Thursday, June 7, 2012

OH2 Goes Into Summer Mode

(Yes, that's me at bottom right)
Summertime, and the livin' is easy, fish are jumpin', and The Balf's takin' a break ... Out Here Too is going into vacation mode folks, that means daily posts will become "occasional posts" for the rest of the summer.  But don't worry.  The global financial meltdown will proceed (albeit erratically), and China will continue to flex it's might as it tries to placate its masses.  Ron Paul will be proven to be right, and Mitt Romney will stumble through gaff after gaff as he hands the election to Obama.  Iran will be taken out sooner or later, and the U.S. "fiscal cliff" will loom ever more ominously.  The universe will unfold - although perhaps not as we would like it to.  Still, there will be lots of local joys.  Reunions, graduations, days at the beach, sailing, rodeos, hikes, and picnics, things like that.  Here's hoping all of our readers have a great summer, and give us a look in September.  To be updated in the meantime just put your email address in the box below at left.  Needless to say, it's safe with OH2.  You can also check out Jewel Of The Canadian West if you're interested in Western history, people, places, and humour.

Wednesday, June 6, 2012

Flame: A U.S. Cyber Spy Detected?

Flame: A Glimpse Into the Future of War by Elinor Mills at CNet.com. "A new 'worm' that's been spying on computers in the Middle East appears to be nation-state sponsored. We have Stuxnet, Duqu, and now 'Flame'. Stuxnet (and likely Duqu) was developed by the U.S., probably in collaboration with Israel. (Israel has denied involvement in both Stuxnet and Flame, while the U.S. has not outright distanced itself from either.) And the Department of Homeland Security (DHS) declined to answer questions about Flame, which has been called "the most sophisticated cyber weapon yet unleashed." Infections have been concentrated in Iran and other Middle Eastern countries, and seem designed mostly for spying. Flame can be instructed to spread itself via USB thumb drive, network shares, or a shared printer spool vulnerability. It has at least 20 different components that do things like sniff network traffic, take screenshots, record audio conversations, log keystrokes, and gather information from nearby Bluetooth devices. Experts believe more modules are in the wild. There are more than 80 command-and-control servers being used to send instructions to infected computers. The malware isn't an entirely new beast really, and the individual functions aren't uncommon. But the size of the program, the fact that it has so many different functions, and its modularity make it unique. An attacker can mix and match components at will. Flame's emergence isn't game changing necessarily, but it does give an indication of how far geopolitically-motivated malware has come and who might be ahead in that "arms race". "This is confirmation for the public that very sophisticated attacks are prevalent," said Stewart Baker, formerly at the DHS and now practicing cyber law in the Washington office of Steptoe & Johnson. "This is bad for countries that have secrets to protect, like the U.S. and Western Europe, and for the Chinese and Russians too. And it's probably good for countries like North Korea and Iran that are going to go to school with this tool." "... Flame suggests we're in a new era here," agreed Scott Borg, director of the nonprofit research institute U.S. Cyber Consequences Unit. Even before Stuxnet hit the news two years ago, he made prescient remarks to the effect that Israel's weapon of choice would be malware that would give the country the ability to interfere with Iran's nuclear program without launching a massive military strike. According to the NY Times, the Bush administration turned to malware as an alternative to launching a military strike against Iran and the Obama administration continued with the operation, code-named Olympic Games. However, while malware might save lives in the short term, it doesn't mean it's safer in the long run. "Cyber can be a much better alternative," Borg said, noting that the Russian cyber campaign against Georgia in 2008 targeted communication and media sites with Distributed Denial of Service (DDS) attacks and spared them from air strikes. But there's nothing to stop an aggressor from using both online and offline attacks. "If you are planning drone strikes, what better intelligence could you ask for than a tool that will turn on a camera and microphone of a machine in your enemy's possession to let you know who is there and what is going on?" One big problem with Flame is that the malware authors didn't use code obfuscation, which means it can easily be dissected and re-used by any organization with some advanced programming skills and experience, which would include a large number of nation-states and terrorist groups, according to Borg. "That's a terrible mistake" on the part of the creators, Borg said. "This is not a good thing to have released into the world in a form that is decipherable." Even though Flame doesn't initially appear to be designed for sabotage, there may be components in the wild that would give it that function. "If it's that sophisticated, it can probably have physical manifestations as well," said Greg Garcia, of Garcia Cyber Partners consulting firm and formerly of DHS. "It could have consequences that are even broader and potentially more deadly than a drone strike if you think about infiltrating and corrupting control systems that are managing electrical grids, water purification, or transportation systems." Borg declined to speculate which country is behind Flame but said he suspects it was created by "friendly forces." "The countries capable of writing these kinds of tools? China, Russia, U.S., Britain, Germany, Israel, and probably Taiwan," he said. The code, which at 20 megabytes is huge compared with Stuxnet, most likely required hundreds of people to be working on it for many months. Don't expect the Stuxnet-Duqu-Flame triumvirate to scare anyone straight though. The perception of threat or possibility for danger in cyber security hasn't been enough in the past to merit much action on the part of responsible parties, be they electricity providers or the untold corporate networks that are hacked daily. "There is no shortage of information that says we have a problem," said Herb Lin, chief scientist at the Computer Science and Telecom Board at The National Academies. "But there have been a lot of other wake-up calls and people just put the snooze button back on."

Monday, June 4, 2012

Don't Write Off Toronto Yet

(Toronto Star photo)
Reports of the total demise of T.O. lately are greatly exaggerated.  (I've been there.  The airport is still functioning.)  Toronto has not become a cesspool of punks, anarchists, and gang violence.  It is still possible to go shopping in Eaton Centre safely during daylight hours.  T.O. is not going the way of Detroit: guns, drugs, and crime.  All decent, law-abiding Torontonians are not moving in droves to Montreal.  (Living with the Mafia in Montreal is not that much easier and safer than the out-of-control punks not running rampant in Toronto.)  Don't worry, Rosedale is still beyond the reach of anarchists.  Toronto's black eye from the G-20 violence is not affecting tourism.  No, Toronto is not getting worse.

Hayek On The Need For Rules in Government

Friedrich A. Hayek
From the WSJ:  Rules for America's Road to Recovery (by John B. Taylor):  "As Hayek taught us, predictable policies help restore economic prosperity and preserve freedom. America's economic future is increasingly uncertain. A reform strategy built on predictable, rules-based fiscal, monetary and regulatory policies will help. As they undertake changes, reformers should pay close attention to what the great economist and philosopher Friedrich A. Hayek wrote in the last century. Hayek argued that the case for rules-based policy goes beyond economics and should appeal to all those concerned about freedom. He wrote in his 1944 book, "The Road to Serfdom," that "nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principle known as the Rule of Law." Hayek added, "Stripped of all technicalities, this means that government in all its actions is bound by rules fixed and announced beforehand - rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one's individual affairs on the basis of this knowledge." Rules make the economy work better by providing a predictable policy framework within which consumers and businesses make decisions. But they also protect freedom, a concept Hayek developed in his 1960 book, "The Constitution of Liberty." Hayek traces the relationship of the rule of law to freedom back to Aristotle, and then to Cicero, about whom he wrote, "No other author shows more clearly ... that freedom is dependent upon certain attributes of the law, its generality and certainty, and the restrictions it places on the discretion of authority." Hayek also quotes from the Second Treatise of Civil Government by John Locke, the father of classical liberalism who had a profound influence on America's Founding Fathers: "The end [purpose] of law is not to abolish or restrain, but to preserve and enlarge freedom ... where there is no law, there is no freedom." But skeptics ask how a system of policy rules can work when politicians and government officials want to "do something" to help the economy. A rules-based system with less discretion sounds good in theory, they say, but rules mean you do nothing, and that is impossible in today's charged political climate and 24-hour news cycle. Hayek had an answer to this. In "The Road to Serfdom" he wrote that it was wrong to say that the "characteristic attitude [of a rules-based system] is inaction of the state" and presented a counter example to this common view, saying that "the state controlling weights and measures (preventing fraud) is certainly acting." Consider other examples. Rules for monetary policy do not mean that the central bank does not change the instruments of policy (interest rates or the money supply), or provide loans in the case of a bank run. Rather they mean that they take such actions in a predictable manner. But in the years immediately preceding the 2008 financial crisis, monetary policy deviated from predictable rules-based policy that worked in the 1980s and '90s, i.e. the Federal Reserve held rates too low for too long. Moreover, government regulators did not enforce existing rules on risk-taking at banks and other financial institutions, including Fannie Mae and Freddie Mac. Then came the discretionary stimulus packages and exploding debt, the regulatory unpredictability associated with ObamaCare and Dodd-Frank, which includes hundreds of rules still waiting to be written, and the unprecedented quantitative easing through which the Federal Reserve bought 77% of new federal debt in 2011. The U.S. tax code has become particularly unpredictable. The number of provisions expiring has skyrocketed to 133 in 2010-12 from 11 in 2000-02. And now the epitome of unpredictable policy is upon us in the form of a self-inflicted "fiscal cliff" where virtually the entire tax code will be up for grabs by the end of this year. It is deviation from a rule or a strategy that creates uncertainty and hinders prosperity. Thus, regulators who decide not to act when financial institutions take on risk beyond the limits of the rules and regulations are not being faithful to the law and indeed to the rule of law. What can citizens do to achieve a more rules-based system? Here Hayek issued a warning. In a chapter in "The Road to Serfdom" called "Why the Worst Get on Top," he argued that there is a bias against individuals in government who firmly believe in rules-based policy. People who have the ambition to get to the top frequently have a bias toward interventionism. Some will claim, of course, that crises force policy makers to deviate from predictable rules. One can argue that bailouts and other discretionary interventions were needed during the panic of the fall of 2008, and perhaps they prevented a more serious panic. But that is like saying that the person who set fire to your house should be exonerated because he helped put out the fire and saved a few rooms."

Sunday, June 3, 2012

Saturday, June 2, 2012

Bill Gross Warns the 1%, Part 2

“Thar she blows,” screamed Captain Ahab, and similarly intentioned debt holders may soon follow suit, presenting the possibility of a new global monetary system, or if not, one which is stagnant, dysfunctional and ill-equipped to facilitate the process of productive investment. While all monetary systems are a balance between debtors and creditors, absent voluntary defaults it is usually creditors that establish the rules. Such was the case in the late 1960s as France’s de Gaulle threatened to empty Ft. Knox unless a new standard was imposed. Now, with dollar reserves widely dispersed in Chinese, Japanese, Brazilian and other surplus nations, it is likely that there will come a point where 2% negative real interest rates fail to compensate for the advantages heretofore gained in buying sovereign bonds. China, for instance, may shift incremental Treasury holdings to higher returning commodity/real assets which might usher in a gradual (or even sudden) reconfiguration of our current dollar-based credit system. Having a reduced incentive to purchase Treasuries and curtail Yuan appreciation, the Chinese and their act-alikes may look elsewhere for returns. In addition, previously feared but now tamed private market bond vigilantes like PIMCO have similar choices, if clients broaden their guidelines. Together, there is the potential for both public and private market creditors to effect a change in how credit is funded and dispersed – our global monetary system. What that will look like is conjectural, but it is likely to be more hard money as opposed to fiat-based, or if still fiat-centric, less oriented to a dollar-based reserve currency. In either case, the transition is likely to be disruptive and an ill omen for investors. This transition continues to point towards higher global inflation as a solution to overextended debt-ladened balance sheets. Investors in general will be hard pressed to repeat the performance of the past 30 years, an era based on excessive credit expansion. Deleveraging economies and financial markets present a different and lower-returning kettle of fish. That is because historical leverage was almost always applied by borrowing at a short-term rate and lending longer and riskier at a higher yield. That “spread” practically guaranteed levered returns over and above the policy lending rate during the past 30 years. No matter whether it was at 10%, 5% or eventually approaching 0% the lending spread at a higher yield was threatened only on a temporary basis during cyclical economic contractions brought about by temporary periods of tight money on the part of the Federal Reserve. As long as the economy bounced back, credit extension and its profitability were never threatened. All of that changed, however, as de-leveraging produced narrower yield margins, asset price exhaustion, and a reluctance on the part of lenders to lend (and in many cases, borrowers to borrow). Combined with now negative real interest rates of 200–300 basis points on the front end of the lending curve, the ability to successfully lever financial market returns has been jeopardized. Bond, equity and all financial assets which are structurally bound together by this dynamic must lower return expectations. The world’s financial markets currently seem obsessed with daily monetary and fiscal policy evolutions in Euroland. Euroland is just a localized tumor however. The developing credit cancer may be metastasized, and the global monetary system fatally flawed by increasingly risky and unacceptably low yields produced by the debt crisis and policy responses to it. Investors should sail carefully and the Wall Street 1% should put on their life vests if they expect to weather the inevitable storm that may threaten the first-class cabins they have come to enjoy." - William H. Gross

Friday, June 1, 2012

Bill Gross Warns the 1%, Part 1

"The Wall Street Food Chain: Soaring debt/GDP ratios in previously sacrosanct AAA countries have made low cost funding a function of central banks as opposed to private investors. Both the lower quality and yields of such debt represent a potential breaking point in our global monetary system. Innovators such as Jobs and Gates are rare within the privileged because the 1% feed primarily off money, not invention. They would have you believe that stocks, bonds and real estate move higher because of their wisdom, when in fact prices float on an ocean of credit, a sea in which all are now increasingly at risk because of high debt and its consequences. Still, as the system de-levers, there are winners and losers, a Wall Street food chain in effect. These economic food chains depend on lots of little fishes. When examining the wealth distribution triangle of land/labor/capital, the Wall Street food chain segregates capital between the haves and have-nots: The Fed and its member banks are the metaphorical whales, the small investors earning .01% on their money market funds are the plankton. Similar comparisons can be drawn between capital and labor. Profits and compensation of the 1% dominate wages of the 99% and the imbalances between the two are as distorted as those within the capital food chain itself. Wall Street and Newport Beach whales like myself don’t have to worry as yet about being someone else’s lunch. Yet the whales' environment is changing – for the worse. The global monetary system which has evolved over the past century, always in the direction of easier, cheaper and more abundant credit, may have reached a point at which it can no longer operate efficiently and equitably to promote economic growth and the fair distribution of its benefits. Future changes may not be so beneficial for our ocean’s oversized creatures. The balance between financial whales and plankton – powerful creditors and much smaller debtors – is dependent on the successful functioning of our global monetary system. What is a global monetary system? It is basically how the world conducts and pays for commerce. Historically, several different systems have been employed but basically they have either been commodity-based systems – gold and silver primarily – or a fiat system, paper money. After rejecting the gold standard at Bretton Woods in 1945, developed nations accepted a hybrid based on dollar convertibility and the fixing of the greenback at $35 per ounce. When that was overwhelmed by U.S. fiscal deficits and dollar printing in the late 1960s, President Nixon ushered in a new, rather loosely defined system that was still dollar dependent for trade and monetary transactions but relied on the consolidated “good behavior” of G-7 central banks to print money parsimoniously and to target inflation close to 2%. Heartened by Paul Volcker in 1979, markets and economies gradually accepted this implicit promise and global credit markets and their economies grew. The global monetary system seemed to be working smoothly. The laws of natural selection and modern day finance seemed to be functioning as anticipated, and the whales were ascendant. Functioning yes, but perhaps not so moderately or smoothly – especially since 2008. Policy responses by fiscal and monetary authorities have managed to prevent substantial haircutting of the $200 trillion or so of financial assets that comprise our global monetary system, yet in the process have increased the risk and lowered the return of sovereign securities which represent its core. QEs and LTROs totalling trillions have been publicly spawned in recent years. In the process, however, yields and future returns have plunged, presenting not a warm Pacific Ocean of positive real interest rates, but a frigid, Arctic sea when compared to 2–3% inflation now commonplace in developed economies. Both the lower quality and lower yields of debt therefore represent a potential breaking point in our global monetary system. Neither condition was considered feasible as recently as five years ago. Now, however, with even the U.S. suffering a credit downgrade and offering negative 200 basis point real policy rates for the privilege of investing in Treasury bills, the willingness of creditors to support the existing system may soon descend. Such a transition occurs because lenders either perceive too much risk or refuse to accept near zero-based returns on their investments. As they question the value of much of the $200 trillion which comprises our current system, they move elsewhere – to real assets such as land, gold and tangibles, or to cash." - William H. Gross