Wikileaks, Watergate and Whistleblowers

It's been a long time between drinks on my blogs - I have been doing some extra study over the past few months which has been keeping me a little busy.

But there has been a lot going on - I think one of the most exciting developments is the Wikileaks movement and the light it is shining on how various international deals, actions and agreements are governed.

The aggressive, arguably irrational rhetoric by many US commentators on the recent Cablegate releases is remarkable in it's anger, suggesting that the work that Wikileaks is doing as akin to terrorism, putting innocent lives at risk by publishing classified information, is in fact a treasonous offence and the perpetrators should be executed.

To compare to something in history, the work that Wikileaks is doing is no different to the groundbreaking journalism of the Washington Post in uncovering the true depths of the Watergate scandal that resulted in President Nixon's resignation in 1974.

The Post, with reporters Bob Woodward and Carl Bernstein, investigated the arrest of 5 men that broke into the Democratic National Committee (DNC) headquarters in Washington in June 1972. It turned out that these men were in fact bugging the DNC and working for President Nixon, and had been undertaking similar covert operations work for the President for some time before that. Their pursuit of the story is now heralded as a watershed moment in investigative journalism, demonstrating that even the highest power is not, and should not, be immune from scrutiny.

Given what we know about Watergate, to suggest that Woodward and Bernstein were committing treason and should be executed is ridiculous. But like Wikileaks, they used whistleblowers (aka Deep Throat, later revealed as former FBI deputy director Mark Felt) who leaked classified information to the Washington Post. Like Cablegate, the information leaked was classified, provided details on operations of intelligence agencies and was very embarrassing for the government. But the leaking of this information did not put innocent lives at risk nor was it terrorism, and quite rightly hasn't been recorded that way in history. It instead shone light on reprehensible activity in the highest office in the US that the American people would not have been aware of had it not been for the courage of both the whistleblowers and the Washington Post.

Unfortunately, we now live in a time where there is no room for a Woodward or Bernstein. Based on the assault against Wikileaks and Julian Assange, had Watergate happened today, Woodward and Bernstein would probably have been indicted or subpoenaed to a US grand jury, ordered to name their sources, and potentially put in jail. And that anger has been consistent across the globe, with our own Prime Minister joining in the chorus calling the release of the Cablegate information "illegal" (although no basis has actually been put forward for that claim).

So what has changed from 1974? Why are journalists less likely to shine a light in to dark corners of government lest they fear persecution? The truth is, they always had fear of persecution. But more than ever, journalists are now “embedded” to the government's own interpretation of events and asking difficult questions about foreign policy, intelligence or defence is often considered "unpatriotic" (John Pilger quite rightly describes the many modern journalists as "spokesmen for the spokesmen"). It would seem that since the 1970's (at least), investigative journalism has taken a backwards step - many journalists are doing a disservice to the public by failing to ensure that all sides of the story, not just the "government line", are investigated and freely available to all.

Given the current state of journalism, Wikileaks is one of our last hopes of ensuring we get what we deserve in a democratic society - transparent, balanced, unfettered information from which we can make a decision about the best way to govern our society.

As Thomas Jefferson, America’s 3^rd president is reported to have said, "information is the currency of democracy".

Visit current news on the Cablegate releases at Aljazeera’s dedicated website area.

How deficits & debt might be extinguished

The concern about government deficits and debt is getting a lot of airtime.

Government deficits and debt are growing at an astronomical rate - look at this graph of the USA debt. Total government and private debt of the USA is 3.5 times its economy at $50 trillion! Similar types of huge ratios exist for the Euro Zone, UK, Japan etc.

Let's face it - the debts and deficits of the major economies, are beyond hope. There is no conceivable, practical, orderly course of action that these governments can take that will get their huge deficits, or debt down to sustainable levels.

So what could happen?

The interesting thing about the concept of "government balance sheets" is that they were formulated at the time of the gold standard - that is, there was a limited supply of money pegged to a commodity, and so taxes and debt needed to be raised in order to pay for government expenditure. If you raised less taxes than the government spent, you had a deficit. Opposite situation, you had a surplus. Sometimes debt would be issued - effectively the same as raising taxes, but the money had to be paid back in the future, with interest.

But in the modern world, governments have a new weapon against deficits - "quantitative easing", in other words, printing money. We have been taught that printing money is dangerous. I remember reading about someone in Germany wanting a newspaper needing more than a wheelbarrow of notes during the 1920s. Or of a 6.5 quindecillion novemdecillion percent (65 followed by 107 zeros) inflation rate in Zimbabwe.

But lets put the fear mongering to one side and think about it. To help me, I have read this excellent paper presented at a recent actuarial conference I attended.

Firstly, split the world up into the government system and the private system.

When the government prints money, it usually spends it, and puts it in the private system. The government is in "deficit", the private system is in "surplus". The deficit and surpluses match, so overall the the system balances. The "cost"of money is now lower (because there is a lot more of it), i.e. interest rates are lower.

The government can keep doing this as much as it wants as long as the printed money is being put to good use (i.e. people are employed, goods and services are being produced in adequate supply). Provided there is a balance of demand and supply of goods and services, inflation can't go up. The system remains in balance.

Along with the printed money, adding flows to the system is credit. This is an additional private system mechanism to keep the flow of money going around the economy. Again, credit is not a problem provided it is being put towards real activity which provides a true, long term, economic return.

But if we have too much credit and money in the system, without real economic activity, we have a problem. Goods and services are in short supply, but the supply of money and credit continues unabated. We get inflation. We get asset bubbles. We get people borrowing money and not able to pay it back.

In this situation, the government takes money back. It can raise the "cost" of money (i.e. interest rates) so that people who can't pay money back can no longer afford it. Governments can raise taxes. The private system can tighten credit. Government does the opposite of printing money - it effectively takes money back. As a result, the government system moves into surplus, and the private system moves into deficit. Once again the system balances.

And provided we watch the warning signs of too much money and credit, of asset bubbles and household debt, these cycles can be managed out.

So where are we today?

Well the government deficits in the major economies are here to stay. The debts supplementing the deficits are here to stay. As long as the countries continue to produce real activity to keep up with this enormous debt, as long as the private system holds up its end of the bargain, the logic here says that it can't cause a problem.

But there are problems.

Major economies are producing less and less at home, and outsourcing and shifting manufacturing overseas. Major economies are reliant on imports. Real GDP growth is slowing. The private system is under enourmous stress, with private job creation in a poor state. The reliability of the private system to regulate its own risk has taken a huge hit (e.g. GFC)

So our logic tells us that the printed money and supply of credit won't be used properly. It will be used to buy imports and to bid for the limited supply of goods we have (e.g. houses). We will be in bubble and inflation zone. The value of the major currencies will reduce, meaning an increase in the cost of imports, further reducing real economic activity in turn propelling inflation further to an eventual breaking point.

And how will it end?

So many different ways are possible. But Marc Faber, a follower of the Austrian school of economics, has a particularly depressing slant on it. He says - "I am convinced that the U.S. government will go bankrupt, but not tomorrow, and before they go bankrupt they’ll print money, and then you get very high inflation rate, then you get depression with high inflation, and eventually they’ll go to war".

We need to make sure our money and credit is being put to good, productive, sustainable use. If we don't, it is hard to see how it is all going to end well.

Can anyone see flaws in this logic? If you can, I would love to hear it.

John Pilger: There Is a War on Journalism

An interview with the (always) excellent John Pilger.

Vagueness and Memory.

Vagueness.

Long Term Capital Management was one of the premier US investment funds during the 1990s. Run by experienced traders and academics with an edge for mathematics and statistics, the fund returned 40% pa during 1994-1997. Leading business publications such as Business Week touted its remarkable achievements, with any critics on the sustainability of the fund relegated as obstructionist or ignorant. One of the funds leading advisers, Myron Scholes (of Black-Scholes fame, the formula used to price most derivatives around the world) was reported to rebuke a critic in an investors meeting questioning how the fund could make such returns by saying “You’re the reason – because of fools like you we can”.

But there was more to it than that. The fund was reliant on borrowing from banks to take bets on the movement of stocks, bonds, currencies and commodities. The bets were based on the precision of the models based on the intellectual firepower of academics like Scholes. The models used historical assumptions to predict where these investments would end up a certain percentage of the time, and the fund would bet appropriately.

The major risks of the fund were two-fold. Firstly, it was using an incredible amount of leverage, so was dependent on the continued liquidity of the market and faith of their lenders to ensure it had enough cash to cover its bets. Secondly, it was operating in a vacuum of precision, with an assumption that the past would realistically continue in the future with absolute certainty.

The reality of such a flawed approach hit the fund during 1998 – this was the year of Russian and Argentinean debt crisis and the Asian currency crisis. According to the firms’ models, these events wouldn’t occur at the same time. But they did, and the fund lost 4bn dollars from its bets being in the wrong direction, wiping out its gains of the past 4 years.

The real danger was to the broader financial system - the same system that ensures credit flows to business and individuals. Because the fund had borrowed to fund its bets, and it hadn’t set aside anything for these bets going badly, the fund couldn’t pay back its lenders (which were the major US banks such as Goldman Sachs, Merrill Lynch, JP Morgan and Lehman Brothers). Failure to pay back the loans could create a crisis in confidence, freezing up the flow of credit.

Clearly, the banks and fund managers did not heed the warning of one of their academic peers, Kenneth Arrow, when he prophetically stated in 1992 - “Our knowledge of the way things work, in society or nature, comes trailing clouds of vagueness. Vast ills have followed a belief in certainty”.

In this situation, the protagonists were so precisely arrogant in their beliefs, and their repeated aversion to taking external, common sense advice created a potential catastrophe for financial markets.

Memory.

If this all sounds familiar, it is. This problem was essentially the same as the allegedly “unprecedented” credit and liquidity crisis of 2008. Banks made bad loans, didn’t understand the risks, and then threatened to refuse to lend each other because they didn’t know how badly exposed the other banks were.

The solution to the 1998 problem was somewhat different to 2008 – in 1998 a consortium of banks bailed out Long Term Capital Management, although this was facilitated by the New York Federal Reserve with the US Federal Reserve providing interest rate cuts to reduce the cost of the bailout to the banks. As in 2008, the solution was agreed quickly (to avoid impacts to financial markets) and the public were not consulted on this approach.

But the precedent was established. The US Government wouldn’t let a private institution with private interests’ fail that could threaten the stability of a financial system; despite the fact the private institution played a significant role in creating the broader systemic risk. The 2008 bail outs of AIG, Freddie Mac and Fannie Mae emerged in similar circumstances; although in 2008 US taxpayer funds were directly used. So an even more dangerous precedent has been established. Rather than a consortium of banks with some additional government assistance, the taxpayer is effectively underwriting substantial downside financial and systemic risks.

Why does the public accept underwriting these substantial risks? It appears to be a matter of trust and fear of the unknown.

Taxpayers quite rightly assume the government is acting in the public interests – if they ask for money, they must need it. If this is the agreed approach, the public also has an equal right to ask during the "normal" times that the risks taken are understood and managed appropriately. As the recent pushback for banking regulation and financial reform in America is showing us, this is proving to be quite a challenge.

We also appear to be so scared of the implications of a failure. But failure happens and we all need to understand and learn from the risks that caused the failure. What is dangerous is creating an environment that downside risks are neutralised – creating such precedents means we don't learn from mistakes, meaning it is more likely the problem (potentially larger) will recur.

In the modern world, memories are such a hard thing to hold onto, particularly if they fall into a vacuum of complex and often-conflicting explanations. Harold Pinter hit the nail on the head during his 2005 Nobel Prize for Literature Speech; although he was referring to our memories or war and conquest, it is equally relevant here –

“It never happened. Nothing ever happened. Even while it was happening it wasn't happening. It didn't matter. It was of no interest. It's a brilliant, even witty, highly successful act of hypnosis.”

It is very hard to fit skepticism and questioning into our fast paced lives, let alone remember history. But if we don't remember or understand, history risks a repeat.

Letter in the Manly Daily

A link to a letter I recently wrote in the Manly Daily (second from the top "Chance to reflect
on nation’s values) - http://manly-daily.whereilive.com.au/your-news/story/viewpoint-may-18/

Large scale failure

When we are confronted with a potentially large failure which seems to come out of nowhere, our natural reaction is to avoid it at any cost. For example, the response to the recent Global Financial Crisis (GFC) was “unprecedented” and “aggressive” (http://georgewbush-whitehouse.archives.gov/news/releases/2008/10/20081014.html) with an incredible overall cost of over US$11 trillion and climbing (http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5995810/IMF-puts-total-cost-of-crisis-at-7.1-trillion.html) that will unlikely be recovered in our lifetime.

The reality is that the underlying causes of the GFC of excessive borrowing and risk taking were very similar to the Great Depression, the 1980s Saving & Loan debacle and the 1987 Wall Street crash. This serves as a reminder that large failure is inevitable – after all, the law of averages means that many times, outcomes will fall short of our expectations.

So if it is going to happen anyway, why don’t we confront potential large failure more openly with a more measured plan - or at least try to lessen the impact of failure before it becomes a problem? In part it is because a big failure and it's impacts are not something we like to be reminded of, let alone think will affect us. Many of us like to talk prospects up, even more so when things have been going well for a very long time. And we definitely don't want to leave a legacy of failure, so we will do all we can to at least defer the failure.

To me there seems to be a large gap in honestly discussing potentially large failure throughout the business cycle, This has become even more important given community reliance on large, global businesses. Failing to plan means paying substantial costs to avoid failure when there seems to be no other choice.

It is easy to find information about the numerous cases of business failure throughout history. Even Wikipedia has a list (http://en.wikipedia.org/wiki/List_of_business_failures). Although the reasons for failure become repetitive, it helps give a sense of what failure looks like, and reminds us that many failed businesses were once successful

To reduce the chance and impact of large scale failure, basic risk management can be followed. At a minimum this means establishing independent checks and balances and paying staff for long term performance rather than short term risk taking. Independent verification of activities remains the responsibility of a small, unappreciated minority of the business world, such as auditors and regulators. In boom times, these people are labelled as negative and any suggestions of better protecting the system are usually ignored or attacked (http://www.washingtonpost.com/wp-dyn/content/article/2010/03/18/AR2010031805370.html). But when boom turns to bust, we ask why these same people didn’t pick up the causes of the failure (http://seekingalpha.com/article/96955-bank-crisis-where-were-the-regulators). Instead of pointing fingers, we should insist on a stronger level of independent oversight of large businesses, both from within a company as well as outside from community representatives

If all else fails (no pun intended), an orderly run-off plan needs to be instituted to manage the community impact of failure rather than just stump up cash to deal with it another day. Unfortunately, from the GFC we have set a dangerous precedent where governments will prevent large scale failure through buy-outs and guarantees – this reaffirms the idea that failure should be avoided at any cost and that there are no consequences today of taking high risks.

Letting AIG or Citibank fail in 2008 would have probably resulted in a long, protracted depression for the Western world. But it would have reminded us that failure is inevitable, and that excessive risky actions do have consequences and exacerbate the impact of failure. Perhaps a large scale failure will remind us of the importance of caution, skepticism and austerity – all of which seem to have no place in modern life.

What housing shortage?

I have been reading/watching with interest recent coverage on Australia's reported shortage in housing, identified as a key reason for the recent and projected increases in Australia's house prices and reduced affordability.

Many commentators report much of this information as fact, despite it usually being provided by industry groups or construction/building businesses. On top of this, many local papers report information provided by local real estate agents, again verbatim, which is likely to be biased towards presenting an upbeat, optimistic view of the housing market.

Some examples of the reporting on the relationship between housing prices, housing shortages and population growth -

http://www.smh.com.au/business/housing-shortage-to-quadruple-hia-20100318-qgzu.html

http://www.smh.com.au/business/sydney-house-prices-tipped-to-push-higher-20100311-q0em.html

http://www.dailytelegraph.com.au/money/money-matters/sydney-the-city-of-broken-dreams-as-mortgage-stress-mounts/story-fn300aev-1225833209356

http://hills-shire-times.whereilive.com.au/real-estate/story/prepare-for-year-of-the-investor/

The general feeling is that there is an impending housing shortage crisis/disaster - so families have to "get in on the action", the effect of which is to keep pushing prices up.

But a look at the underlying ABS data on population growth tells a somewhat different story.

For example, there was an approximate 79,000 increase in the population of NSW for the year ended 30 June 2008 (http://www.abs.gov.au/ausstats/abs@.nsf/Products/3218.0~2007-08~Main+Features~New+South+Wales?OpenDocument#PARALINK3). Looking behind this data (see the spreadsheets in http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/3218.02007-08?OpenDocument), this 79,000 increase is roughly split as follows - Inner Sydney (17,000), Greater Northern/Coastal Sydney (4000), Greater Western/Southern Sydney (26,000) and Greater NSW (32,000).

This information tells us that most NSW house price growth should be in the Greater Western/Southern Sydney or Greater NSW area (these areas appear to account for about 70-75% of the population growth in 2008).

But NSW government housing data (http://www.housing.nsw.gov.au/About+Us/Reports+Plans+and+Papers/Rent+and+Sales+Reports/) shows that across NSW there was an annual reduction in housing prices to June 2008. For the year to June 2007, NSW population growth was 88,000, 67% of NSW population increase was in Greater Western/Southern Sydney or Greater NSW area, and prices were flat in some areas and marginally increasing in others.

It is true that the same housing data also shows house price increases to June 2009, and this does coincide with higher population growth in NSW (up to 115,000 although no regional data is available).

The problem with the population growth argument is that it ignores the obvious - it is likely (based on the experience of the USA, UK, Spain and Ireland) the current housing boom is in part driven by historically low, emergency level interest rates, easy credit, progressive reductions to income tax rates over the last few years, the first home buyers grant, and of course, investment speculation. And maybe the reason we are hearing so much about a housing shortfall is that it aligns to particular groups interests e.g. real estate agents, housing industry groups, construction business and the government (as a way of explaining away an asset bubble).

I think that more responsible, objective reporting by the media is in order to start challenging the information they are given - particularly if we want to avoid going down the calamitous property markets of the UK, USA, New Zealand, Spain and Ireland, where the same types of media reporting justified the booming markets until they fell apart.

And reflecting on it, what does a housing shortage actually mean? Is it that people are choosing between becoming homeless or buying a house? Not likely. People will (and are) renting instead of buying - and financially it is getting to the point where that makes more sense than buying a house. Maybe that will be the start of the bubble deflating.