Tuesday, October 30, 2012

Insider trading, Chinese style

Decoding the Story of the Wen Family Billions

[This article appeared at Asia Times Online on Oct. 31, 2012.  It can be reposted if ATOl is credited and a link provided.]

Regarding the epic financial machinations allegedly practiced by the family of Chinese Premier Wen Jiabao, his supporters can draw consolation from the fact that the Wen family compares favorably to the Bo Xilai family in the matter of financial sophistication, investment success, and in not murdering its financial adviser.

They may also be heartened by the thought that China's tycoons are achieving parity with the West in best practices of legalized insider trading and self-dealing.

There is another group that definitely feels thrilled and empowered by the New York Times' blockbuster revelation concerning an alleged US$2.7 billion nest egg possessed by Premier Wen
Jiabao's family. [1] That group is not China's dissidents. It is Western print journalists, who feel under siege around the world, and especially in China. The Guardian's media critic, Michael Wolff, took it to the next level, calling the revelations the biggest thing since the Pentagon Papers:
The New York Times' unraveling of the holdings of the Chinese premier, Wen Jiabao, and his family may be its most direct challenge to a sitting government since its publication of the Pentagon Papers in 1971. Arguably, its forensic accounting will be even much more damaging and potentially transformational to the Chinese government than its seminal revelations about the roots of the war in Vietnam were to the Nixon government.

As with the Pentagon Papers, the Times now faces the concerted wrath of the government it has challenged. The Nixon administration took the Times to the US Supreme Court in a move that threatened to criminalize the company. The Chinese government has cordoned off the Times' digital reach into China and, effectively, declared it persona non grata in one of the world's most significant markets. In other words, it's a great day. [2]
Easy, tiger.

Actually, I think David Barboza's expose of wealth aggrandizement by the extended friends and family of Wen Jiabao might be the biggest thing in journalism since ... the Guardian's unconscionable butchering of the WikiLeaks release, but that's another story.

In the matter of the Pentagon Papers, the New York Times defied the advice of its lawyers and published the purloined documents at considerable legal risk without checking in with the US government. President Richard Nixon did not learn of the leak until he opened his morning paper.

The US government then tried to impose prior restraint - getting a court injunction to force the Times to stop publishing the ongoing expose - only to be rebuffed by the Supreme Court. The court, however, did not remove the New York Times from legal jeopardy, affirming for the most part that that the paper could be prosecuted after the fact for revealing state secrets under the Espionage Act (something that the Nixon administration considered but didn't pursue). Instead, infuriated by the leak, Nixon set up the "Plumbers" (leak-stoppers) covert operation that burgled the Watergate Apartments and eventually brought down his presidency. [3]

In the Wen Jiabao matter, Barboza collected the facts legally, and the Gray Lady gave the Chinese government a heads-up before publishing, as the New York Times' public editor reported:
On Friday, I interviewed the publisher Arthur Sulzberger Jr about the story, the censorship and what it means for The Times's global push.

"I'm very proud of this work," he said of the story. "Our business is to publish great journalism. Does this have a business impact? Of course."

Mr Sulzberger said the publication of the article was preceded by "conversations with the Chinese government to discuss it".

"They wanted to air their concerns - which I listened to, as I should," Mr Sulzberger said. "And eventually, we made a decision to publish."
The Times' foreign editor, Joseph Kahn, also confirmed discussions with Chinese officials, and put the scoop in the proper perspective vis a vis the Pentagon Papers:
Mr Kahn said that as recently as Wednesday, Mr Sulzberger and the executive editor, Jill Abramson, met with Chinese government representatives at The Times. But the focus of that conversation was not about the journalism - it was about political and cultural differences In short, Chinese officials were making the case that The Times not publish the article.

"I'm gratified - there's no other word to describe it," Mr Kahn said about The Times's decision to publish it. "People cite the Pentagon Papers, but that involved defying a legal order." [4]
The New York Times is suffering genuine and significant financial losses from the story - one can assume its costly Chinese-language launch has been blown out of the water for at least a few months - and it should be commended for running the piece, but the level of institutional risk and political significance does not appear to rise to a Pentagon Papers level.

Pre-warned by the Times, the Chinese government moved into containment mode. The Chinese Foreign Ministry issued a huffy response that the report was a smear, the New York Times US and Chinese-language websites were blocked, and the word was put out to "harmonize", ie scrub, web and blog references to the New York Times, $2.7 billion, so on and so forth. In addition, Western journos in China were subjected to an aggravating slowdown of Internet service.

Within the People's Republic of China, the report - which is inevitably filtering through the Great Firewall - has apparently not excited a new tsunami of disgust against the Chinese Communist Party regime. The response seems to have been muddled by the fact that the article took pains not to implicate Wen Jiabao personally, and by the fact that Wen is regarded as a leader - albeit of suspect efficacy - of the reformist bloc, and giving him a black eye is considered as providing aid and comfort to the enemies of reform.

The fact that Wen is retiring after the 18th party congress, to be started a few days from now, also takes some of the heat out of the allegations. There were even indignant accusations that the revelations had been fed to the Times by partisans of disgraced party official Bo Xilai seeking revenge on Wen for his role in Bo's downfall earlier this year.

This seems unlikely. Barboza is a well-regarded and tenacious reporter who spent almost a year sorting through Chinese corporate records to get the story. Perhaps Wen's adversaries were willing to egg him on, but, as in the case with the Bloomberg expose on Xi Jinping this past June (see here - for which Bloomberg staff were reportedly subjected to death threats by disgruntled Xi cronies - it can be assumed he dug out the story on his own.

The Barboza article is a fascinating expose of how the wealth-creation sausage gets made in the People's Republic of China, revealing how a family with political connections and access to information can leverage opportunities in everything from diamond-trading to construction of wastewater treatment plants with the help of a few billionaire friends in the PRC and overseas.

However - barring further revelations - it is not the devastating legal and factual brief against Wen Jiabao that the excited coverage might lead one to believe. The New York Times made the understandable, if rather questionable decision, to hang its hat on the eye-popping figure of $2.7 billion, inviting the inference that Wen's family exemplified official corruption on a truly heroic scale.
However, $2.2 billion of that figure is derived from ownership of shares of stock of Ping An Insurance imputed to members of the Wen family, shares that were purchased by partnerships in 2002, apparently for around $65 million, and which skyrocketed in value after Hong Kong (2004) and Shanghai (2007) IPOs.

As for those partnerships, the Times was unfortunately unable to come up with a clear determination as to whether they were simply front companies for Wen family skullduggery or, well, partnerships that provided privileged access for wealth creation for PRC and foreign elites, some of whom were members of the Wen family.

The Times carefully characterized the partnerships as:
Partnerships controlled by Mr Wen's relatives - along with their friends and colleagues - made a fortune by investing in the company before the public offering.
Wen family fingerprints are apparently all over these partnerships, but nailing down issues of legitimacy and control are, understandably, slippery issues.

Around $1.3 billion of the purported Wen family stake in Ping An is controlled by Tianjin Taihong, which in turn is controlled by one of the PRC's richest people, Mdme Duan Weihong, who is in turn generally characterized as an old friend of the Wen family and, more specifically of Wen's allegedly rapacious wife Mdme Zhang Beili. [5]

The question can seriously be raised as to whether Mdme Duan is simply a bag-woman for the Wen family, or a close family friend who has benefited herself - and members of the Wen family - through a carefully constructed, morally questionable, but legally defendable web of obligation and opportunity.

A look at Taihong reveals something that looks more like a plausible business enterprise than a slush fund or cut-out. Taihong apparently achieved considerable success in property
management and, subsequently, development in Premier Wen's home town of Tianjin. Taihong's English-language name is Great Ocean Group.
On its website, it touts its strategic investment in Ping An (stating that "outstanding returns ... reflect the group's foresight and execution ability"): In 2002, the Great Ocean Group acquired a major share in Ping An Group, one of China's largest insurance and financial services companies entitling it to a seat on the company's Board of Directors. [6]
Duan Weihong took that seat on the Ping An (supervisory) board from 2003 through 2009.

The Ping An deal shows the hallmarks of privileged information and access; it does not, however, exhibit significant signs of interference by the Wen family to assure Ping An's success. The Great Ocean investment occurred in 2002. The lifting of restrictions on domestic insurance operations - which paved the way for highly successful IPOs by Ping An and other insurance companies - did not occur until 2004. Spotting Ping An as an up-and-comer would not have been extremely difficult, even without the help of a high ranking communist official.

By 2002, Morgan Stanley and Goldman Sachs had already been strategic investors in Ping An for eight years; in 2002, HSBC also put in another $600 million (it would subsequently buy out Morgan Stanley and Goldman Sachs for $1 billion).

The company had employed McKinsey and Co to advise it on its business operations, staffed its company through a well-known European headhunter, and in 2005 it was named one of Asia's best managed companies by Euromoney magazine. It subsequently achieved the distinction of serving as subject of a fawning case study by a leading Western business school.

In short, Ping An's primary identity is as a private company backed by international financial muscle, not a sclerotic state-owned-enterprise relying on government favoritism and protection. Therefore, the corrupt-dealing framing provided for the Times article is, perhaps, not completely apt to the Ping An situation:
As prime minister in an economy that remains heavily state-driven, Mr Wen, who is best known for his simple ways and common touch, more importantly has broad authority over the major industries where his relatives have made their fortunes. Chinese companies cannot list their shares on a stock exchange without approval from agencies overseen by Mr Wen, for example. He also has the power to influence investments in strategic sectors like energy and telecommunications.
Investing in Ping An prior to its IPO and sensational run-up in stock price was something of a no-brainer.

Of course, getting an opportunity to invest prior to the IPO is something else.

It would perhaps be most informative to ask Ping An's hard-charging boss, Peter Ma, or strategic investors Morgan Stanley, Goldman Sachs, and HSBC - all of whom had seats on the Ping An board - to provide some context as to how Taihong/Great Ocean was privileged to get a sweetheart pre-IPO deal.

Mdme Duan married a Hong Kong investment banker, Desmond Shum, who perhaps provided the deal-making expertise to enable Great Ocean to leverage its Ping An windfall into a very successful foray into active, managed investment: the construction of the massive freight logistics center at Beijing Airport, the "Airport City Development Limited" or ACL, with a total first-stage investment of 4 billion yuan (US$640 million). Mr Shum served as vice chairman and chief executive officer for the project, which was completed in 2007. [7]

In 2011, Great Ocean sold its 40% interest in ACL to Singapore's Global Logistic Properties Ltd for around US$270 million (the New York Times may be in error here by imputing the full $400 million proceeds of the sale to Great Ocean; the shares of another company, "Trade Year Properties Limited," amounting to 15% of ACL, were also sold to Global Logistics as part of the deal).

Interestingly, the Times did not choose to impute the ACL deal to Wen-related shenanigans, even though the high profile and highly political deal (involving approvals by the Ministry of Commerce, the Civil Aviation Administration of China, the Beijing municipal government, the General Administration for Customs - which "consult[ed] eight ministries and commissions" - the National Resources Development Council, and the State Council) would seem to welcome influence peddling in a way that the largely opportunistic and passive Ping An investment did not.

In true nouveau riche style, Mdme Duan has turned to high-profile philanthropy to enhance the reputation of her enterprise. Great Ocean established the Kai Feng charitable foundation, which funded the construction of Tsinghua University's new library and, in 2012, sponsored the Yehudi Menuhin violin competition in Beijing. Under the sobriquet of the "Whitney and Desmond Shum Fellowships", the family funded a program to send two Harvard graduate students to China each year to pursue research in the social sciences.

Mdme Duan blotted her tycoon copybook, however, with a flustered response to the most damning piece of evidence unearthed by Barboza: apparently part of Taihong/Great Ocean's stake in Ping An was held in the name of Premier Wen's ancient mother.

Apparently not aware that the correct response to dangerous and intrusive inquiries from the press is "Talk to my lawyer", Mdme Duan provided a novel explanation:
"When I invested in Ping An I didn't want to be written about," Ms Duan said, "so I had my relatives find some other people to hold these shares for me."

But it was an "accident", she said, that her company chose the relatives of the prime minister as the listed shareholders - a process that required registering their official ID numbers and obtaining their signatures. Until presented with the names of the investors by The Times, she said, she had no idea that they had selected the relatives of Wen Jiabao.
It can be assumed that the purpose of this legerdemain was not to enrich Wen Jiabao's oblivious mother. Perhaps the motive was to park some shares in the name of a clueless retail investor - one who would not be subject to the lock-up obligations imposed on strategic and institutional investors in the Ping An IPO - for prompt disposition at a favorable price.

In any case, the case of granny's Ping An shares - which had a value of $120 million in 2007, though it is unclear that they are still in her name - would be an interesting area of exploration for China's securities regulators, if they decided to pursue it.

Of course, if the way the case plays out is that Mdme Duan takes the rap for parking the shares, the Wen family will be shielded from complicity and the matter will be recast as a securities enforcement matter. It may be that this is how things will turn out, and the Wen family will face no criminal consequences - and Wen Jiabao will not be subjected to Party disciplinary action.

Judging from the long list of business ventures described by Barboza - which even absent the Ping An shares amount to interests amounting to hundreds of millions of dollars - the greedy members of Wen Jiabao's immediate family (led by Wen's wife, brother, and son) were careful not to demand or take payoffs as a condition for deploying political influence. No "pay for play" in other words.

Instead, the currency employed was that of shared opportunity, mutual obligation, and the promise of future cooperation.

Nor did the immediate family hold assets in their own names - high party officials are required to disclose their own assets and those of close family members - allegedly relying instead on the good offices of a network of trusted relatives and associates.

In other words, the Wen family appears to have navigated the loopholes, opportunities, and perilous shoals of personal enrichment in an adroit, legalistic, and politically astute fashion that would be recognized and admired immediately by their spiritual brothers and sisters across the sea: the robber barons of Wall Street and the London bourse.

Whether Wen Jiabao and the CCP will see fit to untangle this web in the interests of transparency, decency, and the Party's political viability is an interesting question.

1. Billions in Hidden Riches for Family of Chinese Leader, Yahoo! Finance, Oct 26, 2012.
2. The New York Times' China coup, The Guardian, Oct 26, 2012.
3. Rethinking the Pentagon Papers, National Affairs, Summer, 2010.
4. 'Great Journalism' That Has Unwanted Business Impact in China, NYT, Oct 26, 2012.
5. The Wen Family Empire, NYT, Oct 25, 2012.
6. Strategic China Investment, Great Ocean Group.
7. Airport City Development Lid, DocStoc.
8. China's Ping An Insurance kicks off Shanghai IPO, Reuters, Feb 1, 2007.

Friday, October 26, 2012

US learns hard lessons of Asia 'pivot'

[This piece appeared at Asia Times Online on Oct. 27, 2012.  It can be reposted if ATOl is credited and a link provided.]

The real action in Sino-US relations this week was not the predictable China-bashing in the third election debate between US President Barack Obama and Republican challenger Mitt Romney in Florida on October 22: it was the little-noticed concurrent visit to Asia of a high-powered team of retired US diplomats.

The team, a bipartisan affair consisting of Richard Armitage, Stephen Hadley, James Steinberg and Joseph Nye, had a tough task.

With sanction from Secretary of State Hillary Rodham Clinton as a quasi-official delegation, these Asian-affairs worthies were called on to demonstrate that the Obama administration's strategy for Asia - the famous "pivot" of military forces, diplomatic and economic initiatives, and strategic attention - can deliver effective diplomatic engagement with the People's Republic of China, and
not just produce a threatened and angry Chinese panda.

The team's task is probably impossible - which is probably why it is being undertaken by a group of retirees and not snub-sensitive government officials. The PRC is in no mood to support US pretensions to being the only, indispensable honest broker in the region. Beijing wants to punish the United States for the pivot, which it sees as nothing more or less than a tilt away from China.

These are tense times for "the pivot". The PRC is testing the US strategy in what appears to be an unexpected way: leaving the US alone and selectively beating up on US ally Japan on the issue of the Diaoyu/Senkaku Islands. This is an eventuality the United States does not seem to have planned for.

At the end of September, in a lengthy interview with senior fellow Mike Chinoy at the University of Southern California East Asia Center, Kurt Campbell made the case for the pivot as a savvy piece of US statecraft.

Campbell is a Japan hand. His elevation to the post of assistant US secretary for East Asia - and the later departure from the State Department of China hand James Steinberg - was seen as the manifestation of an important shift in the Obama administration's strategic thinking vis-a-vis the PRC.

China was no longer viewed optimistically as a rising power whose liberal democratic evolution would track its runaway economic growth, albeit with a lag of a few years. Multiple disappointments from climate change to North Korea to currency valuation persuaded the Obama administration that, for practical purposes, the PRC had to be handled as an authoritarian state whose elite is constitutionally unsympathetic to the United States and its aims.

Dealing with China, in other words, was not a matter of appealing to common values and interests; instead, it demanded carrots and sticks. Exit James Steinberg and, from the National Security Council, Jeffrey Bader. And enter Kurt Campbell, and the pivot.

In his September interview, Campbell makes the pitch for the pivot as a win-win for China and the planet, in a reassuring, measured baritone I associate with a funeral director selling a fine casket to a rich and flustered widow. Campbell makes the obvious point that China's nervous neighbors would welcome a US "return to Asia".

He also makes the somewhat more debatable assertions that the pivot was designed with China's well-being in mind, that multilateralizing China's bilateral territorial spats in the Association of Southeast Asian Nations was an initiative to help out Beijing, that the US rapprochement with Myanmar wasn't about China, and Air-Sea Battle, the plan for conventional-warfare Armageddon against the PRC, was simply an expression of the US Navy's "centuries-old" natural rambunctiousness.

In turning to the awkward issue of "sovereignty disputes" - the PRC's clashes with neighbors emboldened by the pivot - Campbell opined hopefully that China's leaders recognized the overriding importance of maintaining good relations with the United States and would therefore look beyond the current unpleasantnesses.

As he put it:
Our sense is that [president-in-waiting Xi Jinping] is a person that's committed to continuing a strong relationship between China and the United States ... [prospective premier] Li Keqiang ... was very clear on his determination to keep US-China relations on a steady course ... So I think we have some confidence that the leadership will follow through accordingly ... Still, we think it is profoundly and deeply in China's interest to maintain a good relationship with the United States ... and we think cooler heads will likely prevail in that assessment during the next leadership cycle [to get underway in November] ... [1]
Beyond Campbell's confidence that the Chinese leadership would consider it absurd to try to go toe to toe with the United States, there was probably reliance on a (to the United States) virtuous cycle that would kick in if China did push back.

It would seem that the PRC's freedom of action would be constrained by the fact that overt Chinese pushiness would be counterproductive, driving allies closer to the United States, further isolating the PRC and strengthening the case for the pivot.

A perfect plan ... not.

I do not believe that Campbell and company reckoned with the PRC's evolutionary adaptation to the serial island provocations committed by Vietnam, the Philippines and Japan, or its determination to make a stand against what it sees as an unambiguous US exercise in containment.

Having learned its lesson about Western command of the diplomatic and international trade battlefield in the first humiliating dust-up over Captain Zhan Qixiong and the disputed Senkaku / Diaoyu islands in 2010, the PRC switched to a strategy of using domestic popular demonstrations and boycott to deliver an economic and political mugging to Japan.

As an indication of China's resolve in this matter, it should be remembered that the central Japanese government's purchase of the Senkakus was conceived in large part as a conciliatory act, to deny the China-bashing xenophobe Shintara Ishihara the chance to buy the islands and use them to engage in serial provocation against China.

At this juncture, perhaps considering that the Obama administration had little appetite for a hot China conflict in the middle of the presidential race, the PRC decided to seize upon the act of the purchase and whip up popular anger to mete out harsh if calibrated punishment to Japan's interests inside China, while eschewing official actions that could be construed as military or economic aggression against Japan or the world free-trade regime.

At the Chinese Foreign Ministry, it's all Diaoyus all the time. The regime is making it clear that it will not back down on the issue regardless of what foreigners might say about the damage to China's regional standing, its economy, or its future as the world's beloved cuddly soft-power panda.

These economic hostilities, while damaging to Chinese interests, are certainly not welcome to Japan. In a generally bleak economy, it is impossible to untangle the Senkaku factor from other international trade and investment issues.

However, Japanese exports to China dropped 14.3% year on year in September, contributing (together with a disastrous drop in exports to the euro zone) to only the second monthly trade deficit for Japan in the past 30 years. Japanese manufacturers are reportedly holding back on China investments, for understandable reasons; time will tell if this harms China, or simply opens up more opportunities for non-Japanese competitors. In any case, the impassioned argument over the uninhabited Senkakus isn't doing Japan's corporations a world of financial good. [2]

In 2012, by its carefully delineated domestic move against Japan, the PRC has cast the United States in the unwelcome role of helpless giant, unable to bring its military might, its prestige or its domination of crucial multilateral diplomatic of financial institutions to bear on Japan's behalf.

So the superhero league of retired and rusticated diplomats was summoned from think-tanks and stately manors to jet to Tokyo and Beijing.

The team included two Republicans: Richard Armitage, deputy secretary of state under George W Bush and a close associate of former secretary of state and chairman of the joint chiefs of Staff Colin Powell, and Stephen Hadley, another Bush administration official but with more of a neoconservative bent and touted as a close adviser to Mitt Romney on foreign affairs.

The two Democrats were James Steinberg, the ex-Obama administration China hand, and Joseph Nye, liberal think-tanker and creator of the "soft power" concept.

In Tokyo, their mission was to advise the Japanese government that there would be no dramatic US lurching on China matters even if Romney is elected president.

Since Romney has promised to go harder on China than President Obama, one can assume the purpose of the bipartisan delegation was to communicate to the Japanese government that it should not expect any upgrade in US military or diplomatic backing for Japan's Senkaku position if Mr Romney becomes President Romney.

Perhaps the team was also able to pass the message to Liberal Democratic Party president Shinzo Abe. With the government of Prime Minister Yoshihiko Noda showing a mere 18% approval rating, Abe - who threw his own gasoline on the Senkaku fire recently with a public visit to the Yasukuni Shrine - has a good chance of becoming prime minister again next summer, if not earlier.

Armitage had already provided an interesting - and, to Japan, not very positive - take on the Senkaku issue in an interview with The Japan Times in early October, indicating that the US government, when given the opportunity, did not treat Japanese claims very seriously:
According to Armitage, the US decided not to take sides on the issue after the reversion of Okinawa to Japanese control in 1972, as Washington was asked by both [mainland] China and Taiwan at that time not to recognize Japanese sovereignty over the islets. [3]
The delegation also had the pleasure of addressing resurgent Okinawan fury at the US military presence - a fulcrum upon which the US pivot depends - as uproar over the gang rape of an Okinawan girl by US servicemen, opposition to the deployment of Osprey vertical takeoff and landing aircraft, and festering anger at the foot-dragging over the promised relocation of US forces highlighted the real-world political price of an ivory-tower strategic gambit, one that posited that only China would bear the real costs in a zero-sum stare-down with the United States.

In Beijing, the delegation probably hoped to convince the PRC regime that beating up on Japan would entail serious consequences ... consequences like the majestic cruise of the aircraft carrier George Washington into the South China Sea and the invitation extended to Vietnamese officials to come aboard and experience the vessel's awe-inspiring might first-hand.

Of course, Vietnamese - and Chinese - officials might remember when this awe-inspiring might was flung unsuccessfully against Vietnam, somewhat blunting its effect ... especially when it is recalled that the PRC has ample venues for interaction, harassment and retaliation with its southern neighbor that don't involve making a vulnerable stand in the South China Sea under the shadow of the George Washington.

The PRC has made it clear that it is in no mood to welcome the United States to the Diaoyu / Senkaku party, certainly not in the form of a quasi-official delegation.

On October 22, the Chinese Foreign Ministry declared:
[The delegation] is invited by the Foreign Affairs Association. Mr Stephen Hadley, National Security Council adviser under the previous presidential administration, and other ex-governmental worthies will visit China from October 22 through October 24 to exchange views on China-US relations and matters of mutual concern. This delegation does not possess the function to engage in so-called "mediation" or "good offices".
In case anybody missed the point, Global Times ran an article titled "China avoids Diaoyu mediation attempts by US delegation":
Chinese Foreign Ministry spokesman Hong Lei said on Monday that the delegation would focus on Sino-US relations.

"Hong's remarks indicated that China will not accept the mediation of the US, which has not shown any sincerity in defusing the Diaoyu Islands dispute so far," Wang Pin, a researcher on Japanese studies with the Chinese Academy of Social Sciences, told the Global Times Tuesday. [4]
To tarnish the sheen of America's honest-broker status further, Global Times sneered:
While the US is scurrying to prevent military clashes between the two Asian giants so that its own interest would not be harmed, it is also trying its best to encourage Japan to boost its defense to contain China, Wang said.
State Councilor Dai Bingguo and premier-in-waiting Li Keqiang met with the group and, in a piece of sly jiu-jitsu, turned the meeting into a discussion of US restrictions on Chinese investment, making the case that the Sino-US relationship was too important for the United States to take lightly for the sake of its precious pivot, not the other way around.

As to the Diaoyu Islands, they were mentioned in passing:
Li also stated China's solemn stance on the Diaoyu Islands issue, stressing the international community should jointly protect the outcomes of the victory of the Second World War and the postwar international order. [5]
This framing puts the United States pretty much where China wants it: ineffectual troublemaker unable to protect its allies or constrain its opponents.

Chinese media gleefully painted a picture of Japan twisting in the wind on the islands issue, unable to elicit European support and even making the unlikely move of turning to Russia - even though Tokyo is locked in its own island dispute with Moscow over the Kuriles:
Despite its call for a peaceful resolution to the [Diaoyu] islands row, Japan spared no efforts during Japanese Foreign Minister Koichiro Gemba's visits to France, Britain and Germany last week to argue in favor of its claim to the islands. But those on the trips only received a cold response when they brought up the dispute, reported Japanese newspaper Mainichi Shimbun, saying that none of the three countries visited has taken a position in the matter. When asked whether support was obtained during the trip, Gemba did not respond directly, only saying that each of the three parties is in a different situation and no details about the matter can be disclosed, Kyodo reported.

Kyodo said Gemba had high expectations for the tour but found it hard to obtain support in the countries he visited.

Meanwhile, Tokyo has started to turn to Moscow. During a meeting between Japan and Russia in Tokyo on Friday, the Japanese asked that Russia show understanding toward Japan's stance on the Diaoyu Islands.

Japanese newspaper Sankei Shimbun said China's presence in the ocean is expanding and Japan and Russia have a "shared a belief about containing China". [6]
Global anxiety over China's rise and hardening anti-PRC sentiment within Japan will probably deny China any clear and satisfying victory over Japan. However, the previous assumption that the PRC was merely a paper tiger both unwilling and unable to retaliate in any meaningful way will have to be re-examined.

This development will probably not provoke a re-evaluation of the underlying policy by the pivot's architects, Secretary of State Hillary Rodham Clinton and Assistant Secretary for East Asia Kurt Campbell.

Instead, it will be seen as a test of America's determination to carry out the policy - the "gut check" - although the real-world "guts" in question reside in the flabby midsection of Japan's economy - and, almost inevitably, the Obama administration will probably "double down", not "back down".

Originally, the polarization provoked by the pivot was probably regarded as a feature, rather than a bug. Japan, increasingly alienated from China, would ally more enthusiastically and effectively with the United States.

But as Japan and China systematically escalate the Senkaku / Diaoyu dispute, the US ability to deter, restrain, exploit, or channel this hostility decreases commensurately.

In Japan, China-bashing is now a political lifeline, not just a diplomatic stratagem. In China, Japan-bashing is becoming a matter of national identity.

Uichiro Niwa, the businessman who was removed from his post as ambassador to China because of his moderate, don't-rock-the-boat views on the Senkakus (he is still serving temporarily, since his designated successor died of a heart attack before he could take the post), said sadly:
"Now, Chinese TV programs constantly show the Japanese flag and a photo of my face," the ambassador said. "And the TV says in simple language that Japan is a thief who stole Chinese territory. Even elementary-school children can connect the flag, theft and my photo. In China, I am feeling like I'm the ringleader."

Niwa said many Japanese volunteers teaching Japanese or working as caregivers, on a program by the Japan International Cooperation Agency, were also feeling a sense of great tension.

"This is the first time they report such a situation since I came to China," said Niwa, who became ambassador to China in 2010. [7]
The fundamental flaw of the pivot strategy was acknowledged by Campbell himself when he referred to the rising hostility between Japan and China, engendered of course by past and present factors but exacerbated by the pivot.
We are worried that persistent high-level tensions are eating away at Sino-Japanese goodwill, at enormous linkages that have developed people to people, on culture, on business ... it is stirring negative feelings on both sides ... We recognize that damage has been done, and we're worried about it.
These people are learning to hate each other for contemporary as well as historical reasons, and there isn't a lot the United States can do about it.

That might turn out to be the most lasting consequence of the pivot.

1. Conversation with Kurt Campbell: The US and Asia - A Status Report, University of Southern California, Sep 29, 2012.
2. Japanese exports tumble on eurozone crisis and China dispute, The Guardian, Oct 22, 2012.
3. Boost deterrence to China, Armitage advises, The Japan Times, Oct 3, 2012.
4. China avoids Diaoyu mediation attempts by US delegation, Global Times, Oct 24, 2012.
5. US Urged to Ease Restrictions on Chinese Investment, China Radio International, Oct 23, 2012.
6. Ex-security officials to try easing tensions, China Daily, Oct 22, 2012.
7. Niwa: Japan-China ties faces worst crisis in 40 years, Asahi Shimbun, Oct 21, 2012.

Wednesday, October 24, 2012

China's reformers hope for a game-changer

[This piece originally appeared at Asia Times Online on October 20, 2012.  It can be reposted if ATOl is credited and a link provided.]

Jaded China watchers observe the fall of Chongqing's "Red Leader" Bo Xilai and see little more than the disposal of another corrupt Communist sociopath who crossed multiple red lines - not of reckless criminality, but of naked ambition, of disobedience to the Center, and of unseemly and embarrassing behavior involving foreigners - and got slapped down by the party leadership.

Score one for the Chinese Communist Party, in other words, for the efficient use of party disciplinary functions, media operations, and kangaroo courts to wrap up the messy package without overt violence and organized public dissent or embarrassing private leaks from Bo's allies inside and outside the CCP, thereby maintaining the public veneer of leadership unity going into the transitional 18th party congress.

This interpretation is not satisfactory to China's reformers, who see the country lurching into crisis and hope to shoehorn the Bo Xilai affair into a narrative of national political, social and economic renaissance.

Their efforts have elicited a faint but unmistakable echo in state media, serving as an indication that the party leadership accepts the reality of crisis and the need for reform, if not the radical changes advocated by the reformers.

Sun Liping - who acted as Xi Jinping's PhD thesis adviser at Tsinghua University and therefore symbolizes the reformers' hopes for access and influence at the highest levels of the new party leadership - recently posted his thoughts on the Bo Xilai case, opining that it would have been better if the verdict had been delivered after, instead of before, the party congress:
If the verdict had come down after the congress, it would have diminished the political tinge of the case. Instead, it could have been part of an overall consideration of the rule of law for the next 10 years ... and even helped create a "force" for reform ... a wedge for further major reforms ... It could have served as the starting point for the political institutionalization of the reformist faction.[1]
Central to Sun's thesis is that Bo was an atypical representative of anti-reform forces, and his fall before the congress was not a decisive victory for reform that would secure the ascendancy of pro-reform forces in the new leadership.

Sun Liping believes that the main obstacle for China's reformers is not nostalgic Maoists trying to push back reforms; it is the inertia represented by the massive, entrenched interests that have corruptly benefited from the current, flawed reforms, and which oppose further, more thoroughgoing reforms that would threaten their advantages.

Sun characterizes this dilemma as the "political transition trap", the real trap, in his view, as opposed to the "income transition trap" (the difficulty of evolution beyond labor-intensive industries and thereby hoisting per capita income into the promised land of middle-class pay packets) that obsesses Chinese and international developmental economists.

A significant if unspoken corollary of Sun's persuasive analysis is that entrenched interests - maybe we should call them the "cadre-industrial complex" in a hat-tip to the late US president Dwight Eisenhower's prescient warnings about the "military-industrial complex" - hold the upper hand under normal circumstances.

In other words, an exceptional set of circumstances, if not a crisis, is necessary to break the inertia and get the reformist bandwagon rolling.

For Sun, a nice, thorough mastication of the Bo Xilai case by the powers that be after the party congress might have provided a suitable kick-start to the reformist movement.

Although the Bo Xilai ship has sailed (Bo has been expelled from the CCP by its disciplinary mechanism and now awaits his final, legal fate in the politically irrelevant civil courts), reformers are apparently still trying to make hay from the state of affairs in Chongqing.

On the serious-progressive end of the reformist spectrum, the financial news outlet Caixin editorialized:
Bo taught us all a painful lesson. Thirty years of reform and opening up has brought China tremendous success, but also created many problems in society. Its people are desperate for solutions. Chinese leaders should heed the call for change and deepen their reform efforts.

Their priority now is to continue fighting corruption and speed up the reform of the economic and political systems, particularly the legal system. "All people are equal before the law" must be more than a slogan, and the system of checks and balances strengthened.

Bo showed us that going backwards or standing still are not options for China; only by striking out can it thrive. [2]
An influential reformer, Han Zhiguo (previously on the staff of the State Planning Commission and then a big wheel at various economic and sociology journals; now head of a private university) tried to exploit the Chongqing issue from another angle by providing a jolt of old-fashioned Communist rabble-rousing.

Han posted an item on his weblog calling for a purge of extreme-left elements in Chongqing. Literally. As in:
The main harm of the Chongqing affair is a return of the Cultural Revolution and the reigniting of an extreme-left line ... Chongqing must completely purge [qingsuan] the extreme left line. [3]
The "Chongqing affair" is the matter of a hapless youth, Ren Jianying, who reposted content hostile to the Bo government on his webpage, was subsequently discovered by the local cops to possess a T-shirt with the inflammatory slogan "Live free or die," and received a sentence of two years' labor reform.

The post is illustrated by a pretty picture of clouds over a pasture intended to convey the image of a ferocious gathering storm.

Leaving aside the completely creepy reference to qingsuan - which literally means "a thoroughgoing settling of accounts" and, in particularly rough times for the CCP, referred to the execution of political enemies - and the question of whether Han is advocating the top-down, legalistic, and numerical quota purges imposed in the 1950s as opposed to the chaotic "bottom-up" assaults orchestrated by the Red Guards in the 1960s or something else - it is somewhat doubtful that Chongqing is groaning under the tyranny of extreme-left red terror.

Zhou Yongkang, an erstwhile political ally of Bo Xilai (and, in the overheated imagination of some bloggers, fomenter of an attempted coup d'etat to repair the fortunes of his buddy), recently made a publicized tour of Sichuan province. Zhou holds the security brief in the Standing Committee of the Politburo and his overweening emphasis on "stability maintenance" was seen as complementing Bo Xilai's public stance as hard-charging, crime-fighting mayor.

Reading between the lines, Zhou's visit was intended to reassure local security cadres that despite the discrediting of Zhou's law-and-order agenda by the exposure of rampant criminality in Bo's government, all would be well as long as Bo's disappointed neo-Maoist acolytes were not allowed to make trouble on the streets in the run-up to the 18th congress:
Zhou visited the procuratorial, judicial and police departments in the provincial capital of Chengdu.

When meeting with representatives from these departments, Zhou urged them to honestly carry out their legal responsibilities by enhancing law enforcement, providing better service for the people, dissolving disputes, and maintaining justice, social harmony and stability.

He asked for major achievements from them to mark the CCP's 18th National Congress, which is scheduled to start on November 8. [4]
It appears that residents of Chongqing fearing a reign of terror by Bo Xilai's red-bandanna diehards can rest easy.

As Sun Liping has asserted, the main problem in China is not maniacal neo-Maoists; it is cadres and businessman happy to suck up bank loans to line their pockets and prop up local governments even as the country slides off a cliff.

Anecdotal support for this view was provided by the blog post of another reformer, who recounted his experience in a Chengdu restaurant:
At the next table some party and government staff people were talking loudly, we couldn't help overhearing. They were discussing one of their friends: should he stay in the first cadre section of the organization department as the leader, or should he leave and act as a bureau chief in a local jurisdiction? They did a comparison: how much could he earn as section chief, and how much could he earn as a bureau chief? (The unit for their discussion was millions of yuan). I asked myself, how far can the country go with this kind of people? How far can they go?
Possibly, Han's provocative post was intended as a nudge in the ribs encouraging Xi Jinping and the new leadership to take advantage of Chongqing's political embarrassment to go in and make a bit of reformist hay, as in: Bo Xilai's fall provides a golden chance for the central government to clean house in Chongqing and put the fear of Marx (or at least Beijing) in the hearts of the local cadres.

It can certainly be argued that impunity of the local party/government regime from legal, administrative, and financial accountability is at the heart of China's inexorably unfolding crisis.
With tax reform, local governments were cut loose from the central government and encouraged to make their own financial way. Where they could, they did so by throwing themselves wholeheartedly into the business of real-estate development: expropriating suburban lands at bargain-basement prices, then reselling them to developers and speculators. When the central government unleashed the Great Stimulus of 2008-09, it was the local governments and state-owned enterprises (SOEs) that took the bank loans and plowed them into infrastructure and real-estate investments, many of dubious profitability.

Now the world and Chinese economies are slowing, and the financial chickens are coming home to roost. With international demand slumping, the Chinese economy is overbuilt and ill-equipped to receive another stimulus without fueling waste and igniting inflation. The real challenge - engineering a soft landing by properly unwinding the indebtedness and ending the addiction to overspending by local governments and SOEs - require central-government levers that, as yet, don't exist.

And the local governments and SOEs have little incentive to change a system in which they are the primary and indispensable conduits for the government to sluice money into the economy.

The discomfiture of central-government leaders, theorists and media can be seen in a spate of articles calling urgently but rather vaguely for reform. What is significant is that the call is for political reform, in a recognition that economic reform - or the neo-mercantilist version of it embedded in the People's Republic of China - does not provide clear solutions for the current problems.

Global Times posted an op-ed that looked as if it came from the Democratic Underground:
[A] limited government is dispensable. So far, China's reform is also a process of transformation from an unlimited government to a limited one. In other words, the central government delegates power to local authorities, and local governments give power to the public.

The building of a limited government does not lower government efficiency. Instead, it helps address problems like the abuse of power, corruption, and the lack of credibility of many government departments.

Building a limited government actually creates great potential for China's future development. At the moment, China must accelerate the establishment of a limited government through constitutional means, so as to ensure the success of its political reform.

In the future, China needs to expand trials in local political reform throughout the nation. Such reform should be gradually boosted in a transparent, open and rational manner. [5]
Under the attention-grabbing headline "Reform or perish, journal warns Communist Party", the South China Morning Post reported that the leading CPP theoretical journal, Qiushi, had published an essay on the eve of the party congress pushing the reform imperative:
Headlined "Sparing no effort in pushing ahead with reform and openness", the long article said China was standing on a historical threshold and "stagnation or turning back would be a dead end".

It called on the government to seize the moment to advance comprehensive reform in all areas, and "actively press ahead with restructuring of the political system and develop socialist democracy". [6]
No question that the leadership sees itself beset by ugly problems without easy solutions.

The status-quoers nibble around the edges of the problem - bailing out banks, cautiously deflating the real-estate bubble, doling out subsidies to the disadvantaged, and applying selective stimulus to industrial sectors that can use the money effectively - and hope that a global economic recovery will help China grow out of its problems.

Reformers appear to want something more: integrating local governments and SOEs into a coherent system of market, legal and public supervision that will reduce corruption and increase economic efficiency and rationality. In other words, democracy, rule of law, further empowerment of free-market forces.

That means taking confrontational, painful, and risky steps to strip the dead hand of local governments and SOEs from national civil and economic life.

That isn't easy.

To advance such a politically difficult and costly agenda, the reformers need a game changer, the existential shock to the system that the Bo Xilai case apparently did not provide to the CPP leadership.

Borrowing a concept from evolutionary biology, the reformists could be said to preoccupied with "catastrophism".

The idea behind catastrophism is that change is not necessarily smooth, incremental, and completely driven by internal forces. To achieve radical change, sometimes an external event - a catastrophe like the asteroid that wiped out the dinosaurs - is needed.

The reformist literature is now a ceaseless search for dark clouds in the local and international media: evidence of looming catastrophe, harbingers like reduced power generation, slowing economic growth, capital flight, and collapsing industrial sectors.

It also seems to manifest itself as Chicken-Littleism: heralding natural and man-made tragedies inside China, such as earthquakes, landslides, and exploding gas tankers, as damning evidence of the current regime's moral and political bankruptcy - especially if they involve the death of children, and can accommodate a blizzard of exclamation points, weeping and raging emoticons, and bathetic harangues.

So far, symbolic and limited calamities have failed to crystallize a conviction as to the compelling need for immediate and thoroughgoing reform, damn the political cost, in the minds of the Chinese leadership.

It remains to be seen whether such a game-changing event will occur - or if such an event can even be recognized in the restricted mental landscape of the insulated, privileged, and risk-averse Chinese national party cadre.

1. Click here for text (in Chinese).
2. The Dark Heart of the Bo Xilai Case, Caixin, Oct 10, 2012.
3. Click here for text (in Chinese).
4. Sr official stresses law enforcement ahead of congress, Xinhua, Oct 16, 2012.
5. Radical ideas mislead real path of reform, Global Times, Oct 16, 2012.
6. Reform or perish, journal warns Communist Party, South China Morning Post, Oct 17, 2012.

Friday, October 12, 2012

America Freaked Out by the Cyberboogeyman It Unleashed

The theme of Secretary of Defense Panetta’s remarks at the Intrepid Air and Sea Museum on October 12 before the “Business Executives for National Security”, in the words of the BBC:

Actually, Mr. Panetta, the “cyber Pearl Harbor” has already happened.  

It was called Stuxnet, the virus designed and delivered by the governments of the United States and Israel to sabotage Iran’s nuclear program.

By unleashing Stuxnet—an act of cyberwar—a Rubicon was crossed.  Not my words, but the words of Michael Hayden, the ex-director of the CIA.

Now the United States is scrambling to deal with the consequences…and the Western media is by and large obligingly doing its best to help shove Stuxnet into the memory hole.

Panetta used his speech to push for more cybersecurity legislation by discussing cyberattacks on Aramco in Saudi Arabia and RasGas of Qatar using the “Shamoon” virus.  The attacks—which occurred and were reported in August 2012, a few months after Stuxnet—wiped data from tens thousands of management computers, replaced some files with a taunting image of a burning American flag, and reportedly rendered the computers useless.

I was amused to hear that Mr. Panetta carefully characterized these incidents as “the most destructive [cyber] attack that the private sector has seen to date.”

I assume he added the “private sector” qualifier to put the fear of cyber-God into the security-obsessed executives he was addressing (although applying the term “private sector” to Aramco, the state-owned Saudi Arabian oil behemoth and  RasGas, which is 70% owned by state-owned Qatar Petroleum is a bit of a stretch).  

But limiting the scope of discussion to  “private sector” cyberattacks also excludes the much more significant, expensive, fiendishly complex, and destructive Stuxnet virus, which attacked and disabled a strategic Iranian government installation.

Stuxnet typifies the grave threat to physical infrastructure that Mr. Panetta got so worked up about much more vividly than an office computer data hack along the lines of Shamoon.

And Stuxnet escaped into the wild to infect computer systems around the world!  Collateral damage-wise, there apparently wasn't much for Stuxnet to do in a non-uranium centrifuge environment, but it did spread to 100,000 hosts in 155 (mostly US-friendly) countries. (There has recently been a good deal of techie back and forth as to whether Stuxnet's global romp was really an unplanned escape; presumably people are implying that the Israeli spooks inserted some kind of hunter-killer app that allowed the virus to search Iran and the globe for similar installations to degrade.)

Despite its obvious utility as an object lesson in the genuine, real world dangers of cyberweaponry, Stuxnet did not come up in Mr. Panetta’s remarks, or in much of the media coverage.  

Wonder why.

Instead, DoD backgrounders painted the Shamoon attacks as dastardly underhanded Iranian payback for (legal and public) sanctions regime, not as possible direct retaliation for a (secret and unilateral) cyberattack.

To its credit, the New York Times, which got the Stuxnet story from the Obama White House back in June, did mention the Stuxnet exploit in its coverage of Panetta’s speech.

In any case, the United States, having committed the first cyberattack, is trying to pull up the cyberdrawbridge in anticipation of retaliation.

One of more interesting elements of this exercise is the U.S. efforts to paint its actions as a response to Chinese and Iranian cyberthreats, instead of its own actions.  As indicated above, the Western media has been an obliging enabler, leading to some topsy-turvy reporting.

The Daily News titled the AP report on Panetta’s speech: 

Maybe a better title would be Anti-Iran Alliance Reaps Viral Retaliation for Stuxnet Sneak Attack.

Now, I’m sometimes accused of promoting false moral equivalence between the PRC and the United States i.e. judging Chinese and US actions by similar standards.

But, in my mind, what is really dangerous is the false assumption of moral superiority that underlies much of the reporting about China and Iran.

According the moral superiority equation, the United States is automatically in the right in any dispute with the PRC and Iran because of the innate superiority of our system and the ideological, economic, and human rights defects of the PRC and Iranian regimes.

Despite the resounding disaster of the Iraq war, this tendency has strengthened in recent years with the further institutionalization of the “responsibility to protect” doctrine as a pretext for US foreign policy intervention.  

Targets of Western intervention are progressively delegitimized so that unprovoked attack elicits no condemnation, and efforts by our adversaries to defend themselves, especially by trying to establish a deterrent by demonstrating an ability to retaliate are ipso facto morally indefensible.

I was struck, for instance, by the reporting of the Daily News and New York Post, albeit tabloid outliers, on President Achmadinejad’s visit to New York to address the UN General Assembly in September (post Stuxnet, of course).

They greeted him with front page, full-sized photos of Ahmadinejad flashing the V sign, garlanded  with the epithet PEACE OF SH!T (Post) and VILE (News).

This sort of stuff is usually forgiven on First Amendment grounds and excused as harmless hyperbole used to sell newspapers.  But it’s certainly not making war with Iran less likely, especially in the minds of the easily excited.

The Daily News reported favorably on the assault by an MEK –linked crowd on a Foreign Ministry official who got separated from his group on the streets of New York:

An Arkansas man landed a blow for democracy Wednesday — right to the gut of an Iranian official.
Gregory Nelson received cheers and handshakes from anti-Iran protesters after slugging Foreign Ministry mouthpiece Ramin Mehmanparast on 48th St. near Second Ave.

“It felt really good,” said Nelson, 50, after delivering his shot to the Iranian bigwig’s stomach. “It wasn’t that hard, but he felt it.”

Nelson was flanked by a horde of protesters, many of them Iranian immigrants demanding democracy in their homeland, when Mehmanparast walked past after President Mahmoud Ahmadinejad’s United Nations speech.

The former Army National Guard member, doing his best Mike Tyson impression, saw an opening and swung at the spokesman’s midsection before he could escape.

“We don’t usually conduct ourselves like that, but he’s a murderer,” said the bearded, ponytailed Nelson. “That whole regime, everybody is responsible for the murders that go on.”

Maybe Ahmadinjad feels he would have been treated with a little more courtesy if he had the atomic bomb; in any case, I don’t think his reception in New York convinced him Iran should abandon its ideas of a nuclear deterrent.

For those with short memories, the whole “delegitimization from an attitude of Western moral superiority” thing was applied to Saddam Hussein before Mahmoud Ahmadinejad, until invading Iraq became a moral imperative, not just an extremely dubious foreign policy option.
That’s why I consider China-bashing rather worrisome, even though the combination of the PRC’s nuclear deterrent and Western squeamishness about land wars in Asia makes an attack on China proper almost inconceivable.  

As the Iran precedent shows, there’s still plenty of room for terrorism, economic warfare, subversion, cyber wars, proxy wars, and every kind of human misery short of outright invasion.

US policy toward China is getting locked into a self-reinforcing cycle of continued provocation, response, and delegitimization which creates an environment of escalating crisis that some in the United States security establishment seem happy to promote and makes confrontation with the PRC more likely.

Escalating responses to cyberthreats feed this dynamic.

As Secretary Panetta's speech demonstrates, touting the insidious cyberwar designs of our adversaries has too much efficacy as a national security hot button for the US government and the Western media to be squeamish about pushing it, no matter what we did with Stuxnet.  We're the good guys, after all!

That's certainly the case for China, which is a cyber-adversary of considerable notoriety, though (unlike the United States) it has apparently confined the bulk of its efforts to espionage rather than sabotage to date.

In any case, Secretary Panetta (and the media)'s contortions over America's Stuxnet legacy provide a nice and timely segue into my most recent piece for Asia Times.

The piece discusses the hullaballoo over Huawei and ZTE, two Chinese telecommunications vendors who the U.S. House of Representatives Intelligence Committee would like to see banned from any private as well as public U.S. networks.

I argue that the reason why Huawei and ZTE can’t be trusted is because the U.S. can’t be trusted.  It unleashed Stuxnet in a unilateral, secret cyberattack and rendered moot the Pentagon’s hopeful effort to negotiate the rules of cyberwar.   With cyberwar not just on the agenda but actually being practiced out in the field, thanks to President Obama, I’d also worry that somehow the Chinese government would try to diddle with our precious networks and the sensitive infrastructure they control.

Whether or not the PRC’s spooks would go through Huawei and ZTE is, of course, another matter, one for the experts in cybersabotage to consider.  For one thing, many of the network suppliers whom the Intelligence Committee considers trustworthy, like Alcatel, already manufacture a lot of sensitive equipment within Chinese borders.  

Anyway, here’s the story on Huawei, the latest Chinese bugbear.  Readers are invited to consider whether pounding on China this way is making us safer, or pushing us unprepared toward some kind of dangerous and uncertain future.

It can be reposted if ATOl is credited and a link provided.
US digs in for cyber warfare
By Peter Lee

Recently the US House of Representatives Intelligence Committee took a meat-ax to Huawei, the Chinese telecommunications giant, and its little brother ZTE in a 60-page report on national-security issues posed by the two companies.

The conclusion:

  • They're commies.
  • We can't trust 'em.        Or, as the executive summary put it:
    The United States should view with suspicion the continued penetration of the US telecommunications market by Chinese telecommunications companies. [1]
    Specifically, the committee recommended that the government not purchase any Huawei or ZTE equipment.

    The committee rubbed further salt in the wound by recommending that private companies not buy any Huawei or ZTE telecommunications equipment either.

    It also invited the legislative branch to expand the jurisdiction of the Committee on Foreign Investment in the United States (CFIUS) to enable it to block procurement of Chinese telecommunication equipment by US customers, in addition to exercising its traditional powers of blocking foreign investment deemed harmful to US security. CFIUS had previously blocked Huawei's participation in a deal to take 3Com private - which was brokered by Mitt Romney's Bain Capital - and recently denied Huawei's attempt to buy 3Leaf, a California cloud computing company.

    Certainly not the clean bill of health that Huawei was hoping for when it invited the US government to investigate its operations.

    It is clear that the Chinese companies were given the Saddam Hussein treatment. Just as the Iraqi despot was put in the impossible position of proving a negative - that he did not have any weapons of mass destruction - Huawei and ZTE executives were called upon to prove their companies were not untrustworthy.

    Mission unaccomplished, for sure.

    The public committee report is little more than a litany of complaints about unclear answers, insufficient disclosure, inadequate clarification, failure to alleviate concerns, making non-credible assertions, failure to document assertions, failure to answer key questions, refusal to be transparent, and so on and so forth. Huawei, in particular, was dinged for "a lack of cooperation shown throughout this investigation".

    The committee's conclusion:
    Throughout the months-long investigation, both Huawei and ZTE sought to describe, in different terms, why neither company is a threat to US national-security interests. Unfortunately, neither ZTE nor Huawei [has] cooperated fully with the investigation, and both companies have failed to provide documents or other evidence that would substantiate their claims or lend support for their narratives.
    To drive a stake into the heart of any dreams that Huawei or ZTE had of providing "mitigation assurances" - bureaucratese for acceptable measures to allay US security concerns - the committee made the interesting decision to dump all over the British government.

    Keen on Chinese investment in its backbone telecommunications networks, the British government accepted the reassurance provided by a cyber-security center, funded by Huawei and staffed by UK citizens with security clearances, with the job of vetting Huawei products for hinky bits.

    The US intelligence committee dismissed these efforts as futile given the complex, opaque and frequently updated character of telecommunications software:
    The task of finding and eliminating every significant vulnerability from a complex product is monumental. If we also consider flaws intentionally inserted by a determined and clever insider, the task becomes virtually impossible.
    In terms of specific evidence of Huawei and ZTE malfeasance, there is little meat on the bones of the public document.

    On the technical side, the evidence supporting Huawei and ZTE infiltration of the US telecommunications software presented in the public report was less than earth-shaking:
    Companies around the United States have experienced odd or alerting incidents using Huawei or ZTE equipment. Officials with these companies, however, often expressed concern that publicly acknowledging these incidents would be detrimental to their internal investigations and attribution efforts, undermine their ongoing efforts to defend their systems, and also put at risk their ongoing contracts.

    Similarly, statements by former or current employees describing flaws in the Huawei or ZTE equipment and other potentially unethical or illegal behavior by Huawei officials were hindered by employees' fears of retribution or retaliation.
    Presumably, the confidential annex to the committee report makes a more compelling case, but one has to wonder.

    According to The Economist:
    Years of intense scrutiny by experts have not produced conclusive public evidence of deliberate skulduggery, as opposed to mistakes, in Huawei's wares. BT, a British telecoms company that buys products vetted in [the cyber-security center at] Banbury, says it has not had any security issues with them (though it rechecks everything itself, just to be sure). [2]
    In a sign that no existential smoking cyber-guns had been revealed, the worst punishment for Huawei's lack of cooperation that the committee could apparently mete out (other than trying to destroy Huawei's US business) was threatening to forward information to the Justice Department concerning possible corporate malfeasance in the routine areas of immigration violations, fraud and bribery, discrimination, and use of pirated software by Huawei in its US operations.

    It can be taken as a given that the People's Republic of China (PRC) is intensely interested in cyber-espionage - diplomatic, military, and commercial - against the United States and cyber-warfare against US government, security, and public infrastructure if and when the need arises.

    However, the case that Huawei is a knowing or even a necessary participant in these nefarious schemes is unproved.

    Nevertheless, Huawei's attempts to generate a clean bill of health for itself with Western critics are pretty much futile.

    That's because government weaponization of communications technology is a given - for everybody, in the West as well as in China.

    Beneath the freedom-of-information rhetoric, the West is converging with the East and South when it comes to protecting, monitoring and controlling its networks.

    In the United States, providing government law enforcement with back-door access to networks, aka "lawful intercept", is a legal requirement for digital telecom, broadband Internet, and voice-over-IP service and equipment providers under the CALEA (Communications Assistance to Law Enforcement Act) law. The Federal Bureau of Investigation (FBI) is currently lobbying the US administration and the Federal Communications Commission to require that social-media providers such as Facebook provide similar access so that chats and instant messaging can also be monitored in real time or extracted from digital storage.

    In Europe, similar law-enforcement access is institutionalized under the standards of the European Telecommunications Standards Institute.

    Particularly in the environment after the attacks of September 11, 2001, law enforcement has expressed anxiety about "going dark" - losing the ability to detect and monitor communications by bad actors as data and telecommunications moved from fixed-wire analog systems to digital, wireless, and band-hopping protocols.

    The situation is aggravated by the availability of theoretically unbreakable public/private key 128-bit encryption.

    (I say "theoretically", by the way, because creation of the private key relies on a random-number generator on the encrypting computer. A recent study found that some programs were spitting out non-random random numbers, raising the possibility that a certain spook agency of a certain government had been able to diddle with the programs to generate certain numbers preferentially, giving said spook agency a leg up to crack the private keys through otherwise ineffective brute-force computing techniques.) [3] 

  • One way to get around the problem of anonymous users employing unbreakable encryption from multiple devices is the trend around the world toward requiring real name registration - stripping anonymity from Internet posters - and requiring Internet service providers to become active participants in law enforcement by monitoring the activities of their customers.

    For encrypted documents and communications using genuinely random numbers - and absent a mandated, law-enforcement-accessible third-party repository for private keys (a demand recently made of RIM, the BlackBerry people, by the Indian government), the government has to employ either judicial compulsion or covert means to obtain information on private keys from individual computers. Covert means presumably involve using a virus or some other means of access to install a keylogger. [4] [5]

    A while back, the FBI admitted it had such a program, code-named Magic Lantern - strictly a research operation, of course - creating the interesting issue of whether or not anti-virus software vendors could be dragooned into modifying their programs to ignore the officially sanctioned virus.

    One plausible reason for excluding Huawei and ZTE from US networks would be to deny them a possibly privileged view of how the legal intercept cyber-sausage gets made.

    Even Western governments have also expressed an interest in flipping the dastardly "kill switch" that deprives Internet users of their precious connectivity and is the badge of shame for totalitarian regimes.

    During the riots in England last year, the British government thought of taking a page from the playbooks of former Egyptian leader Hosni Mubarak and Iranian President Mahmoud Ahmadinejad.
    British Prime Minister David Cameron, in a statement to the House of Commons earlier today, made reference to and mooted the possibility that social media could be "disrupted" or turned off if riots continue.

    Services such as Facebook, Twitter and crucially BlackBerry Messenger - which has been used by rioters and looters to organize disruption across the British capital and other cities in England - could be restricted in a bid to prevent further violence; present day or in future warranted situations.

    Speaking in the House of Commons, David Cameron said: "The free flow of information can be used for good. But it can also be used for ill" ...

    Conservative Tobias Ellwood MP said in Parliament that police should be given the option to switch off cell network masts "and other social networks" used to coordinate trouble, violence and disorder. [6]
    Putting a kill switch in the hands of Huawei is probably the biggest US headache.

    With more and more sensitive data encrypted, it is unclear that squatting on a Huawei switch and copying the flow of 1s and 0s will deliver Chinese spies a considerable incremental benefit over the prodigious targeted hacking operations they are allegedly engaging in already.

    The real danger from a hostile piece of telecommunications kit would be disablement in time of crisis or war, as Fred Schneider, a computer scientist at Cornell University in New York state, told Technology Review:
    A trigger could be built either into the software that comes installed in switches and network hardware or into the hardware itself, in which case it would be more difficult to detect, says Schneider. The simplest kind of attack, and one very hard to spot, would be to add a chip that waits for a specific signal and then disables or reroutes particular communications at a critical time, he says. This could be useful "if you were waging some other kind of attack and you wanted to make it difficult for the adversary to communicate with their troops", Schneider says. [7]
    There is a good reason Huawei can't be trusted to deliver clean kit to critical US infrastructure customers. That is that we now live in a world in which cyberwar is an acceptable and legitimate national tactic.

    This Pandora's box of cyberwar has already been opened ...

    ... by the United States.

    Amid the ferocious Iran-bashing - and "by any means necessary" justifications for covert action against that country's nuclear program - that have become endemic in the West, the true significance of the Stuxnet exploit has been overlooked by many, at least in the West.

    Stuxnet was the release of an important cyber-weapon - a virus that did not simply seek sensitive information or attempt to disrupt communication, but one that was reportedly rather effective in damaging a strategic Iranian facility by an act of sabotage.

    It was an act of cyberwar.

    As David Sanger, The New York Times' national-security adviser, wrote in his White House-sanctioned account:
    "Previous cyberattacks had effects limited to other computers," Michael V Hayden, the former chief of the CIA, said, declining to describe what he knew of these attacks when he was in office. "This is the first attack of a major nature in which a cyberattack was used to effect physical destruction", rather than just slow another computer, or hack into it to steal data.

    "Somebody crossed the Rubicon," he said. [8]
    In true US imperial style, Stuxnet was unleashed unilaterally and without a declaration of war, to satisfy some self-defined imperatives of US President Barack Obama's administration.

    That's not a good precedent for other cyber-powers, including China, to rely on US restraint, or to restrain themselves.

    The Obama administration's attempt to deal with the issue of its first use of cyber-warfare seems to go beyond hypocritical to the pathetic.

    There are rather risible efforts to depict the Stuxnet worm - which caused the centrifuges to disintegrate at supersonic speeds - as little more than a prank, albeit a prank that might impale hapless Iranian technicians with aluminum shards traveling at several hundred kilometres per hour, rather than a massive exercise in industrial sabotage:
    "The intent was that the failures should make them feel they were stupid, which is what happened," the participant in the attacks said. When a few centrifuges failed, the Iranians would close down whole "stands" that linked 164 machines, looking for signs of sabotage in all of them. "They overreacted," one official said. "We soon discovered they fired people."
    According to Sanger, at least President Obama knew what he was getting into:
    Mr Obama, according to participants in the many Situation Room meetings on Olympic Games, was acutely aware that with every attack he was pushing the United States into new territory, much as his predecessors had with the first use of atomic weapons in the 1940s, of intercontinental missiles in the 1950s and of drones in the past decade. He repeatedly expressed concerns that any American acknowledgment that it was using cyber-weapons - even under the most careful and limited circumstances - could enable other countries, terrorists or hackers to justify their own attacks.

    "We discussed the irony, more than once," one of his aides said. Another said that the administration was resistant to developing a "grand theory for a weapon whose possibilities they were still discovering". Yet Mr Obama concluded that when it came to stopping Iran, the United States had no other choice ...

    Mr Obama has repeatedly told his aides that there are risks to using - and particularly to overusing - the weapon. In fact, no country's infrastructure is more dependent on computer systems, and thus more vulnerable to attack, than that of the United States. It is only a matter of time, most experts believe, before it becomes the target of the same kind of weapon that the Americans have used, secretly, against Iran.

     But Obama did it anyway, in the service of a dubious foreign-policy objective - forcibly and unilaterally disabling Iran's (currently) non-military nuclear program - that was arguably an overreaction to Israel's blustering threat to attack Iran unilaterally, and an attempt to get himself some political breathing space from vociferously pro-Israeli interests in US politics.

    And of course there were problems.

    Stuxnet made a mockery of its reputation as a "surgical strike" magic bullet that would destroy Iran's centrifuges but otherwise do no harm. It escaped into the wild - something that Obama's team likes to blame on the Israelis, but an evasion of culpability that would probably not hold up in a court of law - and infected computer systems around the world.

    Presumably, Chinese intelligence services did not have to wait for Stuxnet to arrive in China; they were probably invited to help out with the forensics by the Iranian government, and probably have a very nice idea of how it works, and creative ideas about how it could be modified to target other systems.

    The Stuxnet background provides an interesting context to the immense ballyhoo about Chinese cyber-espionage and cyber-warfare threats, of which the House Intelligence Committee report is only one instance.

    What better way to distract attention from one's own first use of cyber-weapons than to raise the alarm about what the bad guys might do instead?

    One of the sweetest fruits of this exercise in misdirection is an April (pre-Sanger expose) National Public Radio report on what it identified as the real cyber-threat in the Middle East: Iran.
    The big fear in the US is that a cyberattacker could penetrate a computer system that controls a critical asset like the power grid and shut it down. Such an effort is probably beyond the capability of Iranian actors right now, according to cyber-security experts. But a less ambitious approach would be to hack into the US banking systems and modify the financial data. [Dmitri] Alperovitch, whose new company CrowdStrike focuses on cyber-threats from nation-states, says such an attack is well within Iran's current capability.

    "If you can get into those systems and modify those records, you can cause dramatic havoc that can be very long-lasting," he says.
    The possibility that Israel's traditional bugbear, Hezbollah, could be prevailed upon to deliver the fatal code on Iran's behalf is discussed in detail. [9]

    The Pentagon's cyberwar strategists did their best to frame the cyberwar issue as law-abiding America vs the unprincipled cyber-predators of the PRC.

    With Sanger-assisted Stuxnet hindsight, this May report, with its wonderful title "US hopes China will recognize its cyber war rules", is, well, hypocritical and pathetic:
    While no one has, with 100% certainty, pinned the Chinese government for cyber-attacks on US government and Western companies, in its 2012 report "Military and security developments involving the People's Republic of China", the US secretary of defense considers it likely that "Beijing is using cyber-network operations as a tool to collect strategic intelligence" ...

    The report raises China's unwillingness to acknowledge the "Laws of Armed Conflict", which the Pentagon last year determined did apply to cyberspace ...

    Robert Clark, operational attorney for the US Army Cyber Command, told Australian delegates at the AusCERT conference last week how the Laws of Armed Conflict in cyberspace might work internationally to determine when a country can claim self-defense and how they should measure a proportionate response.

    One problem with it was highlighted by Iran, following the Stuxnet attack on its uranium-enrichment facility in Natanz, which never declared the incident a cyberattack.

    Air Force Colonel Gary Brown, an attorney for US Cyber Command, in March this year detailed dozens of reasons why Iran, in the context of the Laws of Armed Conflicts in cyberspace, didn't declare it an attack. This included that difficulties remain in attributing such an attack to a single state. [10]
    A few days later, Sanger's story confirmed that the Obama administration had indeed released Stuxnet, rendering moot the Pentagon's plans for a chivalric, rules-based cyberwar tournament, with the US occupying the moral high ground.

    Heightened mutual suspicion - maybe we should call it endemic mistrust - is now a given in cyber-relations between the United States and its adversaries/competitors, for a lot of good reasons that don't necessarily have anything to do with Chinese misbehavior, but have more than a little to do with the US willingness to unleash a cyberattack on an exasperating enemy without setting clearly defined ground rules, and its need to pull up the cyber-drawbridge over the national digital moat to prevent retaliation.

    Suspicion of other people's cyber-motives has become a self-fulfilling prophecy, and anxious allies are expressing their cyber-solidarity by banding together against the external threat.

    In the midst of important national debates on Chinese investment, Canadian and Australian intelligence services, probably prompted by their opposite numbers in the United States, both issued damning reports on Chinese cyber-threats.

    The Australian government has banned Huawei and ZTE from participation in its massive National Broadband Network project. In Canada, cyber-spying is cited as a justification for limiting investment by Chinese state-owned enterprises (such as CNOOC) in any strategic Canadian businesses.

    On the other side of the fence, Iran, in a decision that was widely mocked in the United States, is developing a more secure national intranet - with equipment allegedly provided by Huawei.

    Of course, in the up-is-down rhetoric that drives US Internet policy, Iran's attempts to shield itself from foreign threats is itself a threat:
    "Any attempt by a country to make an intranet is doomed to failure," Cedric Leighton, a retired deputy director at the National Security Agency, said in an interview. But he said Iran's "cyber-army", a network of government-supported hackers that has attacked Western targets in recent years, does stand to gain from the attempted creation of a national network. By connecting thousands of servers inside Iran, the government would "build on their knowledge of networks and how they operate", he said, increasing their capabilities to both launch and repel cyberattacks. [11]
    By the way, the largest intranet in the world is the unclassified chunk of the US military's data network, known as NIPRNET, a fact that perhaps escaped Leighton. SIPRNet, the classified part of the US military network, with 4.2 million users, is also doing OK, though it was the source for the WikiLeaks CD.

    As The Economist put it, the Internet is becoming balkanized. [12]

    And as Winston Churchill might have put it, a digital curtain is descending across the Middle East, Asia, and virtually every significant national border. This phenomenon is a direct expression of the insecurity of governments as they attempt to limit the vulnerabilities that encrypted connectivity reveal to their internal and external enemies, and as they deal with the consequences of their own efforts to exploit and compromise the Internet.

    It is easy for governments to blame others, but they might as well blame themselves.

    1. Click here for full text of the report (pdf file).
    2. The company that spooked the world, The Economist, Aug 4, 2012.
    3. Crypto-Gram Newsletter, Schneier, Mar 15, 2012.
    4. FBI software cracks encryption wall, MSN, Nov 20, 2001.
    5. India: We DO have the BlackBerry encryption keys, The Register, Aug 2, 2012.
    6. British PM considers turning off social networks amid further riots, ZD Net, Aug 11, 2011.
    7. Why the United States Is So Afraid of Huawei, Technology Review, Oct 9, 2012.
    8. Obama Order Sped Up Wave of Cyberattacks Against Iran, The New York Times, Jun 1, 2012.
    9. Could Iran Wage a Cyberwar on the US?, Apr 26, 2012.
    10. US hopeful China will recognise its cyber war rules, CSO, May 21, 2012.
    11. Iran tightens online control by creating own network, Guardian, Sep 25, 2012.
    12. The company that spooked the world, Economist, Aug 4, 2012

     Newspaper images from Capital New York