Offshore News Digest for Week of October 15, 2007

A WEAK DOLLAR IS BAD FOR AMERICA

Martin Feldstein, the chairman of the Council of Economic Advisors under President Reagan, wrote an article for the Financial Times this week, which outlines why he believes that a “more competitive” or weaker U.S. dollar is good for America. Even though I am a rock-ribbed Reagan Republican, I cannot overstate how strongly I believe that this opinion is incorrect. “Strong Dollar, Strong Currency” is more than a mantra for me since economic history indicates that no country has ever achieved greatness nor maintained it by debasing its currency.

Feldstein rolls out a litany of reasons why he believes America benefits from a weaker dollar. In short, increasing exports as well as maintaining growth and employment. Here is my case for why a weaker dollar hurts America.

First, a weaker dollar translates into a cut in the real spending power of American consumers – in effect, a reduction in real income. Second, a weaker dollar weakens the role of the U.S. dollar as the world’s reserve currency. Why should investors and central banks around the world invest in U.S. assets when their value is steadily declining? Third, the chances of a weaker dollar leading to a sharp reduction in America’s trade deficit is highly unlikely since 40% of the current balance is due to oil imports that are denominated in U.S. dollars. An additional 20% is due to trade with China, which is, of course, controlling the value of its own currency.

Fourth, a weaker dollar is inflationary since it increases the cost of imports. Fifth, business leaders know that discounting prices may bump near-term revenue and profits but at a real cost to long-term profitability, not to mention inflicting damage to the brand name. This is what we are doing to the brand of America by trying to increase exports by lowering their price in the global marketplace. Better to stand firm on price and sell into global markets on the basis of what is great about American products. Sixth, investors seem to like a weaker dollar since the profits of American multinationals get a boost from foreign earnings being translated into U.S. dollars. Again this is short-term thinking and vastly overstated since most multinationals have sophisticated treasury departments that hedge currency exposures.

What a weaker dollar really does is to encourage American and international investors to invest in non-American markets. The more the dollar drops, the more global equities rise. Many Asian currencies are hitting record highs against the U.S. dollar. The Brazilian real has jumped 18% in value against the U.S. dollar this year. Investors are pouring money into global funds while taking funds out of U.S. equity funds. Foreign investors slashed their holdings of U.S. securities by a record amount as the credit squeeze intensified, according to the U.S. Treasury Department.

Last and perhaps most importantly, I view a policy of weakening the U.S. dollar to improve America’s competitive position as the path of least resistance. Let’s not roll up our sleeves and cut federal spending, greatly simplify our tax code to encourage productivity and achievement or reduce corporate tax rates and excessive regulation. Let’s just wink and weaken and let our nation’s currency drift lower on automatic pilot.

My view is that the value of a nation’s currency reflects the perceived value of country in the global marketplace. Maintaining and strengthening the value of our nation’s currency is in the best interest of American consumers, businesses and investors.

CLEAN CARIBBEAN: POLLUTION-FREE AND ORGANIC?

If you are considering moving to the Caribbean to live, retire or start a business, planning to get involved in preserving the environment is important. As part of a series, this article will explore what various organizations, governments, companies and individuals are doing to encourage environmentally responsible practices in the Caribbean, discuss some of the economic opportunities and benefits of developing renewable energy and going organic, profile Dominica and present an overview of Central America. And it will explain why it is imperative that they preserve their environments.

Keeping the Caribbean pristine is one of the keys to its economic stability. A polluted environment would quickly lose its appeal to natives, expatriates and tourists. For this reason most Caribbean countries participate in pollution reduction and the development of organic and pesticide-free farming and related industries. This emphasis on sustainability, a clean environment, and conservation has the potential to improve the quality of life for people throughout the region, preserve the unique natural features of the Caribbean, increase export trade, provide new business opportunities and ensure land values remain strong.

In the context of sustainability, this article will explore four main ideas that have the potential to help improve life in the Caribbean and further develop viable export trade relationships. They are organic/natural farming and value added products, renewable energy projects, ecotourism, and bioprospecting.

Before discussing individual countries and regions, it is beneficial to have a basic understanding of Caribbean Community (CARICOM) and its goals. CARICOM seeks to develop a Caribbean Common Market, thereby, in theory, improving economies, living conditions and encouraging the flow of goods between countries in the region and to other parts of the world. Sustainability is a key component of the initiatives CARICOM sets forth. An important CARICOM initiative is The Caribbean Renewable Energy Development Programme (CREDP), which currently has the support of 13 Caribbean nations, with four more pending. The purpose of CREDP is “To reduce barriers to the increased use of renewable energy thus reducing the dependence on fossil fuels while contributing to the reduction of greenhouse gas emissions.” Eligible projects include wind, biomass, geothermal, landfill, hydro and photovoltaics. These could be small distributed water solar heaters and photovoltaics, as well as larger grid connected projects.

Dominica

Among Caribbean countries, Dominica perhaps has one of the most exciting futures for people who value clean air, food, land and water. In 2006 Lloyd Pascal, Head of Environmental Coordinating Unit (ECU) in Dominica said that a proposal is before the government to make it the world’s first organic country. Dominica is ideally suited to become an environmental model, and by doing so it will ensure that its abundant fresh water can be marketed worldwide at a premium price. This, combined with organic farms producing both fresh and value-added specialty natural foods, would open up additional business opportunities for islanders and those planning to invest and settle in Dominica. (Assuming plans to install an oil Refinery on Dominica’s western shores do not go through. More information here.)

Despite the fact that Dominica is capable of producing all of its own food, approximately 40% is imported from the U.S. Worldwide demand for natural and certified organic products is growing rapidly. Although Dominica does not have official organic certification, companies like Bello produce quality natural products that include juices, concentrates, preserves, spices, coffee and sauces. Thus, many believe that there is potential for economic growth in the agricultural sector, both locally and for export.

According to an article written by Neal Nixon, sales and marketing director for Caribbean Supplies Inc., “Most foods produced in Dominica are substantially organic by default, and have been so for decades, even though we were unaware of the true value of the food we cultivated. Most farmers lacked the means to purchase fertilizers or pesticides, and so depended instead on animal waste and burnt shrubs.” Acquiring organic certification is a process that can be accomplished in under three years, depending upon what the land has been used for. It is a natural step for Dominica to begin instigating organic policies countrywide, and ensuring its land and products will meet international standards for certifications.

Dominica and many other Caribbean countries are developing ecotourism industries. Belize and Costa Rica are known world-wide for their small, environmentally friendly resorts that integrate with nature by practicing sustainability, recycling and other environmentally friendly practices. Dominica, although not as well known, is well-positioned to capitalize on its abundant flora and fauna, unusual topography and diversity of climates.

Currently, land is affordable. Especially in the interior away from the ocean there are a number of existing ecotourism resorts already operating. For anyone looking to relocate in the Caribbean, purchase property and invest in an environmentally friendly business, Dominica should be given serious consideration. More information about land in Dominica is available here. I also recommend you check out the websites of Dominica’s resorts.

Dominica is only 48 miles by 29 miles, but the flora, fauna and topography are amazingly diverse compared to many other Caribbean islands. Unlike most, Dominica still has a rainforest that is home to hundreds of species, flowering plants, orchids, ferns, reptiles (non-poisonous), insects and birds – some are rare and indigenous to the island. Also, over 55 butterfly species make their homes here, along with opossums, land crabs, hummingbirds, hawks, owls and bats. Their survival, as with animals in other parts of the world, is threatened by pollution and pesticides. Many of which are illegal in developed countries, yet these poisons are sold to developing countries the world over.

In light of Dominica’s surprising biodiversity, biotechnology incorporating traditional knowledge and healing is being explored for the purpose of integrating economics and conservation. Developments in science, health and industry have increased the value and importance of genetic resources contained in the planet’s myriad wild and cultivated species of plants, animals, fungi, and microorganisms. Plants are the vessel within which lies a vast genetic library that science is just beginning to explore and utilize, to create new medicines and products. This activity is commonly called “bioprospecting”.

A workshop involving Clemson University in collaboration with the Inter-American Institute for Cooperation on Agriculture (IICA), convened by request from the Government of Dominica, looked to find ways to develop technological and economic partnerships with institutions and technology-rich countries. Carried to fruition, this could provide excellent opportunities, not only for corporations, but also for scientists, researchers and healers looking to discover biochemical health properties of rare plants, many of which have been used for generations by Dominica’s traditional healers.

Dominica has amazing potential for all types of renewable energy, and there are several excellent articles, reports and resources. The Dominica Sustainable Energy Plan (DOC file), Draft, November 14, 2002, describes Dominica’s energy problems and offers solutions, including potential opportunities for establishing private energy-based investments. This article by James Post discusses, among other things, Dominica’s hydroelectric and geothermal resources. Interested in constructing your own micro-hydro plant? I suggest starting here. The project described is inspiring, as it was undertaken and completed by a group of students. Also, run Dominica Yellow Pages and Solar Energy Equipment and Systems through a search engine to find solar energy companies. Yellow Pages is in nearly every country, and it is a great place to research businesses and services before planning a trip or a permanent move.

The Dominica Organic Agriculture Movement, established in 2006, involves stakeholders interested in organic agriculture and sustainable practices in Dominica. The organization seeks to establish Dominican organic industry standards to meet international requirements. If you are considering living in Dominica, it could be beneficial to contact DOAM.

Central America

Central America is comprised of Nicaragua, Belize, Costa Rica, El Salvador, Panama, Guatemala and Honduras. Like Dominica, these fertile volcanic countries are blessed with vibrant rainforests that are rich in flora and fauna, fresh water, rain and sunshine, making them ideally suited for renewable energy projects, ecotourism and agriculture. The region is widely recognized for its friendly people, biodiversity, beaches, surf and marvelous coffee, bananas, cotton, sugar, cacao and various other food products.

Central America has grown economically, especially during the 1990s. But that, coupled with an annual population growth of 3%, has contributed to rapid environmental decline. This is particularly alarming, as the region, though occupying only 0.5% of the planet’s land, is home to 7% of the world’s animal species, many of which are endangered.

Much of the environmental stress is a direct result of the population explosion. Many families live below the poverty line in rural areas where land is often cleared to farm and wood is burned for energy to the tune of 12 tons per year per family. Also, oil exploration and road building has led to deforestation, which in turn has contributed to significant erosion and soil loss, leaving some areas exposed to flooding and mud slides.

Despite the fact that most of Central America’s energy needs are met with oil, the area is not a major contributor of greenhouse gases. Emissions have remained stable since the 80s, partly because of the development of hydroelectric in the region. However, hydropower has also contributed to the loss of Central American forests and breeding grounds for many species. Environmentalists also question the rationale behind building dams in areas where rainfall is extraordinarily high. The potential for breach is significant, as was demonstrated in 1999 when, after two weeks of heavy rain, the Honduran government ordered 100,000 people evacuated from around El Cajon dam. Because of this, the future of large hydroelectric projects is questionable, despite their importance as a primary energy source in the region.

Hydropower, biomass, solar and wind are being used for smaller projects. For example, in northern Belize, a sugar mill in Orange Walk community, once powered by diesel, is now powered by an 18-MW steam plant fueled with sugarcane, wood waste and orange waste. A similar project operates in Sava, Honduras, selling its electric power to Empresa Nacional de Energia Electrica. Both projects contribute to significant reduction of carbon emissions. Additionally, Costa Rica boasts the first private, commercial wind project in Latin America. Investors interested in renewable energy resources and projects in Central America and other parts of the world can contact the Solar and Wind Energy Survey Assessment (SWERA), which is part of U.N. Environment Program (UNEP).

Environmental protection and natural resource management in Central America are of utmost importance, as land degradation, loss of biodiversity and deforestation threaten sustainability in the region. There is substantial monetary assistance available through the U.S. Agency for International Development (USAID), the World Bank, the U.S. government and non-governmental organizations. Various international agreements and accords have been signed to protect the region’s environment.

However, Central American governments are a long way from being able to implement practical environmental regulatory structures. Thus the onus, to some degree, falls on individuals, businesses and corporations to promote awareness and, in fact, self-regulate, something many farms, eco-conscious resorts and other businesses are already doing.

(Part Two: Central America, to be continued as part of this series on sustainability in the Caribbean.)

INDIA GETTING ON BOARD

But much remains to be done.

For more than half a century following Independence in 1947, India perpetuated the sad trend of its poor growing larger in number every year. As we know today, India’s escalating impoverishment was not irremediable. It was essentially caused by the government’s imposition of wrongheaded policies to control economic activity on all fronts. It reserved ownership of companies and services in many sectors for itself, prohibited foreign investment in most activities, placed incredibly restrictive licensing procedures on businesses, overregulated the labor markets, closed the economy tight to foreign trade and maintained extremely high tax rates. In short, the government followed a suffocate-the-market approach to development, which was, of course, doomed to fail.

Fortunately, that approach started to change, grudgingly, in the mid-1980s, and more forcefully in the early 1990s. The old industrial licensing system was progressively dismantled, and other government regulation in sectors such as IT and communications underwent deeper liberalization. Trade and foreign investment barriers were slashed, and financial reform was undertaken to allow for more credit and equity to be channeled into the private sector. Special economic zones were established to provide better infrastructure and to lighten bureaucratic burdens on businesses, and income tax rates for individuals and companies were reduced significantly.

So far the reforms have paid off handsomely. GDP is now growing at an annual rate that, if sustained, will allow average income to more than double in a decade. GDP grew 9% in 2006, making India’s economy the world’s third largest when compared at purchasing power parity exchange rates. The absolute number of Indians living below the poverty line is falling every year, and the middle class is becoming a formidable market that no global company can ignore. Indians are proud of what has been achieved and are optimistic about the future.

Many policies are still in need of reform, however, if millions of Indians – almost 30% of its 1.1 billion population – are to have the opportunity to overcome the abject poverty in which they live. Huge distortions and vulnerabilities remain, seriously limiting the economy’s potential. Government regulation continues to cripple economic freedom and competition. For example, labor laws designed to protect employment are inhibiting job creation in sectors like manufacturing, an area in which India should have a great advantage over other countries. Hiring and firing workers is so onerous that new jobs are being created only in areas where enforcing laws is next to impossible or where specific regimes providing the necessary flexibility have been established, such as in some service sectors. Labor rigidities also cause employers to substitute machines for manpower or to refrain from expanding production capacity. This condemns the poor to remaining in the informal economy, where productivity and incomes are very low.

Overregulation of product markets has equally perverse effects. India’s entrepreneurs, acknowledged as highly creative, still suffer heavy bureaucratic burdens. Red tape constitutes a practical entry and exit barrier to many markets, impairing competition and innovation.

Although India is dramatically more open to imports and investment than it was a few years ago, it continues to be more protectionist than other large emerging economies. Its competitiveness in global export markets would be greatly enhanced if it lowered the level and variance of import tariffs further and liberalized foreign investment. Government ownership of firms is still pervasive, particularly in key areas such as energy and banking. Without more private investment and competition in these sectors, India’s growth could soon encounter severe bottlenecks.

That these and many other items remain on a must-do list awaiting action by India’s lumbering political system could be interpreted as bad news for future development. But the fact that despite persistent and severe problems India has managed to grow so spectacularly in recent years says a lot about its economic potential. India’s leaders should be aware that growth has been driven mostly by those sectors where workers, entrepreneurs and firms have enjoyed the least oppressive environments in which to exercise their economic freedom.

HEDGE FUNDS’ LOVE PUTS INDIA IN A TIGHT CORNER

Investors got a rude shock this week. It seemed like India, the 2nd-best-performing equity market in the past month after Chinese stocks in Hong Kong, was spurning their love. The misunderstanding cleared up pretty quickly, though. It transpired that the Indian government really did have a headache after all, produced by an intolerable surge in capital flows.

The Securities and Exchange Board of India said, after the close of trading on October 16, that it proposes to “urgently implement” a plan that will restrict unregulated overseas investors, such as hedge funds, from accessing the equity market in Mumbai through offshore derivative instruments. When the market opened the next day, the Sensex slumped 10%, leading to trading being suspended for an hour. After an explanation from Finance Minister Palaniappan Chidambaram that the curbs are not a moral judgment on the desirability of hedge-fund money in the Indian market, the benchmark index closed down less than 2%.

The market has always been jittery about the future of “participatory notes” – as the offshore, over-the-counter derivatives are most commonly known – given that the central bank wants them banned. The Reserve Bank of India’s stance on P-notes is that these are “suspicious flows” because it is difficult to identify the ultimate beneficiary. Chidambaram did well to avoid this line of thinking. He made it clear that hedge funds continue to be welcome and the objective of the curbs is only to moderate the pace of capital flows.

P-notes make India’s capital controls porous. If they bring too much money into an overheating economy, as is the case now, the central bank loses control. It has to either accept a considerable increase in the exchange rate or a big fall in local interest rates. The former can stall exports, while the latter could worsen the overheating. Chidambaram has so far resisted the central bank’s conservatism. He has correctly reasoned that the way forward for India is more capital mobility, not less.

However, it was his job, and the job of other ministers in Prime Minister Manmohan Singh’s government, to make the country ready for a sustained pickup in inflows of foreign funds. That never happened. In the past three years, offshore inflows into India have soared. P-notes, alone, have swelled to almost $89 billion from just $7 billion in March 2004.

And yet, the government has done precious little to boost the absorptive ability of the economy so that the flows could be accommodated without stoking inflation. Everything from electricity, airport capacity and skilled labor to real estate and telecommunications spectrum is in short supply because of muddled policies and lack of political will.

The central bank has been behind the curve in accepting that India’s growing trade and investment linkages with the world have effectively robbed the monetary authority of its ability to simultaneously pursue an independent interest-rate policy and aspire to an almost fixed exchange-rate system. Conservative policy makers and apathetic politicians have collectively dug themselves into a hole. Now they want to get out of it by tinkering with capital inflows.

Direct entry into Indian markets requires a permit that is not given to everyone. Pension and mutual funds, insurance companies, university endowments, and investment and charitable trusts are all allowed to invest in India directly as overseas institutional investors. Foreign companies and individuals can also obtain direct access as sub-accounts of global investment banks, which themselves are registered as institutional investors. The latter are responsible for ensuring that their sub-accounts are not conduits for laundering drug money or terror funds or fronts for Indian politicians or businessmen to bring back into India their ill-gotten gains parked overseas. The P-note allows those who have access to the Indian market to share it with those who do not.

Though only 34 of the 1,113 registered foreign investors and their 3,445 sub-accounts write P-notes – Citigroup, Merrill Lynch, Goldman Sachs and UBS are the prominent issuers – the arrangement is definitely a popular one, accounting for an estimated 60% of the $17 billion of overseas money that has flowed into Indian stocks this year. The government wants to tame the flows. Until now, sub-accounts were allowed to sell P-notes to their clients. That flexibility is now being withdrawn. A third of all P-notes are derivatives on derivatives: Their underlying securities are futures and options traded in India. This is now proposed to be banned altogether.

Investment banks can still sell P-notes to their hedge-fund clients as long as the underlying securities are stocks – and not derivatives – though the value of notes can no longer exceed 40% of the registered investor’s assets under custody. Effectively, the government is telling foreign investors, “We know we can no longer choose who gets to invest in India and who does not without banning P-notes. And we will not do something as drastic as that because that is going to hurt us. But allow us some control on the pace at which you are going to bring in money. Without that, we are heading for a blowup.”

It is a message the market can understand. After all, influential voices in India have begun discussing the possibility of a Thai-style lockup on foreign inflows. Thankfully, the Indian regulator’s plan is not nearly as ugly as that.

MEDICAL TOURISM IN INDIA – A HEALTHCARE REVOLUTION?

“Medical tourism” is the act of traveling to foreign locales in search of high-quality, affordable healthcare. India, for example, is currently trying to figure out how to best advertise and support a growing medical tourism industry. Resort-like hospitals that cater to medical tourists are raking in clients by providing a level of care and comfort that is ... well ... foreign to some Americans. The kicker is that it is also insanely cheap.

For example, say John Q. Public elects to have a back surgery but his insurance is balking at covering it. In the U.S., his out-of-pocket cost might be $30,000 if he chooses to pursue the procedure without insurance clearance. If he does not have the cash to make it happen John is usually out of luck. But wait ... For the price of a plane ticket to and accommodations in India – say $10,000 – John can save up to 80% on the surgery itself by getting it half a world away. Bottom line, instead of paying $30,000 in the U.S., John Q. Public might be able to get the same surgery in India plus flights, lodging and the surgery for a hypothetical total of $16,000 – a nearly 50% total savings.

There is a burgeoning medical tourism “travel agency” business in the U.S. They offer all-inclusive packages at hospitals worldwide, depending on exactly what procedure a patient requires. That can lower costs even further. Studies suggest that 150,000 Americans left the country last year to have a medical procedure. Other sources put the number closer to 500,000 – presumably including such “travel” as having a root canal performed in Tijuana or tooth veneers installed in Juarez.

Medical tourism may be the brightest example yet of Americans, albeit out of extreme necessity, embracing a true global economy and spending their dollars in such a way that maximizes return on medical investment. When you look at it like that, traveling a great distance to receive priority treatment and save money seems downright ... smart.

While researching this issue, I expected to find tons of information on the things that would prevent an American from engaging in medical tourism. For example, I expected to find articles and blog posts shouting about under-trained and unprofessional doctors, substandard facilities and arcane witch doctor practices. I knew I would come across at least one post-op horror story about bandages, scissors and exotic bacteria being found inside patients once they returned to the States.

Evidently, those expectations amounted to nothing more than my own prejudices. While the medical tourist does have to be sublimely careful and diligent in their research and planning, there most certainly are high-quality and cost-effective doctors around the world who can perform most procedures for just a fraction of the cost a patient would encounter in America.

Medical tourism is yet another industry in which Indian expansion is helping to break new ground. In time, opportunities for investors will emerge, and the issue of medical tourism will surely break into the consciousness of the mainstream press. As a start, simply enter “Medical Tourism India” in your search engine of choice and sift through the results. Just be careful to avoid the websites written in broken English.

This much is certainly clear: Regardless of who wins the White House in 2008, it appears as if a revolution in how we access our healthcare may be on the horizon.

HONG KONG POISED TO SOLIDIFY FINANCIAL HUB STATUS

Hong Kong leader Donald Tsang has announced new plans designed to ensure that Hong Kong’s position as a leading global finance hub is consolidated and strengthened. In a policy address, Tsang said that the financial sector is a major pillar of the Hong Kong economy, and observed that China’s rapid development and the opening up of its financial sector have presented unprecedented opportunities for Hong Kong’s financial-services sector.

Under the initiative, mainland enterprises and investors will be encouraged to participate in Hong Kong’s stock market through the Qualified Domestic Institutional Investors Scheme, and the pilot scheme for Mainland individuals to invest directly in securities in Hong Kong. “We will also upgrade our market infrastructure, promote financial intermediation, encourage financial reform and launch new financial products to attract more overseas enterprises to list in Hong Kong,” Tsang announced.

The SAR government is currently discussing with the Chinese authorities proposals to introduce new types of renminbi business in Hong Kong, including settling in RMB the accounts of imports from China. Hong Kong will also seek to develop an Islamic finance market, Tsang revealed, stepping up efforts to promote Hong Kong’s financial services to major Islamic countries and regions, while focusing on developing an Islamic bond market.

Tsang said that the Hong Kong government wants to develop Hong Kong into an arbitration centre in the Asia-Pacific region. With increasing demand for arbitration services in Hong Kong and the region, the number of cases handled in the city is on the rise.

“Hong Kong-based arbitral bodies and their arbitrators, with their status well recognized, are committed to promoting the development of arbitration services. An enhanced arbitral environment will help to further develop our arbitration services. To strengthen Hong Kong’s competitive advantage, we have been forging closer ties with international arbitral bodies,” he said. “By updating our legal mechanism.”

According to Tsang, China’s National 11th Five-Year Plan states clearly, for the first time, that support will be given to Hong Kong’s development in financial services, logistics, tourism and information services, and the maintenance of Hong Kong’s status as an international financial, trade and shipping center.

Tsang added that with these large-scale development projects, Hong Kong will need to expand its pool of skilled workers, and will “require talented people from everywhere.” Consequently, to help attract more qualified people, the Quality Migrant Admission Scheme’s requirements will be relaxed and widely promoted. Last year, 28,000 foreigners came to work in Hong Kong and settled in the jurisdiction, including about 5,500 from the Mainland.

LUST AND CAUTION IN CHINA

When Ang Lee’s new thriller, Lust, Caution, opened in Hong Kong in late September to fat box-office takes, moviegoers were subjected to unprecedented measures to prevent piracy. Bags were checked, and security guards patrolled aisles looking for telltale glows from camcorders and cell phones. Online ticket buyers were warned that illegally recording the movie could result in jail time and a fine of $6,400. The producers threw in a reward of $3,800.

So the Chinese are finally getting serious about piracy? Lust, Caution instead flew into sensitive Chinese politics, where it is stuck, at least until its promised November 1 mainland China premiere.

Every five years the Chinese Communist Party holds its National Congress, which starts this month. During that time only patriotic movies are shown in theaters, according to Bill Kong, the movie’s producer. Lust, Caution, set in a Japanese-occupied part of China during World War II – one of the main characters collaborates with the Japanese – did not make the propaganda grade, so Chinese authorities delayed its opening until after the Congress.

That leaves pirates a very profitable one-month window to be sole distributors of the expected blockbuster in China – which led to the purse patrol in neighboring Hong Kong. So far, no reports of illegal DVDs.

CHINA’S BID TO TAME ECONOMY BEGINS A REAL ESTATE BUST

SHENZHEN, China – Sweating in the bright afternoon sun, the men and women stand on the sides of the roads like homeless people clutching wrinkled cardboard signs. Waving the boards, the real estate agents call out to cars zooming by. “Come take a look. ... You’re welcome to visit. ... Over here!”

Surrounding the agents in this upscale neighborhood are vast swaths of empty apartments that just a few months ago were selling at record high prices. The housing market in this city of 14 million adjacent to Hong Kong is among the first casualties of China’s efforts to cool an economy it fears may be overheating.

Faced with surging inflation, shaky loans and a stock market bubble that has grown more than 400% in just two years, the Chinese government in recent months has been pulling all policy levers at its disposal to control growth. China’s central bank has raised interest rates five times this year and upped reserve requirements for commercial lenders eight times. Last month, the central planning agency imposed a price freeze on cooking oil, electricity, water and other household essentials to try to stem inflation that is at an 11-year high. Securities regulators in at least one province have issued new rules banning high school and college students from buying shares to rein in speculative stock market investments.

The tightening measures are alarming some economists who worry that if China slams on the brakes too fast by using communist controls on what is increasingly a capitalist economy, there could be devastating consequences extending far beyond the real estate market in Shenzhen. But others contend that to fix imbalances – such as the growing trade surplus and shrinking private consumption as a percentage of GDP – that echo the problems in pre-bust Japan in the 1980s, China needs to be doing even more.

“Tinkering at the edges” is how CLSA chief economist Jim Walker describes what China has done so far. Walker, who has long been warning about weaknesses in the Chinese economy, predicts that efforts to control inflation will ultimately fail next year and the country’s double-digit growth in GDP will screech to just 5%. “They are walking straight into the Japan problem,” he said.

China may use more, bigger rate moves to siphon excess cash from economy.

China will step up measures to curb excess cash in the economy and may use more or bigger rate increases to prevent overheating, central bank chief Zhou Xiaochuan said. “We don’t rule out steeper or more frequent moves if necessary,” Zhou, governor of the People’s Bank of China, said during an interview with reporters at the Communist Party Congress in Beijing. Controls so far“qhave not been very effective.”

The bank will keep using a mix of policy tools including rate increases, higher reserve ratios and more bill sales, he said. The central bank is concerned with rising asset prices though that is not the sole driver of monetary policy, he said.

The world’s fastest-growing major economy has doubled in size since President Hu Jintao succeeded Jiang Zemin five years ago. A surge in exports that helped drive growth now threaten to derail the expansion by flooding the economy with cash, stoking inflation and a possible stock market bubble.

Zhou, 59, presided over the nation’s first change in currency policy in a decade. He ended the yuan’s peg to the U.S. dollar and revalued it by 2.1% in 2005. The change was partly a response to major trading partners including the U.S., where politicians assert the currency is kept artificially low to boost exports. “The yuan will eventually become a freely convertible currency and China will open its capital account, even if we haven’t set a clear timetable,” Zhou said. “China had agreed in principle to make the yuan convertible in the 1990s, but we halted the plan during the 1997 Asian Financial Crisis.”

CELL PHONE MOGUL OFFERS A RADICAL SOLUTION FOR AFRICA’S ILLS

Mohammed (Mo) Ibrahim, 61, is a Sudanese-born billionaire who made his fortune building Celtel, a mobile phone company that serves 15 African countries. He sold it in 2005 for $3.4 billion and is worth an estimated $2.5 billion today. Now he has a philanthropic idea that is as novel as it is potentially naive. On October 22 his Mo Ibrahim Foundation will award its first $5 million annual prize to a former African head of state who has shown exemplary leadership in things like political freedom and promoting the rule of law. The prize, which dwarfs the $1.5 million Nobel Prize, will be spread out over 10 years, with $200,000 a year after that.

The catch? The leader is eligible for the prize only after he or she has left office and has no plans to return to public service. The idea is to give African politicians an incentive to remain honest in office, and to leave after their terms are up. On that continent prime ministers cannot expect lucrative book deals or speaking tours after leaving office and, faced with dismal opportunities, often cling to power. Ibrahim, who lives in London, talked recently to Forbes.

OECD COMMENTS ON PROGRESS IN COMBATING TAX EVASION

The OECD last week published two new reports outlining the progress made so far in its campaign against tax evasion. “Improving Access to Bank Information for Tax Purposes – the 2007 Progress Report” describes developments in OECD countries and six others (Argentina, Chile, China, India, the Russian Federation and South Africa) with respect to access for tax authorities to bank information.

Meanwhile, “Tax Co-operation: Towards a Level Playing Field – 2007 Assessment by the Global Forum on Taxation” compares the legal frameworks for international tax cooperation of 82 OECD and non-OECD economies. It is the second in a series of factual reports by the OECD’s Global Forum on Taxation, which was formed as part of the OECD’s efforts to curb “harmful” tax practices.

The OECD observed, “Many financial centers, both onshore and offshore, are making progress in improving transparency and international co-operation to counter offshore tax evasion, but some still fall short of international standards that have been developed over the last seven years.”

The OECD went on to suggest that significant restrictions on access to bank information for tax purposes remain in three OECD countries (Austria, Luxembourg and Switzerland) and in a number of offshore financial centers (e.g., Cyprus, Liechtenstein, Panama and Singapore). It further argued that a number of OFCs that committed to implement standards on transparency and the effective exchange of information standards developed by the OECD’s Global Forum on Taxation have “failed to do so.”

“No one country or even a small group of countries can address the issue of harmful tax practices on their own,” commented Paolo Ciocca, chair of the OECD’s Committee on Fiscal Affairs and co-chair of the Global Forum. “This is a global challenge which requires a global response. In co-operation with partner financial centers, that is what OECD is seeking to achieve.” However, Mr. Ciocca went on to announce that in the view of the OECD, progress has recently been made in the following areas:

• Nearly 100 more exchange of information arrangements are now in place vs. last year, including TIEAs between the U.S. and Guernsey, the Isle of Man and Jersey.
• The scope of some existing arrangements has been extended. For example, Switzerland has signed a number of protocols to its bilateral tax conventions to allow it to exchange information, including bank information, in cases of tax fraud and the like. Some of these protocols also allow for exchange of information in both civil and criminal tax matters in the case of holding companies.
• Access to bank information for tax purposes has been greatly improved in economies such as Belgium.
• Increasingly, legislation requires financial and other service providers to have available details of the beneficial as well as the legal owners of corporate vehicles. In Macao, new anti-money laundering legislation requires financial institutions to verify the identity of customers and their beneficial owners. In San Marino, new legislation requires that starting next year meetings of joint stock corporations must be held in the presence of a notary public who is required to identify holders of bearer shares.
• Some jurisdictions, such as Guernsey and Jersey, have brought into force legislation empowering them to fully implement the provisions of their bilateral exchange of information arrangements.

The vast majority of OECD countries already meet or exceed the standards set in 2000 regarding access to bank information for tax purposes, and the direction of change is clear,” Mr. Ciocca stated, but warned that jurisdictions which have not yet implemented the standards for transparency and exchange of information developed by the Global Forum must now do so. “In January 2008 the Committee on Fiscal Affairs will have a review of the future direction of this initiative. We will continue to press for further progress and explore within the Committee how such progress could be achieved.”

IRS CRITICIZED OVER MISSING TAXPAYER CASEFILES

What would be intolerable for a taxpayer is routine for the IRS

The IRS has come in for some severe criticism from senior Senators after a recent study found that the agency was unable to locate almost one in five requested taxpayer files. In a study requested by Senate Finance Committee Chairman Max Baucus, the Government Accountability Office (GAO) found that the IRS lacks an effective process to find paper case files, and then fails to track whether requested case files are located in a timely manner, or document the reasons when they cannot be found.

Baucus argued that missing case files hamper the IRS’s ability to assist taxpayers, impede enforcement efforts, and increase the risk of unauthorized use of private taxpayer information. “The IRS’s case files contain confidential information that taxpayers have a right to expect is stored safe and sound,” stated Baucus. “When these files are lost, taxpayers face increased burdens to sort out their tax matters and may be put at risk of identity theft. Efficient tax administration requires that the IRS follow GAO’s recommendations to increase file security and establish reliable storage practices.”

In a Treasury Inspector General for Tax Administration (TIGTA) audit that called for a random sample of tax records, the IRS could not locate 19% of the requested case files. Lack of staff accountability for file maintenance, misplaced files, and files sent to the wrong locations were found to be the main reasons for the IRS’s problems. For more efficient file management, the GAO has recommended that the IRS comply with the Federal Records Act, track the number of missing files, and ensure that case file performance is monitored across the IRS.

Commenting on the findings of the reports, Sen. Chuck Grassley, the ranking Republican on the Finance Committee, suggested that their conclusions are “very troubling”. Grassley went on to contend that the findings strengthen the case for a continuation of the private tax debt collection project, following a vote in the House of Representatives last week in favor of bringing the project back in-house with the IRS. “If the tables were turned, and it was the taxpayer losing his records, the IRS would have zero tolerance. When it is the IRS losing taxpayer records, it appears to be just another day at the office. If this is indicative of business as usual, we might need more private contractors, not less,” Grassley concluded.

ADVISOR PREDICTS SURGE IN UK BUSINESS SELLOUTS FOLLOWING CAPITAL GAINS TAX MOVE

Business advisor Deloitte expects a short-term flurry in the sale of certain businesses by entrepreneurs in the lead up to the change in the UK capital gains tax regime next year, although it foresees many winners from the new regime. Last week, Chancellor of the Exchequer Alistair Darling announced that a new 18% flat rate of CGT will take effect from April 2008. This will substantially increase the amount of tax payable by business owners hoping to benefit from the 10% taper relief which exists in the current rules.

“Given the proposed increase in CGT rates, it is likely that we will see a short term flurry of activity in the sale of entrepreneurial businesses,” suggested Sam Hart, director of Entrepreneurial Business at Deloitte. “While larger businesses may be impaired by uncertainty in the credit markets, owners of smaller businesses may look to accelerate disposals to take advantage of the 10% rate in the last few months of its existence.”

However, while the change in the CGT rate increases significantly the rate of tax on a sale of a business, Hart noted that the accompanying simplification measures will benefit many business owners, including those who have held business assets for less than two years, and therefore faced CGT rates of either 20% or 40%. “The certainty of a simple 18% rate may be welcomed by these individuals,” Hart stated. “Of course, there are (other) winners from the Government’s proposals. These will include individuals selling assets, such as buy to let properties, which would previously have been subject to a tax rate of 24% after 10 year’s ownership. From April 2008 they can benefit from 18% tax after day one. Shareholders in fully-quoted companies (who are not employees) will also benefit.”

AUSTRALIAN TAX OFFICE ANNOUNCES EXTERNAL DEBT COLLECTION SERVICES PANEL

The ATO has announced the appointment of a panel of external collection agencies to assist with the collection of debt, including tax debts over two years old and employer superannuation guarantee charge debt. Following a competitive tender process, four agencies have been selected.

Acting Tax Commissioner, Jennie Granger said that the appointments follow a successful 3 month trial conducted in 2006, which resulted in $21 million in outstanding debt being collected. “We do understand there are situations when it can be difficult to pay an outstanding debt. What is really important is that people contact us as early as possible so we can agree on a suitable arrangement to get them back on track,” Ms. Granger explained. “The panel will help us follow up more quickly and encourage people and businesses to pay their debts. “Some of the debt to be referred for collection will be superannuation money owed to employees so will help protect retirement savings,” she continued.

The ATO was allocated an additional $42 million over four years in this year’s federal budget to establish and pay for the services of the panel, and expects to commence referring parcels of debt for collection activity towards the end of 2007. “Our debt collection strategies, including the establishment of this panel are about fairness and creating a level playing field for everyone. “I encourage anyone experiencing difficulties to contact us as soon as possible ... and we will work with them to clear any tax debt before it becomes unmanageable,” Ms. Granger concluded.

BURNED BY REAL ESTATE, SOME JUST WALK AWAY

But abandoning investment property to foreclosure carries a high cost. And any personal asset protection measures should be done before storm clouds appear on the horizon.

During the height of Las Vegas’s real-estate boom two years ago, property investor Rob Rozzen bought 16 homes, hoping that skyrocketing prices would pump up his retirement nest egg. Now, Mr. Rozzen says he is considering filing for bankruptcy protection. As the housing market slowed, the 40-year-old was unable to sell the homes, and his full-time job as a real-estate agent was no longer able to support mortgage payments totaling $45,000 a month. So one by one, over the past 14 months, Mr. Rozzen has stopped making payments on his investment properties, for which he paid between $226,000 and $390,000, and lenders have foreclosed.

As a result, Mr. Rozzen’s credit score plunged. The Prada clothes, luxurious vacations, and full-time housekeeper and pool cleaner he once enjoyed are things of the past. Still, he says, walking away from his investment properties was his only option. “You get to a point where your hands are tied,” he says.

A growing number of investors are making the same drastic decision to walk away from their properties and ultimately send their homes into foreclosure, lenders and real-estate agents say. Many investors who were hoping to quickly flip their investments are now left with homes that can no longer be sold for more than the mortgage debt. In many cases, these investors cannot even find tenants willing to pay enough rent to cover hefty mortgages.

According to an August study by the Mortgage Bankers Association, defaults on mortgages where the owner does not live in the house are a major driver of the defaults in Florida, Nevada, California and Arizona – four of the states with the fastest rising rates of seriously delinquent loans. Defaulted mortgages are defined as those 90 days or more past due or in foreclosure, according to the study.

Before walking away from a mortgage, legal experts say, investors should approach a lender about a possible loan “workout”, in which the mortgage payments are reduced but the investor gets to keep the property. Some investors say they have tried this, but without success. Still, banks do not typically want to act as property managers, nor do they want to have high foreclosure numbers on their books.

One of the first effects of walking away from a mortgage is on one’s credit. The foreclosure could remain on your credit report for years and will sharply reduce your credit score, experts say. “This makes it more difficult or extremely costly, and in some cases impossible, to do more financing in the future,” says Jack Guttentag, a professor of finance emeritus at the Wharton School of the University of Pennsylvania who operates a mortgage-advice Web site.

In some cases, lenders can go after an investor’s other assets to satisfy a loan if the borrower defaults. But that often depends on the loan agreement, which sets out what recourse the lender has in the case of a default. In a nonrecourse loan, lenders can take only the property itself to satisfy the debt. Most loans, however, are recourse loans, which means that the borrower’s other assets may be at risk.

Individual investors may even be on the hook if they borrowed through a limited liability company or a partnership. Principals of LLCs, or general partners of partnerships, can be personally liable if they act as guarantors. Lenders often require personal guarantees as part of the loan agreement. “Banks want the individuals on the hook,” says New York lawyer Gideon Rothschild. Partnerships and LLCs are good to “protect you against slips and falls on your property,” adds Jay Adkisson, a Newport Beach, California, lawyer, but they offer little protection if a lender requires you to sign a personal guarantee.

What is more, whether other assets, such as insurance policies and personal residences, are shielded from creditors varies widely by state. In Florida and Texas, for instance, your home, life-insurance policy, annuity or retirement plan are generally shielded from creditors. California, by contrast, offers much less protection for debtors. (More details about your state’s laws are available here.)

Of course, investors can take steps to shield their assets from creditors. But setting up fancy structures, such as offshore trusts designed to keep property off-limits from creditors, typically only works if done before creditors appear on the horizon, says Beachwood, Ohio, lawyer John E. Sullivan III. Similarly, assets in a 401(k) are generally protected from creditors if the plan was already in existence. “If you plan when the coast is clear, you should be OK,” says Mr. Sullivan. “If you choose to wait, it could be too late.”

Mr. Adkisson says he has received about 30 calls a week in recent months from real-estate investors seeking to shield their assets, just as lenders are beginning to chase after them. “There’s just an absolute flood of people seeking asset protection, and it is all after the fact. It is like buying auto insurance after the car wreck.”

There are a few things you can do to protect your money even as creditors are moving in. One idea is move to Florida and buy a big house. As long as you can stay out of bankruptcy and qualify for Florida residency, a creditor cannot force the sale of your home under Florida law, says Mr. Rothschild, who adds that the tactic will not work under new bankruptcy rules if you are forced to file for bankruptcy protection. Laws passed in 2005 make it much tougher in some cases to protect certain assets, such as your primary residence, from creditors during bankruptcy.

Investors who face foreclosure may be left with a big federal tax hit, says Mr. Witt. That is because, in a recourse loan, the amount of the loan forgiven by the lender, in excess of the property’s fair market value, is typically taxed as ordinary income to the taxpayer, he says. The tax code does offer some relief, but only if the loan is forgiven during bankruptcy proceedings or if the borrower was insolvent immediately before the loan was discharged.

However, it is tough to prove insolvency, since the IRS considers many assets, such as 401(k) retirement plans, in determining whether a borrower is insolvent. “These assets are typically exempt from creditors, but not for tax purposes,” says Mr. Witt.

LOST YOUR HOME? YOU MAY OWE IRS

If you thought a foreclosure ended the financial miseries associated with your former home, think again. You soon could be hearing from the IRS about taxes due in connection with the residence you no longer own. “You can walk away from the big house payment, but not from the potential tax implications,” says John W. Roth, senior tax analyst at CCH in Riverwoods, Illinois. “And if you couldn’t afford the mortgage, you probably can’t afford the taxes.”

As the lending crisis continues to shake out, more homeowners, particularly those who used creative mortgages to buy their houses, could be in this predicament. Even longtime homeowners who refinanced their properties based on increased value when the real-estate market was hot could find themselves in tax trouble if they lose their properties to the bank.

In many cases, the tax problem associated with a foreclosure arises from a seemingly benevolent move: The lender forgives some of the loan. This happens when a lender and a borrower negotiate a reduction in loan amount. Or when the lender forecloses on the property and sells it for less than the outstanding mortgage. In both instances, the difference for which the borrower is no longer responsible is considered cancellation-of-debt, or COD, income. It also is called discharge-of-indebtedness income or discharge of debt. Regardless of the name, under the tax code, it is all taxable income. The tax on COD is calculated at ordinary rates, which range from 10% to 35% and depend upon your income.

“People who advise you to walk away talk about payment consequences, not the tax consequences,” says Frederick M. Stein, RIA senior analyst from Thomson Tax & Accounting. “If they owe $50,000 and $10,000 is forgiven, they think of it as a gift. It may be a gift from the lender, but not from the IRS.”

How much and what type of tax the IRS expects after a foreclosure depends in large part on whether the loan is “recourse” or “nonrecourse”. With a recourse loan, the debtor is personally liable for the debt. In a foreclosure, if proceeds from the home sale do not cover the outstanding mortgage, the debtor must pay the difference. This includes interest that accrues during the foreclosure process. Nonrecourse debt is secured by the loan collateral. If money from the sale of the property does not cover the outstanding debt, the lender has no legal ability to get the additional funds from the debtor.

But with either type of loan, a foreclosed-upon homeowner could end up owing capital-gains taxes without ever receiving any money from the foreclosure sale. “Foreclosure is not a sale in normal terms, but it is still treated under tax code as a sale,” says Stephen Trenholm, CPA, and tax manager at Rucci Bardaro & Barrett in Boston. “The outstanding balance of the mortgage is compared to the basis in house. If that produces a gain, it is a taxable gain. If it is a nonrecourse mortgage, it is a capital gain.”

That is right. Even though you are not selling the house and the bank is, the IRS views the transaction as if you were the seller. That means you could owe taxes on the sale. The bad news comes directly from the IRS, via Publication 544. The calculations take into consideration any cancellation-of-debt income and the type of mortgage.

For some struggling homeowners, the taxes on forgiven debt or phantom income are all too real. And “it’s not just the working man having this problem. Everybody’s getting in over their head these days,” says Ted Lanzaro, CPA and owner of an accounting firm in Shelton, Connecticut. “If you have a $700,000 mortgage and the bank can only get $500,000 in a foreclosure sale, now you are talking about some tax liability.”

And the IRS will find out. The agency has a mechanism to catch foreclosure sales. The lender is supposed to issue a 1099-C to alert the former homeowner and IRS of the canceled debt and, in certain cases, a 1099-A showing the information you need to figure your gain or loss. “Some people are moving and the 1099 has trouble catching up,” says Gary Garwitz, tax partner with BKD in Springfield, Missouri. “If you are in that situation and had a mortgage you didn’t pay off, make sure you get that 1099.” The IRS definitely will get its copy and expect the associated taxes. If the taxes are not paid, penalties and interest will be added.

There is one bit of good news for our hypothetical homeowner and others dealing with foreclosure-induced taxes. You can get out from under at least part of the IRS bill if you meet the homeownership tax-exclusion rules. This tax break allows a single homeowner who sells his property under the usual circumstances to exclude up to $250,000 profit from taxes. The exclusion is $500,000 for married couples filing jointly. The exclusion also applies in foreclosures. As long as the “seller”, in this case the foreclosed-upon owner, lived in the home as his principal residence for two of the past five years, he can avoid taxes on any capital-gain profit, phantom or real.

Two other circumstances offer tax relief in foreclosures, but both could cause other financial problems. If a homeowner can show he is insolvent before the discharge of the mortgage and turnover of the property, as well as afterward, proceeds are not taxed. However, says CPA Trenholm, “insolvency is a little tricky. There is no strict definition of what assets (go in the calculation), but for the most part, a lot of people caught in the real-estate crunch can establish that condition.”

The other option is bankruptcy. “Forgiveness debts, in these cases, are not taxed,” says Roth. “They don’t want the bank chasing them down, which is why many times people going through foreclosure also go through bankruptcy.”

However, filing for bankruptcy has its own set of considerations. “New bankruptcy rules do not give (filers) a lot of relief,” says William S. Bost, a member of the Raleigh, North Carolina, law firm Ragsdale Liggett. “If you have a job and are making money, the new bankruptcy rules don’t give you a whole lot of help. It gives you some time, but I don’t think that’s necessarily the way to go.

“It used to be like going to church – you walk in and walk out absolved – but it’s not like that anymore. Now, it’s not worth the pain you pay the rest of your life.”

One thing lending and tax experts all agree on. If you are facing foreclosure, take action as soon as you realize you are in trouble. And get professional help to determine exactly what your personal tax liability might be in the transaction. Lanzaro has two other recommendations. “The best advice is, don’t buy a house you can’t afford, and don’t get an adjustable-rate mortgage.”

U.S. DEMANDS AIR PASSENGERS ASK ITS PERMISSION TO FLY

If you are not on the list, you ain’t getting on.

Under new rules (PDF) proposed by the TSA, all airline passengers would need advance permission before flying into, through, or over the U.S. regardless of citizenship or the airline’s national origin.

Currently, the Advanced Passenger Information System, operated by the Customs and Border Patrol, requires airlines to forward a list of passenger information no later than 15 minutes before flights from the U.S. take off (international flights bound for the U.S. have until 15 minutes after take-off). Planes are diverted if a passenger on board is on the no-fly list. The new rules mean this information must be submitted 72 hours before departure. Only those given clearance will get a boarding pass. The TSA estimates that 90% to 93% of all travel reservations are final by then.

The proposed rules require for each passenger, full name, sex, date of birth, and redress number (assigned to passengers who use the Travel Redress Inquiry Program because they have been mistakenly placed on the no-fly list), and known traveler number (once there is a program in place for registering known travelers whose backgrounds have been checked). Non-travelers entering secure areas, such as parents escorting children, will also need clearance.

The TSA held a public hearing in Washington D.C. on September 20, which heard comments from both privacy advocates and airline industry representatives from Qantas, the Regional Airline Association, IATA, and the American Society of Travel Agents. The privacy advocates came from the American Civil Liberties Union and the Identity Project. All were negative. The proposals should be withdrawn entirely, argued Edward Hasbrouck, author of The Practical Nomad and the leading expert on travel data privacy. “Obscured by the euphemistic language of ‘screening’ is the fact that travellers would be required to get permission before they can travel.”

Hasbrouck submitted that requiring clearance in order to travel violates the U.S. First Amendment right of assembly, the central claim in John Gilmore’s case against the U.S. government over the requirement to show photo ID for domestic travel. In addition, the TSA is required to study the impact of the proposals on small economic entities (such as sole traders). Finally, the TSA provides no way for individuals to tell whether their government-issued ID is actually required by law, opening the way for rampant identity theft.

ACLU’s Barry Steinhardt quoted press reports of 500,000 to 750,000 people on the watch list (of which the no-fly list is a subset). “If there are that many terrorists in the U.S., we’d all be dead.” TSA representative Kip Hawley noted that the list has been carefully investigated and halved over the last year. “Half of grossly bloated is still bloated,” Steinhardt replied.

The airline industry representatives’ objections were largely logistical. In addition, many were concerned about the impact on new, convenient and cash-saving technologies, such as checking in at home, or storing a boarding pass in a PDA. One additional point, raised by Hasbrouck, is that the data the TSA requires will be collected by the airlines who presumably will keep it for their own purposes – a “government-coerced informational windfall,” he called it. The third parties who actually do much of the airline industry’s data processing, the Global Distribution Systems and Computer Reservations Systems, were missing from the hearing.

NSA’S LUCKY BREAK: HOW THE U.S. BECAME SWITCHBOARD TO THE WORLD

Much of the globe’s international telephone traffic flows through the U.S., as shown by this rendering of 2005 international phone-call traffic from telecommunications resarch firm, Telegeography. A lucky coincidence of economics is responsible for routing much of the world’s internet and telephone traffic through switching points in the U.S., where, under legislation introduced earlier this month, the U.S. National Security Agency will be free to continue tapping it.

Leading House Democrats introduced the so-called RESTORE Act that allows the nation’s spies to maintain permanent eavesdropping stations inside U.S. switching centers. Telecom and internet experts interviewed by Wired News say the bill will give the NSA legal access to a torrent of foreign phone calls and internet traffic that travels through American soil on its way someplace else.

But contrary to recent assertions by Bush administration officials, the proportion of international traffic entering the U.S. is dropping, not increasing, experts say. International phone and internet traffic flows through the U.S. largely because of pricing models established more than 100 years ago in the International Telecommunication Union to handle international phone calls. Under those ITU tariffs, smaller and developing countries charge higher fees to accept calls than the U.S.-based carriers do, which can make it cheaper to route phone calls through the U.S. than directly to a neighboring country.

The U.S., where the internet was invented, was also home to the first internet backbone. Combine that architectural advantage with the pricing disparity inherited from the phone networks, and the U.S. quickly became the center of cyberspace as the internet gained international penetration in the 1990s. In those early days, internet traffic from one Asian country often bounced through the first West Coast internet-exchange point, the San Jose-based MAE West, says Bill Woodcock, the research director for Packet Clearing House, which helps create packet-exchange points around the world.

While nobody outside the intelligence community knows the exact volume of international telephone and internet traffic that crosses U.S. borders, experts agree that it bounces off a handful of key telephone switches and perhaps a dozen IXPs in coastal cities near undersea fiber-optic cable landings, particularly Miami, Los Angeles, New York and the San Francisco Bay Area. Miami sees most of the internet traffic between South America and the rest of the world, including traffic passing from one South American country to another, says Bill Manning, the managing partner of ep.net. “Basically they backhaul to the United States, do the switch and haul it back down since [it is] cheaper than crossing their international borders.” And some internet traffic traveling from Asia to Europe still crosses the entire breadth of the U.S., entering in Los Angeles and exiting in New York, says Woodcock.

For voice traffic, the NSA could scoop up an astounding amount of telephone calls by simply choosing the right facilities, according to Stephan Beckert, the research director at Telegeography. “There are about three or four buildings you need to tap,” Beckert says. “In L.A. there is 1 Wilshire; in New York, 60 Hudson, and in Miami, the NAP of the Americas.”

The U.S.’s role as an international communications hub came at a convenient time for the NSA, which in the 1990s began confronting a world moving away from easily-intercepted microwave and satellite communications, and toward fiber optics, which are difficult and expensive to tap. Press leaks in recent months have revealed that the NSA began tapping the U.S. communications hubs for purely international traffic shortly after 9-11, at the same time that it began monitoring communications between U.S. citizens and foreigners as part of the Terrorist Surveillance Program.

After the Democrats took over Congress in 2007, the administration put the NSA surveillance programs under the supervision of a secretive spying court, which ruled shortly thereafter that wiretapping U.S.-based facilities without a warrant was illegal, even for the purpose of harvesting foreign communications. In August, Congress granted the NSA “emergency” temporary powers to continue the surveillance, which are set to expire in February. The RESTORE Act is the Democrat’s effort to extend that power indefinitely, while including some safeguards against abuse. It would legalize both the foreign-to-foreign intercepts, and the domestic-to-foreign surveillance associated with the TSP.

The bill enjoys wide support in the House, but President Bush vowed to veto any surveillance legislation that does not extend retroactive legal immunity to telephone companies who cooperated in the NSA’s domestic surveillance before it was legalized – a provision absent from the RESTORE Act. AT&T, which is facing a class-action lawsuit for allegedly wiretapping the internet on behalf of the NSA, is reportedly among the companies lobbying hard for immunity.

Experts say that, even with a stamp of approval from Congress, the growth of international communications networks will eventually rob the NSA of its home-field advantage in inspecting foreign communications. “The creation of alternative paths are starting to challenge the dominant position the U.S. has,” Manning says. Exchanges in Hong Kong and London are emerging as local hubs for Asian and European traffic, while new fiber cables running north and south from Japan around to Europe will divert traffic from the trans-America route. Meanwhile, more countries are building their own internal internet exchanges.

“Because the decisions are made by the private sector, you are always going to go the direction where you have the cheapest fiber,” Woodcock says. “That is likely to be through the U.S. for a while yet, (but) that’s changing as more and more fiber gets installed around South Asia.”

The trend may leave U.S. spooks longing for a simpler time, like 1992, when the first – and at the time, only – internet exchange point, called MAE-East, was erected in Washington D.C. “All the traffic in the world went through Washington,” Woodcock says. “But it was coincidence that it was Washington, more or less, and it was private-sector. And it probably was not tapped for at least a couple of years.”

FORMER CEO SAYS U.S. PUNISHED QWEST FOR NOT COOPERATING WITH THE NSA

A former Qwest Communications International executive, appealing a conviction for insider trading, has alleged that the government withdrew opportunities for contracts worth hundreds of millions of dollars after Qwest refused to participate in an unidentified National Security Agency program that the company thought might be illegal. Former chief executive Joseph P. Nacchio, convicted in April of 19 counts of insider trading, said the NSA approached Qwest more than six months before the September 11, 2001, attacks, according to court documents unsealed in Denver this week.

Verizon gave data to government more than 700 times.

If the government wants information on Verizon customers apparently all it has to do is ask. Verizon told congressional investigators it provided phone records to the government without court orders hundreds of times in the past two years, according to the Washington Post.

Can you hear me now? Wrong question. The question is, “Who can hear me now?”

NAIVE P2P USERS CERTAIN TO BE TRACKED

Use a blocklist or you will be tracked. But resistance is not futile.

The old cliché, “You’re not paranoid if they really are out to get you,” turns out to apply quite nicely to the world of P2P file-sharing. A trio of intrepid researchers from the University of California-Riverside decided to see just how often a P2P user might be tracked by content owners. Their startling conclusion is that “naive” users will exchange data with such “fake users” 100% of the time.

The researchers collected more than 100GB of TCP header information from P2P networks back in early 2006 using a specially-doctored client. The goal of the research was a simple one, to determine “how likely is it that a user will run into such a ‘fake user’ and thus run the risk of a lawsuit?” The results are outlined in a recent paper (PDF), “P2P: Is Big Brother Watching You?”

For years, P2P communities have suspected that affiliates of the RIAA, the MPAA, and others have been haunting P2P networks to look for those who might be swapping copyrighted files. It is more than a hunch. It is well documented that companies like SafeNet engage in this sort of work, and that their testimony is routinely produced at trials. It helped to bring down Jammie Thomas, in fact.

But identifying these organizations is hard. The nature of their business is to remain shadowy, but P2P advocates have spent years compiling “blocklists” of IP ranges that are suspected of belonging to such companies. Connect to a “user” who has an IP address (IPA) in one of the blocklists and you have just been tracked swapping a file. By parsing all of the TCP headers that they collected over the course of 90 days, the UC-Riverside researchers came to several conclusions:

1. If you do not use a blocklist, you will be tracked. Every one of the researchers’ test clients that did not use a blocklist soon connected to an IPA found within those lists. It turns out that 12-17% of all IPAs on the network belonged to these blocklisted ranges.
2. Trackers are not that hard to avoid. Researchers found that “avoiding just the top 5 blocklisted IPs reduces the chance of being tracked to about 1 percent.”
3. Content owners hide their tracks. Much of this tracking work is farmed out, and those companies take care to hide their tracks. When the researchers ran reverse DNS lookups on the blocklisted ranges, they found that only 0.5% of those addresses resolved back to media companies in an obvious way.
4. Meet the BOGONS. One of the strategies for remaining anonymous is to operate from BOGON IP ranges. These ranges are unallocated blocks of addresses that should ordinarily not be used on the public internet. Of the top 15 blocklist entities that were discovered during testing, 12 were in BOGON ranges. The researchers note that “these sources deliberately wish to conceal their identities while serving files on P2P networks,” and reverse DNS queries on these addresses produce little useful information.

The takeaway here is simple. P2P users who do not utilize the blocklists are just about guaranteed to be tracked by “fake users” operating out of those ranges, and thus seem to open the door to possible litigation should the dice be rolled against them.

The study did not attempt to determine if the blocklists actually correspond to tracking organizations. The researchers note that “this would be interesting and challenging future work.” Conversely, there is no way to know if addresses not on the list might in fact be tracking users.

NIGHT OF THE LIVING VISTA

Today, I think of Vista as the zombie operating system. It stumbles around, and from a distance you might think it is alive, but close up it is the walking dead.

The first sign that Vista was in real trouble was when major vendors started to offer XP again on new machines. It came as no surprise at all to me when Mike Nash, Microsoft’s corporate vice president for Windows product management, announced that, due to OEM demand, Microsoft will keep selling XP until June 2008. Of course, he also claims there is little chance the June 30 date will be extended. Want to bet?

There are many reasons why Vista is doing the zombie stumble. Microsoft has and continues to mislead customers about how much PC is really needed to run Vista. Even some of Windows’ most loyal users are finding that its poor performance, lousy software support and pathetic driver support is too much to stomach. And, last but never ever least, if XP ain’t broke, why “fix” it with Vista?

Now you might think some of this is legacy backlash. People would rather use Windows 2000 than XP, Windows 98 SE than 2000,and Windows ME more than ... well, OK, no one liked ME. But I have been through these cycles many times before. This is different. XP SP2, with XP SP3 finally due to show up soon, is not only the best Windows to date, I cannot think of a single reason to switch from XP to Vista. Not a good reason, I really mean any reason.

If you want a better operating system than XP, may I recommend Xandros as the most painless way for an XP user to give Linux a try. If the idea of installing Linux gives you hives, you can just buy an Ubuntu-powered Dell 1420 laptop, which is a very sweet machine. Whatever you do, even if it is just sticking with XP, you will be doing better than moving to Vista. Vista is the walking dead of the operating-system world.

AN IN-DEPTH LOOK AT PUPPY LINUX

With hundreds of Linux distributions available, how do you determine which one is right for you? Start by listing your needs. What will you use it for? Which features are important? How would you prioritize them? Which features do you not care about?

Once you have developed your “user profile”, measure it against the strengths of different Linux distributions. Linux is configurable and gives you the full control you expect from open source software – so theoretically you could probably tailor (or strong-arm) almost any Linux distro into meeting your needs. But it makes more sense to start with the one most suited to your requirements.

Puppy Linux is one of the twenty most popular Linuxes worldwide, according to the distro-tracking website Distrowatch. Puppy’s distinct personality makes it of interest to those who want a Linux that ...

• Includes all the applications required for daily use
• Works right out of the box
• Is easy to use, even for Linux newbies and Windows refugees
• Runs fast and performs well, especially on limited hardware
• Runs on old computers, thin clients, and diskless workstations
• Installs and boots from any bootable device, including USB memory sticks, hard disks, Zip drives, LS 120/240 SuperDisks, CDs and DVDs, rewritable CDs and DVDs, and network interfaces

Unlike most Linux distributions, Puppy is not based on some other distro. It was created from scratch to meet these goals. We will discuss Puppy’s distinguishing characteristics. We will wrap up by summarizing how it differs from other Linux distributions.

PRISON BLUES

As prosecutors collect the scalps of white-collar defendants, corporate executives have to think about what it is like on the inside of a prison, and what might land them there. A new book details the story of a promising executive who embezzled $6 million from MCI and paid the price.

The turn-of-the-century bubble and bust set off a wave of business scandals, followed by cries for a crackdown on crime in the executive suite. Prosecutors stepped up to the task. Since 2002, when the Sarbanes-Oxley Act passed, the number of FBI corporate fraud cases pending has risen 70% to 490.

Among those recently joining the prison lineup, or soon to do so, are oil baron Oscar Wyatt, former Computer Associates chairman Sanjay Kumar, former Qwest chief executive Joseph Nacchio, former Brocade chief executive Gregory Reyes and former Comverse general counsel William Sorin.

What is it that compels formerly upstanding executives to step over the line? Stolen Without a Gun, co-written by Walter Pavlo Jr. and Forbes Senior Editor Neil Weinberg, delves into the question by telling the story of Pavlo, a fast-tracker who pleaded guilty to siphoning off $6 million as a debt collector for MCI Communications. Pavlo and a couple of cronies cooked up a scheme in which they persuaded troubled clients to pay a bogus financing firm in the Cayman Islands to cover their MCI debts while Pavlo secretly erased them from his employer’s books.

In an all-too-familiar pattern, this is the story of executives losing their moral bearings since everyone around them is playing it fast and loose, too. It tells of the self-serving rationalizations they use to launch themselves down the slippery slope, plus the personal consequences and punishments that await them. Here is an excerpt adapted from the book.

STATE OF TEXAS’S CASE AGAINST BUSH HITS HIGH COURT

It is the official, considered position of the state of Texas that President Bush is a constitutionally ignorant power-grabber. An unusual case that the Supreme Court will hear as it begins its new term features Texas accusing its former chief executive of overstepping his office, by ordering Texas judges to comply with an International Court of Justice ruling involving a condemned killer from Mexico.

“It is, in my judgment, a breathtaking order,” the state’s chief appeals lawyer, Solicitor General Ted Cruz, said a few days ago as he previewed his arguments for the Federalist Society, a conservative legal group. “This president’s exercise of this power is egregiously beyond the bounds of presidential authority.”

It is an extraordinary confrontation, not just because Mr. Bush used to live in the Governor’s Mansion but because his chief accuser helped put him into the White House. Mr. Cruz served as domestic policy adviser to the Bush-Cheney campaign, was a key player during the Florida recount in 2000, coordinated hiring for the Justice Department and served as an associate deputy attorney general.

28 states, two former U.S. attorneys general, three former U.S. solicitors general and top legal theorists, liberal and conservative, side with Texas. California Attorney General Jerry Brown and Reagan Attorney General Ed Meese find common ground, Mr. Cruz said, because of the “enormous mischief” presidents could wreak if the Bush assertion stands.

Imagine, he argued, what President Dick Cheney might do, or President Hillary Rodham Clinton – a boogeyman for each side – if they were free to “flick state laws off the books on a simple assertion of international comity.” Mr. Cheney might scrap California emissions laws that undermine Kyoto treaty negotiations and put a stop to punitive damage awards that hurt multinational corporations. Mrs. Clinton might set aside bans on gay marriage and adoption and halt capital punishment.

THAT WHICH IS ABOUT TO FALL DESERVES TO BE PUSHED. THE NATION-STATE IS WOBBLING

Empowering Ron Paul’s grassroots army.

We are seeing a political phenomenon like no other in history. We are seeing the creation of an army of volunteers who have not been actively recruited. This is as close to Hayek’s concept of the spontaneous order as politics has ever provided.

Back in 1937, Albert Jay Nock wrote an essay titled “Isaiah’s Job”. It dealt with the strategic error of starting a political movement to save America. It will not work, Nock said. The kind of people who you need in order to change America cannot be attracted by active political recruiting. Such people will seek out those leaders who they approve of. He called them the Remnant. We are now seeing what Nock did not foresee, the coming together of a grass roots army. It is assembling itself. The internet’s technology is making this possible. The Remnant is forming.

What if Ron Paul does not get the Republican Party’s nomination. What will his newly self-assembled army do then? If it disbands, that would be a tragedy. If it is given the digital tools to work with, free of charge, this really could change America.

There will come a day when the checks from Washington will stop coming, or – more likely – the money delivered by Washington’s checks will not buy much. On that day, Americans will look locally for leadership. Almost no one with a long-run perspective sees this coming. No one is preparing politically. No local politician has sat down with Jacques Barzun’s From Dawn To Decadence and Martin van Creveld’s The Rise and Decline of the State and read the final chapter in each, where each scholar discusses the looming failure of the nation-state to provide either protection or welfare.

No one has said, “What will fill this coming vacuum?” No one has developed a strategy for the transition from Washington to localism. Such thoughts are not common in today’s world of Federal power and Federal money. It takes a specific worldview even to ask such a seemingly utopian question. Ron Paul has such a worldview. So do his followers.

We hear about empowerment. How can his grassroots army become empowered? By getting simple tools, basic training, and long-term motivation from a central source. What is needed is freeware. What is needed is a lawyer-drafted web site privacy policy statement and terms of use statement that every local site manager can adopt in order to keep the Federal regulators at bay. What is needed is mailing lists – lots and lots of local mailing lists. The internet has made possible a low-cost program for local political mobilization. Someone is eventually going to do this. Why not Ron Paul’s troops?

The grass roots army that has spontaneously assembled itself around Ron Paul’s candidacy is motivated by one powerful idea: shrink the state. There is an old rule – “When you see something wobble, push it.” For all its braggadocio, the modern nation-state is wobbling. It has issued more promises than it can possibly deliver. As this reality becomes apparent to millions of voters, there will be a search for local alternatives. There will be local power-seekers who will offer one set of alternatives. That is when we will need power-shrinkers in positions of local influence. Remember, we cannot beat something with nothing.

ATLAS SHRUGGED AND THE CORPORATE STATE

Landmark novel celebrates its 50th birthday.

This week marks the 50th anniversary of the publication of Ayn Rand’s stunning novel, Atlas Shrugged. So many words have been written about the book that the task of saying something new is daunting. It is a celebration of the creativity that is required for the production of material goods no less than for the production of music, art, and literature. And it is an elaboration of the precondition for that creativity – individual freedom, which necessarily includes property rights. In sum, Atlas Shrugged is a literary brief for the proposition that human beings can live fully as human beings only in a society founded on the freedom philosophy, i.e., on self-ownership, private property, privacy, consent, free trade, and peace – in a phrase, laissez faire.

What sometimes goes unappreciated by readers of the novel is the extent to which Rand targeted business people as potentially the most egregious saboteurs of freedom. While many of the novel’s heroes operated businesses, key villains did also. It is no exaggeration to say that Atlas Shrugged can function as a guide to how the corporate state, or mixed economy, works. Rand well understood that liberty is threatened by business owners who seek privileges from the state in order to gain protection from open competition, domestic as well as foreign. Those privileges do not merely limit the selection of consumer goods and raise prices higher than they would be. They also reduce competition for workers’ services and suppress self-employment opportunities. Moreover, they encourage others to seek countervailing privileges. If businesses are protecting their market positions with protectionist licensing, taxes, regulations, subsidies, trade restrictions, patents, and the like, why should labor and other interest groups not also seek protection? Before you know it, the state is involved in all aspects of life.

Endless trouble is wrought by focusing only on the later interventions and forgetting about the earlier ones. (That is what Kevin Carson calls “vulgar libertarianism”.)

Not all of Rand’s work demonstrated such a sound intuition about real-world “capitalism”. While her fiction and some of her essays astutely describe the system generated by the businessman-as-privilege-seeker – she called it the “new fascism” – some of her nonfiction work takes another tack, lamenting “big business” as “America’s persecuted minority.” But as the late Roy Childs documented in his 1971 Reason magazine article, “Big Business and the Rise of American Statism”, historically business was the major impetus to centralized control of the American economy. The advocates of corporatism in the business world are usually overshadowed by the German-educated American intellectuals who espoused statism in lofty philosophical terms. But in fact, corporatism was mostly the handiwork of business leaders’ efforts to protect their market positions from upstart competition. Childs’s article (which I heartily recommend) draws substantially on work of New Left historian Gabriel Kolko (The Triumph of Conservatism and Railroads and Regulation), who demonstrated that despite earlier pro-business protectionist regulation at the state and, to a lesser extent, federal levels, dominant businesses were under vigorous competitive challenge in the late-19th and early-20th centuries.

“Ironically,” Kolko writes, “contrary to the consensus of historians, it was not the existence of monopoly which caused the federal government to intervene in the economy, but the lack of it.” Innovative entrepreneurs found ways to win customers and take market share from incumbent firms. A strategy of mergers and acquisitions failed to stem that challenge. “Competition was unacceptable to many key business and financial leaders, and the merger movement was to a large extent a reflection of voluntary, unsuccessful business efforts to bring irresistible trends under control. ... it became apparent to many important businessmen that only the national government could [control and stabilize] the economy.”

This is the origin of the Progressive-Era “reforms”, the Interstate Commerce Commission, Federal Reserve, Federal Trade Commission, and most of the rest of the new regulatory state. Well-connected corporate leaders favored measures that would cartelize their industries and inhibit competition in the manner of FDR’s later, short-lived National Recovery Administration. (Many of the same business leaders applauded the New Deal. See “America’s Engineer”.) Centralized government supervision of industry, finance, and agriculture, which those business leaders reasonably expected to influence, was vastly preferable to both laissez faire and state-level regulation.

Readers of Atlas Shrugged can gain valuable insights into this process, and for that we have one more reason to praise the novel.

The biggest threat today is not from communism or state socialism or even terrorism. The threat is from the concentration of power in the hands of pedestrian centrist politicians on the pretext of national and economic security. This has a powerful corporatist element that must not be overlooked. For example, all the so-called top-tier presidential candidates favor a comprehensive energy policy designed to cut back the use of imported oil and to stimulate development of alternative fuels. Who stands to gain most from the subsidies, tax preferences, and market manipulations that will constitute such a policy? You guessed it. The energy companies, which have never stood on their own, independent of government. And who is pushing hard for deeper government intervention in medicine and pensions? Big corporations, which are competitively burdened by the obligations they have taken on over the years. Who will stake these beneficiaries? Consumers, workers, and net taxpayers.

The message of Atlas Shrugged is that human creativity and the good life it provides require freedom and that state coercion, always justified in terms of self-sacrifice, is contrary to our rational interests. If you have not already done so, read it. Then join the struggle for freedom, free markets, and peace.