Trojan Horse in the Pentagon?

May 24, 2013

  • U.S. military communications outsourced to China? The true story behind a little-known Pentagon scandal, and how it’s being cleaned up to the benefit of a tiny subcontractor
  • Stocks stumble into the weekend: Elmerraji on why the U.S. equity market is not in a bubble… and how to recognize a bubble when you see it
  • “Doomed to fail”: Amoss on the real reason Japan’s stock market fell out of bed… plus, a warning you don’t want to ignore
  • North America’s 10-year lead on the rest of the world: Byron King’s takeaway from a gathering of his fellow oil field geologists
  • How Britain’s “super tax” set off a chain of events that ended with the breakup of the Beatles… and more!

  “The U.S. military-industrial complex will not be satisfied until it has outsourced its entire activities to China,” declares an outraged and not-entirely hyperbolic Eamonn Fingleton at Forbes.

On April 25, during a hearing of the House Armed Services Committee, a Pentagon flunky disclosed that the U.S. military uses a commercial Chinese satellite to provide communications for the U.S. Africa Command.

5 readers with keen memories and a keener sense of irony will recall that’s the same Africa Command the military formed in 2006… for the express purpose of checkmating China’s ambitions to lock up oil and other resources in Africa.

Seriously.

“The nation that launched the world’s first communications satellite (I remember it well — it was called Telstar),” Fingleton fumes, “has so lost its manufacturing mojo that it has to rely on its most formidable military adversary to provide the hardware for some of its most sensitive communications.”

Nor is the satellite an isolated case.

  “America’s dependence on foreign suppliers is a growing problem that hurts our nation’s defense industrial base and threatens our security independence,” declares Rep. Mo Brooks (R-Ala.), a member of the committee that heard the China satellite revelation last month.

Brooks is pointing to a new study called “Remaking American Security: Supply Chain Vulnerabilities and National Security Risks Across the U.S. Defense Industrial Base,” prepared for the Alliance for American Manufacturing.

It spotlights scads of weapons programs that depend on foreign supplies…

  • The F-35 fighter jet
  • The F-22 fighter jet
  • The littoral combat ship
  • The V-22 “Osprey” tiltrotor aircraft
  • JDAM — the hardware and software behind “smart bombs”
  • Night-vision gear
  • Submarine-launched missiles.

100  The issue has been literally decades in the making… and spotlighted in an obscure 2005 report issued by an obscure Pentagon-funded think tank called the Defense Science Board.

Forbes’ Fingleton sums it up: “Reporting that most of the key capabilities and technologies on which the U.S. semiconductor industry rested had moved offshore, the board summed up its inquiries with this chilling comment:

“‘The potential effects of this restructuring are so perverse and far-reaching and have such opportunities for mischief that, had the United States not significantly contributed to this migration, it would have been considered a major triumph of an adversary nation’s strategy to undermine U.S. military capabilities.'”

Worst-case scenario: Suppliers from a hostile nation might plant “Trojan horse” computer chips inside critical systems — circuitry that’s nearly impossible to detect.

Could an F-22 misfire, thanks to “Trojan horse” computer chips?

  A more likely scenario: counterfeit parts that might not function as intended.

“We can’t tolerate the risk of a ballistic missile interceptor failing to hit its target, a helicopter pilot unable to fire his missiles or any other mission failure because of a counterfeit part,” said Sen. John McCain during a 2011 hearing that brought the issue to light.

Profit-maximizing U.S. military contractors,” Fingleton concludes, “have clearly long since given up even the pretense of serving the U.S. national interest.”

Undoubtedly true… but it appears events deep in the bowels of the bureaucracy have escaped Forbes’ notice.

  The Pentagon’s 2012 funding bill included a hard-and-fast requirement, as described at Law360.com: “to eliminate counterfeit electronics… from its supply chain, through regulations that would shift liability for replacing counterfeits to the contractors.”

Get that? The contractors can no longer slough off responsibility to the government if counterfeits are discovered. They’re liable… at the very least for making the situation right, and at worst for civil and even criminal damages.

If you’re the likes of Boeing, Raytheon and Lockheed Martin, you’d want to do everything in your power to avoid that. Which is why more than three dozen defense contractors are beating down the door of a subcontractor that the Pentagon has granted a virtual monopoly on anti-counterfeiting technology.

The proposed regulations were published in the Federal Register only last week. They could be final as early as July — propelling this subcontractor into top-of-mind awareness among the industry’s giants.

“Imagine,” says our tech guru Patrick Cox, “owning shares in a small, as of yet unrecognized company destined to become a juggernaut of profits for anyone with the good sense to grab their shares.” Patrick lays out the fascinating — and lucrative — background in this presentation.

Be advised our publisher is pulling this presentation offline at midnight Sunday night… so take a look while you still can.

  The few traders who haven’t knocked off early for the long weekend have teamed up with the high-frequency robots to send the major stock indexes down this morning.

The S&P rests uneasily at 1,640; a mere 48 hours ago, it hit an all-time intraday high at 1,685. Our trading specialist Jonas Elmerraji is, however, resting easy; the index remains solidly within the uptrending “channel” going back more than six months now.

“The most hated stock rally in history” is still on.

  On the other hand, “I spotted an article that got my blood boiling,” Jonas tells us.

“It was a MarketWatch column that argued that we’re in a stock market bubble right now. Here’s the sentence that really did it for me:

“This is an attribute of almost all bubbles; everyone knows they will come to an end, everyone knows what has happened when other bubbles have burst, but very few want to get off in the middle of the parade.”

“Huh?” Jonas says, incredulous. “That’s pretty much the OPPOSITE of what happens in a bubble.

“When the housing market was rising to a foamy froth, everybody leveraging themselves to the hilt to buy real estate thought it would go on forever. When the tech bubble shoved valuations in garbage stocks like Pets.com up to ludicrous levels, nobody thought that the air was suddenly going to get let out of their portfolios — they just thought that the old ways of evaluating stocks didn’t apply to amazing Internet companies…

“Could stocks be overvalued right now? Sure. Could momentum fizzle out in the short term? Of course. But those two risks do not a bubble make.”

  “The Bank of Japan’s bold monetary experiment may blow up in its face,” suggests our Dan Amoss.

“The Japanese government bond (JGB) market — one of the biggest bond markets in the world — is acting strangely. It’s a dynamic, potentially explosive situation.

“Despite huge amounts of newly printed yen constantly flooding the JGB market, it appears supply is overwhelming demand. Japanese banks and insurers are selling JGBs more aggressively than the central bank is buying. Prices are falling and yields are rising.”

That, suggests Dan, is the real reason the Nikkei crashed 7.3% on Thursday — only a small chunk of which was recovered in today’s session.

“The Nikkei crash coincided with weak Chinese economic data,” says Dan, “but the real fuel for the crash was fear that the JGB market could spiral out of control.

“In its effort to push inflation up to 2%, the Bank of Japan may get more than it bargained for. It may find itself the only buyer willing to absorb JGBs at interest rates the government can afford.

“The cost of borrowing is the key to understanding Japan’s trap: The private market for JGBs is doomed to fail. It’s doomed because the supply of private-sector savings to fund a bankrupt government at just 1% will dry up — especially if savers become convinced inflation is heading to 2% (or more).

“Here’s the problem: The Japanese government can’t afford to pay more than 1%, or it would fall into a trap of committing its entire government budget to pay interest on the debt. At that point, default would be inevitable.” PRO-level subscribers can read on for a “final warning” from Dan…

  “How many times have I started a weekly note by stating, ‘I’m in (fill-in-the-blank)’?” asks our resource guru Byron King. He was giving us an update from the American Association of Petroleum Geologists (AAPG) convention in Pittsburgh.

According to Byron, the convention draws an international crowd — a part of the oil industry he calls “Big Geology.” Surprisingly, he said that foreigners are still wrapping their heads around fracking.

“It strikes me,” he noted, “that North America is a decade or more ahead of the rest of the world in fracking. We’re pioneering the fracking process here. It makes sense, because North America is where the energy supply deficit has been made up by expensive oil imports for many years.”

So what will it take for others hoping to enter the fracking fray? “The new breed had better be well versed in using Big Data, math and statistics,” he answered.

“At AAPG conventions of old, there used to be all manner of ‘hard’ exhibits — drill bits, logging tools, etc. Doing oil geology still involved kicking steel and getting your hands dirty. Now the AAPG displays are all screens, on which you see examples of data being manipulated by workstation levels of computational power.

“The future is strong for unconventional plays. There’s much drilling and fracking yet to come.”

But, says Byron, keep an eye out for another trend coming out of nowhere: “At the same time, new tech is moving backward, into older, ‘mature’ oil fields from days past. By incorporating fracking into traditional oil extraction, the Permian Basin of West Texas, for example, is now growing oil output after literally generations of decline.”

Yet another surprising wrinkle in the ongoing “Remade in America” story. If you haven’t acquainted yourself with it lately, give it a look…

  “Is this a good weapon?” said a man clutching an umbrella. “It is if it’s in my hands at the time of attack.” His name is Mark Donnelly, and he practices a martial art called Bartitsu.

Our daily, tireless search for “quirk” with which to keep The 5 entertaining has hit a wall on this Friday before a long weekend. The news gods will simply not comply. We’re forced to examine the “A-Hed” story on The Wall Street Journal’s front page… where we find “an obscure Victorian system of gentlemanly self-defense practiced by Sherlock Holmes, Sir Arthur Conan Doyle’s legendary detective.”

Uh-huh.

“Holmes is fictional,” said Donnelly at the Steampunk World’s Fair. “Bartitsu is real.”

Apparently, it was developed by Edward William Barton-Wright, a British engineer, in 1898.

“Ahem. Pardon me, good sir. Yes, over here. Would you care to altercate? You would? Splendid.”

Mr. Donnelly agrees that “Bartitsu’s value is more historical than it is a practical means of self-defense today — though, he adds, it would be easy to substitute a Starbucks cup for a snuffbox, blinding an attacker with hot coffee, rather than a cloud of snuff.”

We recall reading speculation a few years ago, after Rupert Murdoch bought The Wall Street Journal, that he might kill the A-Hed, the better to fulfill his fantasies of taking on The New York Times mano a mano. Didn’t happen, but if this is the best they can come up with…

  “None of the Beatles ever moved to France,” a reader writes with one of the more obscure emendations we’ve run in The 5.

“The Stones did, in 1971, producing their masterpiece, Exile on Main Street, in Keith Richards’ basement in Villefranche-sur-Mer.”

The 5: We indeed got our iconic British rockers mixed up. That said, the Fab Four also went to great lengths to avoid the “Taxman” — leading, however indirectly, to their breakup.

“In 1967,” wrote George Cassidy in a 2011 National Review piece, “the Beatles were informed that they would need to invest the large pile of cash they had amassed if they wished to avoid a major haircut from Her Majesty’s tax collectors.”

Thus were birthed the infamous Apple Records, Apple Electronics, Apple Films, etc. Most of them hemorrhaged cash. John Lennon brought in Allen Klein to clean up the mess, over Paul McCartney’s objections.

“Klein’s laser focus on money,” Cassidy wrote, “often slighted artistic goals — witness the doctored ‘Let It Be’ tapes, released without McCartney’s consent. McCartney, finding the prospect of continuing with Klein unacceptable, ultimately enraged the other Beatles by suing them to dissolve their partnership in 1970.

“Without the potent tax dilemma, it is doubtful that the Apple group of companies would ever have been founded in the first place. In other words, no super tax, no Apple fiasco. No Apple fiasco, no Allen Klein. No Allen Klein, no lawsuit.”

Who knows what might’ve been?

Just think, McCartney might have never inflicted Wings on an unsuspecting world…

Cheers,

Dave Gonigam
The 5 Min. Forecast

P.S. U.S. markets are closed Monday for Memorial Day. We’re back tomorrow with our weekly wrap-up, 5 Things You Need to Know. The weekday edition of The 5 returns on Tuesday.

rspertzel

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