponzi scheme.

Hong Kong based Sino-Forest Corp had apparently been overstating timberland holdings and production in China. The land the company said it bought from Lincang City in China’s Yunnan province doesn’t match city records and it couldn’t have produced as much timber in the area as it claimed.

Fraud has plagued several Chinese IPOs in recent years, including China Energy Savings Technology, Fuwei Films, and China Water and Drinks, Fuqi International, Rino, and China Life Insurance which was plagued by $625 million in “financial irregularities” months after it floated. In total, some 40 Chinese companies have either acknowledged accounting problems or seen the SEC or US exchanges halt trading in their stocks because of accounting questions, since February.

The Sino-Forest scandal follows reports that Chaoda Modern Agriculture Holdings Ltd, a Chinese supplier of fruit and vegetables, exaggerated the amount of land it controls. Muddy Waters has itself caused the shares of Orient Paper to fall 50%, Rino to fall 60%, China MediaExpress to de-list altogether, and Duoyuan Global Water to fall 40%.

Indeed, so tainted by fraud have such Chinese companies become that the Bloomberg Chinese Reverse Mergers Index of US listed stocks has fallen 38% in 2011. Now the SEC is investigating the use of reverse takeovers, in which a closely held firm becomes public by purchasing a shell company that already trades. “Stock manipulators have devised a kind of template for stock fraud — one that exploits fundamental weaknesses in the regulatory apparatus of the two countries — and now use the template to cheat investors in deal after deal,” reports The Street.

What makes this extra interesting is that the SEC is now investigating the accounting firms that audit these firms. Perhaps this will now include Ernst & Young, which audits Sino-Forest.

As for Muddy Waters, it is broadening its scope to include Latin America.