Wealth International, Limited

Offshore News Digest for Week of August 9, 2004

Note:  This week’s Financial Digest may be found here.

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Oil prices are set to remain at record highs at least until the uncertainties surrounding supply from Russian oil giant Yukos can be resolved, analysts said. “The outcome lies in the Russian government’s hands. Prices will remain at high levels until there is some kind of resolution,” said WestLB analyst John Bates. The big question is whether supply from Yukos will come to a halt, exacerbating already tight global conditions.

Demand from around the globe -- especially China -- continues to rise while OPEC, through years of under-investment, has little excess capacity to help ease the situation. Yukos pumps 1.7 million barrels per day, just under 20% of OPEC heavyweight Saudi Arabia’s production but still a substantial amount by any standard. When the Russian justice ministry lifted the freeze on Yukos assets last Wednesday, oil prices fell by as much as $2 in reaction. But a subsequent about-turn from the ministry saw oil prices scale new all-time highs, of almost $45 in New York.

More on this story here. Further news from the affair here and here.


On July 25, the State Council released the Decision on Reform of Investment System. It not only marked the most significant step in economic reforms since the 16th National Congress of the Communist Party of China (CPC), but also was a turning point from a planned economy to a market economy. Since enterprises were given the right of decision-making in setting prices on output and labor and selecting raw materials in the late 1970s, they have become mostly independent businesses. However, three decades later, enterprises, State-owned, State-held or private, still have to follow government instructions and obtain the government’s approval in their choice of investments.

Under such circumstances, the State Council’s decision to relax administrative controls over investment has removed the last boundaries of the State over specific decision-making for enterprises and economic reforms have overcome the last obstacle of the planned economy. According to economics theories, investment is a decision that reallocates resources. Under the planned economy, investment projects from various industries all over the country have to apply for licences from the central government. The central government chooses those they think proper in line with an overall plan for the national economy.

To realize high efficiency, such decision-making processes have several preconditions that can hardly be fulfilled in reality: the cost of information accumulation, investment plans and enforcement are close to zero; the different levels of local government have the same interest as enterprises; and all officials in charge of the investment selection are knowledgeable, honest and insightful. These preconditions are proven to be false in practice. As a result, the economy is obsessed by many problems resulting from such central-controlled investment systems.

More on this story here.

BBC profiles China.

China is the world’s most populous country, with a continuous culture stretching back nearly 4,000 years. Many of the elements that make up the foundation of the modern world originated in China, including paper, gunpowder, credit banking, the compass and paper money. After stagnating for two decades under the rigid authoritarianism of early communist rule, China now has the world’s fastest-growing economy and is undergoing what has been described as a second industrial revolution. In the early 1980s it dismantled collective farming and allowed private enterprise again. Now it is one of the world’s top exporters and is attracting record amounts of foreign investment.

More on this story here.

China GDP Up 9.6% vs. a year earlier at end of Q2.

China’s second-quarter economic growth weakened more than expected, suggesting the government may be achieving a soft landing for the economy. GDP was 9.6% higher than a year earlier. But some analysts said it had probably shrunk from the previous quarter. Several economists said the figures pointed toward a soft landing, in which the worryingly fast growth of earlier quarters would ease gradually to sustainable rates without falling into a bust.

The economy is the world’s 7th largest and an increasingly important driver for the others. It grew 9.8% in the year ending March 31, 2004 as the government limited investment in red-hot sectors such as property and autos and battled mounting inflationary pressures. Banks were ordered to hold more money in reserve, making less available for lending.

More on this story here.

China to ease entry for foreign banks.

Perhaps influenced by the enormous overhang of domestic and foreign exchange holdings in its citizens’ hands and the inefficiency of domestic banks, the China Banking Regulatory Commission (CBRC) will scrap a mandatory one-year waiting period between branch openings by foreign lenders, and cut the minimum capital requirement for foreign bank branches to conduct yuan business with mainland companies 25% to 300 million yuan, while the requirement for branches doing yuan business with Chinese individuals will fall to 500 million yuan from 600 million yuan.

Sixty-four foreign banks were operating 192 outlets in China at the end of last year, but they have been allowed to offer yuan-based services to mainland companies only since December. Under a timetable agreed with the WTO, China is scheduled to allow foreign banks to do yuan business with mainland citizens from the end of 2006.

More on this story here.


Dump trucks carry construction crews and equipment to sites in Hyderabad, where futuristic buildings reach skyward. Cows wander in their midst, and barefoot delivery boys lug pots of tea and lunch tins to and from makeshift cafes to builders and office workers. Then there are the sightseers. A stream of locals comes by foot, motorcycle and car to gaze at the tangible evidence of India’s rising stature in the world.

Yet not all of India is feeling the benefits of the soaring economy and surging technology industry. The contrasts are jarring between ancient and modern India, its rich and its poor, its triumphs and its challenges, especially in cutting-edge cities like Hyderabad. And despite their pride in the country’s rising stature, Indians are divided over whether the new prosperity is trickling down to the masses. They recently voted out of office the business-oriented leaders who took credit for the country’s growth.

Hyderabad is playing catch-up to Bangalore, a city to the east that emerged as India’s Silicon Valley in the 1980s. While the U.S. tech workers fret about competing with Indians for jobs, cities in India are competing among themselves for their share of the tech boom. Foreign investment and companies are pouring in, and cities across the country are in a beauty contest similar to Texas, Alabama and Washington state’s competition for Boeing’s 7E7 project last year. In some ways the change in Hyderabad is similar to Seattle’s transformation in the late 1990s.

More on this story here.


Bacon & Woodrow Channel Islands senior partner Stephen Ainsworth believes Guernsey’s location, tax structure and regulatory system make it attractive for international firms setting up pension schemes and captive insurance companies managing corporate risk. Speaking as BWCI marked 25 years of business in Guernsey, Mr. Ainsworth said that over the years the firm had also benefited from the growth of the local finance industry and the related on-island demand for actuarial services. He is now seeking to build on the base that BWCI has built locally and further diversify the company’s operations.

More on this story here.


The snub The Bahamas’ financial services industry received from the Financial Action Task Force (FATF) in the form of continued formal monitoring, highlights the urgent need for a more level playing field and the convening of a global forum on money laundering, said Attorney General Alfred Sears, who recently ended his term as chairman of the regional arm of the Caribbean Financial Action Task Force (CFATF). He continued that if these two ideas were implemented, countries like The Bahamas that have made enormous progress in the areas of money laundering and anti-terrorism financing regimes would be recognized.

Mr. Sears said that, e.g., “We for example have abolished bearer shares [while they] still have bearer shares in the United States and other jurisdictions and FATF member countries.” Regulation of gatekeepers like lawyers and accountants was another change made by The Bahamas that is still ongoing in other FATF member countries. In its annual review, the FATF stated that although it had ended the formal monitoring of other CFATF member countries blacklisted with The Bahamas in 2000 or immediately afterwards, concerns regarding adequacy in the areas of international cooperation required that the jurisdiction undergo continued monitoring.

More on this story here. Bahamas and U.S. tackle fraud and counterfeiting -- more on this story here.


The central bank, the State Administration of Foreign Exchange, the China Banking Regulatory Commission and the China Securities Regulatory Commission are reportedly cooperating in a bid to crackdown on corrupt government officials and businesses who channel illegally obtained monies into offshore accounts. The Chinese state news agency Xinhua has claimed that around 4,000 corrupt officials have fled the country after embezzling more than $5 billion, although some news reports place the monetary loss to the state at nearer $50 billion.

China’s Ministry of Commerce has also apparently expressed concern at the number of Chinese firms that are registering in offshore jurisdictions. Although offshore financing centers have helped bring massive funds into China, they also have a significantly negative impact on the economy by allowing corrupt businesses and government officials to channel out illegal money, the ministry report said.

China’s dual tax system to encourage foreign firms to set up operations on the mainland is partly to blame. Foreign-funded companies enjoy a range of preferential tax policies including an average 17% corporate tax rate compared with around 33% for domestic companies. Seeking the same tax advantages or to more easily win an overseas listing many Chinese companies try to register their companies in offshore financing centers, the ministry added.

More on this story here.

Over $400 million suspected in China money laundering.

China said it has unearthed over $20 million worth of money laundering activities recently and suspects another $400 million worth of illegal foreign exchange transactions by individuals and companies that have been placed on a “black list”. The State Administration of Foreign Exchange, the communist nation’s FOREX watchdog, ordered its regional branches to check the FOREX transactions of more than 18,000 companies and individuals from March to December last year.

More on this story here.


Standard & Poor’s Rating Services of New York said it raised its long-term sovereign credit rating on Andorra to AA from AA minus. S&P said the rating change followed an improvement in the country’s fiscal position. It said the outlook on the rating was stable.

More on this story here.

Belize ratings slip as Moody’s points to growing debt concerns.

The firm cut Belize’s country ceiling for bonds and notes to B2 from Ba3, lowered its foreign-currency country ceiling for bank deposits to B3 from B1 and reduced Foreign-currency bond ratings to B2 from Ba3. “The debt buildup that led to the downgrade was largely a direct consequence of expansionary policies, although it also incorporates financing incurred to cover the reconstruction costs associated with various infrastructure projects,” Moody’s said.

More on this story here.


Panama’s President-Elect Martin Torrijos has signalled a potential change in course for the country’s trade policy with the announcement that the leadership is interested in aligning itself with the South American free trade bloc, Mercosur. The President’s comments, made on a recent trip to Buenos Aires, is an acknowledgement of growing support in Latin America for a regional alternative to the US-led NAFTA (North American Free Trade Area) approach. The move would also be something of a reversal from the policy of the Moscoso administration which has seemingly distanced itself from South America in favor of aligning Panama more with the Central American republics.

More on this story here.


Dangerous places can be hugely profitable, as many small mining firms have long known from staking claims to mines in unstable countries and hanging on to them until larger and only slightly less daring businesses buy them out. South African firms are especially deft at judging risks in their continent: MTN, a big telecoms firm, makes almost as much money in Nigeria as in South Africa. Risk-taking wins markets. Peter Singer of the Brookings Institution has written a book on private military firms. “For firms that are second or third in a market, taking risks is a way to get ahead,” he argues.

Until the invasion of Iraq, most operations in dangerous places were of two kinds. If a country had oil or minerals, it attracted energy and mining firms; if it had none, aid agencies were often still there. Both bring work for other businesses, such as in telecoms and air transport. Iraq, and the outsourcing of many support activities once performed by soldiers, has changed things. For a start, the scale there is immense and circumstances are changing constantly. For private security firms, in particular, soaring demand has turned Iraq into a bonanza.

Managing staff in dangerous places brings special challenges. Richard Fenning, chief operating officer of Control Risks Group, a British business-risk consultancy, employs lots of ex-military folk and ex-journalists (“they are resourceful and self-sufficient,” he says). The most difficult employees to cope with, says Will Geddes, boss of ICP, a London “threat-management” group, are those who want to work in a hostile country in order to boast about it when they get home. Also problematic are staff who go to nasty places without warning their company security department -- especially if they are then abducted or locked up. To reduce such risks to their home-country staff, some operators employ lots of local staff.

More on this story here.



Under the amnesty scheme, which has been operating since January, individuals are permitted to bring home undeclared assets held overseas so long as they pay a penalty of between 6% and 9% of the assets’ value to reflect unpaid back taxes. However, a survey has revealed that almost 60% of the 402 members of the Belgian Institute of Accounts and Tax Consultants polled would advise their clients against repatriating assets under the scheme, citing a lack of clarity in the legislation.

More on this story here.


The Bahamas government has taken the decision not to enter into any more TIEAs in the near future, Minister of State for Finance James Smith said last week. “Until we have a level playing field with regard to tax information exchange we are not entering into any treaties with other OECD members," commented Mr Smith.

The recent TIEA entered into with the United States has sparked worry in the financial community that the Bahamas has left itself at the mercy of the IRS. The criminal element of the US TIEA came into effect on January 1, giving the Bahamas the status of a permanent US Qualified Jurisdiction. The TIEA is not retroactive and will only apply to criminal matters from January 1, 2004. Civil tax matters will be covered by the TIEA starting January 1, 2006.

More on this story here.


Tax cost, one of the major factors that has an impact on the bottom-line of a company, has attracted more attention from business communities recently. The question of how to reduce tax cost in order to enhance a company’s overall competitiveness and profits has become the most pressing issue for many businesses in recent years. Restructuring an organization and its operations may be the best approach for achieving tax optimization for some companies. Legitimate tax planning may help companies structure their investment holdings, streamline their operations, and design their operational flows to achieve the best tax environment. In general, a good tax planning strategy involves the procedures outlined below.

More on this story here.


The newly elected president of the Barbados Financial Services Board, Penny Ettinger, has suggested that the gap in tax rates between local and international businesses be narrowed as a step towards a converged tax system and improved national competitiveness. Ms. Ettinger, a former offshore banker and Canadian tax lawyer, said this could be achieved through a 2.5% rise in the current maximum rate paid by businesses in the offshore sector, in tandem with a larger reduction in the rate now paid by local companies from 25% to below 10%.

However, she acknowledged that an attempt to narrow or harmonize tax rates would need to be approached carefully by the government. “For the Barbados Government to consider reducing the corporate tax rate overall from 25% to seven or eight per cent is going to be difficult, but on the other hand, of all the corporate tax collected in Barbados, 40% comes from the international business sector,” Ms. Ettinger observed. Pointing to Ireland, she said there are successful precedents for the merging of dual tax systems.

More on this story here.


The Treasury’s refusal to rule out a shake-up of the tax rules for expatriates could leave many Britons living abroad facing higher tax bills in the future, a senior Opposition spokesman has claimed. Conservative Party chairman Dr. Liam Fox has made a written enquiry into the Treasury’s plans for non-resident taxation. Dr. Fox’s chief fear would be a switch to the American style tax system for non-resident nationals whereby expats will effectively pay the same amount of tax as if they were living in the U.K.

Under current rules, Britons are taxed on income earned wholly abroad according to the tax rules of the jurisdiction in which they reside. The U.S. government however, compels its citizens working abroad make up the difference between local tax and U.S. tax if the former taxes are lower. “It is clear from the Treasury’s lack of a denial that it is looking at new ways to milk British taxpayers whether they live in the United Kingdom or not,” Dr. Fox accused the government.

More on this story here.


A federal appeals court in San Francisco ruled that Irwin Schiff, the nation’s best-known tax protester, cannot sell his book The Federal Mafia because it gives fraudulent advice and encourages people to evade income taxes. Anyone but Mr. Schiff or his associates may sell the $38 volume. However, the court hinted that Mr. Schiff may be able to sell a new edition of his book if he takes out the portions that promote his tax-evasion products and services. Mr. Schiff, 76, of Las Vegas, has twice gone to federal prison for tax crimes. He was indicted in March for helping more than 3,600 people try to evade $56 million of taxes by filing returns reporting zero income.

The court held that the book was central to the tax-evasion schemes that Mr. Schiff marketed, making it commercial speech. The government may ban commercial speech if it encourages people to commit crimes. The court’s decision upheld a June 2003 order by the Federal District Court in Las Vegas that prohibited sale of the book by Mr. Schiff and two associates. The tough language of the opinion contrasted with the tone of a February hearing in which Justice Department lawyers were grilled by two judges, who expressed skepticism that the book could be banned.

In his self-published book, Mr. Schiff asserted that people could legally escape income taxes by putting “zero” in each box for reporting income on their tax returns. The courts have rejected that claim. Mr. Schiff, reached by telephone at his store, Freedom Books in Las Vegas, said demand for his tax advice continued undiminished. “I just finished meeting with this elderly couple -- the guy has emphysema -- who owe no taxes, but the government is trying to make them pay,” he said, adding that he kept only half his usual fee in that case.

More on this story here and here.


The investors and officers of a Boca Raton web-hosting company have filed an eight-figure lawsuit claiming that accounting giant KPMG and a Chicago law firm tricked them into dumping millions into phony tax shelters during the 1990s “dot com” craze. The complaint says KPMG and law firm Sidley Austin Brown & Wood tricked their clients at Best Communications into investing millions of dollars in a succession of tax-avoidance schemes. In just one set of transactions, the suit claims, lawyers and accountants working for the defendants received $10 million commissions.

“This is a blatant example of late-90s pigs at the trough,” plaintiff attorney Ricci said. “KPMG solicited my guys and showed them extensive data from Sidley Austin and other corporate giants to hook them. KPMG’s internal analysts knew the IRS would not approve the scheme, but the commissions were so big that they went ahead anyway.”

More on this story here.


The Bush administration’s drive to outsource 850,000 federal jobs has made but slow progress, due partly to Union intransigence and partly to the administration’s lack of experience in this area, but last week saw an announcement from the IRS that restructuring of the agency’s information technology operations at 10 tax-processing sites would result in the loss of 218 jobs. The cuts will reduce staffing at the agency’s Modernization and IT Services mainframe printing operation to 60 jobs by June 1, 2005.

Colleen Kelley, president of the National Treasury Employees Union, described the cuts as a direct result of IRS officials doing their best to meet the Bush administration’s unstated quota of contracting out a certain percentage of federal jobs at each agency. As regards true “competitive sourcing”, it seems the Unions may have the upper hand: “We’ve done everything we can to slow it down, I’m very proud to say,” said Kelley recently.

More on this story here.


President Bush said on Tuesday that abolishing the U.S. income tax system and replacing it with a national sales tax was an idea worth considering. Republican economists who speak regularly to the White House have said that the Bush campaign has been mulling the idea of an overhaul of the tax code as part of an agenda for a second term should Bush win reelection. Some lawmakers have floated ideas of simplifying the tax code by putting in place a “flat” income tax rate or a national sales tax. But those ideas have so far not gained much traction in Congress.

More on this story here.

Bush not interested in national sales tax after all, says White House.

White House officials attempted to backtrack from comments made by President George W. Bush on the campaign trail this week relating to a national sales tax. Administration officials have since confirmed that the President is not considering a national sales tax as a policy initiative for a second term, according to reports. Bush’s words supplied some ammunition to his Democratic opponent in the Presidential race, John Kerry, who responded to the idea by saying, “Families already squeezed by rising health care costs, gas costs and college costs would have to carry a whole new tax burden.”

More on this story here.


As part of the Tax Exempt Compensation Enforcement Project, the IRS will contact nearly 2,000 charities and foundations to seek more information about their compensation practices and procedures. The IRS said the enforcement project will consist of examinations as well as other contacts. Because part of the project’s objective is to gather information regarding current practices, contact by the IRS should not necessarily imply improper activity by an organization. “We are concerned that some charities and private foundations are abusing their tax-exempt status by paying exorbitant compensation to their officers and others,” said IRS Commissioner Mark W. Everson.

The initiative will focus on particular areas including the compensation of specific officers and various kinds of insider transactions, such as loans and the sale, exchange or leasing of property to officers and others.

More on this story here.



New provisions contained in the third EU directive on money laundering will require professional advisers to obtain identification from trust beneficiaries. Any EU-regulated financial institution with an offshore business in the Caribbean will be governed by the new rules. Under the new proposals, which bring trusts under the same legislation which governs most other areas of the financial services sector, professional advisers will be required to obtain identification from beneficiaries who may receive more than 10% of a trust’s assets.

An unnamed legal professional explained that, “When these people are asked to produce identification, they will immediately be alerted to the existence of the trust. If they didn’t know about it, it would be quite natural for them to ask for more details. If some children are to get more than others, for instance, this could cause serious arguments.” Trusts have been extensively employed as offshore financial vehicles in most, if not all, of the Caribbean tax havens.

More on this story here and here.


A number of bogus medical malpractice insurers claiming to be based in Bermuda, but listing no more than a mailbox as their address, are under fire in the US for providing coverage to abortion clinics without state licensing. But mystery surrounds who is behind the sham companies, nor was any light shed on how they can claim to be based on the Island. The companies in question -- which are each listed on the website of investor watchdog, the Bermuda Monetary Authority (BMA), as being bogus companies, and reportedly hold no licences in the states where they have provided coverage -- were said to have been the medical malpractice insurers for a number of abortion clinics across the US.

Warnings on more than a dozen suspect companies came last month from the BMA after it became aware of sham entities purporting to be licensed, regulated or established in Bermuda. Now three of the companies on the BMA’s warning list -- Professional Liability Insurance Corp. (PLIC), Medical Risk Associates RPG and Unimed -- are cropping up in US media reports as being the subject of several state actions banning them from writing business in those states.

The trail to the beneficial owners or management of the companies goes cold at a joint mailing address with Mailboxes Unlimited. The BMA was also unable to shed any further light on the identity of the individuals behind the bogus firms.

More on this story here.


A Purpose Trust Act, a Segregated Accounts Companies Act, enhancements to the International Business Companies Act and amendments to the Perpetuities Act have all been enacted and represent the latest initiatives in what has become a busy period for legislative developments in The Bahamas. In addition, Bahamas foundations will be available in September. Investment Funds and E-Commerce Acts were also recently enacted.

More on this story here.


A consultation paper is shortly to be issued to the industry to consider whether the Island should introduce legislation allowing the formation of foundations, which act like a trust but provide the flexibility of a company. It is proposed that the legislation will be based broadly on Caribbean models.

More on this story here.


The prevalence of some phishing attacks are beginning to rival even high-level viral outbreaks, according to email filtering firm MessageLabs. For example, MessageLabs recently identified a new phishing attack directed at a well-known US bank and its customers. Within the first five hours of its appearance, MessageLabs had already intercepted over 125,000 phishing emails containing URLs to a replica of the bank’s website. By comparison, during the recent high profile MyDoom-O outbreak MessageLabs intercepted approximately 23,000 copies within the first five hours.

Scam emails that form the basis of phishing attacks often pose as “security check” emails from well-known businesses. These messages attempt to trick users into handing over their account details and passwords to bogus sites. The collected details are used for credit card fraud and identity theft. First seen more than a year ago, phishing emails are becoming increasingly sophisticated, directing users to bogus websites which accurately reproduce the look and feel of legitimate sites. In some cases the lines between phishing attacks and computer viruses have disappeared.

More on this story here.



The Patriot Act is a grab bag of enhanced police and prosecution powers. In the presidential campaign, it serves as bumper-sticker fodder for opponents, and a centerpiece of President Bush’s effort to show he has responded aggressively to domestic terror. In fact, most of the fine points in the 342-page law have generated minimal debate. But at least two parts have caused a furor across party lines.

One provision empowers the authorities to search people’s homes without notifying them at the time. That provision may have been used by federal agents to rummage through possessions of Brandon Mayfield, the lawyer from the Portland, Oregon, area suspected and later cleared of a connection to the bombings in Madrid earlier this year, said his lawyer, Steven T. Wax. Another clause, granting the government authority to go through personal library, business, medical and other personal records, may have been used in another case, though federal documents make it unclear just what the purpose was. Librarians are so riled about that provision of the Patriot Act -- Section 215 -- that they plan a nationwide survey to see whether reading and Internet habits have changed because of it. And in Congress, a vote to knock out that section fell one vote short of passage on July 8.

Last September, Attorney General John Ashcroft, in trying to quell what he called “baseless hysteria”, declassified some data and said the government had not once used the law to go into libraries. His assurance did little to curb opposition, and town-hall-style resolutions against the law -- more than 330 communities and 4 states that have condemned or expressed worry about the act -- have only picked up steam. Part of the problem may be because of the official secrecy that is welded to so much of the law, making it difficult to assess its use or effectiveness.

More on this story here.


The U.S. State Department is moving ahead with a plan to implant electronic identification chips in U.S. passports that will allow computer matching of facial characteristics, despite warnings that the technology is prone to a high rate of error. Federal researchers, academics, industry experts and some privacy advocates say the government should instead use more-reliable fingerprints to help thwart potential terrorists.

The enhanced U.S. passports, scheduled to be issued next spring for people obtaining new or renewed passports, will be the first to include what is known as biometric information. Such data, which can be a fingerprint, a picture of parts of eyes or of facial characteristics, is used to verify identity and help prevent forgery. Under State Department specifications finalized this month for companies to bid on the new system, a chip woven into the cover of the passport would contain a digital photograph of the traveler’s face. That photo could then be compared with an image of the traveler taken at the passport control station, and also matched against photos of people on government watch lists.

But federal researchers who have tested face-recognition technology say its error rate is unacceptably high -- up to 50% if photographs are taken without proper lighting. They say the error rate is far lower for fingerprints, which could be added to the chip without violating the international standard. Privacy advocates argue that taking fingerprints is no more invasive than face recognition, and certainly not more than other Bush administration initiatives launched since Sept. 11, 2001, that have sought to link databases of buying habits, bank accounts and other personal information to try to predict terrorist activity. The fingerprint data could be placed on the passport chip but not saved in a database , they said, removing the concern over a central government repository. The data on the chip is simply matched against a finger scan when the traveler arrives at the passport control station.

More on this story here.


The American Civil Liberties Union and the Privacy Rights Clearinghouse (PRC) expressed consternation over the Bureau’s provision of detailed data on individuals of Arab descent to the Department of Homeland Security, and urged the Bureau to create “a new outside body to advise the bureau on privacy and civil liberties issues.” The letter also asked the Bureau to institute procedures for overseeing the provision of sensitive data in such cases. “No law appears to have compelled the Bureau to provide this information, and we believe that the decision to do so violates the spirit of trust held by millions of Americans that the information they furnish on the Census will not be used against them by law enforcement agencies,” said the letter.

More on this story here.


Expanding its US-VISIT pilot program starting Sept. 4, the U.S. Homeland Security Department will begin recording and verifying digital fingerprints and photographs of all visa-holding foreign nationals who leave the United States through Marin Airport. The airport has been collecting photograph and fingerprint information of foreign visa holders entering the country since January. By combining the entry and exit systems, the Homeland Security Department will know when visitors have overstayed their welcome and will be able to track exactly who is in the country -- but not where they are -- at any given time. The department also can compare the verified identities to names on security watch lists.

More on this story here.


The government is increasingly using corporations to do its surveillance work, allowing it to get around restrictions that protect the privacy and civil liberties of Americans, according to a report released by the ACLU. Data aggregators -- companies that aggregate information from numerous private and public databases -- and private companies that collect information about their customers are increasingly giving or selling data to the government to augment its surveillance capabilities and help it track the activities of people. Because laws that restrict government data collection do not apply to private industry, the government is able to bypass restrictions on domestic surveillance. Congress needs to close such loopholes, the ACLU said, before the exchange of information gets out of hand.

“Americans would really be shocked to discover the extent of the practices that are now common in both industry and government,” said the ACLU’s Jay Stanley, author of the report. “Industry and government know that, so they have a strong incentive to not publicize a lot of what’s going on.” The ACLU released the Surveillance-Industrial Complex report in conjunction with a new website designed to educate the public about how information collected from them is being used.

The report listed three ways in which government agencies obtain data from the private sector: by purchasing the data, by obtaining a court order or simply by asking for it. Corporations freely share information with government agencies because they do not want to appear to be unpatriotic, they hope to obtain future lucrative Homeland Security contracts with the government or they fear increased government scrutiny of their business practices if they do not share. And a 2002 survey found that nearly 200 colleges and universities gave the FBI information about students. Most of these institutions provided the information voluntarily without having received a subpoena.

More on this story here.


Government officials at the National Transportation Safety Board are trying to leverage an emotive incident to push regulations that infringe on American privacy and civil liberties. On July 16, 2003, George Weller, 86, drove his car headlong into an outdoor farmers market in Santa Monica, California, killing 10 people and injuring 63. The safety board said last week that, based on its investigation of that accident, the government should require “black box” data recorders in all passenger vehicles. But officials failed to substantiate why the accident, while certainly tragic, proved a need for black boxes -- which record vehicle performance and driver actions, such as brake activity, speed and whether seat belts were in use.

An elderly man hit the wrong pedal, and no magic box would have saved the lives of the victims. It appears the safety board, which has only the power to investigate and make recommendations, picked that particular accident not because it technically supported its recommendation, but because of its egregious nature. An estimated 25 million vehicles are equipped with black boxes, though many consumers are not aware of them. This points to another problem. Who does the information in the boxes belong to? At the very least, consumers should be allowed to decide whether they want to purchase a car that could be used for or against them.

More on this story here.

New RFID chip-based technology tracks cars.

South African RFID chip and reader design firm iPico Holdings announced the commercial availability of its Electronic Number Plate (ENP) RFID technology. The company says its technology is already being deployed in a pilot in South America. IPico’s new technology uses an passive chip design already used for supply chain management and tire-tagging applications. For its ENP system, however, the company redesigned the tag so it could be attached to the inside of a vehicle’s windshield and developed readers for roadside placement.

Using RFID in electronic vehicle identification promises to support a range of applications both for government and local authorities and for businesses. The technology is being considered for electronic vehicle licensing, traffic, speed and cross-border control and traffic ticketing, as well as for existing operations such as road toll collection and fleet and parking management.

More on this story here.


The Federal Communications Commission voted 5-0 last week to prohibit businesses from offering broadband or Internet phone service unless they provide police with back doors for wiretapping access. Formal regulations are expected by early next year. But the commissioners did not give the FBI and its allies at the Justice Department and the Drug Enforcement Administration everything they wanted. In the police agencies’ original request they asked the FCC to force surveillance back doors into instant-messaging programs and voice over Internet Protocol (VoIP) applications that do not use the traditional telephone network. The FCC politely declined, with Chairman Michael Powell saying those services were exempt from the Communications Assistance for Law Enforcement Act (CALEA) and that it was “unnecessary to identify future services and entities subject to” mandatory wiretapping requirements.

So what happens next? Here are some questions that could be asked of Attorney General John Ashcroft and FBI Director Robert Mueller.

More on this story here.


Federal security officers will take over the screening of all passengers on helicopter tours in New York City, after officials found that suspected Qaeda operatives in Pakistan had photographs, a brochure and other information about the tours. A security directive orders federal screeners to begin doing passenger inspections in the city’s three heliports, a job now done by private security contractors. Passengers will be subject to the same types of searches for weapons, explosives and suspicious items as are now in place at airports.

The helicopter tour operators will also be required to provide the names of passengers to the federal government to run against federal “no fly” lists of terrorist suspects and to provide names and data on their own employees for federal background checks. The operators will also have to name a security coordinator, to be available 24 hours a day to respond to federal inquiries. While federal officials have imposed broad safety measures on the aviation and rail industries since the Sept. 11 attacks, the move to tighten security at New York’s heliports marks the first time that they have imposed these types of stepped-up measures at specific sites because of a perceived threat.

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The American Civil Liberties Union announced that it has created a coalition of more than a dozen non-profits opposing the policies of the Combined Federal Campaign (CFC) that require charities to check their employees against a “watch list” in order to receive CFC donations. The ACLU will pursue all available remedies to counter this policy and is working in coalition with 15 organizations that “proudly join the ACLU in protesting this dangerous and ill-informed policy.”

“The government’s ‘war on terror’ now threatens America’s non-profit charities,” said ACLU Executive Director Anthony Romero. “The administration’s requirement to check employees against a watch list in order to receive CFC funds has created a climate of fear and intimidation that threatens the health and well-being of all non-profits -- the people who depend on them and, indeed, the nation as a whole.”

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While biometric technology is not new, having seen use for years to restrict access in corporate and military settings, it is only now creeping into everyday life. Over the next few years, people currently unfamiliar with the technology will be asked to use it in everything from travel settings to financial transactions. To rent, close and reopen lockers, Statue of Liberty visitors touch an electronic reader that scans fingerprints. The Nine Zero, an upscale hotel in Boston, recently began letting guests in its $3,000-a-night Cloud Nine suite enter and exit by looking into a camera that analyzes their iris patterns. Piggly Wiggly Co. grocery stores in the South just launched a pay-by-fingerprint system, though pilot tests elsewhere have had lukewarm results.

Fingerprint biometric systems generally work by reducing the image of a print to a template, a mathematic algorithm that gets stored in a database and can be checked when the person returns for later scans. In applications like the biometric lockers, the print itself is not stored or sent to authorities. However, prints are being run through terrorist watch lists in the biggest deployment of biometrics yet -- the federal government’s new system for tracking foreign travelers.

Now in its early stages, the program, known as US-VISIT, calls for visitors to go through biometric scans to ensure that they are who their visa or passport says they are. Passports issued by the United States and other countries are getting new chips that will have facial-recognition data, and other biometrics might be added. Separately, iris-scanning systems have cropped up in European airports as a way to speed immigration controls.

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Riggs National Corp.’s money-laundering problems, which included a $25 million fine and the loss of its embassy banking business, cost the D.C. banking company at least $40 million in the second quarter. As a result, Riggs is likely to report a hefty loss when it releases its results for the quarter ended June 30. In addition to the record fine assessed by bank regulators in May for failing to follow anti-money-laundering procedures, the bank’s bottom line also will be eroded by other costs, which the bank has announced previously. These include a charge of between $15 million and $21 million to account for the costs of exiting its embassy and international banking divisions -- not to mention a pile of bills from lawyers and consultants hired to help Riggs with the fallout from the scandal.

Riggs, which has agreed to be acquired by PNC Financial Services Group of Pittsburgh, will be a significantly smaller company. The bank has said that its decision to exit or sell its embassy and international business will eliminate about $1.05 billion of deposits -- about a quarter of its entire deposit base. Included in that is about $360 million from one customer, Equatorial Guinea, which was told by Riggs officials in February to take its business somewhere else after internal investigators -- acting after banking regulators raised concerns -- found evidence of potential money laundering by the country’s ruling family. Equatorial Guinea had been with Riggs for nearly 10 years, and it was the company’s biggest depositor, most of the money coming from huge contracts for oil extraction off the coast of West Africa. Its dealings with Equatorial Guinea as well as its deposit relationship with the embassy of Saudi Arabia led to the $25 million fine. Riggs had failed to file reports of suspicious transactions involving those customers.

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Thousands of Tube passengers are being stopped in a secret operation using tactics the police are specifically forbidden from deploying. Immigration officers are stopping anyone they consider to look or sound foreign and asking them to produce their papers to prove their right to British residence. Their aim is uncover illegal immigrants and failed asylum seekers. The existence of the spot-check operation has been kept secret by the Home Office but an Evening Standard investigation discovered that teams of immigration officers have been carrying out the procedures since May 2003.

The discovery that these tactics are being used prompted a political row -- the Liberal Democrats are set to write to the Home Secretary demanding an explanation for a scheme civilrights groups dubbed “Stalinist”. Barry Hugill, of the civil rights group Liberty, said that, “Stopping people and checking their papers is what we used to associate with the old communist states. It’s real stab-in-the-dark stuff. It is not intelligence-led, it’s ‘lets see what we can get today’.”

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Jose Padilla will have to be released -- unless the government somehow conjures up charges of treason or criminal acts. To be sure, the Supreme Court’s June 28 opinion in Rumsfeld v. Padilla literally said nothing of the sort. In fact, it did not reach the merits of the case at all. Still, the inescapable conclusion, based on the Court’s same-day opinion in Hamdi v. Rumsfeld, is that Padilla will soon be charged or freed.

Here is what is happening: Jose Padilla is the U.S. citizen who supposedly plotted to detonate a “dirty bomb” and use natural gas to blow up apartment buildings in Washington D.C., New York and Florida. Since his capture -- not on the battlefields of Afghanistan or Iraq, but at Chicago’s O’Hare Airport -- he has not been charged with any crime. Yet since June 2002, Padilla has been held incommunicado in a South Carolina military brig -- indefinite detention, without access to a lawyer until the government acceded to outside pressure in March 2004.

Essentially, the Supreme Court ducked its opportunity to decide whether Padilla’s detention is permissible. Chief Justice Rehnquist, joined by his four conservative allies, held that the head of the military brig in South Carolina, Commander Marr, not Defense Secretary Donald Rumsfeld, was the person whom Padilla should have sued. Marr was Padilla’s immediate custodian, and she was not within the jurisdiction of the New York federal courts, where Padilla filed his case. That rule, said Rehnquist, is to prevent “forum shopping” by detainees seeking release under the habeas corpus statute. As a result, Padilla had to start over -- he has now re-filed his petition in South Carolina.

So what happens next? I doubt that the government has a compelling case, or the Justice Department would have filed charges long ago. Still, charges will probably be filed, if only because the logic of the Hamdi case suggests that the government’s alternative, like it or not, is to release Padilla.

Padilla may deserve the treatment he is receiving -- maybe worse. That is not the point. When American citizens are taken into custody, they have, at a bare minimum, the right to retain an attorney. Then an impartial court, not the president, should make the ultimate decision as to whether the arrest and imprisonment comport with the Constitution. In Padilla’s case, five justices now say his ongoing detention is unacceptable. That is why Padilla must be charged or released.

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A report by Daniel W. Sutherland, Officer for Civil Rights and Civil Liberties at the U.S. Department of Homeland Security, in a lecture at the Heritage Foundation.

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Data storage and retrieval is the critical compliance issue facing IT directors at investment banks, life and pensions firms and insurance companies, according to a survey conducted on behalf of Microsoft. According to the survey of 80 financial institutions, one in five IT manangers feel information retention and the ability to prove to the Financial Services Authority (FSA) that data is secure and accessible is the most critical compliance issue.

Microsoft says respondents are concerned that the increasing need to retain vast amounts of unstructured data, such as telephone conversations, text messages and e-mails, to ensure compliance, is overloading systems. Data retrieval is also seen as a major hurdle, with respondents highlighting prolems such as an inability to keep track of files that are sent across different lines of business and applications. The storage and retrieval of e-mail is also cited as a major concern, particularly in light of recent regulatory legal cases such as Andersen and CSFB where e-mails have been used as evidence.

Furthermore, IT directors at financial institutions believe that strategies for document retention and retrieval are being hindered by conflicting regulatory requirements. For instance the Data Protection Act states that customer data should not be retained unnecessarily, while anti-money laundering laws require firms to store customer data for significant periods of time.

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Citing concerns about terrorists crossing the nation’s borders, the Department of Homeland Security announced that it planned to give Border Patrol agents sweeping new powers to deport illegal aliens from the frontiers with Mexico and Canada without providing them the opportunity to make their case before an immigration judge. The move, which will take effect this month, represents a broad expansion of the authority of the thousands of law enforcement agents who currently patrol the nation’s borders. Until now, Border Patrol agents typically delivered undocumented immigrants to the custody of the immigration courts, where judges determined whether they should be deported or remain in the United States.

Homeland Security officials described the deportation process in the immigration courts -- which hear asylum claims and other appeals to remain in the country -- as sluggish and cumbersome, saying illegal immigrants often wait for more than a year before being deported while straining the capacity of detention centers and draining critical resources. Under the new system, immigrants will typically be deported within eight days of their apprehension, officials said.

Joseph Giuliano, assistant chief of the U.S. Bureau of Customs and Border Protection station in Blaine, said yesterday’s directive would affect just “a small segment” of the people his border station sees. The order, he said, also allows authorities to hold those aliens in custody pending the final resolution of their case -- as opposed to the current system, which allows detainees to be released on bond pending the outcome of their cases. What Giuliano said has frightened him is the possibility that someone could have been released on bond just long enough to allow completion of nefarious plans -- “and then have something go ‘boom’ somewhere in the United States.”

The decision prompted a flurry of criticism from advocates for immigrants who feared that the new system lacked adequate safeguards to ensure that people fleeing persecution, U.S. citizens lacking paperwork or other travelers with legitimate grounds to be in the United States would not be improperly deported. Neha Chandola, legal director with the Northwest Immigrants Rights Project, said the ruling will inevitably increase the number of people who face mandatory detention -- and could increase the length of time some stay in the system without legal recourse, despite the ruling’s stated objective of expediting the removal process.

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Though it sounds simple enough, the State Department has yet to reform meaningfully this crucial component of the war on terror. The backbone of visa policy for temporary travelers, a category that included all 19 9/11 hijackers, is a law known as 214(b). Enacted in order to limit temporary visas to legitimate travelers, it states that a visa applicant is considered ineligible until proving his own eligibility. To overcome the presumption, an applicant must show sufficient ties to his home country, such as a house, spouse or secure employment, to convince the consular officer he will return home. How does this work to keep out terrorists? The people most likely to be refused under 214(b) are those most likely to be terrorists: young, single, unattached males. Which is exactly what happened before September 11 -- but for the most part only to non-Saudis.

The September 11 commission connected the dots, revealing in their report that properly enforced visa policy dealt a severe blow to al Qaeda’s plot: Eight of Khaled Sheikh Mohammed’s 27 handpicked operatives were effectively prevented from entering the United States. Six were denied entry because of 214(b), and two Yemenis personally chosen by Osama bin Laden also never reached our shores, because as the commission noted in a previous staff statement, “It soon became clear to KSM that the other two operatives, Khallad bin Attash and Abu Bara al Taizi -- both of whom had Yemeni, not Saudi, documentation -- would not be able to obtain U.S. visas.”

Had visa policy been enforced uniformly for all 27 operatives, however, potentially at least 23 of them would have been denied entry. The visa applications of 15 of the hijackers (those of the other four had been destroyed pursuant to standard procedures) were so deficient that none cleared the hurdle set by 214(b). All contained significant errors and omissions, as the commission found. Even if the applications had been completed properly, notes former consular officer Nikolai Wenzel, “each applicant fit the profile of a classic overstay and should have been refused on the merits.” It was no coincidence that all but one of the 15 were Saudis. The General Accounting Office (GAO) found in an October 2002 report that the red carpet shown them was par for the Saudi course: 99% of Saudi nationals applying for visas before September 11 were approved.

This open door was provided despite abundant evidence of pre-September 11 al Qaeda activity in Saudi Arabia. With 15 of the hijackers hailing from the Kingdom, such evidence is now sadly tangible. The continual al Qaeda bombings there only provide further proof that the terrorist outfit is alive and well in Saudi Arabia. Yet the State Department’s approach to Saudi visas has changed only marginally. Enforcing 214(b) in Saudi Arabia as is done elsewhere, though, might be a blow to diplomacy. Therein lies the basic problem.

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The use of torture to obtain evidence against suspected terrorists was endorsed by the Court of Appeal in a ruling that has brought Britain into conflict with international human rights campaigners. Two of the country’s senior judges granted the Home Secretary the right to hold terror suspects on the basis of intelligence from tortured prisoners at Guantanamo Bay and other US detention camps. Human rights groups and experts on international law said Britain had, in effect, been given the green light to trawl for evidence from torture victims across the world. David Blunkett said the judgment on the fate of the detainees is a clear vindication of his policy on terrorism.

In a 190-page judgment, Lord Justice Laws said he was “quite unable” to see why the Home Secretary could not rely on evidence “coming into his hands which has or may have been obtained through torture by agencies of other States over which he has no power of direction.” The judge added, “If he has neither procured the torture nor connived at it, he has not offended the constitutional principle which I have sought to outline.” He said he could not believe “that the law should sensibly impose on the Secretary of State a duty of solemn inquiry as to the interrogation methods used by agencies of other sovereign states.”

The solicitor of the men who brought the case, Gareth Peirce, described as “terrifying” the suggestion in the judgment that evidence obtained through torture could be admissible. “It shows that we have completely lost our way in this country legally and morally,” she said. “We have international treaty obligations which prevent the use of evidence obtained by torture in any proceedings.” Shami Chakrabati, director of the human rights group Liberty, said the effect of the judgment would encourage the police and security services to adopt a policy of “hear no evil, see no evil.”

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Rep. Porter Goss, President Bush’s nominee to head the CIA, recently introduced legislation that would give the president new authority to direct CIA agents to conduct law-enforcement operations inside the United States -- including arresting American citizens. The legislation, introduced by Goss on June 16 and touted as an “intelligence reform” bill, would substantially restructure the U.S. intelligence community by giving the director of Central Intelligence (DCI) broad new powers to oversee its various components scattered throughout the government. But in language that until now has not gotten any public attention, the Goss bill would also redefine the authority of the DCI in such a way as to substantially alter -- if not overturn -- a 57-year-old ban on the CIA conducting operations inside the United States.

The language contained in the Goss bill has alarmed civil-liberties advocates. It also today prompted one former top CIA official to describe it as a potentially “dramatic” change in the guidelines that have governed U.S. intelligence operations for more than a half century. A congressional source familiar with the drafting of Gosss bill said the language reflects a concern that he and others in the U.S. intelligence community share -- that the lines between foreign and domestic intelligence have become increasingly blurred by the war on terrorism.

At the time he introduced the bill, Goss thought the 9/11 commission might recommend the creation of a new domestic intelligence agency patterned after Britain’s M.I.5. The commission ended up rejecting such a proposal on civil-liberties grounds. Congressional staffers predicted that the Goss bill, even if it has little chance of passage, is likely to get substantial scrutiny at his upcoming confirmation hearings -- in part as an opportunity to explore his own attitudes toward civil liberties. Those hearings are already expected to be unusually contentious -- partly because of concerns among Democrats that the Florida Republican, a former CIA officer himself who has chaired the House Intelligence Committee, has been too partisan and too close to the Bush White House.

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Former New York City Mayor Rudolph Giuliani was entering his final days in office when the city was attacked by terrorists on September 11. The experience changed him forever, and made him a national symbol of someone who helped the city and the country stand up and respond to what had happened. Although he has been mentioned as a possible national political candidate, he remains in the private sector for now, helping client companies best prepare a defense against future attacks. His company, Giuliani Partners, advises on everything from crisis management and data security to promoting technologies that help detect and contain the effects of chemical, biological, radiological, nuclear, or explosive devices (see “Security: What Companies Need to Do”).

He recently spoke with BusinessWeek Associate Editor Diane Brady about the latest talk of terrorist threats. Edited excerpts of their conversation follow.

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The war on terrorism is the first political growth industry of the new millennium. After the September 11 attacks on the World Trade Center and the Pentagon, President George W. Bush promised to lead a “crusade” to “rid the world of evil-doers.” Unfortunately, the political fallout from the 9/11 attacks could fatally blight both individual liberty and public safety.

After the terrorists killed thousands of Americans, the United States had the right and the duty to retaliate against the perpetrators -- the Al Qaeda network -- and destroy their ability to ever strike the United States again. Bush’s initial response to the attacks received almost universal support among the American public and pervasive support from foreign governments. But as time passed, the Bush administration continually broadened the war. The response to attacks by a handful of killers is morphing into a campaign to vanquish all potential enemies of U.S. hegemony and to impose American political values on much of the world.

Like a phoenix rising from the ashes, Americans’ trust in government soared after the terrorist attacks. The surge in trust was spurred by a profusion of false government statements in the aftermath of the attacks. The Bush administration did everything possible to portray the United States as a blindsided innocent victim. In reality the feds were asleep at the switch. After 9/11, the Bush administration rushed to increase the power of federal agencies across the board. Because of the actions of a handful of terrorists on September 11, federal agents could have more power over all Americans in perpetuity. The Bush administration converted the terrorist assault into a trump card against American privacy. The Patriot Act gave the feds the right to financially strip-search every American. It created new financial “crimes without criminal intent”.

At the same time that Bush is making government more powerful, he is making it much less accountable. While Bush perennially invokes freedom to sanctify his antiterrorism policies, freedom to dissent may be on the endangered list. The federal Homeland Security Department is urging local police departments to view critics of the war on terrorism as potential terrorists. In a May 2003 terrorist advisory, the Homeland Security Department warned local law enforcement agencies to keep an eye on anyone who “expressed dislike of attitudes and decisions of the U.S. government.”

Despite continual victory proclamations out of Washington, there is no end in sight for Bush’s war on terrorism. Despite scores of billions of dollars of new government spending, despite the hiring of legions of new federal agents, and despite the U.S. military campaigns to overthrow the Taliban and Saddam Hussein, Americans continue to be at grave risk. The federal government must vigorously defend America against terrorists. But is the United States suffering more from political exploitation of terrorism than from terrorists? Is the Bush administration’s aggression creating more terrorists than it is vanquishing? And what are the prospects for the survival of American liberty from an endless war against an elusive, often ill-defined enemy?

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Police State USA

ast week’s announcement that the terrorist threat warning level has been raised in parts of New York, New Jersey, and Washington, D.C. has led to dramatic and unprecedented restrictions on the movements of citizens. Americans wishing to visit the U.S. Capitol must, for example, pass through several checkpoints and submit to police inspection of their cars and persons. Many Americans support the new security measures because they claim to feel safer when the government issues terror alerts and fills the streets with militarized police forces. Freedom is not defined by safety. Freedom is defined by the ability of citizens to live without government interference. Government cannot create a world without risks, nor would we really wish to live in such a fictional place.

To understand the nature of our domestic response to the September 11th, 2001 attacks, we must understand the nature of government. Government naturally expands, and any crises – whether real or manufactured – serve to justify more and more government power over our lives. Bureaucrats have used the tragedy of 9/11 as an excuse to seize police powers sought for decades, such as warrantless searches, Internet monitoring, and access to bank records. It should be no surprise that the recently released report of the 9/11 Commission has but one central recommendation: bigger government and more spending at home and abroad.

Every new security measure represents another failure of the once-courageous American spirit. The more we change our lives, the more we obsess about terrorism, the more the terrorists have won. Every generation must resist the temptation to believe that it lives in the most dangerous time in American history. The threat of Islamic terrorism is real, but it is not the greatest danger ever faced by our nation. Liberty is lost through complacency and a subservient mindset. When we accept or even welcome automobile checkpoints, random searches, mandatory identification cards, and paramilitary police in our streets, we have lost a vital part of our American heritage.

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Many pundits have noted that political conventions no longer excite us. They bore us to death. The nominations are already locked up before conventions even begin, so there is no suspense. Why even hold these empty political orgies? Well, they do serve one function: They support the fiction of the two-party system. Both parties pretend it makes a big difference which candidate wins. Both sides agree to pretend they are not essentially the same party.

Hollywood is about to give us another candidate: The Manchurian Candidate, a remake of the 1962 satirical political thriller. This time, the Cold War being behind us, the villains aren’t Commies. They are corporate executives, in keeping with Hollywood’s preference for conspiratorial businessmen. Sounds pretty implausible. I can imagine a more believable version for our age: A robotic Texan from a prominent Republican family is kidnapped and brainwashed by a shadowy group of political “progressives”. He is then set up in a political career in order to subvert the conservative movement. His mission is to keep expanding the government, while using conservative rhetoric in order to fool gullible talk-show hosts whose support he needs. When he is elected president of the United States, he is to complete the consolidation of the two parties into one huge big-government party. Chilling, eh? But of course such a conspiracy would be superfluous. The same result is being achieved without it.

G.K. Chesterton long ago identified the flaw in a two-party system: “The democracy has the right to answer questions, but it has no right to ask them. It is still the political aristocracy that asks the questions. And we shall not be unreasonably cynical if we suppose that the political aristocracy will always be rather careful what questions it asks.” The myth of democracy requires the voters to be assured that they are making real choices. It will not do to admit that the choices that count have already been made for them. The Single Party must go on pretending that it is Double.

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Reality has not dealt kindly with the hopes and expectations conjured up to justify Operation Iraqi Freedom. Although the war may not be lost, it cannot be won, at least not as the Bush administration once defined winning. What then are we to make of this experience? The question may strike some as premature. Whether President Bush (or President Kerry) “stays the course” or cuts American losses, difficult days lie ahead. The bill yet to be levied for this misadventure promises to be steep. More Americans and even larger numbers of Iraqis will lose their lives.

Yet even as events wind their way toward what promises to be a deeply unsatisfactory denouement, the argument over what it all means must necessarily be joined. Common sense dictates that we apply to future U.S. policy what we have learned in Iraq, and the future will not wait. With an eye toward that future -- and with no claim that any of what follows qualifies as definitive -- herewith a first cut at identifying the war’s operative lessons.

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Iraq on the verge of implosion.

After five weeks in Iraq, British reporter Robert Fisk gave a very pessimistic assessment of the situation in Iraq. Keep in mind that Fisk is not the kind of hotel-bar reporter who occasionally picks up a press release. He risks his life to get out among the Iraqis to find out what is really going on. He recently drove south on the main highway and found that for 70 miles every single Iraqi police post had been abandoned. He says that the American-appointed government does not even control all of Baghdad, much less the rest of the country. He reports that the country is in chaos, so much so that the cheerful assessments being put out in London and Washington are mystifying.

Iraq has never been easy to govern, even by a dictator. And one thing all Iraqis share is a hatred of foreign occupiers. And, despite the public-relations sleight of hand in supposedly giving sovereignty to a government with no power to assume it, we are still viewed as occupiers -- which, in truth, we are. Unfortunately, we are occupiers who, despite all these months and all these billions of dollars, cannot get the electricity up and running on a consistent basis, cannot repair the sewer and water plants our bombs destroyed, and cannot keep the oil flowing to the world market at a regular pace. Most Iraqis live in fear and squalor, and they blame us. After all, we bombed them for a decade and imposed sanctions that were the equivalent of a medieval siege. We stood by while looters destroyed what the bombs had left. We disbanded their army and police force.

If we do not get out of Iraq soon -- in months, not years – we are going to be as intensely hated by the Iraqis as the Israelis are by the Palestinians -- for the same reason. In the meantime, the number of Americans killed is pressing steadily toward the 1,000 mark, and the number of permanently maimed is already profoundly sad. For what have these brave young men and women sacrificed their lives? I think Rudyard Kipling has the answer. “If any question why we died, Tell them because our fathers lied,” he wrote in a bitter poem after the war that had claimed his only son.

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Certain historical events become so covered in myth and significance, so overlaid with patriotism and emotion, that over time many people forget what really happened and why. Napoleon’s fatal 1812 march on Moscow is one such event. As Adam Zamoyski puts it, “No other campaign in history has been subjected to such overtly political uses.” Generations of Russian children were brought up on a story of the gallant Czar Alexander, who rallied the peasantry to defend the homeland, cleverly enticed the French into Moscow, then burned the city and forced Napoleon’s army to retreat during a frozen winter. Romantic writers -- C.S. Forester, for one -- turned the story into a fable of heroism in defeat; romantic composers -- Tchaikovsky, most famously -- were inspired to write stirring music. Leo Tolstoy put the 1812 campaign at the heart of his novel War and Peace, celebrating it as a parable: the expulsion of corrupting foreign influences from the soil of ancient Russia.

But all of the patriotism, mythology, fiction and song that followed the events of that year has, in the subsequent two centuries, nearly obscured the story of the invasion itself. Zamoyski, a British historian of Polish origin and the author of numerous books, wanted to use firsthand accounts and memoirs in order to put right the facts and bring alive the history in a way that would make sense to contemporary readers. He has succeeded, in Napoleon’s Fatal March.

Some 600,000 troops crossed the Niemen River into Russia in the summer and fall of 1812, among them Frenchmen, Germans, Poles, Italians and Swiss. About 400,000 of them died, on the march, in battle and during the horrific winter retreat. Similar numbers are thought to have perished on the Russian side. The tragedy was not only vast, it was also pointless. “I have no wish to make war on Russia,” Napoleon told a Russian envoy in 1811. In fact, the two monarchs had engaged in an odd dance of friendship and enmity for many years preceding the war. But when Alexander began moving his troops to his Western borders, apparently challenging Napoleon’s control over former Polish territory, Napoleon simply felt obligated to respond. The drift to battle looks a lot like the chain of unstoppable events that led to the outbreak of World War I. This was hardly a war of ideas.

The pointlessness of the high politics surrounding 1812 did not make the experiences of those doing the fighting any less powerful. Both armies contained an extraordinary group of personalities, and there are many wonderful portraits in this book. By the end of the book, the tragedy is so vast that it is hard not to feel some more recent echoes. The movement of mass armies over vast tracts of Central Europe, the terrible privations suffered by ordinary soldiers, the devastation of the landscape, the loyalties sworn to various vague causes -- all are eerie precursors of much later wars. Napoleon’s wasteful, hubristic march on Moscow was truly a harbinger of the greater devastation to come. For that reason alone, it is worth retelling.

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In any war, one of the most useful opportunities is a chance to see the conflict through the other side’s eyes. A Marine captain recently sent me a fascinating look at the misnamed “war on terror” through the eyes of al Qaeda, in the form of an interview by an al Qaeda journal, Sawt Al-Jihad, of Fawwaz bin Muhammad Al-Nashami, who is identified as the leader of the attack at Khobar, Saudi Arabia, on May 29 of this year in which 22 “infidels” were killed. Internal evidence suggests the account probably is genuine, even as there is also no doubt that much of what Al-Nashami says is propagandistic. But al Qaeda is a sophisticated operation, sufficiently so to understand that good propaganda contains as much truth as possible.

The story is a blow-by-blow, hour-by-hour tale of the Khobar raid. From the standpoint of Fourth Generation war (4GW) theory, what stands out most strongly is its intense mix of ancient and modern. Much of Al-Nashami’s account could come straight from Homer. It stresses the vast strength and great riches of the opponent, contrasted with the weakness of the four men who made up the al Qaeda raiding group. Allah is a constant player, just as gods fought for Greeks and Trojans. Yet the modern is intimately mixed in, with precision timing, multiple recons, and the use television both to send and receive information. This mix of ancient and modern is a central characteristic of 4GW, and it is one of the strengths of religiously motivated non-state forces. It is also a very difficult thing for militaries such as our own to understand. It is central to our opponents’ strength at the moral level.

Again, there is no question that the account is propaganda. But propaganda is itself revealing. It allows us to see our enemies as they see themselves, and the self-image of al Qaeda that emerges from this account is one that should concern us. The seamless blending of ancient and modern, of divinely protected heroism and technological competence, is potent. That is particularly true when, as in this case, al Qaeda’s opponent is the hired troops of a corrupt regime -- a regime America depends on to keep the oil flowing. If, in war, one of the keys to success is pitting strength against weakness, al Qaeda knows all too well what it is doing. And its chances of victory are substantially greater than any tally of resources or troops numbers would suggest.

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Economists use the terms “on the margin” or “marginality” often. The Mises Circle in interwar Vienna even had songs with refrains that included the words “Marginal Utility”. On the very first day of my principles courses, I teach my students that people make decisions “on the margin”. Of course, this pronouncement is greeted primarily with looks of resigned boredom and/or helplessness. I try to clarify by saying that if we look at a piece of paper, the margin is just the edge, not the entire sheet. This explanation also does little good. The fact is, economists are so used to marginal thinking that they have a hard time explaining it to someone who has never heard of it before. And so what I do is jump quickly into some examples.

The most famous application of marginalism is the solution to the so-called water-diamond paradox, which seemed to stump Adam Smith in his Wealth of Nations. Why do diamonds have a higher exchange value than water, when diamonds are a mere frippery while water is essential to life? Should people not be willing to offer more in exchange for a unit of water than for a unit of diamonds? The solution, of course, is that no individual is ever in the position of choosing between all of the diamonds in the world and all of the water in the world. A given choice is made on the margin. If offered a choice between a cup of water and a handful of diamonds, most people would pick the latter because the marginal utility of those particular diamonds is higher than the marginal utility of that particular cup of water.

The classical confusion over use and exchange value resurfaces in modern times whenever someone laments: “Teachers make only a fraction of what professional athletes make! Doesn’t this country care about education more than sports?!?” Again, such statements do not take into account the fact that decisions are made on the margin. The fact that a teacher makes $25,000 while a baseball player makes $250,000 does not imply that anyone thinks baseball is more important than education. All it really means is that the first employer believes that the services of that particular teacher are worth (at least) $25,000, while the second employer believes that the services of that particular baseball player are worth (at least) $250,000. As with water and diamonds, the issue is one of relative scarcity.

A logical extension of marginalist thinking is the notion of sunk cost. The principle here is usually summed up by the expression, “Bygones are bygones”. For some reason, people have a tendency to make inferior present decisions out of a misguided attempt to mitigate previous errors in forecasting. An example would be someone who spends $1000 on a gym membership, and then forces himself to go every day, even though he would not do so if the membership had cost only $100. That $1000 is already gone -- the man must now decide, each day, whether to go on that day or not. Each choice is a marginal one; his earlier actions cannot be undone. He is no longer in the position of choosing whether or not to join the gym.

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Washington, D.C., as designed by the French artist and engineer Pierre L’Enfant, was meant to be a city of grand open spaces, with wide, tree-lined avenues flowing into graceful circles. In 1899, the U.S. Congress restricted the height of buildings in the city to keep its skyline of national memorials intact. The city’s splendid parks reinforce its quality of physical openness. But today, Washington’s open spaces -- symbolic of unfettered democracy -- are under attack in the “war on terrorism”. The capital’s public areas have been ambushed, victims of security measures that are destroying the fabric of the city.

On Aug. 1, Homeland Security Secretary Tom Ridge announced that the threat alert level for the financial services sector in Washington and two other cities had been raised from yellow (elevated risk) to orange (high risk). He cited new and unusually detailed intelligence regarding targets that al-Qaida planned to attack, including the headquarters of the International Monetary Fund and the World Bank. Under an orange alert, federal departments and agencies “should take additional precautions at public events” and restrict “threatened facility access to essential personnel only.”

The result of these and other guidelines is that in downtown Washington, site of America’s most important monuments, it is becoming increasingly difficult to live a normal urban life. The tightening of security looks set to continue. Ordinary Washingtonians are reacting with confusion, irritation and frustration to the security measures, the logic of which, starting with the color code itself, is not clear to most folks. “Alert fatigue” is an increasingly common psychological condition in Washington. Current city leaders are outraged at what the federal security apparatus is doing to the city.

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The U.S. government’s budget deficit this fiscal year will be in the range of $450 billion. If we assume an $11 trillion economy (GDP), the deficit is in the range of 4.2%. The figure for GDP is deliberately misleading. It counts government expenditures as part of the productive output of the nation. If we are comparing the burden of the national deficit on the productivity of taxpayers who actually produce something of value, the deficit’s burden is much higher. Governments at all levels extract about 40% of the output of the nation. If we reduce the GDP estimate by, say, 80% of 40% (32%), we get a GDP of a little under $7.5 trillion ($11 trillion x 0.68). The deficit this year will be in the range of 6.2% of total productive output. The official federal debt is over $7.3 trillion. You can monitor this on the U.S. national debt clock. Your personal share of this is a little under $25,000. If you are married, add another $25,000. This is the per capita burden, which includes children. Like the GDP, this figure is misleading. It does not count off-budget programs, most notably Social Security/Medicare. Add another $50 trillion for Social Security/Medicare.

When interest rates rise -- as they surely will -- the economic burden imposed by these growing deficits will increase. The stock market will be in even worse shape than it is today. Corporate debts must be repaid. Rising rates will be bad news for holders of bonds, because existing bonds fall in price when long-term interest rates rise.

No one in Washington is willing to tell us how they can cut taxes, increase benefits, and get out of Iraq. Kerry gave assurances, but his assurances are not backed up by numbers. Bush will either follow suit at the Republican convention or just avoid giving assurances. Voters do not want to hear the economic truth. The economic truth, even more than Medicare, is the third rail of American politics. Here is the economic truth: “If you ain’t got any, you can’t re-distribute it.” The government has only one thing left, the illusion that it can and will pay its bills with money that is still worth what it is worth today. It cannot. It will not. Do not be on the receiving end. Neither a borrower from the government nor a debtor be.

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