Offshore News Digest for Week of April 23, 2007

GLOBAL LIVING & BUSINESS

U.S. RETIREES FUEL BOOM IN PANAMA

Dollar economy, widespread use of English, and cheap health care are drawing many.

Sharyn and Reuben Bronstein are witnessing a building frenzy from the balcony of their 22nd-floor apartment in Panama City. Towering cranes and more than a dozen residential skyscrapers under construction obscure the retired Houston couple’s view overlooking Punta Pacifica, Panama City’s hot new foreign enclave.

In one direction, Donald Trump is building a 68-story, sail-shaped edifice on the Pacific Ocean called the Trump Ocean Club International Hotel & Tower. In another, Spanish company Grupo Mall, which is selling properties out of Houston, is putting up Los Faros de Panama, The Lighthouses of Panama, a glitzy development complete with apartments, a casino and a hotel. At least 170 residential towers worth $3.2 billion are planned or currently under construction, according to a recent survey by real estate consultancy Prima Panama. Fueling this boom, in part, are U.S. retirees lured by Panama’s cheap health care, dollar economy and widespread use of English.

Between 2003 and March 2006, the Panamanian government issued 1,379 visas to Americans 55 and older, adding to the already growing retiree population. In 1990, by contrast, 491 American retirees called Panama home. With 78.2 million U.S. baby boomers expected to reach retirement age in the next two decades, developers and the real estate industry are counting on Panama to issue many more visas. “Panama is the latest country to join this boom – and with a lot of dynamism,” said Orlando Lopez, general manager of Central America for Houston-based Stewart Title, which plans to open an office in Panama City later this year. Lopez, based in Costa Rica, estimates the office could guarantee $300 million in properties within a year of operation.

Panamanian developers began aggressively catering to U.S. buyers, with golf courses, gated communities and American-style shopping centers, about three years ago. Magazines and even television shows with tips for buying property abound in Panama. Promoters tout the nation’s warm weather, flights to the U.S. and discounts for a variety of items, including movie tickets and doctor’s visits. The Panamanian government is also selling the nation, offering some exemptions on property taxes, duties for importing household goods and a car. Such incentives seem to be at least sparking the interest of American retirees.

More than 150 U.S. real estate agents recently attended a weeklong conference providing tours of dozens of properties in Panama City and along the Pacific Ocean. Though there are plenty of promotions of projects, real estate agents and interested buyers can view few completed developments for now. Instead, they stop by fenced-in construction sites, model homes and empty Pacific Coast beaches where developers promise to build high-rise buildings and gated communities. “This phenomenon right now is all about sales and beginning to get into construction,” said Paul McBride, chief executive officer of Prima Panama, the real estate consultancy, which also publishes Paradise, a magazine for North American retirees. His company also offers a travel-discount program, and in 10 months it issued 3,500 memberships. “The inventory is not going to show up for another three to six years.”

Although few properties are complete, Panamanian, European and American developers continue their plans for posh skyscrapers in the city and luxury beachfront communities in the Panamana City’s suburbs. “We are finding the city is getting a little bit crowded with developers,” joked Jose Manuel Bern, sales director at Empresas Bern, a nearly three-decade-old developer and builder. “It seems like everybody is either a developer or a Realtor.” The pace of construction tends to delay some developments as builders cannot find enough equipment or workers.

“URUGUAY: WELFARE STATE GONE WILD” UPDATED

Back in 1969, Henry Hazlitt’s Man Versus the Welfare State appeared. It was a valuable collection of essays, one of which was “Uruguay: Welfare State Gone Wild”. This essay consisted largely of a series of verbal “snapshots” of Uruguay, in the form of quotations drawn from a variety of sources over the years 1956 to 1968. What Hazlitt described by means of the quotations was an economic system plunged into ruin by unrestrained welfare-state spending.

Having taken a tour of Montevideo, Uruguay’s capital, last month, I would like to offer a “snapshot” as of the present year, 2007. What I saw was a city of almost unrelieved drabness and ruin. Graffiti filled walls within a hundred yards of the seat of the country’s Congress. The city’s public parks, presented as an attraction to tourists, were overgrown with weeds. The wrought-iron fences they contained were in a state of collapse. Building after building, in neighborhood after neighborhood, was in a state disrepair. Often, only a burnt-out concrete shell was left. Hardly anything, anywhere, looked new. Much of the city was reminiscent of the South Bronx, an area devastated by more than two generations of rent controls. Only one, small area of the city, near the River Plate, appeared to be at all prosperous.

Uruguay no longer has trains. “They do not work anymore,” our tour-guide announced. “Uruguay has been resting for the last 50 years and has made no progress in that time,” she said. The population of Montevideo and of the country as a whole are both declining. A large proportion of university graduates in particular leave, in search of better opportunities elsewhere. If there are another 50 years of such “rest”, there may be nothing much left of Montevideo beyond an impoverished village.

NEW WAVE OF MULTINATIONALS POSES COMPETITIVE THREAT TO U.S.

A new wave of foreign competitive pressure is beginning to ripple through the U.S. economy, from companies in emerging markets like Brazil, Russia, India and China. These companies are seeking to become world-spanning multinationals – just as Samsung Electronics emerged from South Korea and Toyota sprang from Japan in earlier phases of globalization.

From Brazil, Embraer has become a big supplier of regional jets in the airline industry. Other Brazilian companies, like Braskem, Embraco and Natura, are also expanding in a variety of global markets. Russian companies like Gazprom, Lukoil and Rusal are using Russia’s natural resources to leap into the U.S. and other countries. India is producing powerhouses in technology services like Wipro, Infosys Technologies and Tata Consultancy Services, and global competitors in manufacturing and pharmaceuticals. The world’s largest steel company is now controlled by Lakshmi Mittal, an Indian living in Europe. China may be the largest single source of new multinationals. Aside from Lenovo, which bought IBM’s personal computer division, Haier is emerging in appliances, Huawei Technologies is competing against Cisco Systems to sell telecommunications equipment around the world and the Pearl River Piano Group is carving out a huge share of the piano market.

The emergence of these new multinationals is part of “the biggest shift in the global economy since the Industrial Revolution of the 18th century,” says Antoine van Agtmael, the author of a new book, The Emerging Markets Century: How a New Breed of World-Class Companies is Overtaking the World. “We are seeing a rebalancing of the global economy back to where it was before the Industrial Revolution, when China and India were major powers in the world.”

How is it that so many companies that once would have been content to operate in their home markets have so rapidly gained the expertise to manage complex multinational operations? One explanation is the new ease of global communication and air travel. Another is that the necessary expertise is available for sale. “These companies are hiring people from anywhere in the world,” said Peter Williamson, a professor at Insead, the business school, and co-author of Dragons at Your Door: How Chinese Cost Innovation Is Disrupting Global Competition. “They are engaging Ogilvy & Mather to do their advertising. They are using McKinsey for their strategy. There has been a very big shift in the ability to obtain knowledge that once would have been very slow to build up.”

Estimates of the number of these new multinationals vary considerably. Van Agtmael’s book identifies 25 of them. A study from the Boston Consulting Group last year named 100. Accenture, the consulting firm, says that there were 62 emerging-market multinationals in the Fortune Global 500 in 2005, up from 20 in 1995. It predicts that the number may hit 100 within 10 years.

Not all the would-be competitors will be successful, of course. Van Agtmael acknowledges that some will have to learn to focus on a few core areas where they truly excel, rather than engaging in a broad mix of activities as they have done at home. Western multinationals also have advantages in distribution, logistics and branding. But clearly, enough of these new companies will succeed that Americans will feel it, with both positive and negative results. On the positive side for consumers, most of these companies have low cost structures and will be able to offer lower prices.

But there will be some pain as well. “A lot of people who felt that their companies or their jobs were protected because they were in the high-value-added or high-tech kinds of businesses used to think that the rise of these companies was irrelevant to them,” Williamson said, referring to fields like architecture, design and pharmaceuticals. But now, “their companies are going to face competitors providing pretty much the same level of technology or design competence at a quarter or 20 percent of their price.” Companies that do not design business models that are competitive with those of the emerging multinationals will simply be blown away, said William Green, chief executive of Accenture.

ST. KITTS AND NEVIS ECONOMY TO OUTPERFORM REGION IN 2007, SAYS IMF

The International Monetary Fund, while predicting lower economic growth in the Caribbean this year and next, says St. Kitts and Nevis will be among the best performers in 2007. The IMF also suggested that Cricket World Cup could be a mixed blessing for the region.

In its annual report on the region, the IMF predicted that the economies of 15 Caribbean countries collectively should grow by 5.4% this year, down from the 8.3% in 2006. The IMF forecast covers the nations that make up the CARIFORUM region – the 14 independent CARICOM States and the Dominican Republic. The IMF forecasts that the best performers are likely to be Trinidad and Tobago (7%), St. Kitts and Nevis (6%) and the Dominican Republic (6%). The IMF explained that the factors in determining performance this year include the ripple effect of a sharper than expected downturn in the U.S. economy, and tighter global credit conditions. It anticipates that things will be no better for most countries in 2008, with overall growth expected at just over 4% for the entire region.

Meanwhile, the IMF said the Caribbean’s inaugural hosting of the Cricket World Cup has been a boon to the region’s economy. But it warned that the party may end in a debt and fiscal hangover. Caribbean governments have spent about $250 million in the past two years to build or upgrade stadiums and other infrastructure in the nine countries hosting the March 5 to April 28 contest. “Partly as a result of this expenditure, primary balances have deteriorated in most countries, and average public debt remained over 100% of GDP at end-2006 in host countries,” the IMF said in its semiannual regional outlook. It added that the Caribbean’s long-term growth prospects hinge on marketing itself as a tourist destination.

FINANCIAL SERVICES KEY TO BAHAMAS ECONOMY, REPORT CONCLUDES

An Economic Impact Assessment of the financial services industry commissioned by the Bahamas Financial Services Board (BFSB) has concluded that financial services plays a vital role in supporting economic growth and employment in the Bahamas. The study was conducted by Oxford Economics (OE) with the lead consultant, Adam Sacks, also being responsible for a similar study for the Ministry of Tourism.

BFSB’s CEO & Executive Director, Wendy Warren explained that the study was undertaken to obtain a comprehensive picture of direct, indirect, induced and catalytic impacts of the sector. “Our objective is to have data which will enable us to engage in wide ranging communication with all stakeholders, not only on the contribution of the sector to the nation, but also on the need for continued development and growth of the industry,” she said.

The OE study indicates that the direct contribution of financial services to the Bahamian economy over the period studied was 15%. Tourism, the jurisdiction’s other major economic pillar, contributed 21%. Of the 15% direct contribution of financial services, over one-third (5.5% of Bahamas GDP) was generated by international financial service providers. Additionally, many of the domestically licensed banks also provide services to international clients. Financial services supports around 22,000 jobs in The Bahamas, representing over 13% of total employment.

The report noted the financial services sector is responsible for oiling the wheels of other industrial sectors, encouraging investment and improving the quality of that investment, providing a secure home for savings and access to capital markets for firms and households alike, as well as providing high paying job opportunities for Bahamians.

“Financial services plays a crucial role in supporting the Bahamian economy, both directly by providing highly rewarding employment opportunities for Bahamians, and indirectly by procuring from and providing vital services to other key sectors of the economy, such as tourism and real estate, and to individuals,” Oxford Economics stated.

BRITISH VIRGIN ISLANDS AND U.S. PLEDGE TO ENHANCE COOPERATION

The BVI and U.S. Governments have agreed to tighten their cooperation in a number of areas after the successful conclusion of a high level meeting. Illegal immigration, human smuggling, money crimes, and advanced clearing for yachts and ferries operating between the two jurisdictions were among the issues discussed.

BVI’s Chief Minister welcomed an offer of assistance from the U.S. Government to help the Territory in securing its borders. “I think they understand that in trying to protect their borders, protecting our borders will serve both of us efficiently,” he said, while adding that Government welcomes the offers of assistance to combat illegal immigration and in patrolling the Territory’s airspace among other areas of cross-border illicit activity.

Head of the visiting delegation to the Territory, and Chairman of the Committee on Homeland Security, U.S. Representative Bennie Thompson said it is prudent for the BVI and U.S. Governments to formalize their cooperation in light of the many issues of common worry.

LATVIA NO LONGER DEPENDENT ON WORLD BANK

Latvia’s strengthening status on the world stage was confirmed on April 13 when the World Bank annulled its status as a borrower with the International Bank of Reconstruction and Development. The move means Latvia is no longer dependent on the World Bank for financial assistance. The Baltic country will soon move toward becoming a donor to the institution to provide aid to other developing nations.

Latvia joined the IBRD as a borrower in 1992, and accessed funds to help finance more than 15 projects. It has not taken a loan from the bank since 2002, but has continued to access technical advice. Both Lithuania and Estonia voided their borrower status with the bank in 2006.

NO CHOICE FOR CHINA

The government has no choice but to move quickly and aggressively to rein in the excesses of this white-hot economy.

For those of us who have been steadfast in our optimism on China, the blistering first-quarter GDP report throws down the gauntlet. The government has no choice but to move quickly and aggressively to rein in the excesses of this white-hot economy. To stay bullish on China – and that remains my view – policy makers must do a much better job in establishing traction with both the bank lending cycle and the real economy. China has no other choice.

The numbers speak for themselves. The 11.1% y-o-y comparison for real GDP in Q1 2007 follows a 10.4% gain in the previous quarter and a 10.7% increase for 2006 as a whole. It was the second strongest quarterly comparison of the past 12 years. Gains in the period just ended were broad based, with exports (+30%) and fixed investment (+25%) leading the way. Collectively, these two sectors now account for more than 80% of Chinese GDP. If the Chinese leadership is serious about controlling its economy – and I believe they are – then these are the two sectors that must now be brought down to earth.

In the aftermath of this blistering Q1 2007 GDP report, there is considerable focus in the markets on a new round of monetary tightening that will be needed to bring the Chinese economy back under greater control. While I have no doubt that additional actions will be taken by China’s central bank, I continue to believe that such moves are largely window dressing for a still blended economy. Fueled mainly by the combination of excessive bank lending and internal cash flow, China’s runaway investment boom has not responded to repeated tightening actions by the monetary authorities. That is certainly not for any lack of trying. During the past year, bank reserve ratios have been increased seven times while domestic lending rates have been hiked four times. But these actions have not put a dent in bank lending growth, which was still surging at a 16% y-o-y rate in March 2007. That is not surprising. Despite a long string of increases, bank reserve requirements stand at just 10.5%, well short of the 14.4% level of actual reserves currently maintained by Chinese banks. At the same time, even though short-term interest rates are over 100 bps higher than a year ago, at 6.4%, one-year lending rates still remain too low relative to the vigorous rate of underling expansion in the real economy.

As is typically the case in this still-blended economy, the real tightening is likely to come in the form of administrative edicts issued by the modern-day counterpart of China’s central planning agency – the National Development and Reform Commission (NDRC). By setting stringent criteria for project approval on a case-by-case basis, the NDRC has both the clout and the tools needed to exercise much tighter control over the investment process. I had expected a new round of administrative actions to be unveiled around midyear, tied to increasingly stringent requirements on energy consumption and greenhouse emissions. But in the aftermath of the blistering first-quarter GDP report, I now believe that the next series of administrative edicts will be announced sooner than that, followed by additional actions on energy conservation and pollution. The longer China waits, the harder it will be to strop its rapidly moving investment train.

From where I sit, the Chinese government has no choice other than to up the ante on tightening and macro control. China is attempting to achieve three objectives in the current tightening campaign: (1) To get real GDP growth down to less than 10% by year-end 2006. (2) A deceleration in bank lending; down to the 10-12% range over the course of the next year is my best guess. (3) To rein in excessive growth rates in both exports and fixed investment. The former making an increasingly easy target for “China bashers” around the world, and the latter ultimately posing a threat of excess capacity, which could well trigger a corrosive bout of deflation. My best guess here is that Beijing is aiming to take both investment and export growth below 20% by year-end 2007. Such an outcome, if it came to pass, would have important implications for commodity markets and for commodity-sensitive equities.

It is clear to me that Premier Wen Jiabao has put his personal reputation on the line in favor of tightening further to slow the runaway Chinese economy. I think he will pull it off, but given the limited traction between the money supply and the real economy, it will definitely require more administrative tightening to get the job done. At this point in its growth cycle, China cannot afford the alternatives. The costs of failure would be huge – excess capacity, deflation, and protectionism. By moving sooner rather than later, China will avoid the dreaded hard landing of the classic boom-bust cycle.

Paulson may be unable to get China, U.S. off collision course.

When China allowed a small rise in the value of its currency in 2005, Hangzhou food-company executive Wang Yuzhou saw his profits squeezed. Any further move threatens the livelihoods of his 1,000 workers and the 5,000 rural households that supply his plants, he says.

John Walker says China’s currency policies have already cost 100 jobs at his Lewisburg, Tennessee, die-casting company. He wants the U.S. Congress to do “whatever it takes” to force an increase in an undervalued yuan that he contends gives an unfair advantage to Chinese competitors.

Wang’s and Walker’s interests collide next month when U.S. Treasury Secretary Henry Paulson and Vice Premier Wu Yi hold their next set of talks under a semiannual schedule set up last year. Without steps to allow a significant increase in the yuan, which most economists consider unlikely, Paulson may not be able to continue holding off moves in Congress to punish China. “After years of talk and bluster, protectionism no longer seems like an empty threat,” says Stephen Roach, chief global economist at Morgan Stanley in New York. “Trade sanctions against China are now all but inevitable.”

Exports, which accounted for about 40% of China’s economy last year, bring growth, jobs and stability that compel the nation’s leaders to avoid any dramatic rise in the yuan, says Don Straszheim, vice chairman of Newport Beach, California-based Roth Capital Partners. “The weak currency is central to China’s whole growth strategy,” says Straszheim, who specializes in China’s economy. “They are going to take their chances and move as slowly as they possibly can.” China’s textile industry says it loses 8.2 billion yuan ($1.1 billion) of annual profit for each percentage point rise in the currency.

Until now, Paulson has demonstrated sympathy for China’s predicament and has headed off sanctions with promises of slow but steady progress on yuan appreciation. That may no longer be possible with a weakened President George W. Bush, a new Congress controlled by Democrats and a presidential campaign already under way. Since China scrapped a fixed exchange rate in July 2005, the yuan has gained 7.2% against the dollar. It will rise 4% this year, predicts Jan Lambregts, head of research at Rabobank International in Hong Kong. U.S. lawmakers say that is not enough.

China’s mental default.

On a recent trip to China, it did not take long to catch a whiff of the fact that all is not perfect in the Middle Kingdom. During the bus ride from Beijing airport to the Shangri-La Hotel, the tour guide kept mentioning housing prices. These were soaring, “unlike in the days of Mao,” she kept telling us, “when the government provided for housing.” The guide linked the dead dictator’s name with free housing a half-dozen times. There it was: Mao nostalgia.

She also fed us bad chop suey regarding the U.S. dollar. “The street vendors do not take dollars anymore” she said. “You must change dollars to yuan.” This turned out to be laughably untrue. Tiananmen Square was crammed with vendors who gladly took U.S. dollars. They pushed, elbowed and practically knocked down your children to get to your U.S. dollars. I bought two Mao watches for $15. Each ceased working about an hour after the purchase, just like Mao’s economy.

Now, I do not doubt for a minute that China’s spectacular 9%-to-10% economic growth rate will continue for many more years. You can bet on it. The Chinese economy is like a huge rubber band. At one end is the economy that can turn out Apple iPods to perfection. At the other end are all those sad, sunburned fellows with bad teeth and Mao hats – refugees from rural China – who stand by the roadside with shovels. You see scores to hundreds of them at every construction site. They stand around smoking cigarettes and occasionally haul a load of dirt from here to there. Prison work gangs are more productive. Which is why the Apple iPod economy will snap the shovel economy forward. This is guaranteed.

What is not a slam dunk are changes in the average Chinese person’s attitude. For every Chinese entrepreneur like Alibaba’s Jack Ma (check him out on Wikipedia), there must be 10,000 who fear sticking out, bucking authority or going off-script. You see this everywhere. One afternoon at the Shangri-La, my wife, kids and I decided to abort a long elevator wait and take the stairs. Up we trudged to the 13th floor – they have 13th floors in China – but on the 12th we were met by a startled hotel employee. He nearly passed a brick seeing us on the stairway. He shouted for us to walk back down. “Just one more floor,” we begged. “Down! Down!” he shouted.

One night the hotel left a complimentary bottle of wine in our room. We took it to dinner in a hotel restaurant. This confused the waitstaff no end. Four or five of them consulted frantically. Finally, their leader stepped forward to say that bringing the bottle of wine was “not permitted!”

“But it is a gift from the hotel,” we protested.

“Not permitted,” repeated the waiter. He was not angry. He wanted to do the right thing, but he was afraid. You could see it in his eyes.

Perhaps my Western eyes see this unfairly, but it seems to me that 99.99% of Chinese wake up each day with the core belief that anything not expressly permitted is not permitted at all. But that is most of life! How far can China really go if “not permitted” is the default mental mindset of the country’s vast majority? Maybe this will not be a key question during the next 10 years. China has so much catching up to do it can easily grow 10% a year for another decade. Crunch time, I think, will come in the 10- to 20-year time frame. Unless attitudes change, that is when the “not permitted” mental default will begin to slow China’s incredible march forward.

RUSSIA’S FINANCIAL BOOM WILL COME TO A PAINFUL END “IN THE NEAR FUTURE”

So warned a leading London banker with long experience of the country. After seven years of growth, Russia was reaching its capacity limits in an expansion fuelled by credit, much of it from foreign markets, said Hans-Joerg Rudloff, chairman of Barclays Capital, the investment banking arm of Barclays. “It is a boom which is not sustainable and I have to warn people ... there will be downturns. There will be more difficulties,” Mr. Rudloff told the Russian Economic Forum in London.

While many bankers disagreed with his prediction, others recalled that Russian markets had not suffered a serious downturn since 1998 and might be ready for a correction. Bank credit in Russia leapt by more than 30% last year with a 90% rise in retail lending, the fastest-growing sector. Mr. Rudloff said, “Financial markets will always react excessively ... There’s no soft landing after such excessive rewards and ... I would say the last seven years [have been] rewarded somewhat excessively and ... the present boom will be penalized somewhat excessively in the near future.”

Mr. Rudloff’s words are significant because he has generally been a supporter of the economic changes under President Valdimir Putin. He seems to enjoy the Kremlin’s confidence and sits on the board of Rosneft, the state-run oil group. Mr. Rudloff said the predicted downturn would not divert Russia from its long-term economic development as long as it remained on the track of international economic integration. He also took a swipe at western critics who complained about the Russian state’s strong economic role, saying economic development was only possible where there was stability.

Natalya Orlova, chief economist of Alfa Bank, a leading Russian bank, said Mr. Rudloff’s fears were exaggerated. While retail credit was growing rapidly it was expanding from a small base, with retail loans equalling just 8% of GDP. “While certain banks may have problems, they are unlikely to damage the entire banking system,” she said.

UAE THE MOST COMPETITIVE ARAB ECONOMY

The United Arab Emirates is the most competitive economy in the Arab world among the countries in the third and most advanced stage of development, according to The Arab World Competitiveness Report 2007, released by the World Economic Forum. The WEF said that sound economic management in the UAE has contributed to stabilizing the macroeconomic environment and strengthening public institutions. However, it also noted that a lack of educational attainment, in particular at the primary and secondary levels, needs to be tackled on a priority basis, because an uneducated workforce could put current diversification efforts at risk. The UAE is ranked 29th out of the 40 most advanced economies in the world.

This year’s report has expanded coverage to 13 Arab economies – Algeria, Bahrain, Egypt, Jordan, Kuwait, Libya, Mauritania, Morocco, Oman, Qatar, Syria, Tunisia and UAE. Libya, Oman and Syria are assessed for the first time. Rankings are presented in three country groups according to their stage of development to enable benchmarking against peers in other parts of the world.

“Today, the Arab world is at a critical juncture,” observed Klaus Schwab, Founder and Executive Chairman of the World Economic Forum. “Although the region’s economies are currently very dynamic and offer tremendous business opportunities, there is no doubt that improvements to national competitiveness and closer integration with the global economy and within the region are necessary if this growth momentum is to be sustained.”

TAXES

I.R.S. AUDITS MIDDLE CLASS MORE OFTEN, MORE QUICKLY

Middle-class Americans, listen up. the I.R.S. is much more likely to audit you this year. Those caught cheating can expect to pay about $4,100 more on average in income taxes. Since 2000, authorities at the I.R.S. have nearly tripled audits of tax returns filed by people making $25,000 to $100,000 as part of a broad change in audit strategy.

Audits of these middle-class taxpayers rose to nearly 436,000 last year, up from about 147,000 returns in 2000. For these 61 million individuals and married couples, who make up nearly half of all taxpayers, the odds of being audited rose from 1 in 377 to 1 in 140. Kevin Brown, the I.R.S. deputy commissioner for services and enforcement, said the audits “were out of whack” in 2000, with far too little attention paid to the middle class and to the very highest income generators, those making $1 million or more. “We try to run a balanced audit program,” Mr. Brown said.

But even with the stepped-up scrutiny of middle-income taxpayers, they still are less likely to be audited than those earning more – and those earning less. For taxpayers with incomes above $100,000 the odds of being audited in 2006 were 1 in 59. Above $1 million, the odds increased to 1 in 16. People in lower income brackets, reporting incomes below $25,000, faced a 1 in 94 chance of being audited.

The increased focus on the middle class is part of a broad I.R.S. strategy to deal with a major reduction in the ranks of the tax police as the population continues to grow and Congress has made the tax system ever more complex. The I.R.S. has fewer than 13,000 revenue agents, down from more than 17,000 at the peak in 1988. The core of the new strategy is to audit more individuals and businesses, even if the examinations are more cursory. Without more audits, I.R.S. executive say, people may behave as if no one is watching. Chris Edwards, director of tax policy at the Cato Institute, a libertarian research and advocacy group, said that Congress is driving the need for more audits. Since 1995, he said, “the Republicans greatly complexified the tax code, contributing to tax evasion and making the I.R.S.’s job more difficult.”

Deputy Commissioner Brown and others said the strategy of pursuing more audits, even if each one receives less time and attention, has proved a success. Tax revenue from enforcement actions, he said, rose from $33.8 billion in 2000 to $48.7 billion in 2006. Critics have said the increased revenue from enforcement actions shows only how widespread tax evasion has become and how easy it is to find tax cheating. The I.R.S.’s most recent estimate is that $290 billion in taxes due were not reported and paid. But studies have suggested the figure is higher, mostly from hidden investment gains, multinational businesses and entrepreneurs.

Individual audits increased up and down the income ladder. For those making under $25,000, audits rose from 369,000 to 589,000, with most of the attention focused on the working poor who applied the earned income tax credit, a form of negative income tax aimed at encouraging people with families to work rather than seek government benefits. About 15% of audits of low-income taxpayers find nothing amiss, Deputy Commissioner Brown said.

Audits of those making more than $100,000, the 11 percent or so of Americans who pay about 80 percent of individual income taxes, rose to more than 256,000 from just fewer than 100,000. At the very top, those making more than $1 million a year, the data showed that from 2004 to 2006 the number of audits rose from almost 9,600 to 17,000. But more than half of those audits were only letters asking for documentation.

The middle class was lightly audited in recent years because it relies mostly on wage income, which is reported by employers and from which taxes are withheld. The I.R.S. has told Congress that it captures 99% of wage income, but only about 70% of income in which there is little or no independent verification of the figures that people report on their tax returns.

Middle-class Americans most likely to have their tax returns examined under the new strategy are those who own a business, even a side business, or are landlords or have investment income. There is little or no independent reporting of such income. The I.R.S. has proposed increased verification and some withholding of payments to independent contractors to reduce cheating, but Congress has not moved on any of those suggestions. Middle-class taxpayers who file a Schedule C – freelancers, consultants and very small businesses – are three times as likely to be audited as those in the same income group with no such business income.

The I.R.S. is also increasing scrutiny of people whose returns show they have bought into any of the growing number of schemes sold by people who teach, falsely, that wages are not subject to tax. Some customers of these schemes have received prison terms of more than 10 years, and the Justice Department is pursuing civil and criminal cases against scores of tax fraud promoters.

GOVERNMENT ACCOUNTABILITY OFFICE SAYS U.S. TAX GAP CAN BE NARROWED

A GAO review of an IRS research project has outlined 14 opportunities for IRS to identify and collect more unpaid taxes. GAO reviewed IRS files to see where the most taxpayers willfully or mistakenly misreported their tax obligations. Improving reporting in these areas will help the IRS bring in more of the $345 billion in taxes that go unpaid each year, a loss known as the tax gap.

According to the GAO, areas of individual taxpayer noncompliance that are promising targets for additional research to improve reporting compliance include (1) income from partnerships and S corporations, (2) income from rental real estate, (3) sole proprietor income, (4) income from farming, (5) other income – net operating losses, (6) gambling income and losses, (7) capital gains for assets other than securities, (8) other gains and losses, (9) Earned Income Tax Credit, (10) Additional Child Tax Credit, (11) deduction for charitable contributions, (12) deduction for medical and dental expenses, (13) deduction for job expenses and most other deductions, and (14) exemptions.

These areas are types of tax deductions and exemptions where taxpayer mistakes or deliberate fraud caused a significant loss – where taxpayers reported the wrong amounts by more than 5% or by more than $450 each, or where the total amount of misreporting among all taxpayers in that area topped $3 billion.

GAO also found that the IRS’s overall estimate of the tax gap, and opportunities to improve compliance with tax laws, would be helped by better technology and information storage. Paper storage of some files, as opposed to electronic storage, makes tax data from the National Research Project harder to assess. The GAO found in two other studies that the IRS was unable to locate 153 paper files.

Henry Paulson tells Senate Democrats to get real.

After a week in which leading Democrats and the General Accounting Office looked to the fabled “tax gap” to collect more money without seeming to increase tax rates, Treasury Secretary Henry Paulson told a Senate hearing that trying to reduce the level of uncollected tax significantly would do more harm than good. “There is a big part of the tax gap that we simply won’t be able to reach without adding draconian and painful requirements on all taxpayers,” he said. “The cost of compliance for individuals and businesses, most of whom already pay what they owe, would far outweigh the gains,” he added.

Addressing the Democrats’ plan to finance tax cut extensions by closing the tax gap, he warned, “The tax gap is simply not a pot of gold. Nor should it be viewed as an easy solution to existing challenges, such as the alternative minimum tax.”

Last week, the GAO said that improved IRS reporting would help the IRS bring in more of the $345 billion in taxes that supposedly go unpaid each year. And Senate Finance Committee Chairman Max Baucus, at the same hearing, challenged the Treasury and the RS to increase voluntary tax compliance to 90% within ten years from the current 83.7%.

In order to collect more taxes, the IRS would have to impose significantly more reporting requirements on taxpayers, say opponents of Democrat plans. But as Nina Olson, the National Taxpayer Advocate, recently said, “No one wants to be obligated to file a document with the IRS every time he or she takes a cab ride, has someone mow their lawn, or calls a plumber to fix a broken faucet.”

A better approach, says the Heritage Foundation, would be to simplify the tax code by reducing rates and broadening the tax base by getting rid of the myriad of deductions and loopholes that now plague the system. At 17,000 pages, the tax code is incredibly complex, leading to many compliance problems, and every year Congress inserts more complicating loopholes and special interest provisions into it.

House-Senate tax agreement leaves Grassley scratching head.

Given their near daily rhetoric concerning the need to narrow the tax gap between legally-owed and collected taxes, the decision by Congressional Democrats to omit provisions from tax cut legislation moving through Congress that would have closed tax shelters and offshore tax abuses is “a real headscratcher,” says the Republicans’ senior Senate tax writer.

“Tax gap measures are yesterday’s news. Corporate inversion and leasing deal crackdowns are in the dust bin,” Grassley remarked in response to last week’s House-Senate tax agreement, which aims to provide tax relief to small businesses affected by the proposal to increase the federal minimum wage to $7.25 per hour from $5.15. “The Democratic leaders say they want to shut down tax shelters but when they have a chance to do it, we get a package that’s the toast of tax shelter hucksters.”

Included in the pre-conference Senate bill, which Grassley was instrumental in drafting, were offset provisions which would have closed loopholes, shelters and offshore arrangements such as sale-in lease-out (SILO) shelters on foreign properties. It also included measures against offshore corporate inversions, and a doubling of some fines, penalties and interest on underpayments related to certain offshore financial arrangements. However, these have been omitted from the provisions agreed by the leaders of the Senate Finance Committee and the House Ways and Means Committee as part of a military spending package last Friday. “[M]issing are many of the tax abuse crackdowns from the Senate bill. Apparently the lobbyists’ crocodile tears over those crackdowns were effective,” Grassley contended.

U.S. CONGRESS COULD SLICE PRIVATE EQUITY BUY-OUT WEALTH

Expectations are growing on Wall Street that Congress will move to increase the tax rate that applies to carried interest, a major change that would slice into the main source of wealth for private equity executives, who are currently enjoying record prosperity. Private equity executives, along with the lawyers and bankers who advise them, say the increasing likelihood of a change in carried interest tax is one of the main reasons buy-out groups are considering public offerings. Blackstone has already filed for an IPO and others are expected to follow soon.

An aide to Max Baucus, chairman of the Senate Finance Committee, said, “We are looking at this area of the tax code – among others this year – to see whether its treatment of income is appropriate and fair to all taxpayers.” House Democrats are expected to make a formal proposal by June. One Wall Street executive said the issue had come up in meetings with Democratic presidential candidates.

Congress is determined to address the alternative minimum tax, a levy intended to target the wealthy but that is ensnaring more upper-middle class Americans. But scaling back the AMT will cost about $50 billion a year and lawmakers are looking for tax revenues to offset that loss. “This is a big potential revenue offset and one that can be conceptually justified,” said Victor Fleischer, a professor at the University of Colorado Law School. He suggested that raising the carried interest tax by 20% could generate at least $6 billion per year in additional tax revenue and perhaps much more.

While private equity executives fear change may be coming, they are by no means conceding the issue. The Private Equity Council, a trade association formed in December by the largest U.S. buy-out groups, is expected to lobby hard against the change, arguing that the current tax treatment rewards private equity executives for taking risk.

RESEARCH ON WELFARE IMPLICATIONS OF INTERNATIONAL TAX COMPETITION PRESENTED

The European Tax Policy Forum (ETPF) and the Institute for Fiscal Studies (IFS) have readied new research on international taxation and tax competition for presentation. The ETPF was set up in 2005 to commission independent academic research into the impact of tax policy on business in Europe. This represents the second phase of its research programme. The research consists of five separate studies, which have been undertaken by academic researchers across Europe. Key findings of the research argue that:

• Corporation tax is borne by employees, not shareholders. According to the IFS, “Economic theory indicates that in an open economy, shareholders do not bear the burden of corporation tax. Higher taxes require higher pre-tax rates of return so that shareholders can earn the same rate of profit after tax as they can in other countries. Instead the tax burden must be passed on to the workforce and consumers. ... The results strongly support the theory.”
• UK corporation tax revenue would rise under the EU’s Common Consolidated Corporate Tax Base proposals. The research paper analyses the likely impact of introducing these proposals on corporation tax revenues. Depending on the allocation method used, UK corporation tax revenues could increase by over 20%.
• Corporation tax creates unemployment. The central estimate of the effect of corporation tax is that a fall in tax rates of around 8 percentage points – equivalent to reducing revenues by 0.5% of GDP – would increase employment by half a percentage point. There is some variation in this effect between EU countries. The effects of corporation tax on unemployment are lower than the effects of income tax and VAT.
• Globalization generates higher corporation tax revenues. According to the IFS, “It is commonly believed that globalization introduces tax competition as countries reduce tax rates to attract inward investment. This is supported by evidence of falling corporation tax rates in the EU and elsewhere. But it is contradicted by evidence from the same countries of high corporation tax revenues. One reason for this apparently contradictory evidence may be that globalization also leads to increased profit, which in turn generates higher corporation tax revenues, offsetting the cuts in tax rates.”
• There is tax competition in income tax as well as corporation tax. The Institute observed that, “The academic evidence for competition between counties in setting corporation tax rates is well established. But until now, there have been no studies considering whether there is competition in other taxes. ... Based on data from OECD countries over the last 10 years, the project finds substantial evidence of tax competition in both income tax rates and corporation tax rates. Further, it finds that these taxes are substitutes for each other. If corporation tax rates in other countries fall, a country will respond by reducing its corporation tax rate and raising its income tax rate.”

SWITZERLAND REVEALS EU SAVINGS TAX DIRECTIVE INTEREST PAYMENT WITHHOLDINGS

The Swiss government’s Federal Department of Finance has released figures showing the amount of tax withheld from the savings of individuals resident in EU member states under the much-maligned EU Savings Tax Directive regime. The gross revenue generated from the imposition of Switzerland’s system of tax retention on interest payments in Switzerland, on earnings liable to tax in the EU for the 2006 tax year, amounts to CHF536.7 million (€327 million). For the second half of 2005 the amount collected was CHF159.4 million. Overall in 2006, approximately 55,000 declarations were received (35,376 declarations were received for the second half of 2005, following the institution of the directive on July 1).

On March 31, the payment deadline expired for EU tax retained from individuals resident in EU member states on interest payments made by Swiss paying agents during the course of 2006. The agreement on the taxation of savings income with the European Community in force since 1 July 2005 makes provision for 75% of the proceeds to be passed on to the member states concerned. 25% goes to the Confederation, of which 10% is passed on to the cantons. This meant that CHF402.54 million was passed on to EU member states, while Switzerland’s share amounted to CHF134.18 million. By far the largest sums were remitted to Germany (CHF103.4 million) and Italy (CHF103 million).

In addition, the agreement on the taxation of savings income makes provision for the recipients of interest payments to choose between the system of tax retention and a voluntary declaration to the tax authorities. The precise results of the voluntary declarations in the 2006 collection period are not yet available. These will be published at a later date on the website of the Federal Tax Administration.

ASSET PROTECTION / LEGAL STRUCTURES

‘TIL DEBT DO US PART?

In a marriage, borrowing money should not be a secret affair.

The decision to enter into matrimony is one of the most momentous choices anyone can make. So is the decision to go into debt. Going into debt when you are married, then, is very serious business.

Surveys show money troubles, i.e., high credit card balances, are one of the leading causes of divorce. And debt can be especially troublesome if one spouse is amassing it behind the other’s back. “We think the only way that we can break the fidelity bond that we have with our spouse is by committing adultery,” says Janet Brumley, family law attorney in Dallas. “We can break it a thousand different ways, and one of those ways is by acting single in the financial arena, by creating debt, by spending money as though we have no one else to think about but ourselves.”

One spouse’s debt troubles can affect the other. Credit reports are compiled on individuals, not couples, and if a couple shares a joint credit account, they share equal responsibility for ensuring that payments are made.

Experts strongly advise couples to talk openly and unemotionally before taking on debt. “Avoidance is the worst possible thing you can do,” says Bettye Banks, senior VP of education at Consumer Credit Counseling Service of Greater Dallas. “If you have an issue that needs resolving financially, put it on the table first. You cannot work together unless you are both dealing from all the facts.”

For many couples, falling into the debt hole can start even before they are married, when they buy the engagement ring. The jewelry industry will tell you the rule of thumb is to spend two months’ salary for an engagement ring. That is fine if you have got two months’ salary lying around. If not, common sense tells you that going deep into debt is not the way to begin a marriage.

In advertising and popular culture, society imprints on newlyweds the importance of flying off to their dream honeymoon on some tropical isle. The culture does not encourage discussions regarding finances. “We should encourage all young couples to include how future financial decisions will be made to their pre-marriage discussions of family and careers,” said Martin P. Mesecke, a certified financial planner in Plano, Texas. That is how his clients Matt and Tina Bolding do it in their marriage. “Finances cause so much trouble for people when one partner wants something and the other partner says, ‘That may not be the best right now,’ and it causes stress,” says Mr. Bolding. “We wanted to have the same kind of goals, and it made a big difference that we were working at it together.”

Mrs. Bolding says that during the early years of their 17-year marriage, they came up with a set of principles that they agreed would guide their financial decisions. Those include:

• Living below their means.
• Not letting material things become the center of their attention.
• Taking on debt only when necessary – when it is a matter of need vs. want. “If it is a want, then usually it is not a good choice to go into debt,” Mrs. Bolding says. “When it gets challenging is when one of us really wants something that is not a need and that will cause debt. Negotiating becomes sensitive, and therefore we do so by trying to stick to the facts and figures, keeping emotion out of the picture.”

The Boldings have a pact not to incur “bad debt”. The only debt they would consider would be for a home or car, and even with a car, the plan would be to save as much as possible so they would not have to take out a big loan. “We really try hard to avoid any kind of debt for personal items,” Mr. Bolding says. “If we couldn’t afford it, we did not need to buy it.” That philosophy has been financially liberating for the couple. “We’ve been able to save much more money because the drain of debt hasn’t been there. We have one car that is leased and the house payment, and that is it.”

Of course, there are needs and wants, and then there are really, really, really wants. Does not matter. You still have to talk it out. For Mark and Katherine Strassel of Frisco, the issue was a motorcycle. They were able to work things out and financed the motorcycle. Mrs. Strassel says her and her husband’s business backgrounds have helped shape their financial playbook. “We have seen people who get into bad situations, so that has helped us get a debt-free philosophy,” she says. “We don’t buy the best of the best, and we live below our means so we know if something were to happen to us, everything would be OK.”

It is difficult living in consumption-happy Collin County, especially with two young children, the couple says. “This area is very much materialistic,” Mr. Strassel says. “Cars are a very big status here. This area lends itself to ‘Buy now, go into debt, gratify your needs today,’ and that is the way people feel they should live.”

Mrs. Strassel advises couples to share their feelings about debt and spending before they marry. “You need to figure out your partner’s philosophy, because it is a long road ahead of you if you have opposite philosophies,” she says. “Are you a spender or are you a saver? Negotiate a middle ground there of how you are going to take on new debt.”

DUBAI REGULATOR SHUTS ANOTHER BOGUS WEB TRADER

The Dubai Financial Services Authority (DFSA) has been successful in closing down a Dubai-hosted website, smiequity.com, used to front an unlicenced investment company, SMI Equity, which used the UAE as a base address on its website.

The DFSA was alerted to the unlicenced operation of SMI Equity, having received information from an investor in the Czech Republic. The investor had already deposited $45,000 into the bank account of SMI Equity and received no response from SMI Equity after the investment was made. The investor contacted the DFSA having seen DFSA’s website warnings, which list information and past media releases on internet scams and frauds. While unlicenced, SMI Equity claimed to offer investment opportunities and provide investment advice to prospective customers in Eastern Europe, using an UAE address and P.O. Box. The website was used to encourage investors to invest mainly in pre-IPO securities in the U.S.

The DFSA immediately contacted the website host provider in Dubai and arranged to close the site down with immediate effect. David Knott, Chief Executive of the DFSA said, “Cold calling schemes will increasingly occur in the Middle East, as Dubai and other regional centres expand their capital markets. The DFSA regards awareness of these risks being a matter for constant reminder and public education and we are fortunate that some of the investors in this scam had the good sense to contact the DFSA.”

PRIVACY

LENDERS MISUSING STUDENT DATABASE

Some lending companies with access to a national database that contains confidential information on tens of millions of student borrowers have repeatedly searched it in ways that violate federal rules, raising alarms about data mining and abuse of privacy, government and university officials said. The improper searching has grown so pervasive that officials said the Education Department is considering a temporary shutdown of the government-run database to review access policies and tighten security. Some worry that businesses are trolling for marketing data they can use to bombard students with mass mailings or other solicitations.

Students’ Social Security numbers, email addresses, phone numbers, birth dates and sensitive financial information such as loan balances are in the database, which contains 60 million student records and is covered by federal privacy laws. DoE spokeswoman Katherine McLane said the agency has spent more than $650,000 since 2003 to safeguard the database. The department has blocked thousands of users that it deemed unqualified for access after security reviews, McLane said, and it has blocked 246 users from the student loan industry for inappropriately accessing the data. In general, the department allows lenders to search records in the database only if they have a student’s permission or a financial relationship with the student.

Concerns about possible abuses of the database are emerging as the student loan industry is under investigation by congressional Democrats and the New York attorney general. Critics say the $85 billion-a-year industry has cozied up to government and university officials who are in a position to help lenders.

The database, known as the National Student Loan Data System, was created in 1993 to help determine whether students are eligible for student aid and to assist in collecting loan payments. About 29,000 university financial aid administrators and 7,500 loan company employees have access to it. In a recent meeting with university financial aid directors, Theresa S. Shaw, chief operating officer of the department’s Office of Federal Student Aid, which manages the database, said lenders have been mining it for student data with increasing frequency, according to three participants at the meeting. “She said the data mining had gotten out of control, and they were trying to tone it down,” said Eileen K. O’Leary, director of student aid and finance at Stonehill College in Massachusetts.

The department first started noticing a problem in mid-2003 when loan consolidation became more popular, according to an agency official. As companies began to aggressively look for low-risk borrowers to target for consolidation plans, they turned to the database for prospective customers, the official said. Database users can view only one student record at a time, and the department can monitor each time they view an entry. “When we see them go in and out very quickly, that is when it raises flags” about data mining, the official said. Officials grew so concerned that in April 2005, the department sent out a letter to database users warning that inappropriate use of the system could cause their access to be revoked. After the warnings, inappropriate usage of the system seemed to decline, according to the official. But several months ago, top managers learned that the practice had resumed – “a pattern that is very alarming,” he said.

AMISH FARMERS BALK AT FARM ID NUMBERS

Amish dairy farmers who oppose a Wisconsin livestock identification system that takes full effect May 1 contend it is forcing them to make a choice between their livelihood and their religion. The Amish, members of a Christian sect that favors plain living with little reliance on modern conveniences, cite Biblical passages as prohibiting them from buying and selling animals that are numbered, or have what they would consider the “mark of the beast.”

The new ID system that was passed into law three years ago requires livestock farms to register with the state and receive a farm ID number as a way of making it easier to track animals in case of a disease outbreak or other emergency. A number of Amish producers said they may stop selling milk and animals if the number requirement stands. “Look at all the electronic gadgets in the world – have they done more good for the American family or have they done more evil?” one of them asked.

Donna Gilson of the state Department of Agriculture, Trade and Consumer Protection said farmers have had more than a year to comply with the law, and as of May 1 it will not be possible for producers to renew their dairy license without a premise identification number. She said 90% of the state’s livestock farms, or about 54,000, have registered. According to Gilson, there has been a high degree of acceptance in the Amish community, but the religious objections have arisen among certain Amish in the Coulee Region of western Wisconsin.

CANADIAN MP INTRODUCES “CLEAN INTERNET ACT”

Conservative MP Joy Smith has introduced the Clean Internet Act (Bill C-427). The private member’s bill would establish an Internet service provider licensing system to be administered by the CRTC along with “know your subscriber” requirements and content blocking powers.

Just about everything associated with this bill is (to be charitable) rather odd. Smith introduced it by warning against the use of the Internet to support human trafficking and added that “the bill would address the fact that child pornography is not okay to put on the Internet throughout our nation,” though the Criminal Code already does that. The bill itself includes (and I am not making this up):

• An ISP licensing system to be administered by the CRTC that is defined so broadly that it would seemingly capture anyone offering a wifi connection.
• A “know your subscriber” requirement where ISPs would be required to deny service to past offenders.
• A new power that would allow the Minister of Industry to order an ISP to block access to content that promotes violence against women, promotes hatred, or contains child pornography.
• The Minister of Industry can prescribe special powers to facilitate searches of electronic data systems (i.e., lawful access)

Given that this is a private member’s bill, it is very unlikely to become law. That said, this bill would not look out-of-place in countries that aggressively censor the Internet and it makes the dangerous Jennings lawful access bill look positively harmless by comparison.

WHEN THE YOUTUBE REVOLUTION IS A THREAT

Internet censorship is on the rise globally.

As YouTube, the Internet video-sharing service, generates millions of new fans in far-flung countries, it is making enemies of some of their governments. Many are putting pressure on the company to tailor, or self-censor, its site to take account of local sensibilities, analysts say.

So far, YouTube, which Google acquired in November for $1.6 billion, has refused to back down in its standoff with the military-appointed government of Thailand, which recently cut off access to YouTube over a video that denigrated the country’s king, Bhumibol Adulyadej. But Thailand is only one of a growing number of countries that are worried about the power of Internet video, which cuts across linguistic borders and allows individuals anywhere to publish dissident tracts, sexually risqué films or other undesirable “user-generated content”. Since April 11, for instance, China has quietly blocked access to DailyMotion, a French video-sharing site, for unexplained reasons, company executives said.

“You have got this explosive growth in the popularity of YouTube, and a lot of countries feel threatened by this,” said Ronald Deibert, director of the Citizen Lab at the University of Toronto and a member of the Open Net Initiative, a group of academics who monitor Internet censorship. “Governments are getting more savvy about the way people use these tools to promote revolutions.”

Though YouTube is based in the U.S., much of its recent growth has come overseas. According to ComScore Networks, which tracks Internet traffic, three-quarters of the 134 million unique visitors to YouTube in February were outside North America, with the Middle East and Africa recording the most rapid increases. YouTube says that a big part of its appeal is that it provides would-be video stars, and their fans, with a single, global platform, unlike localized user-generated content sites.

But analysts say localization would be a logical step in the wake of Google’s acquisition. Google has embraced the idea of local versions for its search engine, introducing separate sites for more than 100 countries. YouTube declined to comment on whether it was considering such a move, which might not come without criticism. Google’s decision last year to censor the Chinese version of its search engine, Google.cn, to placate government concerns drew scorn from some free-speech advocates.

Analysts say there are several ways in which YouTube could be adapted for international markets. “It would not be that difficult technologically for YouTube to do geographical zoning,” said Jonathan Zittrain, a professor of Internet governance and regulation at Oxford University. “But it is partial censorship.”

For now, YouTube relies on a two-step editing method to try to ensure that videos comply with the site’s “terms of use”, which state that material deemed to be pornographic, violent or racist, among other things, is unwelcome. The site asks users to flag any videos they see as inappropriate. Editors at YouTube then review these clips and have the final say on whether they stay up or go. The problem with this system is that video that seems inoffensive to viewers in California can be incendiary in other places, at least to some individuals or governments.

In general, Deibert said, Internet censorship is on the rise globally. The Open Net Initiative found that over the past year, more than two dozen countries regularly blocked sites entirely or filtered out content they considered offensive.

HOW COMPUTER SECURITY COMPANIES SUCKER US WITH LEMONS

More than a year ago, I wrote about the increasing risks of data loss because more and more data fits in smaller and smaller packages. Today I use a 4-GB USB memory stick for backup while I am traveling. I like the convenience, but if I lose the tiny thing I risk all my data.

Encryption is the obvious solution for this problem – I use PGPdisk – but Secustick sounds even better. It automatically erases itself after a set number of bad password attempts. The company makes a bunch of other impressive claims. The product was commissioned, and eventually approved, by the French intelligence service. ... It is used by many militaries and banks. ... Its technology is revolutionary.

Unfortunately, the only impressive aspect of Secustick is its hubris, which was revealed when Tweakers.net completely broke its security. There is no data self-destruct feature. The password protection can easily be bypassed. The data is not even encrypted. As a secure storage device, Secustick is pretty useless.

On the surface, this is just another snake-oil security story. But there is a deeper question: Why are there so many bad security products out there? It is not just that designing good security is hard, and it is not just that anyone can design a security product that he himself cannot break. Why do mediocre security products beat the good ones in the marketplace?

In 1970, American economist George Akerlof wrote a paper called “The Market for ‘Lemons’” (abstract and article for pay here), which established asymmetrical information theory. He eventually won a Nobel Prize for his work, which looks at markets where the seller knows a lot more about the product than the buyer. Akerlof illustrated his ideas with a used car market. A used car market includes both good cars and lousy ones (lemons). The seller knows which is which, but the buyer cannot tell the difference – at least until he has made his purchase. I will spare you the math, but what ends up happening is that the buyer bases his purchase price on the value of a used car of average quality.

This means that the best cars do not get sold, because their prices are too high. Which means that the owners of these best cars do not put their cars on the market. And then this starts spiraling. The removal of the good cars from the market reduces the average price buyers are willing to pay, and then the very good cars no longer sell, and disappear from the market. And then the good cars, and so on until only the lemons are left. In a market where the seller has more information about the product than the buyer, bad products can drive the good ones out of the market.

The computer security market has a lot of the same characteristics of Akerlof’s lemons market. Take the market for encrypted USB memory sticks. Several companies make encrypted USB drives – Kingston Technology sent me one in the mail a few days ago – but even I could not tell you if Kingston’s offering is better than Secustick. Or if it is better than any other encrypted USB drives. They use the same encryption algorithms. They make the same security claims. And if I cannot tell the difference, most consumers will not be able to either.

LAW

CAUGHT IN THE DEADLY WEB OF THE INTERNET

Any political filth or personal libel can be hurled at the innocent ... and the U.S. and Canadian feds take it seriously.

Could it possibly be that the security men who guard the frontiers of North America are supporting Holocaust denial? Alas, it is true. Here is the story.

Taner Akcam is the distinguished Turkish scholar at the University of Minnesota who, with immense courage, proved the facts of the Armenian genocide – the deliberate mass murder of up to a million and a half Armenians by the Ottoman Turkish authorities in 1915 – from Turkish documents and archives. His book A Shameful Act was published to great critical acclaim in Britain and the U.S.

He is now, needless to say, being threatened with legal action in Turkey under the infamous Law 301 – which makes a crime of insulting “Turkishness” – but it is probably par for the course for a man who was granted political asylum in Germany after receiving an 8-year prison sentence in his own country for articles he had written in a student journal. Amnesty International had already named him a prisoner of conscience.

But Mr. Akcam has now become a different kind of prisoner – an inmate of the internet hate machine, the circle of hell in which any political filth or personal libel can be hurled at the innocent without any recourse to the law, to libel lawyers or to common decency. The Armenian-Turkish journalist Hrant Dink was misquoted on the internet for allegedly claiming that Turkish blood was “poisonous”. This total lie – Dink never said such a thing – prompted a young man to murder him in an Istanbul street.

But Taner Akcam’s experience is potentially far more serious for all of us. As he wrote in a letter to me this month, “Additional to the criminal investigation (law 301) in Turkey, there is a hate campaign going on here in the USA, as a result of which I cannot travel internationally any more. ... My recent detention at the Montreal airport – apparently on the basis of anonymous insertions in my Wikipedia biography – signals a disturbing new phase in a Turkish campaign of intimidation ...”

Akcam was traveling to lecture in Montreal and flew from Minneapolis on 16 February this year. The Canadian immigration officer, Akcam says, was “courteous” – but promptly detained him at Montreal’s airport. Even odder, the Canadian immigration officer asked him why he needed to be detained. Akcam tells me he gave the man a brief history of the genocide and of the campaign of hatred against him in the U.S. by Turkish groups “controlled by ... Turkish diplomats” who “spread propaganda stating that I am a member of a terrorist organization.”

All this went on for four hours while the immigration officer took notes and made phone calls to his bosses. Akcam was given a one-week visa and the Canadian officer showed him a piece of paper which was the obvious reason for his temporary detention. “I recognized the page at once,” Akcam says. “The photo was a still from a 2005 documentary on the Armenian genocide. ... The still photo and the text beneath it comprised my biography in ... Wikipedia, the online encyclopedia which anyone in the world can modify at any time. For the last year ... my Wikipedia biography has been persistently vandalized by anonymous “contributors” intent on labelling me as a terrorist.”

So let us get this clear.U.S.u and Canadian officials now appear to be detaining the innocent on the grounds of hate postings on the internet. And it is the innocent – guilty until proved otherwise, I suppose – who must now pay lawyers to protect them from Homeland Security and the internet. But as Akcam says, there is nothing he can do. “By now, my name in close proximity to the English word ‘terrorist’ turns up in well over 10,000 web pages.”

I am not surprised. There is no end to the internet’s circle of hate. What does shock me, however, is that the men and women chosen to guard their nations against Osama bin Laden and al-Qa’ida are reading this dirt and are prepared to detain an honourable scholar such as Taner Akcam on the basis of it. I do not think the immigration lads are to blame. No, it is their bosses in Ottawa and Washington I wonder about. Put very simply, how much smut are the U.S. and Canadian immigration authorities taking off the internet? And how much of it is now going to be flung at us when we queue at airports to go about our lawful business?

ARTICLE III

There is a rich variety of reasons why a “minimal government” cannot work, starting with the entirely sufficient one that since every human owns his own life, any interference with his exercise of that fundamental right imposes a negative effect upon his wellbeing. Here, though, I offer a consideration I think to be new, and of interest to those minarchists who believe that the U.S. Constitution would form an ideal basis for a limited-government society. Their reasons are, I understand, that (a) human nature is flawed and so eradication of criminal behavior (that which overrules somebody’s self-governance right) is impossible, (b) that unavoidable degree of criminality is best minimized by an elected government with powers limited by a written Constitution, and (c) the U.S. Constitution and especially its Bill of Rights form such a sublime example of that needed limitation as to be beyond improvement and probably God-given.

I deny all three of those reasons, and the logical contradiction in (b) – that criminal behavior is best minimized by instituting an organization whose very nature is criminal from tip to toe – is especially absurd. But I want to focus here on (c). “Patriots” and other admirers of the Constitution see it as so close to Holy Writ as to need no serious differentiation, and in particular that the men who drafted it were uniquely eager to do their utmost to establish a government unfortunately necessary (for example, to provide an efficient, socialized defense system lest the British return for a second round) but whose powers were soundly and tightly limited. In current terms, those drafters are seen by those admirers as Libertarians or Classical Liberals, and their sincerity is not doubted.

I have for quite a while perceived the Founders as mistaken, but for many years I shared that belief in their sincerity – that they were mistaken to suppose that any slight degree of government was required, but sincere in their wish to maximize individual self-ownership in practice by setting tight limits on its powers. I think now that I was wrong to suppose that they were sincere – and so that their work should not be admired in any degree.

My first doubts about their sincerity were expressed here and pointed out that the Preamble to the U.S. Constitution is a pack of lies. The further doubts expressed here derive from Article III – and it is worth digressing via that link to read it now. It is very short. This ought at once to arouse suspicions.

Like numbers I and I, Article III sets up a branch of the new Federal Government – the “Judicial” one. It says “the judicial power shall be vested in” an arrangement of courts, at whose apex lies the Supreme Court. It specifies the types of case that this Branch shall hear, and states that in criminal cases, trials shall be by jury. It warns that judges must remain of “good behavior”. And that is about it. The whole thing is done, in a mere 390 words. The wording completely fails to spell out what the phrase “judicial power” means or includes – and does not include – or how many shall sit on the required “jury” or what its powers shall be, relative to the judge’s. It completely fails to define what “good behavior” means or who shall determine it. In effect, Article III is a carte blanche. It is a delegation of presumably enormous power but with no stated components or limitations at all. It stands in stark contrast with Articles One and Two. How are we to interpret this astonishing contrast, this massive change of pace and lack of oversight concern. And in particular how can it square with a belief in the sincerity of the writers?

One possible answer is that everybody knows what “judicial power” means, and what juries can and cannot do, and what “good behavior” is all about – and so it was not necessary for Article III to spell out such matters.

The other possible answer is that the 55 men who convened to draft the U.S. Constitution, all of them being politicians and 35 of them being lawyers, knew perfectly well that Article III would provide the new government with powers that, over time, would break through all supposed limits and deliberately designed it so – that is, they were no more “sincere libertarians” than your run-of the-mill legalized crook in Congress today. They presented the new government as being limited and constituted of, by and for “The People” (a clear fraud anyway, as Spooner has proven) but in reality it was set up of, by and for themselves, as lawyers – in such a way that lawyers could drive a coach and four through the supposed limits any time they saw fit. Let us give that possible answer the whistle test. ...

I suggest that the Founders knew very well what they were doing when they left Article III wide open to interpretation and placed no limits on the judicial power. I say they carefully crafted a Constitution that appeared to give only specific and limited powers to the central government, while providing an escape route through which, in the generations following, any edict could be enforced in total disregard of those limits. The end result was a charter that would appeal to most Americans as giving them power over their own government, while in practice and with effect increasing over time, it would ensure the government had absolute power over the people. What we see all around us today is exactly what was planned.

This has, I hope, removed all remaining grounds for a naive belief in the goodness of Government Man. The Founders met to establish a government, they established one good and hard without any effective limit on its powers, and they did that by deception, and the open ends of Article III are the smoking gun. I shall no longer refer to them with a capital “F”.

HOW TO STOP THE NEXT CAMPUS SHOOTINGS

Make the Second Amendment live up to its promise.

Since there undoubtedly will be a next time, probably in the not so distant future, what useful counsel on preventive measures can we offer students and faculty and campus police forces across America? There have been the usual howls from the anti-gun lobby, but it is all hot air. America is not about to dump the Second Amendment to the U.S. Constitution giving people the right – albeit an increasingly circumscribed one – to bear arms.

A better idea would be for appropriately screened teachers and maybe student monitors to carry weapons. A quarter of a century ago students doing military ROTC training regularly carried rifles around campus. U.S. Supreme Court Justice Antonin Scalia recently recalled regularly traveling on the New York subway system as a student with his rife. Perhaps there should be guns in wall cases, behind glass, at strategic points around campuses, like those fire axes, usually with menacing signs about improper use.

Five years ago Peter Odighizuwa a 43 years old Nigerian student killed three faculty members at Appalachian Law School Dean with a semi-automatic handgun, but before he could wreak further carnage two students fetched weapons from their cars, challenged the murderer with guns levelled ,and disarmed him. When the mass murder session began in the engineering building the police cowered behind their cruisers till Cho Seung-Hui finished off the last batch of his 32 victims, then killed himself. Then the police bravely rushed in, started sticking their guns in the faces of the traumatized students, screaming at them to freeze or be shot. Similar timidity was on display in Columbine, where Harris and Klebold killed students in the library over a period of 15 minutes and then committed suicide. The police finally mustered up the nerve to enter the library over two hours later.

Years ago campus police were greeted as a welcome alternative to regular cops hassling students and creating trouble. But now they mostly are regular cops, hassling students, dishing out speeding tickets like the one the Virigina Tech campus police issued Cho. The Virginia Tech terrible massacre should prompt a radical review of the utility of SWAT teams which now infest almost every community in America. Each time there is a hostage taking or a mass murderer on the rampage, one sees the same familiar sight – overweight SWAT men, doubled up under the weight of their costly artillery, lumbering along in their body armor and then hiding behind trees or cars or walls while the killer goes about his business. SWAT teams perform most efficiently when shooting down unarmed street people menacing them with cellphones.

The answer is to disband SWAT teams and kindred military units, and return to the idea of voluntary posses or militias: a speedy assembly of citizen volunteers with their own weapons. Such a body at Columbine or Virginia Tech might have saved many lifes. In other words, make the Second Amendment live up to its promise.

The left complain about SWAT teams, but does not see that the progressives bear a lot of responsibility for their rise. If you confer the task of social supervision and protection to professional soldiers – cops – and deny the right of self and social protection to ordinary citizens, you end up with crews of over-armed thugs running amok under official license, terrorizing the disarmed citizens. In the end you have the whole place run by the Army or the federalized National Guard, as is increasingly evident now with the overturning of the Posse Comitatus laws forbidding any role for the military in domestic law enforcement.

There are many ways of learning to be an American, of which the Cho family learned at least two. Cho’s sister went to Princeton and now administers Iraq reconstruction money for the State Department – a cog in the mighty wheel of empire. Cho raved that his victims brought it on themselves, and richly deserved fire and brimstone. There are no innocent bystanders who should be spared. In practical terms this is the imperative of Empire too, as we see every day in Iraq.

OPINION & ANALYSIS

LEW ROCKWELL ON LIBERTARIANISM

Interview by Jedrzej Kuskowski, for the Polish Libertarian website Liberalis

KUSKOWSKI: Your site, LewRockwell.com, is greatly popular and is still growing. The internet has proven to be an invaluable tool in the hands of libertarians. What has your experience shown you to be the most important for a growing movement: individual blogs, professional sites with an abundance of materials, like Mises.org, or something of a collective effort, like LRC?

ROCKWELL: The movement is growing beyond belief, in all sectors of society and in nearly all countries, so far as I can tell. The web has been important, obviously. Libertarians have always believed that getting the ideas out there is the most important step we can take. Any media that get our message out are thrilling, especially the media that are not highly controlled by government. The government made a mistake with the internet, from its own point of view. It controlled radio, television, and much of the print media by default. But the web took off before the government got its hooks in it.

K: Do you think that it is the poor or the rich who benefit from State regulations the most? Seeing how libertarianism is often accused of being a “rich man’s philosophy,” what can we offer those less fortunate and how to convince them of the promise of libertarianism?

R: Government is always and everywhere a rich man’s business. The poor have never played a role in the administration of the State, except insofar as they are used by elites as a cover. In fact, the emergence of the State itself grows out of the successful cartelization of one sector of elites against all its competitors. So of course these same elites rule on behalf of themselves. In the whole history of humanity, there is only one means by which the class of the poor have successfully converted their lot into something higher, and that is capitalism.

K: What do you think about the mainstream more-or-less libertarian groups, like neolibertarians, neoliberals, “Beltway libertarians,” or “vulgar libertarians”? Is it better to treat them as part of the movement, or should we remain neutral, or maybe denounce and criticise them?

R: This phenomenon proves that libertarians are not immune to seduction by power. Indeed, there is a special premium that the State pays to libertarians who sell out. The State wants nothing more than to be seen as promoting liberty, so when libertarians assist in providing that cover, the State is pleased to oblige. It is, however, easy to tell the difference between the phony and real libertarians by observing their proximity to the centers of power.

K: Are there certain strategic errors made in the beginnings of the libertarian movement that continue to haunt it? If so, what could we do to evade them in Poland?

R: The biggest strategic error is collaborating with the powers that be, as if the people in charge – those consumed by what St. Augustine called “the lust to rule” – can be convinced by libertarian arguments. This isn’t going to work. We need to come to terms with the fact that we are ultimately a revolutionary movement.

KEVIN PHILLIPS ASSESSES THE ONGOING DECLINE OF THE AMERICAN EMPIRE

Kevin Phillips delivered a talk on his latest book, American Theocracy: The Peril And Politics Of Radical Religion, Oil And Borrowed Money In The 21st Century. The Empire Salon meets regularly in Washington D.C. where one can practically hear the beating heart of empire and feel its tremors in the ground. They look to hash out the implications of American Empire. In Phillips they had the man for the job.

Phillips is a former Republican strategist turned fiery critic of the Republican Party’s metamorphosis under George W. Bush. He has also dedicated much of efforts in studying leading economic powers of the past – Great Britain, Spain, the Dutch and Rome in particular. Phillips has come up with some yardsticks to gauge the decline of these powers. All past empires suffered through the following. And all of the below “seem to be intensifying under the George W. Bush administration.”

1. As the empire topped out, there was a popular sense that something was wrong – loss of jobs, increased violence, moral decay and more.
2. An intensification of religious fervor. (See the rise of the mega churches in the “red states”.)
3. Conflicts between faith and science. (Witness the Evolution-creationism “debate”.)
4. Imperialism and global overreach. (See the Iraq War, which Phillips called “the most poorly thought out war in U.S. history.”)
5. Decline of industry and the rise of finance. (As Phillips says, “moving money around as opposed to building things.”)
6. The burden of excessive debt. No need to comment here.

The other interesting wrinkle Phillips tackles is the role of energy. Past empires mastered an energy source and as the importance of that energy source diminished, they could not make the adjustment. America’s addiction to increasingly expensive oil will play a role in its downfall, Phillips says. “The U.S. is not going to make it with another energy regime.” It is oil or bust.

Globalization and its discontents.

It is widely believed that the Chinese are eating our lunch. Their factories hum and belch smoke, while ours go silent and send up weeds in the parking lot. This phenomenon is commonly called “globalization”. But it is also commonly misunderstood. In the reverie of modern Americans, globalization means the rest of the world sends you things you do not have to pay for. The burden of today’s little essay is two-fold. The first part is easy. We point out that anyone who thinks such a thing is a fool. The second point is harder. And more important.

Globalization is nothing more than the extension of the division of labor across international boundaries. Individuals ... towns ... enterprises ... regions ... can divide up the labor, work more efficiently, and produce more things at lower cost. Everyone involved gets a little richer.

There are really only two ways to get what you want in life. You can do so honestly, or dishonestly. By working for it, or by stealing it. By trade and commerce, or by force and fraud. By civilized methods, or by barbaric ones. You can get rich by “economic means” or by “political means”, as the great German sociologist, Franz Oppenheimer put it. Globalization is merely an elaboration of the economic means of getting things. It requires civilized relationships to make it work. People have to get along with each other in order to trade. They must rely on others – even other people in strange, faraway places – for their daily bread. They must also be able to count on the medium of exchange that they trade goods and services in. If they cannot trust the money, they are not likely to want to do business.

The end of history has been announced several times. But it never seems to arrive. People always tend to think that what is will remain ... that trends in place right now will continue at least indefinitely, and perhaps forever. The odds of anything going wrong, they tell themselves when the going is good, are like the extreme edges of a bell curve – vanishingly small. But people badly “underestimate the persistence of history’s traditional side, the rise and fall of empires, the rivalry of regimes, and the disastrous exploits of great men,” wrote French historian Raymond Aron. That is to say, they tend to ignore the political means that tend to mess things up. And the rare, fat tail events that make history interesting.

Such a fat tail event happened in 1914. A European war disturbed nearly 100 years of peace and progress. People thought the war could not happen. And if it did happen, they said, it would be short and sweet. They were wrong on both points. Globalization had entered a shrinking phase.

Then, on April 2, 1917, Woodrow Wilson stood before Congress and announced that the world’s biggest economy was about to shift to “political means” to get what it wanted. Instead of merely doing business with the Entente powers, America, too, was going to get involved in killing people. This day marked not only another big setback for globalization. It also established a demarcation for where one empire ended and another began. Britain ceased being the world’s hegemonic imperial power. Henceforth, the U.S. was the Alpha nation.

There are times when civilization goes forward. And there are times when it goes in the other direction. Woodrow Wilson slammed the U.S. into reverse in 1917. It has been backing up ever since, in the sense that Americans rely more on force and fraud to get what they want. Gun-toting soldiers now defend America’s many supposed interests all over the world – even in places where America seems to have no interests. The U.S. government takes far more of its citizens’ money than it did in 1917, and provides detailed instructions to Americans on such a wide variety of matters that one can scarcely toss a chicken out the window or blow up an outhouse without asking permission of the authorities.

While the U.S. Empire was growing, so was world trade. In the free world until 1989, and now almost everywhere, a “pax dollarum” greatly aided the cause of globalization throughout the second half of the 20th century. But this new globalized commerce has a fraudulent side to it. The hegemonic power is using political means, even while it shops. During the last big boost in the division of labor, in the 19th century up until 1914, the money in which transactions were calibrated was backed by gold. No country – not even an imperial one – could cheat.

If a country consumed more than it produced, other countries found themselves with surpluses of the laggard nation’s currency. They then could ask for gold in settlement. Gold was real, the ultimate money. When a nation’s gold horde was in danger, it quickly adjusted its policies to correct the imbalance. The dollar, on the other hand, is merely a piece of paper, backed by nothing more than the full faith and credit of the U.S. treasury. How good a promise is that? No one knows for sure.

The odd thing about this century’s spurt of globalization is that it is so lopsided. The U.S. takes, but it does not give. It borrows, but it does not pay back. It buys, but it does not sell. The only reason foreigners put up with those shenanigans is because they receive paper currency in payment. They assume their dollars will be as valuable in the future as they are now. They assume the trends of the last 50 years will continue unchanged. They assume that no terrorists will knock off an archduke ... and no fat tail will plop itself down in the currency markets. They assume that someone, somewhere, had the situation under control. And yet, “If the private market – which knows that with high probability the dollar is going down someday – decides that that someday has come and that the dollar is going down now,” writes Brad DeLong, “then all the Asian central banks in the world cannot stop it.”

What will happen when the world figures out that the United States is pulling a fast one? We do not know. But like the period following the sinking of the Lusitania, we are sure it will make the history books.