Deficits, Militarization, Privatization, Financialization

by Sinclair Noe

DOW – 126 = 14,995
SPX – 13 = 1612
NAS – 36 = 3400
10 YR YLD + .03 = 2.23%
OIL + .38 = 95.76
GOLD + 10.20 = 1389.40
SILV + .10 = 21.89

Pretty much all markets looked a little weak today, except maybe precious metals, but its hard to call that market strong right now. Quantitative easing, the $85 billion per month shelled out by the Federal Reserve, comes down to the purchase of two kinds of securities: Treasury paper and mortgage-backed securities. The Fed buys the Treasury paper from the federal government and the mortgage-backed securities from commercial banks. The first is a direct form of monetization (money printing); the second is an indirect form since a good portion of those funds is in turn also used by the banks to purchase Treasury paper. The two together comprise the bulk of what appears on the Fed's balance sheet as "reserve bank credit"; that figure stands at just over $3.2 trillion; up about $2.4 trillion since late 2008. At first glance, it looks like reserve bank credit and the gold price are correlated, but what is really going on with this tandem is that they are both being pushed by the same force - a bad economy. It causes the Fed to print money and investors to buy gold.

The government reported Wednesday that the US budget deficit widened in May by $139 billion. But the annual deficit stayed on track to finish below $1 trillion for the first time since 2008. With the May increase, the deficit through the first eight months of this budget year totaled $626 billion, according to the Treasury. That's down $218 billion lower than the same period last year. And that means we are on track to the smallest deficit in 5 years.

Many analysts believed the huge revenue gains seen in the first few months of 2013 would fade away as we moved into spring. Higher taxes, and a big increase in dividends which were pushed forward to beat the fiscal cliff, and other income in 2012 helped create huge tax liabilities that people had to pay in the early months of 2013. Yet in May, revenues again rose sharply from May 2012. They came in at $197 billion, compared with $180 billion in May 2012, or up 9.1 percent. Through the year thus far, revenues are up 15 percent from the year before.

The spending side was a little different. In general, the trend so far this year has been for spending to be down a bit, thanks to the sequester, and less spending on defense and unemployment benefits. Thus far this year, spending is up about 1 percent.

Next, consider that for the next four months, assuming no big shocks or great changes, the government will essentially break even. That hasn’t been done in well over a decade. In the first eight months of the fiscal year the deficit was $626 billion, down about 25 percent from the first eight months of fiscal 2012. But the Congressional Budget Office is predicting that’s all the red ink we’ll print this fiscal year. It is projecting the deficit for the entire fiscal year will be $642 billion.

One area of government that is growing is data collection, the amount of surveillance information that the government collects is enormous and growing really fast; in fact the new name for it is metadata, and we have no idea how it is used by the government, how long it is held and which agencies, or companies, have access to it. The culture of secrecy that pervades Washington borders on the absurd. American officials say they cannot discuss “classified” U.S. counter-terrorism tactics that are well-known worldwide, including data mining.

From drone strikes to eavesdropping to torture, the American public is not allowed to know the rules and results of U.S. counterterrorism policies. At the same time, a sprawling secrecy industrial complex does. More than 4.9 million Americans now have government security clearances, and another 1.4 million have top secret clearance.  Major U.S. civilian government agencies — from the CIA to State Department — have become dependent on contractors to operate. Today, the federal government pays contractors $300 billion a year, according to the Project on Government Oversight, a watchdog group. Many are believed to operate in intelligence agencies.

Contracting has become a huge profit center for defense contractors and Wall Street alike. Ed Snowden is the guy who leaked the most recent info about the government's data mining. Snowden worked for a private contractor, Booz Allen, which was purchased by the Carlyle Group in 2008. Last year, 99 percent of the Booz’s $3.8 billion in revenue came from government contracts. Booz Allen, which employs 24,500, had a net profit of $219 million on revenue of nearly $5.8 billion for the fiscal year ended March 31. For the same period ending in 2010, the year the company went public, the company earned $25 million on $5.1 billion in revenue. Whatever they do, they've figured out a way to improve the margins. Unfortunately, the margins are paid with tax dollars.

Snowden is now believed to be somewhere in Hong Kong, and he keeps releasing info; the latest is that the US government has been hacking the Chinese since at least 2009. The National Security Agency, Central Intelligence Agency and Defense Intelligence Agency, for example, all rely heavily on contractors to operate. Roughly 480,000 — one-third of the 1.4 million people with security clearances — are contractors.

Of course, private sector and public sector work in different ways. The major motivation for the private sector is profit. How does a firm increase profit? Do they mine more data? Do they promote more fear? Surely, complacency would be bad for business. You wouldn't want to make a mistake with your biggest client, which is what Booz Allen Hamilton did in the case of Snowden. But government contracting is a different ballgame. When a company screws up, the government delivers a slap on the wrist—and then awards the company with new contracts.

This is the way the government has grown the military industrial complex, and it doesn't seem to matter if Lockheed Martin overcharges for fighter jets, or if Boeing goes over budget on helicopters, or if Haliburton builds latrines for soldiers in Iraq and happens to electrocute a few in the process; in these cases, the new contracts continued to flow.

The reality is that these contractors have become part of the government. The national-security and defense apparatus needs them to carry out essential operations as much as the private companies need their federal benefactor to deliver returns to the shareholder. Government agencies these days simply lack the resources, permissions, and wherewithal to hire all the people they need to conduct operations. Using contractors is a necessity. At least that's the argument of the contractors.

On the one hand, it is a fiercely competitive industry in which big firms compete with one another. On the other hand, the fix is in. The government spreads its contracts around between large companies. Small businesses and start-ups have a tough time competing for the biggest of the contracts. And there is a limited number of domestic large players, especially in sensitive defense areas. Lobbying also plays an important role. Big contractors hire lobbyists and make campaign donations in order to work the system.

In its recent annual report, Booz Allen said that the main risks to its business includes changes to “U.S. government spending and mission priorities” (like the sequester) and “mishandling or the perception of mishandling of sensitive information, such as our failure to maintain the confidentiality of the existence of our business relationships with certain of our clients or a failure to maintain adequate protection against security breaches,” which “could harm our relationship with U.S. government agencies.”

Ed Snowden, the guy who leaked the stories, is a 29-year old, reportedly making $122,000 a year at Booz Allen, until they fired him this week. That means this guy made more than most Army Colonels.

Maybe another risk to the profits of these companies is that the public reconsiders the price we pay for privatization of national defense, and maybe we just get tired of paying companies to snoop into our phone calls and emails.

Yesterday I talked about the financialization of the economy, and how an ever-growing financial sector was actually hurting the economy and hurting the prospects for jobs growth. So, let's go back just a little bit; remember the Libor rate rigging scandal? About a year ago we heard that there was widespread manipulation of the London Interbank Offered Rate, which is the benchmark interest rate that affects borrowing costs around the world. A handful of big banks have already paid fines in that case, and some traders have been fired. Given that set of fairly manageable consequences, it's understandable that traders would continue to find different things to manipulate for fun and profit.

And then we heard about credit swap derivatives being manipulated via something called the ISDA Fix; then there was the gold and silver markets, and the British natural gas market, and the crude oil market. This is going to shock you; it's hard to believe, but there is even more manipulation. Bloomberg is reporting that the Forex market, which is where currency is traded, has been manipulated for at least the past ten years. One trader compared it to the Wild West, which I think is an insult to the Wild West.

One thing that makes the alleged currency-market manipulation especially unpleasant is that this apparently involved front-running client trades. So, they are literally stepping in front of someone's trade and stealing a little. And traders allegedly worked together with traders of other banks to do this, in order to spread the wealth around -- to everybody but the poor dumb clients, that is. 

Monday, June 10, 2013 - New Journalism and Cyber Wars

New Journalism and Cyber Wars

by Sinclair Noe

DOW – 9 = 15,238
SPX – 0.57 = 1642
NAS + 4 = 3473
10 YR YLD + .05 = 2.21
OIL - .26 = 95.77
GOLD + 2.40 = 1388.00
SILV + .26 = 22.05

Last week, the Guardian, a British newspaper, published classified information on phone and internet monitoring by the US government, as well as classified information about how the US has been conducting cyber attacks around the globe. Today we learned that the guy who leaked the classified information to the Guardian is a guy named Edward Snowden; he's 29 years old; he got the classified data while he worked for Booz Allen Hamilton, a private contractor. Snowden recently moved to Hong Kong. Still waiting to hear if he'll be extradited.

For several years now, my friends Pat and Linda Gorman have invited me to speak at the economic conferences each year. Each day, here on the radio I talk about the economic news of the day, so when I speak at their annual conference I try to make those presentations about big trends. In 2011, one of the trends I brought up was something I labeled New Journalism, based in part on the Wikileaks model. In 2012, another trend was CyberWars. I've expanded on those ideas in this presentation I made this past April. So, I went back and looked at that speech over the weekend. I'll share some of it with you today.

The idea of New Journalism was that we have seen a failure of main stream media to pull back the veil of secrecy in government and in corporate America; not surprising since corporate America controls the media and has an almost incestuous relationship with government. Here, I hoped we might see a Wikileaks bank dump. We still haven't seen that. I did not expect changes in main stream media. I wasn't that naïve. The bank dump supposedly exists, but make no mistake, the bankers are in control. They have choked off funding sources for Wikileaks, and the US government has threatened legal action against Julian Assange.

I also told attendees at the conferences about CyberWars. And I was spot on with that trend. We've been attacked. The Cyber World has been exposed for huge vulnerabilities. We all use those interconnected tubes that form the internet, and everything you do on the internet is extremely unsecured. One of the major threats is to the electric grid; beyond the physical threat from cyberattack, there is the concern about secrets. Major corporations, and major departments of government have been hacked. What gets scary is that the Department of Defense and Department of Justice and major financial institutions are vulnerable to attacks. Even Michelle Obama's finances were hacked. The best thing I can tell you is that you need some physical assets in your hot little hands. Otherwise, there will come a time when you get caught.

It's important to recognize that although no cyberwar has ever been declared, cyberwarfare is now a part of life. The war is pervasive and we are all vulnerable to attack. It's impossible to say who fired the first "shot" in this war, but the US government has certainly stepped up the fight. President Obama accelerated cyberattacks (begun during the Bush administration) on the computer systems that run Iran's nuclear enrichment facilities. The worm that the US (in conjunction with Israel) created to carry out the attacks accidentally became public in the summer of 2010; a programming error allowed it to escape its target in Iran, and it was discovered by computer security experts. They named it Stuxnet. Stuxnet was the US's first sustained use of cyberweapons; the attacks marked the first time that a computer worm was used to cause physical damage.

Well that's both kind of scary and cool, but so what? What's the point? How does it affect me? The point is that the genie is out of the bottle, and there's no going back. Unlike in a traditional war, in a cyberwar it's the more developed nations that are the most vulnerable to attack. The fact that the US has recently been so brazen in its cyberwar efforts, virtually ensures an increase in cyberattacks against the US government and US businesses.

Security has now become the third pillar of computing, joining energy-efficient performance and Internet connectivity in importance. The takeaway for US businesses should be that they need to pay more attention to securing their networks. The takeaway for investors should be that with the proliferation and increasing sophistication of cyberthreats, there will be growing demand to protect against it. As the weapons in this cyberwar evolve, so too must the defenses against them. And that's big business; the market is in the neighborhood of $25 billion worldwide, and double-digit growth is projected for years to come.

This past week's leaks to the Guardian newspaper weren't really new. We knew the government has been working with telecom companies to monitor telephone and internet communication. It's been going on for years now. When intelligence agencies talk about terrorist “chatter”, they're not talking about conversations using walkie talkies. And the CyberWar – well, we started it, and it isn't some virtual video game, it is very real; and it affects our most basic infrastructure, from defense to transportation to electricity to water to food, and the entire supply chain.

Booz Allen Hamilton, the company that employed Edward Snowden – the man who has admitted he leaked top secret info to the Guardian, Booz Allen Hamilton has approximately 25,000 employees, 76 percent of whom have a US government security clearance and 49 percent of whom have security clearances at the level of "top secret or higher." That's 12,250 people employed at Booz Allen alone who have "top secret" clearance. How much of the company's work is for the US government? Almost all of it. In each of the past three years, 98 percent or more of its income came from government contracts.

How on earth can you keep secrets if just one American company has enough people with top secret access to fill a mid-sized American town?There's no small irony that much of Booz Allen's work for the government is about securing government data from hackers and spies. The first subsection of the annual report is titled "Keeping Information Secure: An integrated approach enables effective cybersecurity." How much of their work is with the NSA and other intelligence agencies is hard to say. Understandably, that's not played up in the annual report, and the company has contracts focusing on everything from veterans affairs to air traffic control.

But plenty of intelligence work is disclosed, most of it with military, like the work it does with the Army's Intelligence and Information Warfare Directorate to build a database that "delivers massive and elastic data storage and processing capacity, with the power to query, sort, and analyze hundreds of millions of textual intelligence products in less than one second." Booz Allen Hamilton's sales have doubled in the last four years and profit has nearly tripled. Oh, and guess who the majority owner of Booz is? Carlyle Group, the long-time DC heavyweight private equity firm with deep connections to the Bush family. We can see how clever it is proving to be to have outsourced big chunks of the defense, security, and intelligence apparatus.

In other words, there are a lot of companies making big bucks in the Cybersecurity business, and there are way too many people with access to top secret info, and that access is not just to government secrets but also corporate secrets. It's just a matter of time until we see a Wikileaks style bank dump, or other major corporations wake up one morning to realize their dirty laundry is on the line. And when that happens, every time that happens, we pull back the curtain a little more.

Sun's CEO Scott McNealy may have stated it best, or at least the most bluntly. "You have zero privacy. Get over it." In this view, the Internet opened the door, the NSA just tiptoed through it.

Every day, we voluntarily upload mountains of data -- our thoughts, our jokes, our activities, our photos -- for at least part of the world to see. If we assume any degree of privacy for that material, we probably shouldn't be allowed to operate a television, much less a computer.

But we send emails to named recipients, we visit websites for our own information or entertainment. Despite the warnings from experts to encrypt everything but our underwear, we do those things with an expectation of privacy. The problem is that we do almost all those things for free.

Yes, we hear the triumphant cry of the early Internet enthusiasts ringing in our minds' ears: Information wants to be free. However, people's time and effort is never free. The people whose ingenuity and expertise have made all our online activities possible certainly weren't doing it for free. If you doubt that, check what the founders of Google are driving these days. And at least since the advent of the web portal, online companies have engaged us in a bargain no less unproclaimed and undebated (if as of now less sinister) than the security-for-privacy deal the federal government has made on our behalf: our "free" activity in return for our transactional data, which is then used to lure advertisers. It's a cliche by now, but no less true for that: If you don't pay for the product, you are the product.