According to the IMF (International Monetary Fund) and the IIF (Institute of International finance) global debt has soared to a new record high. The level of government debt around the world has ballooned since the financial crisis, reaching levels never seen before during peacetime. This has happened in the middle of an unprecedented monetary experiment that injected more than $20 trillion in the economy and lowered interest rates to the lowest levels seen in decades. The balance sheet of the major central banks rose to levels never seen before, with the Bank Of Japan at 100% of the country’s GDP, the ECB at 40% and the Federal Reserve at 20%.
If this monetary experiment has proven anything it is that lower rates and higher liquidity are not tools to help deleverage, but to incentivize debt. Furthermore, this dangerous experiment has proven that a policy that was designed as a temporary measure due to exceptional circumstances has become the new norm. The so-called normalization process lasted only a few months in 2018, only to resume asset purchases and rate cuts.
Despite the largest fiscal and monetary stimulus in decades, global economic growth is weakening and leading economies’ productivity growth is close to zero. Money velocity, a measure of economic activity relative to money supply, worsens.
We have explained many times why this happens. Low rates and high liquidity are perverse incentives to maintain the crowding out of government from the private sector, they also perpetuate overcapacity due to endless refinancing of non-productive and obsolete sectors t lower rates, and the number of zombie companies -those that cannot pay their interest expenses with operating profits- rises. We are witnessing in real-time the process of zombification of the economy and the largest transfer of wealth from savers and productive sectors to the indebted and unproductive.
However, as monetary history has always shown, when central planners face the evidence of low growth, poor productivity and higher debt, their decision is never to stop the monetary madness, but to accelerate it. That is why the message that the ECB (European Central Bank) and the IMF are trying to convey is that there is a savings glut and that the reason why negative rates are not working as expected is that economic agents do not believe rates will stay low for longer, so they hold on to investment and consumption decisions. Complete nonsense. With the household, corporate and government debt at still elevated levels and close to pre-crisis highs, the notion of excess savings is ludicrous. What informs such a misinformed opinion? The often-repeated “there is no inflation” fallacy. If money supply is high and rates are low but inflation does not creep up, then surely there must be a savings glut. False. There is massive inflation in financial assets and housing but there is also a very clear rise in inflation in non-replicable goods and services versus replicable ones, which means that the official consumer price indices (CPI) misrepresent the true cost of living increase. That is the reason why there are demonstrations all over the eurozone against the rising cost of living at the same time as the ECB repeats that there is no inflation.
When central planners blame economic agents for a non-existent savings glut and repeat that there is no inflation when there clearly is a lot, they also tend to add a conclusion: if households and corporates are unwilling to spend or invest, then the government must do it. This is, again, a false premise. Households and corporates are spending and investing. There is no evidence of a lack of capital expenditure, let alone solvent credit demand. The private sector is simply not investing and spending as much as governments would want them to, among other reasons because the private sector does suffer the consequences of taking a higher risk when the evidence of debt saturation is clear to all those who risk their capital.
Unfortunately, the next wave of central bank action will be the full monetization of government excess. The excuse will be the so-called “climate emergency” and “green deals”. Yet governments do not have better or more information about the best course of action in the energy transition, and by artificially picking winners and losers, ignoring the positive forces of competition and creative destruction to deliver faster innovation and progress, governments tend to delay, not accelerate change.
In any case, it will happen. The ECB, always happy to repeat the mistakes of Japan with an even stronger impetus, is likely to start new programs of debt monetization for green projects and claim it is a different, radical and new measure… as if it was not doing so already with the Juncker and Green Energy Directives.
The result is easy to predict, unfortunately. Governments hate two things that disruptive technologies do: reduce consumer prices and generate lower tax revenues. Yes, disruptive technologies are, by definition, disinflationary both in CPI and in tax receipts. Furthermore, disruptive technologies also demolish government control of the economy. These three reasons, lower inflation, lower tax revenues, and less control, are the reasons why governments will never adopt true changes in the economic growth pattern. And because of these reasons, the massive spending financed with new money creation is likely to be even worse for economic growth. Not only it is likely to be an even bigger crowding-out of the private sector, but make economies less dynamic, less productive and more indebted.
There are ways to incentivize change and a green revolution. It is called competition and creative destruction. None of those are favored by governments, not because they are evil, but because governments have the incentive to maintain the obsolete sectors via subsidies.
If the previous $20 trillion stimuli have delivered more debt, less growth, and rising discontent among the middle class that always pays for government experiments, the next one will likely be the last step towards full Japanization. If anything, what are already prudent spending and investment decisions from the private sector are likely to be even more conservative, and the resulting negative productivity growth will mean lower salaries and employment but higher debt and a larger size of government in the economy… Which is, in reality, the ultimate goal of these massive plans.
Surging “surprise” medical bills in the U.S. are private equity’s fault, a new FT opinion piece claims.
These “surprise” medical bills continue to be a major talking point in the U.S. and are likely to be a key issue during the upcoming 2020 Presidential race. The term refers to invoices that are generated after a patient is admitted to the hospital and treated, without their knowledge, by someone not in their insurance plan.
And a recent Stanford study shows that these “surprise” bills continue to become more ubiquitous. They are up from about 33% of visits in 2010 to almost 43% in 2016. For inpatient stays, the number is even more alarming: the jump goes from 26% to 42%, with the average cost per patient rising from $804 to $2,040. It’s an issue that only adds to the overwhelming debt bubble we have again created in the U.S.
The opinion piece notes that these rising costs come not from hospitals, but rather from the “backwaters of the financial markets”:
The prices of junk bonds issued by “physician services companies” have been sliding in the past month as their owners weigh the possibility and costs of political intervention. These point to the real source of the problem: private equity’s silent colonisation of parts of the healthcare profession.
A recent paper by two US academics highlights how private equity activity has driven up the price of healthcare for American consumers. The problem is a result of “the interplay of buyout strategies (which pile leverage on to companies and emphasise financial returns) and the business of treating people, where sick patients have no power to shop around and outcomes come first,” the piece notes.
Private equity has acted as a consolidator in healthcare services, building giant physician services groups like Envision, HealthTeam and AirMedical Group.
Envision was a company that was flipped between public and private ownership since 2005. It employs 70,000 staff and spans services like emergency rooms, radiology and anaesthesiology. The businesses are perfect for what private equity is looking for. The academic paper states:
“Emergency medical services are a perfect buyout target because demand is inelastic, that is it does not decline when prices go up.”
And in addition to being inelastic, demand is robust: about 50% of medical care comes from emergency room visits.
The deals that physician service groups work out with hospitals are rarely transparent to the public. And this is probably for good reason:
But a study by Yale University of the billing practices of EmCare, Envision’s physician staffing arm, showed that when it took over the management of emergency rooms, it nearly doubled patient charges compared with those levied by previous physician organisations.
Which raises the question why hospitals go along with these arrangements. Well, some have struck joint-venture deals with physician companies, splitting the extra revenues these entities stick on patients. But for many, they don’t have the resources or the industry clout to combat surprise billing on their own.
As a result, congress is now considering legislation to curb “surprise” billing in healthcare. The larger debate, as the U.S. will certainly be subjected to leading up to 2020, is whether or not private equity companies belong in the healthcare sector to begin with. Their tactics have done nothing but “give more credence to the arguments of Elizabeth Warren and others,” the piece concludes.
Economics is the only profession where the more an idea fails, the more it is believed. Consider the following theory:
Low interest rates lead to higher growth and higher inflation.
If it were true, then a decade of the lowest rates in recorded history would have seen the global economy go gangbusters. Instead it’s been mostly the opposite, leading any reasonable person to at least question this theory.
But wait a second! A wunderkind econ whippersnapper fresh from Davos interrupts.
If not for low interest rates, things would have been even worse!
This kind of defensive argument is popular among failed forecasters. And to be fair, I can’t prove that it isn’t true and low rates didn’t prevent some unforeseen calamity. That’s the beauty of the Hyperbolic Avoided Hypothetical (HAH! for short) and why it has become a favorite of the Central Banking elite. But it’s junk science, because you can’t disprove it either. For example: I just used my superpowers to prevent a zombie apocalypse. Go ahead and prove that I didn’t. (Do you see any zombies? No? You’re welcome.)
These twin tendencies of believing an idea that keeps disappointing and justifying it with all the worse outcomes that didn’t happen are the pillars of the global liquidity trap that is slowly pulling us all under. Ten years ago, there was a plausible theory that lower rates were a good idea. When they failed, rates were taken to zero (zero interest rate policy, or ZIRP). When that failed, they were taken negative (negative interest rate policy, or NIRP). At no point was it ever even considered that maybe, just maybe, it’s the theory that’s wrong.
My belief is that in the short term, artificially low rates are deflationary, as they result in investing booms that create excess capacity and misallocation of resources that hurts growth. Uber, Lyft, WeWork and AirBnb have caused plenty of deflation by constantly raising money to operate at a loss. Cheap debt enabled a fracking boom that’s flooded the oil market. Public companies that can borrow for nothing are more likely to spend that money on buybacks than wages.
But don’t say any of that to a central banker. In a profession where the things that didn’t happen matter more than the things that did, where giving free money to billionaires reduces income inequality and iPad prices matter more than the cost of food, the only thing that’s wrong with low interest rates is that they aren’t low enough.
And so, the ECB has just announced it will cut rates from negative 0.4% to negative 0.5%, because clearly what’s ailing Europe in the year 2019, a year of hard Brexits, Yellow Vests and right-wing uprisings is the fact that NIRP isn’t NIRPy enough, and should in fact be even NIRPier.
Here in the US we don’t have NIRP (yet) but the Fed is about to cut rates, despite the fact that unemployment is at an all time low, the stock market is at an all time high, and inflation is sitting just below the Fed’s own target. So why start easing? The Wall Street Journal asks the same question and concludes:
Federal Reserve Chairman Jerome Powell is leading his colleagues to cut interest rates this week for the first time since 2008, even though the economy looks healthy, partly because it isn’t behaving as expected.
Translation: The Fed’s economic models have once again failed to predict the behavior of millions of people, and that could only mean one thing: the people are wrong. It’s tempting to get on these economists for their folly, and lord knows they deserve it, but what we are witnessing is the all too common tendency among smart people to double down on a false belief when confronted with the limitations of their own intelligence. (Unfortunately, and unlike a degenerate gambler, Central Bankers get to double down with our money.)
The great philosopher Homer (Simpson, not the Greek dude) once toasted: “To alcohol: The cause, and cure, of all of life’s problems.” The same can be said for low rates. As the extremity of these policies continue to cause a widening wealth gap, social discord and populist uprisings, they will accelerate the feedback loop. As the drama unfolds, two assets, gold and crypto, will become increasingly sought after.
Yes, you can also use equities, venture capital and real estate to hedge against negative rates. And in fact, that’s exactly what Central Bankers want you to do, along with buying shit you don’t need and taking on debt you might not be able to repay. But too many of us lived through the financial crisis to forget its lessons, and stocks, startups and skyscrapers have already had an epic run anyway.
Gold has been a great hedge against insanity for thousands of years, and with crazy shit like the entire Swiss yield curve being negative out to 50 years being the new normal, these are historically insane times.
Crypto represents a lot of things to a lot of different people, and it remains to be seen whether it ends up being more of a store of value, medium of exchange, equity in decentralized network or some combination therein. But going forward, it will also start to act as a vote against the insanity, for the simple reason that it exists entirely outside of the traditional financial system. In that regard, it is rather undervalued.
Over the weekend, we were surprised to learn that some readers were prevented by Facebook when attempting to share Zero Hedge articles. Subsequently it emerged that virtually every attempt to share or merely mention an article, including in private messages, would be actively blocked by the world’s largest social network, with the explanation that “the link you tried to visit goes against our community standards.”
We were especially surprised by this action as neither prior to this seemingly arbitrary act of censorship, nor since, were we contacted by Facebook with an explanation of what “community standard” had been violated or what particular filter or article had triggered the blanket rejection of all Zero Hedge content.
To be sure, as a for-profit enterprise with its own unique set of corporate “ethics”, Facebook has every right to impose whatever filters it desires on the media shared on its platform. It is entirely possible that one or more posts was flagged by Facebook’s “triggered” readers who merely alerted a censorship algo which blocked all content.
Alternatively, it is just as possible that Facebook simply decided to no longer allow its users to share our content in retaliation for our extensive coverage of what some have dubbed the platform’s “many problems”, including chronic privacy violations, mass abandonment by younger users, its gross and ongoing misrepresentation of fake users, ironically – in retrospect – its systematic censorship and back door government cooperation (those are just links from the past few weeks).
Unfortunately, as noted above, we still don’t know what event precipitated this censorship, and any attempts to get feedback from the company with the $500 billion market cap, have so far remained unanswered.
We would welcome this opportunity to engage Facebook in a constructive dialog over the company’s decision to impose a blanket ban on Zero Hedge content. Alternatively, we will probably not lose much sleep if that fails to occur: unlike other websites, we are lucky in that only a tiny fraction of our inbound traffic originates at Facebook, with most of our readers arriving here directly without the aid of search engines (Google banned us from its News platform, for reasons still unknown, shortly after the Trump victory) or referrals.
That said, with Facebook increasingly under political, regulatory and market scrutiny for its arbitrary internal decisions on what content to promote and what to snuff, its ever declining user engagement, and its soaring content surveillance costs, such censorship is hardly evidence of the platform’s “openness” to discourse, its advocacy of free speech, or its willingness to listen to and encourage non-mainstream opinions, even if such “discourse” takes place in some fake user “click farm” somewhere in Calcutta.
A recent article in Inside Higher Ed argued that “We need to abolish the Harvard M.B.A degree for the good of the people who pursue that path, as well as the world at large.”
This is a nice sentiment, but the problem is bigger than the Harvard MBA, or even MBAs generally.
The underlying problem is increasingly mercenary values in society, and the rising popularity of MBA programs was more a symptom than a cause. The reason I am pretty sure the causality runs largely the other way is that it was during the 1980s that societal values moved in a big way towards valuing profits and markets over relationships and communities. This in turn was the product of a long-running, well-funded effort by then extreme right wingers to undo the New Deal and make prevailing views in the US more friendly to Corporate America. The strategy for that project was set forth in the 1971 Powell memo.
It is true that the explosion in MBA programs, and the number considered to be high quality, has exploded since I was a kid. Then, the prestigious names were Harvard, Stanford, Wharton, and Chicago, and for Wall Street jobs, you could add Columbia. Since then, a raft of programs considered second-tier (Darden, Sloan, Tuck, Yale, Kellogg) are now seen as close to on a par with the glam programs.
The resulting growth in the number of people getting MBAs who expected to earn big bucks in turn led to MBAs colonizing not for profits like hospital and higher education administration. That in turn has led to societal harm like the corporatization of medicine (see Health Care Renewal for a long-form treatment) and less and less university revenue going to teaching, and more to turning the schools into hedge funds with educational arms attached to them.
Tolerance for misconduct also rose. It would have been inconceivable in the 1960s that someone who had gone to prison, like Mike Milken, could ever recover any semblance of respectability. Admittedly, Harvard Business School did go through a bout of navel-gazing after some alumni were involved in 1980s scandals. But the school then determined that students’ moral compasses were set long before they went to grad school. HBS resolved to enroll more ethical students, but that sounded like a silly idea, since the crooked types would figure out what to say.
Similarly, just having more MBAs out there doing whatever they do is probably a bad thing because studying economics, even thinking about economics, makes people less compassionate, and MBA logic is economic logic with a little less jargon.
But as the same time, there’s corruption in fields where MBAs are scarce to non-existent. Look at scientific publication. As Dr. Marcia Angell, who had been the editor in chief of the New England Journal of Medicine, wrote in 2009:
It is simply no longer possible to believe much of the clinical research that is published, or to rely on the judgment of trusted physicians or authoritative medical guidelines. I take no pleasure in this conclusion, which I reached slowly and reluctantly over my two decades as an editor.
However, MBAs were positioned to benefit most from the rise of “Greed is good”. And the fact that economists promoted the idea that companies existed to increase shareholder value, a made-up idea with no legal foundation, led to equity-linked executive pay, which led to its explosive rise.
And the rise in MBAs is directly related to the increase in inequality. The 0.1% consists largely of hedge fund and private equity managers, fields colonized by MBAs. The 1% is the domain of CEOs and top professionals.
Now we get to the second beef about the Harvard MBA, that it makes people miserable, as confirmed by Charles Duhigg’s report on his 15 year reunion.
Again, the causality is backwards. Most people are miserable. The great world religions’ main purpose is to reconcile mortals to the inevitability of suffering. Money does not make you happier once a certain (not all that high) level of income is met.
On top of that, highly unequal societies are unhappy societies. Stress is high, even at the top, because if you fall, your decline in status is great and you are almost certain to lose all of your former supposed friends. Most MBAs live in worlds where the gradients are high.
The Victor Frankl school is that what keeps people going is having creative work they consider to be important or a strong personal relationship. MBAs, almost by definition, are not creative in the Frankl sense (as in artists, writers, scientists). They have (hopefully) average to high intelligence and decent social skills along with being sufficiently organized and responsible to be allowed to be in charge of things.
MBA programs select for ambition, and then the competitiveness of most schools plus the pressure cooker of the most sought-after recruiters further encourages graduates to invest in their careers at the expense of their personal lives. And despite the plush settings and lofty pay, the substance of many MBA jobs isn’t that great. A classic scene from Frank Partnoy’s book Fiasco has the members of the Morgan Stanley derivatives team saying to a person that they hate their work, they’d rather do anything else, even dig ditches….as long as they could make the same amount of money.
But things may have gotten even worse by virtue of younger people being over-coddled and over-praised and having even less realistic expectations for their adult life. For instance, in an essay I hope to address soon, the author wrote, “I came into my job as a McKinsey consultant hoping to change the world from the inside…” I think he sincerely meant that. I would not be surprised to learn that McKinsey made a sales pitch along those lines.
In my day, (mid 1980s), if anyone had said that, they would have been seen as a nutter. One of my friends who wound up being the first woman partner in M&A on Wall Street, said of her job, “It’s indoor work”. A job at an elite firm was understood to confer high wages, respectability, and good downside protection if it didn’t work out. If you wanted to change the world, join the Peace Corps.
So I’m not surprised to learn that most MBAs are unhappy, and I suspect that unhappiness is much more pervasive these days due to 24/7 demands on just about everyone and much greater career instability. I do know some people in my peer group who seems happy, and a couple that I think are genuinely happy. But they had the same temperament when they were young. But many people who get MBAs, particularly the sort that winds up at McKinsey, are insecure overachievers. So their dissatisfaction should come as no surprise. Those highs of meeting a goal are short-lived and the underlying anxiety resurfaces pretty quickly.
One week ago, President Trump stood up at a meeting of the United Nations Security Council and accused China of attempting to tamper with US elections – mimicking some of the same allegations that had first been levied against Russia nearly two years prior. In his speech, Trump claimed that China was working to undermine Republicans, and even the president himself, warning that “it’s not just Russia, it’s China and Russia.” While the media largely shrugged off this proclamation as more presidential bombast probably inspired by the burgeoning US-China trade beef, the administration continued to insist that it was taking a harder line against Chinese efforts to subvert American companies to aide the Communist Party’s sprawling intelligence apparatus. As if to underline Trump’s point, the FBI had arrested a Taiwanese national in Chicago the day before Trump’s speech, accusing the 27-year-old suspect of trying to help China flip eight defense contractors who could have provided crucial intelligence on sensitive defense-related technology.
But in a game-changing report published Thursday morning, Bloomberg Businessweek exposed a sprawling multi-year investigation into China’s infiltration of US corporate and defense infrastructure. Most notably, it confirmed that, in addition to efforts designed to sway US elections, China’s intelligence community orchestrated a pervasive infiltration of servers used to power everything from MRI machines to the drones used by the CIA and army. They accomplished this using a tiny microchip no bigger than a grain of rice.
BBG published the report just hours before Vice President Mike Pence was expected to “string together a narrative of Chinese aggression” during a speech at the Hudson Institute in Washington. According to excerpts leaked to the New York Times, his speech was expected to focus on examples of China’s “aggressive moves against American warships, of predatory behavior against their neighbors, and of a sophisticated influence campaign to tilt the midterms and 2020 elections against President Trump”. His speech is also expected to focus on how China leverages debt and its capital markets to force foreign governments to submit to its will (something that has happened in Bangladesh and the Czech Republic.
But while those narratives are certainly important, they pale in comparison to Bloomberg’s revelations, which reported on an ongoing government investigation into China’s use of a “tiny microchip” that found its way into servers that were widely used throughout the US military and intelligence infrastructure, from Navy warships to DoD server farms. The probe began three years ago after the US intelligence agencies were tipped off by Amazon. And three years later, it remains ongoing.
Nested on the servers’ motherboards, the testers found a tiny microchip, not much bigger than a grain of rice, that wasn’t part of the boards’ original design. Amazon reported the discovery to U.S. authorities, sending a shudder through the intelligence community. Elemental’s servers could be found in Department of Defense data centers, the CIA’s drone operations, and the onboard networks of Navy warships. And Elemental was just one of hundreds of Supermicro customers.
During the ensuing top-secret probe, which remains open more than three years later, investigators determined that the chips allowed the attackers to create a stealth doorway into any network that included the altered machines. Multiple people familiar with the matter say investigators found that the chips had been inserted at factories run by manufacturing subcontractors in China.
With those two paragraphs, Bloomberg has succeeded in shifting the prevailing narrative away from Russia and toward China. Or, as Pence is expected to state in Thursday’s speech (via NYT) “as a senior career member of our intelligence community recently told me, what the Russians are doing pales in comparison to what China is doing across this country.”
The story begins with a Silicon Valley startup called Elemental. Founded in 2006 by three engineers who brilliantly anticipated that broadcasters would soon be searching for a way to adapt their programming for streaming over the Internet, and on mobile devices like smartphones, Elemental went about building a “dream team” of coders who designed software to adapt the super-fast graphics chips being designed for video gaming to stream video instead. The company then loaded this software on to special, custom-built servers emblazoned with its logo. These servers then sold for as much as $100,000 a pop – a markup of roughly 70%. In 2009, the company received its first contract with US defense and intelligence contractors, and even received an investment from a CIA-backed venture fund.
- Elemental also started working with American spy agencies. In 2009 the company announced a development partnership with In-Q-Tel Inc., the CIA’s investment arm, a deal that paved the way for Elemental servers to be used in national security missions across the U.S. government. Public documents, including the company’s own promotional materials, show that the servers have been used inside Department of Defense data centers to process drone and surveillance-camera footage, on Navy warships to transmit feeds of airborne missions, and inside government buildings to enable secure videoconferencing. NASA, both houses of Congress, and the Department of Homeland Security have also been customers. This portfolio made Elemental a target for foreign adversaries.
Like many other companies, Elementals’ servers utilized motherboards built by Supermicro, which dominates the market for motherboards used in special-purpose computers. It was here, at Supermicro, where the government believes – according to Bloomberg’s sources – that the infiltration began. Before it came to dominate the global market for computer motherboards, Supermicro had humble beginnings. A Taiwanese engineer and his wife founded the company in 1993, at a time when Silicon Valley was embracing outsourcing. It attracted clients early on with the promise of infinite customization, employing a massive team of engineers to make sure it could accommodate its clients’ every need. Customers also appreciated that, while Supermicro’s motherboards were assembled in China or Taiwan, its engineers were based in Silicon Valley. But the company’s workforce featured one characteristic that made it uniquely attractive to China: A sizable portion of its engineers were native Mandarin speakers. One of Bloomberg’s sources said the government is still investigating whether spies were embedded within Supermicro or other US companies).
But however it was done, these tiny microchips somehow found their way into Supermicro’s products. Bloomberg provided a step-by-step guide detailing how it believes that happened.
- A Chinese military unit designed and manufactured microchips as small as a sharpened pencil tip. Some of the chips were built to look like signal conditioning couplers, and they incorporated memory, networking capability, and sufficient processing power for an attack.
- The microchips were inserted at Chinese factories that supplied Supermicro, one of the world’s biggest sellers of server motherboards.
- The compromised motherboards were built into servers assembled by Supermicro.
- The sabotaged servers made their way inside data centers operated by dozens of companies.
- When a server was installed and switched on, the microchip altered the operating system’s core so it could accept modifications. The chip could also contact computers controlled by the attackers in search of further instructions and code.
In espionage circles, infiltrating computer hardware – especially to the degree that the Chinese did – is extremely difficult to pull off. And doing it at the nation-state level would be akin to “a unicorn jumping over a rainbow,” as one of BBG’s anonymous sources put it. But China’s dominance of the market for PCs and mobile phones allows it a massive advantage.
One country in particular has an advantage executing this kind of attack: China, which by some estimates makes 75 percent of the world’s mobile phones and 90 percent of its PCs. Still, to actually accomplish a seeding attack would mean developing a deep understanding of a product’s design, manipulating components at the factory, and ensuring that the doctored devices made it through the global logistics chain to the desired location – a feat akin to throwing a stick in the Yangtze River upstream from Shanghai and ensuring that it washes ashore in Seattle. “Having a well-done, nation-state-level hardware implant surface would be like witnessing a unicorn jumping over a rainbow,” says Joe Grand, a hardware hacker and the founder of Grand Idea Studio Inc. “Hardware is just so far off the radar, it’s almost treated like black magic.”
But that’s just what U.S. investigators found: The chips had been inserted during the manufacturing process, two officials say, by operatives from a unit of the People’s Liberation Army. In Supermicro, China’s spies appear to have found a perfect conduit for what U.S. officials now describe as the most significant supply chain attack known to have been carried out against American companies.
Some more details from the report are summarized below:
The government found that the infiltration extended to nearly 30 companies, including Amazon and Apple.
- One official says investigators found that it eventually affected almost 30 companies, including a major bank, government contractors, and the world’s most valuable company, Apple Inc. Apple was an important Supermicro customer and had planned to order more than 30,000 of its servers in two years for a new global network of data centers. Three senior insiders at Apple say that in the summer of 2015, it, too, found malicious chips on Supermicro motherboards. Apple severed ties with Supermicro the following year, for what it described as unrelated reasons.
Both Amazon and Apple denied having knowledge of the infiltration (Amazon eventually acquired Elemental and integrated it into its Amazon Prime Video service). Meanwhile, the Chinese government issued a conspicuous non-denial denial.
- In emailed statements, Amazon (which announced its acquisition of Elemental in September 2015), Apple, and Supermicro disputed summaries of Bloomberg Businessweek’s reporting. “It’s untrue that AWS knew about a supply chain compromise, an issue with malicious chips, or hardware modifications when acquiring Elemental,” Amazon wrote. “On this we can be very clear: Apple has never found malicious chips, ‘hardware manipulations’ or vulnerabilities purposely planted in any server,” Apple wrote. “We remain unaware of any such investigation,” wrote a spokesman for Supermicro, Perry Hayes. The Chinese government didn’t directly address questions about manipulation of Supermicro servers, issuing a statement that read, in part, “Supply chain safety in cyberspace is an issue of common concern, and China is also a victim.” The FBI and the Office of the Director of National Intelligence, representing the CIA and NSA, declined to comment.
Bloomberg based its story on interviews with 17 anonymous sources, including 6 former government intelligence officials. One official told BBG that China’s long-term goal was “long-term access” to sensitive government secrets.
- In all, 17 people confirmed the manipulation of Supermicro’s hardware and other elements of the attacks. The sources were granted anonymity because of the sensitive, and in some cases classified, nature of the information.
- The companies’ denials are countered by six current and former senior national security officials, who – in conversations that began during the Obama administration and continued under the Trump administration – detailed the discovery of the chips and the government’s investigation. One of those officials and two people inside AWS provided extensive information on how the attack played out at Elemental and Amazon; the official and one of the insiders also described Amazon’s cooperation with the government investigation. In addition to the three Apple insiders, four of the six U.S. officials confirmed that Apple was a victim. In all, 17 people confirmed the manipulation of Supermicro’s hardware and other elements of the attacks. The sources were granted anonymity because of the sensitive, and in some cases classified, nature of the information.
One government official says China’s goal was long-term access to high-value corporate secrets and sensitive government networks. No consumer data is known to have been stolen.
Notably, this revelation provides even more support to the Trump administration’s insistence that the trade war with China was based on national security concerns. The hope is that more US companies will shift production of sensitive components back to the US.
- The ramifications of the attack continue to play out. The Trump administration has made computer and networking hardware, including motherboards, a focus of its latest round of trade sanctions against China, and White House officials have made it clear they think companies will begin shifting their supply chains to other countries as a result. Such a shift might assuage officials who have been warning for years about the security of the supply chain—even though they’ve never disclosed a major reason for their concerns.
As one government official reminds us, the extent of this attack cannot be understated.
- With more than 900 customers in 100 countries by 2015, Supermicro offered inroads to a bountiful collection of sensitive targets. “Think of Supermicro as the Microsoft of the hardware world,” says a former U.S. intelligence official who’s studied Supermicro and its business model. “Attacking Supermicro motherboards is like attacking Windows. It’s like attacking the whole world.”
But perhaps the most galling aspect of this whole scandal is that the Obama Administration should have seen it coming.
- Well before evidence of the attack surfaced inside the networks of U.S. companies, American intelligence sources were reporting that China’s spies had plans to introduce malicious microchips into the supply chain. The sources weren’t specific, according to a person familiar with the information they provided, and millions of motherboards are shipped into the U.S. annually. But in the first half of 2014, a different person briefed on high-level discussions says, intelligence officials went to the White House with something more concrete: China’s military was preparing to insert the chips into Supermicro motherboards bound for U.S. companies.
And thanks to Obama having dropped the ball, China managed to pull off the most expansive infiltration of the global supply chain ever discovered by US intelligence.
- But that’s just what U.S. investigators found: The chips had been inserted during the manufacturing process, two officials say, by operatives from a unit of the People’s Liberation Army. In Supermicro, China’s spies appear to have found a perfect conduit for what U.S. officials now describe as the most significant supply chain attack known to have been carried out against American companies.
The inconspicuous-looking chips were disguised to look like regular components but they helped China open doors that “other hackers could go through” meaning China could potentially manipulate the systems being infiltrated (as a reminder, these chips were found in servers used in the US drone program).
- The chips on Elemental servers were designed to be as inconspicuous as possible, according to one person who saw a detailed report prepared for Amazon by its third-party security contractor, as well as a second person who saw digital photos and X-ray images of the chips incorporated into a later report prepared by Amazon’s security team. Gray or off-white in color, they looked more like signal conditioning couplers, another common motherboard component, than microchips, and so they were unlikely to be detectable without specialized equipment. Depending on the board model, the chips varied slightly in size, suggesting that the attackers had supplied different factories with different batches.
- Officials familiar with the investigation say the primary role of implants such as these is to open doors that other attackers can go through. “Hardware attacks are about access,” as one former senior official puts it. In simplified terms, the implants on Supermicro hardware manipulated the core operating instructions that tell the server what to do as data move across a motherboard, two people familiar with the chips’ operation say. This happened at a crucial moment, as small bits of the operating system were being stored in the board’s temporary memory en route to the server’s central processor, the CPU. The implant was placed on the board in a way that allowed it to effectively edit this information queue, injecting its own code or altering the order of the instructions the CPU was meant to follow. Deviously small changes could create disastrous effects.
- Since the implants were small, the amount of code they contained was small as well. But they were capable of doing two very important things: telling the device to communicate with one of several anonymous computers elsewhere on the internet that were loaded with more complex code; and preparing the device’s operating system to accept this new code. <strong>The illicit chips could do all this because they were connected to the baseboard management controller, a kind of superchip that administrators use to remotely log in to problematic servers, giving them access to the most sensitive code even on machines that have crashed or are turned off.
- This system could let the attackers alter how the device functioned, line by line, however they wanted, leaving no one the wiser. To understand the power that would give them, take this hypothetical example: Somewhere in the Linux operating system, which runs in many servers, is code that authorizes a user by verifying a typed password against a stored encrypted one. An implanted chip can alter part of that code so the server won’t check for a password—and presto! A secure machine is open to any and all users.
Shortly after the report was published, the US Department of Defense has scheduled a national-security related press conference for 9:30 am ET on Thursday. It didn’t reveal the subject of the briefing, but the timing is certainly suspicious…
Something’s popping tomorrow pic.twitter.com/z66dNh6Px6
— Chuck Ross (@ChuckRossDC) October 4, 2018
But regardless of what is said on Thursday, one thing probably won’t change: Expect to hear a lot less about Russia, and a lot more about China as the deep state’s interference myopic focus on the former shifts to the latter. As Kevin Warsh framed the question during a Thursday interview with CNBC where he asked “are we at the beginning of a 20-year Cold War?” in response to a question about curbing China’s influence – both economically and defensively. We imagine we’ll be hearing a lot more about the breach from senior US officials, including both the vice president and the president himself, in the very near future
Today’s financial malaise for pension funds, state and local budgets and underemployment is largely a result of the 2008 bailout, not the crash. What was saved was not only the banks – or more to the point, as Sheila Bair pointed out, their bondholders – but the financial overhead that continues to burden today’s economy.
Also saved was the idea that the economy needs to keep the financial sector solvent by an exponential growth of new debt – and, when that does not suffice, by government purchase of stocks and bonds to support the balance sheets of the wealthiest layer of society. The internal contradiction in this policy is that debt deflation has become so overbearing and dysfunctional that it prevents the economy from growing and carrying its debt burden.
Trying to save the financial overgrowth of debt service by borrowing one’s way out of debt, or by monetary Quantitative Easing re-inflating real estate, stock and bond prices, enables the creditor One Percent to gain, not the indebted 99 Percent in the economy at large. Therefore, from the economy’s vantage point, instead of asking how the banks are to be saved “next time,” the question should be, how should we best let them go under – along with their stockholders, bondholders and uninsured depositors whose hubris imagined that their loans (other peoples’ debts) could go on rising without impoverishing society and preventing creditors from collecting in any event – except from government by gaining control over it.
A basic principle should be the starting point of any macro analysis: The volume of interest-bearing debt tends to outstrip the economy’s ability to pay. This tendency is inherent in the “magic of compound interest.” The exponential growth of debt expands by its own purely mathematical momentum, independently of the economy’s ability to pay – and faster than the non-financial economy grows.
The higher the debt/income ratio rises, the more interest, amortization payments and late fees are extracted from the economy. The resulting debt burden slows the economy, causing defaults. That is what happened in 2008, and is accelerating today as debt ratios are rising for corporate debt, state and local debt, and student debt.
Neither legislators, academics nor the public at large recognize a corollary Second Principle following from the first: An over-indebted economy cannot be saved unless the banks fail. That means writing down the financial claims by the One to Ten Percent – in other words, the net debts owed by the 99 to 90 Percent. Wiping out bad debts involves writing down the “bad savings” that are the counterpart to these debts on the asset side of the balance sheet. Otherwise the economy will suffer debt deflation and austerity.
“Recovery” since 2008 has been much slower than earlier recoveries because debt deflation is siphoning off more and more personal and corporate income. To make matters worse, the bailout’s policy of Quantitative Easing to re-inflate asset prices has reduced rates of return for pension funds, insurance companies and employee retirement savings. This means that more state and local government income must be diverted to meet retirement commitments.
Something has to give, and it is not likely to be the savings of the donor class at the top of the economic pyramid. As a result, the economy at large is threatened with an exponentially expanding erosion of disposable income and net worth for most people and companies. Investment managers are warning of a financial meltdown, given today’s historically high price/earnings ratios for stocks and also for rental properties.
What is not acknowledged is that such a crisis is a precondition for today’s economy to recover from the rising debt/income and debt/GDP ratios that are burdening the United States, Europe and other regions. At least the United States has been able to monetize its budget deficits and subsidize banks to carry its rising debt overhead with yet new debt. The Eurozone has banned budget deficits of over 3 percent of GDP, imposing austerity that leaves the only response to over-indebtedness to be Greek-style austerity: depopulation, shrinking living standards, wipeouts of retirement income and pensions, mortgage defaults, shortening lifespans, and mass selloffs of public infrastructure to foreign financial appropriators.
None of this was spelled out in the September 15 weekend marking the tenth anniversary of Lehman Brothers’ failure and subsequent rescue of Wall Street. President Obama, Treasury Secretary Tim Geithner and their fellow financial lobbyists at the Federal Reserve and Justice Department are credited with saving “the economy,” as if their donor class on Wall Street was a good proxy for the economy at large. “Saving the economy from a meltdown” has become the euphemism for saving bondholders and other members of the One Percent from taking losses on their bad loans. The “rescue” is Orwellian doublespeak for expropriating over nine million indebted Americans from their homes, while leaving surviving homeowners saddled with enormous bubble-mortgage payments to the FIRE sector’s owners.
What has been put in place is not a restoration of traditional status quo, but a reversal of over a century of central bank policy. Failed banks have not been taken into the public domain. They have been enriched far beyond their former levels. The perpetrators of the collapse have been rewarded, not penalized for lending more than could possibly be paid by NINJA borrowers and speculators whose mortgage applications were doctored by systemic fraud at Countrywide, Washington Mutual, Bank of America, Citigroup and their cohorts.
The $4.3 trillion that could have been used to save debtors was given to the banks and Wall Street firms whose recklessness and outright fraud caused the crisis. The Federal Reserve “cash for trash” swaps with insolvent banks did not restore normalcy or the status quo ante. What occurred was a financial revolution by stealth, reversing the traditional responsibility of creditors to make prudent loans.
Quantitative Easing saved creditors and the largest stockholders and bondholders by lowering the interest rates by enough to make it profitable for new loans to inflate asset prices on credit. This revived the value of collateral backing bank loans and bondholdings. “Saving” the economy in this way actually sacrificed it. That is why our “recovery” is only “on paper,” a result of calculating GDP to include bank earnings and hypothetical homeowner windfalls as rents are soaring.
Among Democrats, the most extreme tunnel vision denying that debt is a problem comes from Paul Krugman: Writing that “The purely financial aspect of the crisis was basically over by the summer of 2009,”he criticized what he called the “bizarre Beltway consensus that despite high unemployment and record low interest rates, debt, not jobs, was the real problem.”
This misses the point that 2009 was the real beginning for most of the nine million homeowners being foreclosed on and evicted from their homes. Consumers found themselves with less income “freely disposable” after paying their monthly FIRE sector nut off the top of their paycheck – housing charges, credit card charges, medical insurance, student debt, FICA withholding and tax withholding. Krugman says that he would have solved the problem by more deficit spending to pump enough money into the economy to enable debtors to keep paying the banks their exponential growth of interest claims.
We are still living in the destabilized, debt-ridden aftermath of such pro-bank advocacy. In the New Yorker, John Cassidy celebrates a book by Columbia professor Adam Tooze promoting the idea that “the economy” cannot exist without the credit (that is, debt) provided by the financial sector.True enough, but does it follow that rescuing the economy must involve rescuing Wall Street and enriching the banks at the expense of the rest of the economy. That conflation is an Orwellian rhetoric of deception that has been introduced to the discussion of how the economy was “rescued” by locking in today’s Great Debt Deflation.
At the neoliberal/neocon Brookings Institution, Treasury secretaries Hank Paulson and Tim Geithner joined with the Federal Reserve’s Ben Bernanke to explain that the public simply didn’t understand how successful they all were in saving not only the banks, but non-bank financial institutions. Unlike Sheila Bair, they did not point out that behind these institutions were the bondholders, the One Percent of savers who held the rest of the economy in debt. Bernanke wrote a Financial Timespiece producing junk statistics purporting to show that there was no underlying debt or financial problem at all, merely a “panic.” To paraphrase, he said: “The crisis was all in the mind folks. Nothing to see here. Keep moving on.” It is as if, as Margaret Thatcher liked to insist, There Is No Alternative.
Can this bailout without debt writedowns really bring prosperity? Can economies achieve growth by “borrowing their way out of debt,” by creating enough new credit to cover the interest charges out of capital gains from the asset-price inflation fueled by new bank credit. That is the logic that has guided the Federal Reserve’s net $4.3 trillion in Quantitative Easing, and the parallel credit creation by the European Central Bank under Mario “Whatever it takes” Draghi. Ellen Brown recently published a review, “Central Banks Have Gone Rogue, Putting Us All at Risk, noting that the ECB has become a major stock buyer.The beneficiaries are the stockholders who are concentrated in the wealthiest percentiles of the population. Governments are not underwriting homeownership or the solvency of labor’s pension plans, but are underwriting the value of collateral backing the savings of the narrow financial class.
The GDP accounts report the widening gap between low government bond rates and the cost of credit to banks compared to the higher rates paid by mortgage borrowers, credit-card holders and student loan customers as “financial services.” What is extracted from the economy is added to the GDP statistic instead of being treated as a subtrahend. This absurd practice reflects the degree to which Wall Street lobbyists have captured economic statistics. The National Income and Product Accounts (NIPA) have been turned into a vehicle for deception. What is celebrated as growth of the GDP since 2008 has been mainly the growth in financial extraction, along with the health-insurance sector profiting from Obamacare.
Glenn Hubbard, chairman of the Council of Economic Advisors under George W. Bush, uses Orwellian doublethink to pretend that “Debt is Wealth.” He concludes a Wall Street Journal op-ed: “An ability to recapitalize banks remains crucial and must be explained to a skeptical Congress and public,” so that wealthy bondholders and speculators will not suffer losses.
On a brighter side, Adair Turner pokes fun at the “Authoritative experts such as the IMF [who] explained how increased securitisation and trading activity made the financial system more efficient and less risky.” It was as if “options” and hedges can get rid of risk entirely, not shift them onto Wall Street victims such as the naïve German Landesbanks.
The aim of this week’s disinformation campaign is to prevent popular anger advocating what was done in classical antiquity. The ancients fought civil wars for land redistribution and debt cancellation. Today the demand should be for mortgage writedowns to bring their carrying charges in line with reasonable rent charges, limited to the former normal 25 percent of homeowner income – while rolling back the FICA wage withholding and allied taxes levied to bail out the creditor class.
An Athenian antecedent to today’s financial takeover
It is an old story, with a striking parallel in classical Athens. After losing the Peloponnesian war to oligarchic Sparta in 404, a Pinochet-style military junta – the Thirty Tyrants – was installed. During its eight months of terror its members killed a reported 1,500 democratic advocates whose land and other property they grabbed. Advocates of democracy took refuge in Thrace and other neighboring regions.
After the exiled democratic leaders reconquered Athens, they sought to restore harmony, going so far as to pay off all the debts that the oligarchic junta had run up to Sparta. To top matters, the subsequent 4thcentury obliged Athenian jurors and indeed, mayors in some Greek cities to swear an oath: “I will not allow private debts (chreon idiom) to be cancelled, nor lands nor houses of Athenian citizens to be redistributed.”
If no such pledge is needed today by public officials, it is because the financial administrators at the Treasury, Federal Reserve and other regulatory agencies already have shown themselves to be so tunnel-visioned from graduate school through their employment history that they can be trusted to find debt writedowns as unthinkable as enforcing laws against criminal financial fraud to punish individuals rather than their institutions. Academia joins in the deception that financial engineering can sustain a geometric growth in debt ad infinitumwithout imposing austerity.The bailout aftermath has demonstrated that corporations are not really “persons” if they cannot be given jail time.
The key financial principle is that this self-expansion of interest-bearing debt grows to absorb more and more of the economic surplus. The solution therefore must involve wiping out the excess debt – and savings that have been badly lent. That is what crashes are supposed to do. It was not done in 2008. That is why the status quo was not restored. A vast giveaway to the financial elites occurred, setting the rest of the economy on a road to debt peonage.
It would have been nice to have read an article by Sheila Bair explaining the procedures that the FDIC had in place, ready to take over insolvent Citigroup and other banks in similar straits, saving all the insured depositors by taking over these institutions. No doubt as public institutions they would not have indulged in junk mortgages or, for that matter, takeover loans.
It would have been nice to hear from Hank Paulson and perhaps Barney Frank on how they tried to get incoming President Obama to write down bad mortgages whose carrying charges were as far above the debtor’s ability to pay as they were above the going rental value for similar properties. It would have been nice to hear a mea culpa from Mr. Obama apologizing for representing the interest of his campaign donors by standing between them and his voters with pitchforks. Even an article by Tim Geithner or Eric Holder on how lucky they felt at getting such high-paying jobs after they left office from the financial sector they had overseen and “regulated.”
What is needed now is to follow up the primary policy perception that today’s financially dysfunctional economy cannot be saved without a bank crash. That means rolling back the enormous gains that the FIRE sector has made since 1980 at the expense of the “real” economy. Banks have ceased to be an “engine of growth.” They are not making loans to create new means of production. They are lending to asset strippers, not asset creators. It is not hard to show this statistically. (I drafted an attempt in Killing the Host, and am now working with Democracy Collaborative to prepare a larger study.)
At stake is whether the U.S. and Western European economies are going to end up looking like those of Greece, Latvia and Argentina – or imperial Rome for that matter. Neoliberals applaud today’s victorious finance capitalism as the “end of history.” One such end has already occurred once, at the close of Roman antiquity. It is remembered as the Dark Age. Progress stopped as the creditor and landowning class lorded it over the rest of society. Trade survived only among the lords at the top of the economic pyramid. Today’s “End of History” dream threatens to unfold along similar lines. It is all about relative power of the One Percent.
 Paul Krugman, “Days of Fear, Years of Obstruction,” The New York Times, September 14, 2018.
 John Cassidy, A World of Woes: A global take on a decade of financial crisis,” The New Yorker, September 17, 2018.
 “Ben Bernanke pins blame for Great Recession on bank panic,” Financial Times, September 13, 2018.
 Ellen Brown recently published a review, Central Banks Have Gone Rogue, Putting Us All at Risk.” Public Banking Institute and Truthdig, September 13, 2018.
 Glenn Hubbard, “Bailouts Shouldn’t Be Only for Banks”Wall Street Journal, September 14, 2018. To be sure, Hubbard acknowledges that Republicans had agreed to but incoming President Obama nixed: “The government should have directed a mass refinancing of mortgages for primary homes in which the borrower was current in payments.”
 Adair Turner, “Banks are safer but debt remains a danger,” Financial Times, September 12, 2018.
 Demosthenes Against Timocrates (xxiv.149).