AEI » Latest Content http://www.aei.org American Enterprise Institute: Freedom, Opportunity, Enterprise Fri, 19 Dec 2014 14:08:55 +0000 en-US hourly 1 US defense cuts may undermine security in Western Pacifichttp://www.aei.org/publication/us-defense-cuts-may-undermine-security-western-pacific/ http://www.aei.org/publication/us-defense-cuts-may-undermine-security-western-pacific/#comments Fri, 19 Dec 2014 14:08:55 +0000 http://www.aei.org/?post_type=publication&p=825198 In its January 2012 Defense Strategic Guidance (DSG), the Obama Administration stated that the United States “will of necessity rebalance toward the Asia-Pacific region.”1

Yet one month later, the administration released its 2013 defense budget request, including $487 billion in cuts mandated under the 2011 Budget Control Act (BCA), which provided a framework for medium-term deficit reduction—primarily through large cuts in defense and domestic discretionary spending. While the new strategic guidance garnered headlines for its renewed emphasis on the Asia-Pacific, the 2013 budget request turned out to be the far more important document.

The 2013 request was the first in a succession of BCA-driven budgets and strategic reviews that slowly-but-surely lifted the veil on America’s military decline. As the BCA’s original cut of $487 billion—contained in the 2013 request—combined with an additional reduction of close to $500 billion triggered by sequestration, ongoing crises in modernization, force structure, and readiness were laid bare.

The Congressionally-chartered, bipartisan National Defense Panel (NDP) recently issued a stark warning about the implications of mounting defense shortfalls. The NDP found that “Not only have [the cuts] caused significant investment shortfalls in U.S. military readiness and both present and future capabilities, they have prompted our current and potential allies and adversaries to question our commitment and resolve.”2

Eroding US military power is especially disconcerting because America’s military underwrites the other components of its national power. In the words of the NDP, “The effectiveness of America’s other tools for global influence, such as diplomacy and economic engagement, are critically intertwined with and dependent upon the perceived strength, presence and commitment of US armed forces.”3 Consequently, as America’s military power declines, so too will its global influence.

Nowhere is this trend more apparent than in the Western Pacific today. While the US has traditionally relied upon a qualitative edge to prevail against numerically superior forces, this technological edge may be rapidly shrinking.4 Indeed, the NDP warned, “The balance of power in the Western Pacific is changing in a way unfavorable to the United States, and we believe that China’s rapid military modernization is creating a challenging context for US military posture, planning, and modernization.”5

Left unsaid by the panel is the disturbing reality that as the military gap between the US and the People’s Republic of China (PRC) narrows, the likelihood of conflict increases. If an overwhelming American conventional military advantage minimizes the chances for miscalculation or conflict, a lessened American military edge brings with it higher odds of conflict.

Moreover, despite the relative priority placed by senior officials on America’s military presence in the Asia-Pacific, current plans are wholly inadequate to properly support the US military presence in the region. A rapidly shrinking US military is increasingly stressed by commitments worldwide, especially as instability grows in the Middle East, and Russia continues its assault on its neighbors. At the same time, much-needed modernization plans are too expensive for existing resources. The end result is a US military that is too small and too old to meet its many regional commitments.

In the absence of higher defense budgets, this would lead to a rapid erosion of American conventional deterrence in the Western Pacific. In the face of this challenge, the Republic of China (ROC) and other regional allies and partners can take several steps in order to minimize the danger of conflict. For one, the ROC is suggested to increase its defense spending—by as much as its finance allows. With additional defense resources, the ROC should continue and expand investments in anti-access/area-denial capabilities that seek to impose asymmetrical costs against PRC forces and the Mainland.

Fortunately, momentum seems to be building inthe US to at least partially overturn defense cuts and their consequences. Driven by international crises from Ukraine to Iraq and Syria, a clear shift seems to be taking hold both in terms of policymakers and public opinion. For instance, the NDP called for an emergency readiness supplemental to address immediate funding shortfalls, as well as a return to former Secretary of Defense Robert Gates’ 2012 budget plan over the longer-term.6

At the same time, senior military leaders are also expressing rising discontent with the current state of affairs. General Martin Dempsey, Chairman of the Joint Chiefs of Staff, recently testified that ongoing operations against the Islamic State (IS) would expose base budget funding deficiencies, while Army Chief of Staff Ray Odierno has argued that current global crises should prompt a reevaluation of cuts to ground forces.7 Moreover, members of the Republican establishment, such as former presidential candidate Mitt Romney and Senator Marco Rubio (R-FL), have recently issued high-profile calls for increased defense spending.8

Hopefully, this momentum will continue and policymakers will reverse self-inflicted US military decline. Yet responsible statecraft demands that governments prepare for the worst while hoping for the best. America’s allies and partners, including the ROC, must expand their defense spending and capabilities in case of the eventuality that US defense spending remains stagnant at best. With conventional deterrence in the Western Pacific and beyond at stake, there is no margin for miscalculation.

Mounting Defense Reductions Are Leaving a Painful Bill

Given the considerable media and congressional attention accompanying the sequestration cuts to the US military, it can be easy to forget that declining defense spending did not begin on March 1, 2013 when sequestration went into effect. Rather, defense cuts began four years prior, when the Obama Administration in 2009 and 2010 cut or redirected roughly $400 billion in planned Pentagon spending—about three quarters of which directly impacted vital modernization programs.9

While the Pentagon tried to downplay the national security impacts of these reductions, the reality is that the outright cancellation, early termination, or delay of programs such as the CG (X) next generation cruiser, F-22, and next-generation bomber significantly delayed the fielding of new military technologies in an effort to concentrate on programs more directly relevant in Iraq and Afghanistan. Five years later, as high end technological competition becomes increasingly vital in the Western Pacific, it is hard not to view the budgetary decisions of 2009 and 2010 as shortsighted—as many argued at the time.10

Of course, the Pentagon bill did not stop there. Still prior to the 2011 BCA, the budget path laid forth by Gates for fiscal year 2012 reduced an additional $78 billion—bringing the pre-BCA total of cut and redirected planned spending to $478 billion. The first tranche of cuts under the BCA more than doubled this total, cutting Gates’ baseline spending plan for fiscal years 2012-2021 by $487 billion. And because the Super Committee failed to reach an agreement on deficit reduction, sequestration was triggered beginning in fiscal year 2013, cutting an additional $450 billion as currently modified through fiscal year 2021.

Taken collectively, these numbers are staggering. However good the intentions behind the “pivot” and America’s ostensible emphasis on the Asia-Pacific are, the math does not support the administration’s policy. Increasingly, America’s global commitments are taxing its shrinking military—to the point where not even theaters of priority, such as the Asia-Pacific, will escape the consequences.

Crucially, as the NDP argued, the problem is not just sequestration or automatic budget cuts. The limited relief brought by last minute budget deals in Washington has been welcome, but it has addressed only a fraction of the problem. In the words of the NDP, “the increases above sequester levels proposed thus far, while desirable, are nowhere near enough to remedy the damage which the Department has suffered.”11

As the NDP recommended, the entire BCA should be discarded and US defense planners should start afresh to build a ground-up appraisal of the armed forces the US requires and what they would cost. In the absence of such action, the American military posture will only continue to deteriorate in Asia—with potentially catastrophic results.

Shrinking Fleet Size May Undermine US Conventional Deterrence Overseas

On a daily basis, the most important US contribution to peace and security in the Asia-Pacific is the regular presence of the US military. In the words of the 1993 Bottom-Up Review, “The presence of U.S. forces deters adventurism and coercion by potentially hostile states, reassures friends, enhances regional stability, and underwrites our larger strategy of international engagement, prevention, and partnership. It also gives us a stronger influence, both political as well as military, in the affairs of key regions.”12

To take the Bottom-Up Review’s conclusions a step further, the stronger the American military presence in a given region, the greater America’s diplomatic influence will be. Unfortunately, as we are seeing today, the inverse is just as true.

Chief of Naval Operations Admiral Jonathan Greenert has made an increased presence in the Asia-Pacific a major keystone of the Navy’s near-term plans, calling for an increased presence from 50 ships in the region in 2014 to about 65 ships in 2019.13 This is part of a broader initiative to increase the Navy’s forward presence from an average of 97 ships in 2014 to 120 by 2020.14

While this increased emphasis on forward presence is a worthy goal, questions remain about how the Navy will be able to afford its plan given current budget constraints. Options available to increase ship presence overseas include extending the length of deployments, swapping crews mid-deployment, and forward-stationing more ships.15 Yet many of these options present their own problems. For instance, as Bryan McGrath has outlined, the Navy has in some cases already resorted to scheduled ten-month deployments— well over past standards of six months.16 Stressing crews and families beyond their breaking point is not a sustainable assumption upon which to base force structure.

Most problematically, the increased presence figures are predicated upon the Navy’s aggressive 2015 thirty-year shipbuilding plan. At first glance, the 2015 shipbuilding plan is a marked improvement over recent iterations.17 While the Navy’s September 2011 plan for a 313 ship fleet averaged just under 306 ships each year over the duration of the plan, the 2013 and 2014 plans each averaged just about 298 ships per year. Surprisingly, the 2015 plan averages nearly 308 ships per year.

If this remarkable jump seems too good to be true, it is. After all, given shrinking budgets and another year of near-sequestration levels of spending, it seems hard to imagine how the Navy could suddenly afford to average a larger fleet over the course of the plan than in previous years—let alone buy three more ships over the first five years of plan than it could last year, as the 2015 plan calls for.

As it turns out, the Navy inflated its ship counts in the 2015 plan through a number of technical changes. For one, the Navy changed its fleet counting rules to include more types of ships, including patrol craft, mine countermeasure ships, and hospital ships as part of its total battle force.18 With these ships excluded from the count, average fleet size over the course of the plan drops from about 308 to 305. Additionally, this fleet of 305 ships also includes 11 cruisers that the Navy has proposed to “layup” for repairs and return to service in the future.19 Seven of these cruisers had been proposed for retirement in the 2014 plan, meaning they were not part of last year’s projected fleet ship count. Yet they are included over the entire duration of the 2015 plan—even for the years during which they will be inactive.

These creative accounting practices serve only to mask the real and ongoing damage to the fleet. That being said, while the Navy could be doing a better job of showcasing the devastating impact of defense reductions, most of the blame for suspect ship counts lies with the policymakers who mandated cuts in the first place. The Navy is doing what it can to do under difficult circumstances, but even with the best of intentions, declining ship levels are beginning to take a toll.

The Navy is especially candid, for instance, that its 2015 plan is unaffordable under sequestration level budgets. By its own projections, the service will require, at the very least, defense budgets at the President’s 2015 request level of $115 billion over the next five years above the sequestration imposed caps. Yet even if the Pentagon ultimately receives funding at the requested level, the Navy raises serious concerns about how it will afford its own plan. The Navy forecasts that its plan, from fiscal year 2020 through fiscal year 2044, will require an annual average of about $17.2 billion in 2014 dollars.20 The Navy notes that this is about $4 billion more per year than its shipbuilding plan has historically averaged.

The funding problem is most acute during the period of fiscal years 2025-2034, when the Navy will be purchasing the bulk of its Ohio-class replacement ballistic missile submarine fleet. Over this period, the Navy expects to spend an average of $19.7 billion per year—close to $7 billion above the historical average of $13 billion per year. Yet the Navy’s funding problems extend well beyond the Ohio-class replacement. As the service notes, even if it completely removes the Ohio-class replacement SSBN from its shipbuilding costs, its plans will still demand between $14-15 billion per year from 2020 onwards.21

Moreover, the Congressional Budget Office (CBO) has found that the Navy frequently understates the true costs of its shipbuilding plans. In its assessment of the 2014 shipbuilding plan, CBO found that the Navy underestimated projected costs by six percent over the first ten years of the plan, 14 percent over the second ten years of the plan, and by a staggering 26 percent over the final ten years of the plan.22

Taken collectively, this paints an alarming picture. Under the best circumstances, the Navy’s shipbuilding plan—upon which it is relying to increase its presence in the Asia-Pacific (and along with it, America’s strategic and diplomatic influence)—is counting on an additional $4-7 billion per year above what it has received historically. In the absence of additional resources, it is extremely difficult to see how the Navy will be able to meet its goals for overseas presence—even in the Pacific—in the coming decades.

Declining US Military Power May Reverberate through Pacific

In the absence of higher budgets, the Department’s shrinking plans and force structure will only become more acute in the near future, with devastating consequences around the globe. The NDP made clear that current budget plans would prevent DoD from generating and sustaining the forces necessary to conduct its strategy.23 In the words of the NDP, “the existing baseline will fully support neither the capability nor the capacity that the Department needs.”24 This is especially troubling given the warning of General Dempsey in the 2014 defense strategy:

The smaller and less capable military outlined in the QDR makes meeting [strategic] obligations more difficult. Most of our platforms and equipment will be older, and our advantages in some domains will have eroded. Our loss of depth across the force could reduce our ability to intimidate opponents from escalating conflict. Nations and non-state actors who have become accustomed to our presence could begin to act differently, often in harmful ways. Moreover, many of our most capable allies will lose key capabilities. The situation will be exacerbated given our current readiness concerns, which will worsen over the next 3 to 4 years.25

Increasingly, there are signs that the grim future outlined by General Dempsey is already becoming manifest. The NDP notes that Combatant Commanders consistently called for a larger force in order to “meet the requirements of contingency plans, regional presence, and theater cooperation and engagement.”26 Critically, these missions are among the most important not just for fighting and winning wars, but for preventing them in the first place. As a shrinking US military increasingly leads to zero-sum tradeoffs between regions, overseas American conventional deterrence will be weakened.

Even before the most recent round of defense cuts, the military was already stretched thin. In an interview with Military.com, Rep. Randy Forbes (R-VA) stated that while the Navy met about 90 percent of force requirements from Combatant Commanders in 2007, it was able to meet just 51 percent in 2012.27 This growing gap between force supply and demand led Admiral Greenert to testify recently that in order to meet the demand for forward-deployed naval forces, he would need a fleet of 450 ships.28

While administration officials have made clear that the Asia-Pacific is still a priority, the reality is that current global crises driven in no small part by America’s shrinking military—may lead the Pentagon to reconsider its global allocation of forces. As the NDP notes, “the Russian invasion of Crime aand ongoing threat to Ukraine call into question the 2014 QDR’s conclusion…that Europe is a net producer of security.”29

For instance, earlier this year, General Philip Breedlove, Supreme Allied Commander Europe and chief of US European Command, disclosed plans to reduce America’s F-15 fighter force in Europe.30 While General Breedlove did not say where the F-15s might be moved, it stands to reason that reductions in Europe would likely have been planned as part of the broader goal to shift forces to the QDR’s regions of emphasis, including the Asia- Pacific. However, given the crisis in Ukraine, General Breedlove recently announced that the Pentagon was reconsidering its plans to further shrink forces in Europe.31 While this move is understandable given the current security situation, it is indicative of the fact that crises caused by a shrinking military in one part of the world are weakening US plans in other regions—reducing deterrence there as well.

This all leads to a sobering conclusion: while US defense budgets remain in freefall, its military will be increasingly hard-pressed to provide adequate conventional deterrence, even in key regions of the world. In order to prevent regional balances from tipping in unfavorable directions, US allies and partners must be prepared to step in and prevent a power vacuum.

The Republic of China Must Expand Defense Capabilities

While “burden sharing” has long been a fashionable idea in US military circles as a way to encourage allied partners to contribute more to their own security, the situation today is such that increased allied defense investment is no longer a “nice to have”—it is increasingly vital to maintaining a favorable status quo in key regions, and particularly in Asia.

Simply put, America’s friends in the region must raise their defense spending in the near term to help deter aggression. This is especially important for the ROC, which as Michael Mazza has noted, must face arguments in Washington that the US “should not defend countries that do not defend themselves.”32 While the only long-term solution is a return to American military supremacy through restored budgets, modernization, force structure, and readiness, US partners have an important role to play to help stabilize the situation before the kind of aggression seen from Russia makes an appearance in the Pacific.

The first step is for the ROC to reverse its defense budget decline and invest in expanded military capabilities. As Mazza has chronicled, in 2012, the ROC spent 20 percent less on defense than it did, in real terms, in 1996.33 This dramatic decline in defense spending—contrasted with the rapid development of PRC military capabilities over the past decade—sends the exact wrong message to potential aggressors—and potential allies.

One promising area for increased ROC defense investment, according to a recent RAND report, could be to “employ inexpensive anti-access technologies similar to those used by the PLA to significantly raise the cost of a conflict for China and, should deterrence fail, to drastically limit China’s ability to inflict damage off the Asian Mainland.”34 Notably, this strategy would turn anti-access and area-denial capabilities against the PRC. Depending on how it was executed, this kind of approach not only could complicate invasion plans and raise the barriers to conflict, but it could also promise to hold targets on the Mainland at risk and thereby deter aggressive actions short of all-out invasion.35

Fortunately, the ROC has realized the potential of these kinds of technologies and has developed the Hsiung Feng IIE (HF-2E) and Hsiung Feng III (HF-3) cruise missiles for just this purpose. The ROC should continue to develop large amounts of both of these weapons as a relatively low-cost way to threaten enemy forces and in the case of the HF- 2E, hold targets on the Mainland at risk.36 The ROC, however, must learn from the experience of NATO, which almost exhausted its supply of precision guided munitions in less than a month in Libya in 2011.37 While investing in the HF-2E and HF-3 missiles is a good start, the ROC must maintain a large and survivable supply of these and similar weapons.

Another critical area for increased defense investment is modernizing and expanding ROC capabilities in the undersea domain, and its submarine fleet in particular. Given the PRC missile threat to land and surface-based assets, a sizeable submarine fleet would likely play a major role in contesting any attempted amphibious landing.38

Nearly a decade and a half after President George W. Bush offered to sell eight diesel submarines to the ROC with little subsequent progress, it is time to move on from this potential deal. While American production of diesel submarines for the ROC would be a welcome development, at this point, it is unlikely to materialize. Instead, the ROC and the US should continue their announced cooperation on a domestic ROC submarine program.39 Over the long-term, an indigenous ROC submarine production capability would serve as a vital deterrent and an indispensable component of the ROC’s defense strategy.40 Yet this ambitious goal would still leave unaddressed ROC submarine modernization in the near-term. As a short-term fix, the ROC should pursue acquiring diesel submarines from a third party such as Germany, Japan, or Australia, requesting US assistance throughout the negotiation process as necessary.41

Complementing this fleet could be an array of undersea sensors. Given its prime location, the ROC could provide a wealth of sustained maritime surveillance that would be indispensable in monitoring the movements of the People’s Liberation Army (PLA) inside the Straits and beyond.42 As Mazza argues, expanded ROC surveillance capabilities would help complicate PLA plans relying on strategic, operational, or tactical surprise.43

Over the long-term, the ROC should invest in next-generation systems that could dramatically impact control of its airspace, including emerging technologies such as directed energy weapons.44 While the US military continues its development of these “game changing” technologies, the same attributes that makes these systems so alluring to US defense planners should make them doubly relevant to the ROC. Most importantly, these weapons would help address the most glaring problem facing an island defense: limited magazines against overwhelming numerical superiority. Emerging technologies like directed energy weapons could play a vital role in eliminating missile threats and maintaining control of ROC airspace. These weapons will not arrive overnight, but the sooner they come online, the sooner that ROC defense planners can begin to address the large PLA missile inventory.

Critically, investing in key military capabilities is important for both war and peacetime. While capabilities such as advanced cruise missiles, submarines, and directed energy weapons might be vital for wartime operations in the coming years, their most important contribution would likely be at the strategic level. A capable and survivable ROC anti-access/area-denial network would cause key PRC leaders to think twice before attempted coercion. As Daniel Blumenthal has argued, capabilities that can inflict both material and psychological costs upon the mainland would strengthen deterrence while enhancing the ROC’s warfighting position.45

While a robust ROC anti-access/area-denial network, supported by increased defense spending, is not enough to maintain peace and security by itself in the Asia-Pacific, it does present a promising route forward for the US and its friends in the face of ongoing American military decline. In the best case, if the ROC develops a capable anti-access/area-denial network and the US reverses its current spending trends, the situation in the Asia-Pacific will become all the more stable. If US defense reinvestment does not come soon, new ROC defense capabilities may play an indispensible role in upholding the regional balance.

America’s Defense Investments May Have Enduring Consequences for the Asia-Pacific

In order for deterrence to be successful, it must first be credible. Unfortunately, the current decline in US defense capabilities is undermining its conventional deterrence in the Pacific and indeed, around the entire globe. If this trend continues, we can expect to see increased aggression in Asia and elsewhere as potentially hostile actors find fewer restraints on their actions.

While rapidly deteriorating global events may be causing a major re-evaluation of US defense budgets, it behooves America’s regional partners to bulk up their defenses as necessary in order to maintain conventional deterrence even as the American military shrinks in size and capability.

For the ROC, increased defense spending, along with increased and expanded investment in asymmetrical weapons would be a good start to bolster allied defense capabilities in the Asia Pacific. As the world has seen in Ukraine, military vacuums do not last for long. The United States and its partners around the world must seek to act before competitors take the initiative.

 

1 United States Department of Defense, “Sustaining Global Leadership: Priorities for 21st Century Defense,” January 2012, p2, <http://www.defense.gov/news/defense_strategic_guidance.pdf>.

2 William J. Perry & John P. Abizaid, “Ensuring a Strong U.S. Defense for the Future,” United States Institute of Peace, July 31, 2014, p1, <http://www.usip.org/sites/default/files/Ensuring-a-Strong-U.S.-Defense-for-the-Future-NDP-Review-of-the-QDR_0.pdf>.

3 Perry & Abizaid, et al., “Ensuring a Strong U.S. Defense for the Future,” p1.

4 Perry & Abizaid, et al., “Ensuring a Strong U.S. Defense for the Future,” p20.

5 Perry & Abizaid, et al., “Ensuring a Strong U.S. Defense for the Future,” p16.

6 Perry & Abizaid, et al., “Ensuring a Strong U.S. Defense for the Future,” p30.

7 Mackenzie Eaglen, “These Days, Defense Dollars Don’t Go As Far,” US News & World Report, September 17, 2014,<http://www.usnews.com/opinion/blogs/world-report/2014/09/17/defense-spending-alone-wont-fix-pentagon-woes>. See also Julian E. Barnes, “Army Chief Calls for Rethink of Cuts,” Wall Street Journal, September 19, 2014 <http://online.wsj.com/articles/army-chief-calls-for-rethink-of-cuts-1411168293>.

8 Mackenzie Eaglen, “Why Sen. Rubio’s Vision for Rebuilding US Strength Matters,” AEIdeas, September 18, 2014, <http://www.aei-ideas.org/2014/09/why-sen-rubios-vision-for-rebuilding-us-strength-matters/>. See also Mitt Romney, “MittRomney: The Need for a Mighty US Military,” Washington Post, September 4, 2014, <http://www.washingtonpost.com/
opinions/mitt-romney-the-world-needs-a-mighty-us-military/2014/09/04/f5234064-342d-11e4-a723-fa3895a25d02_story.html>.

9 Secretary of Defense Robert M. Gates, “Statement on Department Budget and Efficiencies,” United States Department of Defense, January 6, 2011, <http://www.defense.gov/speeches/speech.aspx?speechid=1527>.

10 Thomas Donnelly and Gary Schmitt, “Obama and Gates Gut the Military,” Wall Street Journal, April 8, 2009, <http://online.wsj.com/articles/SB123914897083399179>.

11 Perry & Abizaid, et al., “Ensuring a Strong U.S. Defense for the Future,” p30.

12 Secretary of Defense Les Aspin, “Report on the Bottom-Up Review,” United States Department of Defense, October 1993, p8 <http://www.dod.mil/pubs/foi/administration_and_Management/other/515.pdf>.

13 Admiral Jonathan Greenert, “CNO’s Navigation Plan 2015-2019,” United States Department of the Navy, August 19, 2014, p3, <http://www.navy.mil/cno/docs/140818_cno_navigation_plan.pdf>.

14 Greenert, “CNO’s Navigation Plan 2015-2019,” p3.

15 Bryan McGrath, “CNO’s Losing Battle to Avoid a Hollow Navy,” Real Clear Defense, August 26, 2014 <http://www.realcleardefense.com/articles/2014/08/26/the_cnos_losing_battle_to_avoid_a_hollow_navy_107392.html>.

16 Bryan McGrath, “CNO’s Losing Battle to Avoid a Hollow Navy,” Real Clear Defense, August 26, 2014,<http://www.realcleardefense.com/articles/2014/08/26/the_cnos_losing_battle_to_avoid_a_hollow_navy_107392.html>.

17 Deputy Chief of Naval Operations, “Report to Congress on the Annual Long-Range Plan for Construction of Naval Vessels for FY2015,” United States Department of the Navy, June 2014, <http://news.usni.org/2014/07/07/document-navys-30-yearshipbuilding-plan-fiscal-year-2015>.

18 Secretary of the Navy Ray Mabus, “Congressional Notification of Changes to the Navy’s Battle Force Ship Counting Methodology,” United States Department of the Navy, March 7, 2014, p2 <http://www.crenshawconsultingassociates.com/wp-content/uploads/2014/03/211911894-mabusbattleforce.pdf>.

19 Ronald O’Rourke, “Navy Force Structure and Shipbuilding Plans: Background and Issues for Congress,” Congressional Research Service,” August 1, 2014, p8, <http://fas.org/sgp/crs/weapons/RL32665.pdf>.

20 Deputy Chief of Naval Operations, “Report to Congress on the Annual Long-Range Plan for Construction of Naval Vessels for FY2015,” p5.

21 Deputy Chief of Naval Operations, “Report to Congress on the Annual Long-Range Plan for Construction of Naval Vessels for FY2015,” p5.

22 Eric J, Labs, et al., “An Analysis of the Navy’s Fiscal Year 2014 Shipbuilding Plan,” Congressional Budget Office, October 2013, p13, <http://www.cbo.gov/sites/default/files/cbofiles/attachments/44655-Shipbuilding.pdf>.

23 Perry & Abizaid, et al., “Ensuring a Strong U.S. Defense for the Future,” p36.

24 Perry & Abizaid, et al., “Ensuring a Strong U.S. Defense for the Future,” p48.

25 United States Department of Defense, Quadrennial Defense Review 2014, March 4, 2014, p64, <http://www.defense.gov/pubs/2014_Quadrennial_Defense_Review.pdf >.

26 Perry & Abizaid, et al., “Ensuring a Strong U.S. Defense for the Future,” p47.

27 Kris Osborn, “Navy’s Plan for a 306-Ship Fleet Fading Away,” Military.com, July 31, 2013,
<http://www.military.com/dailynews/2013/07/31/navys-plan-for-306-ship-fleet-fading-away.html>.

28 O’Rourke, “Navy Force Structure and Shipbuilding Plans: Background and Issues for Congress,” p23; p29

29 Perry & Abizaid, et al., “Ensuring a Strong U.S. Defense for the Future,” p7.

30 Jon Harper, “Expect cuts to F-15 fleet in Europe, Breedlove says,” Stars and Stripes, June 30, 2014,<http://www.stripes.com/news/europe/expect-cuts-to-f-15-fleet-in-europe-breedlove-says-1.291346>.

31 Nick Simeone, “Breedlove: U.S. Reconsidering Troop Reductions in Europe,” DoD News, September 16, 2014,<http://www.defense.gov/news/newsarticle.aspx?id=123181>.

32 Michael Mazza, “Taiwan’s Crucial Role in the US Pivot to Asia,” American Enterprise Institute, July 2013, p5,
<http://www.aei.org/files/2013/07/09/-taiwans-crucial-role-in-the-us-pivot-to-asia_082026691749.pdf>.

33 Michael Mazza, “Taiwanese Hard Power: Between a ROC and a Hard Place,” American Enterprise Institute, April 2014,
p2, <http://www.aei.org/files/2014/04/24/-taiwanese-hard-power-between-a-roc-and-a-hard-place_092826925958.pdf>.

34 Terrence K. Kelly et al., “Employing Land-Based Anti-Ship Missiles in the Western Pacific,” RAND, 2013, p2,
<http://www.rand.org/content/dam/rand/pubs/technical_reports/TR1300/TR1321/RAND_TR1321.pdf>.

35 Mazza, “Taiwanese Hard Power: Between a ROC and a Hard Place,” p9.

36 Mazza, “Taiwanese Hard Power: Between a ROC and a Hard Place,” p7.

37 Zachary Fryer-Biggs, “NATO Allies Might Be Unprepared for Syria,” Defense News, December 17, 2012, <http://www.defensenews.com/article/20121217/DEFREG01/312170002/NATO-Allies-Might-Unprepared-Syria>.

38 Kyle Mizokami, “How Taiwan Would Defense Against a Chinese Attack,” USNI News, March 26, 2014, <http://news.usni.org/2014/03/26/taiwan-defend-chinese-attack>.

39 Zachary Keck, “US to Help Taiwan Build Attack Submarines,” The Diplomat, April 15, 2014, <http://thediplomat.com/2014/04/us-to-help-taiwan-build-attack-submarines/>.

40 For more on the ROC’s ambitious domestic shipbuilding plan, see, Wendell Minnick, “Taiwan Previews Major Naval Acquisition Plan,” Defense News, September 20, 2014, <http://www.defensenews.com/article/20140920/DEFREG03/309200024/Taiwan-Previews-Major-Naval-Acquisition-Plan>.

41 James R. Holmes, “Why Taiwan Wants Submarines,” The Diplomat, April 22, 2014,
<http://thediplomat.com/2014/04/whytaiwan-wants-submarines/>.

42 Mazza, Taiwan’s Crucial Role in the US Pivot to Asia,” pp. 6-7.

43 Mazza, Taiwan’s Crucial Role in the US Pivot to Asia,” p7.

44 William Lowther, “Chinese Missile Has ‘Profound Effect on Taiwan: Expert,” Taipei Times, January 15, 2014,
<http://www.taipeitimes.com/News/taiwan/archives/2014/01/15/2003581338>.

45 Daniel Blumenthal, “5 Faulty Assumptions About Taiwan,” Foreign Policy, February 12, 2014,
<http://shadow.foreignpolicy.com/posts/2014/02/12/5_faulty_assumptions_about_taiwan>.

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The magic and miracle of the marketplace: Christmas 1964 vs. 2014 – there’s no comparisonhttp://www.aei.org/publication/magic-miracle-marketplace-christmas-1964-vs-2014-theres-comparison/ http://www.aei.org/publication/magic-miracle-marketplace-christmas-1964-vs-2014-theres-comparison/#comments Fri, 19 Dec 2014 03:54:44 +0000 http://www.aei.org/?post_type=publication&p=825458 ...]]]> Pictured above are some color TVs from the 627-page 1964 Sears Christmas Catalog, available here at the WishbookWeb website along with many other Christmas catalogs from 1933 to 1988. The original prices are listed ($750 for the Sears color TV console and $800 for the more expensive one), and those prices are also shown converted to today’s 2014 dollars using the BLS Inflation Calculator: $5,700 for the basic console TV model and $6,100 for the more expensive model.

To put that in perspective, the pictures below illustrate what $5,600 in today’s dollars would buy in the 2014 marketplace using current prices from the Sears and Best Buy websites:

appliances2014

Bottom Line: For an American consumer or household spending $750 in 1964, all they would have been able to afford was a console color TV from the Sears Christmas catalog. An American consumer or household spending that same amount of inflation-adjusted dollars today (about $5,600) would be able to furnish their entire kitchen with 5 brand-new appliances (refrigerator, gas stove and oven, washer, dryer, and freezer) and buy 7 state-of-the-art electronic items (Toshiba Satellite 14″ Laptop, Garmin 5 Inch GPS, Canon EOS Rebel T5 DSLR Camera, Sony 1000 Watt, 5.1-Ch. 3D Smart Blu-Ray Home Theater System, Sharp 50 inch LED HDTV, an Apple iPod Touch 32GB MP3 Player, and an Apple iPhone 6). And of course, even a billionaire in 1964 wouldn’t have been able to purchase many of the items that even a teenager can afford today, e.g. laptop computer, GPS, iPhone, digital camera.

As much as we might complain about a slow economic recovery, the decline of the middle class, stagnant median household income, rising income inequality and a dysfunctional Congress, we have a lot to be thankful for, and we’ve made a lot of economic progress in the last 50 years as the example above illustrates, thanks to the “magic and miracle of the marketplace.”

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On the left’s dream of turning America into Scandinaviahttp://www.aei.org/publication/lefts-dream-turning-america-scandinavia/ http://www.aei.org/publication/lefts-dream-turning-america-scandinavia/#comments Thu, 18 Dec 2014 22:25:17 +0000 http://www.aei.org/?post_type=publication&p=825452 Many left-liberals have a real thing about the social democracies of Scandinavia. As University of Arizona sociologist Lane Kenworthy has put it, “Over the course of the next half century, the array of social programs offered by the federal government of the United States will increasingly come to resemble the ones offered by [the Nordic welfare states].” And he might be right, if Democrats have their way. No sooner the arrival of universal healthcare did Democrats move into their next project: universal preschool. And next perhaps a universal basic income. (Hey, where is the VAT to pay for all this stuff?) There are fans in the media, too. Again, here is New York Times reporter Neil Irwin on what lessons America can learn from Scandinavia’s high labor force participation rates  in creating a pro-work safety net:

In short, more people may work when countries offer public services that directly make working easier, such as subsidized care for children and the old; generous sick leave policies; and cheap and accessible transportation. If the goal is to get more people working, what’s important about a social welfare plan may be more about what the money is spent on than how much is spent. If correct, it could have broad implications for how the United States might better use its social safety net to encourage Americans to work. In particular, it could mean that more direct aid to the working poor could help coax Americans into the labor force more effectively than the tax credits that have been a mainstay for compromise between Republicans and Democrats for the last generation.

AEI’s Mike Strain, quoted in the Irwin piece, has a response here. So too does AEI’s Stan Veuger. Let me pull out a few of their insights. First, Strain:

I’m quoted in an article in the New York Times on the paper, and as the article reports I do think that we can learn some things from Scandinavia — better transportation, better public education — and I oppose expanding the government’s role in child care (we have enough middle-class entitlements, thank you very much). … I would make two other points as well. Americans might be willing to fork over more of their hard-earned cash to the government if they had more confidence that the government would spend the money in a productive way. … And, as I have written, very high marginal income tax rates would likely be very damaging to the long-term future of the United States. Why would a young person want to be a surgeon or an entrepreneur if the government will take seventy cents of her top dollars of income? Like Scandinavian culture, the longer-term reactions to high top rates — skill acquisition, occupational choice, general attitudes about work — are much harder to measure. And it is fine for economists to focus on what they can measure when writing their papers. But it is not fine for the public debate to assume that these effects are zero just because economists can’t measure them.

And Veuger:

But might policy and politics be downstream from culture? Well, that certainly appears to be the case once we look at Scandinavian culture. Scandinavians trust their fellow citizens. They think poor people have typically been unlucky instead of lazy. They vote actively and participate in civil society. They respect the rule of law, and they donate to charity. Professor Kleven recognizes all of these things, and ultimately chooses not to guess what causes what. Yet for the ambitions of American progressives, that distinction matters very much. If all of these things are so precisely because the Scandinavian countries are small and homogeneous and have been that way for quite some time, then there is not much to be learned from this Scandinavian business. The Scandinavians themselves seem quite confident that they know the answer: culture matters and that their countries are small and homogeneous matters. They are the most Euroskeptic peoples of the continent. Norway is not a member of the European Union, Sweden joined only recently, and none of the three adopted the eurozone’s common currency. They seem to like their small, homogeneous countries just fine. And perhaps that’s what Scandinavia ultimately teaches us: the value of subsidiarity, not of subsidies.

Other economists wonder if Nordic-style capitalism is as conducive to innovation. Certainly they file fewer patents and generate fewer superrich entrepreneurs. (Recall Strain’s remarks on taxes.) As economists Daron Acemoglu, James Robinson, and Thierry Verdier explain in their paper “Can’t We All Be More Like Scandinavians?”: “We cannot all be like the Scandinavians, because Scandinavian capitalism depends in part on the knowledge spillovers created by the more cutthroat American capitalism. … Some countries will opt for a type of cutthroat capitalism that generates greater inequality and more innovation and will become the technology leaders, while others will free-ride on the cutthroat incentives of the leaders and choose a more cuddly form of capitalism.”

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Negative interest rates: The Swiss Central Bank joins inhttp://www.aei.org/publication/negative-interest-rates-swiss-central-bank-joins/ http://www.aei.org/publication/negative-interest-rates-swiss-central-bank-joins/#comments Thu, 18 Dec 2014 22:02:31 +0000 http://www.aei.org/?post_type=publication&p=825451 Negative interest rates keep happening although economists generally assured us they couldn’t. They will soon apply to large deposits with the central bank of Switzerland, as today (December 18), the Swiss National Bank (SNB) joined the European Central Bank in the negative interest rate club.

The SNB announced that starting January 22, 2015, demand deposits over a certain threshold held with it by banks and financial institutions will have a negative interest rate of -0.25%. Further, said the SNB, “we aim to take the three-month [Swiss franc] Libor into negative territory.”  Its target range for this rate will be -0.75% to -0.25%.

As it was in the 1970s, when the Swiss imposed negative interest rates on Swiss franc deposits by foreigners, the cause of this action is the unwanted pressure for further appreciation of the Swiss currency. “We are introducing negative interest rates,” they explain, “to support the minimum exchange rate.” More clearly stated, this phrase means: to cap the maximum appreciation of the Swiss franc.

How widespread can negative interest rates become? How negative can they get? Nobody, including economists, knows.

Follow AEIdeas on Twitter at @AEIdeas.

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‘Cuba the Morning After’http://www.aei.org/publication/cuba-morning/ http://www.aei.org/publication/cuba-morning/#comments Thu, 18 Dec 2014 21:15:02 +0000 http://www.aei.org/?post_type=publication&p=825440 Yesterday, President Obama announced a decision to reestablish diplomatic relations with Cuba. Discussions to reopen the relationship will begin immediately and will include efforts to reestablish an embassy in Havana. The president’s announcement makes particularly relevant a book by AEI emeritus scholar and Latin American expert Mark Falcoff.

In “Cuba the Morning After: Confronting Castro’s Legacy” (AEI Press, 2003),  Falcoff surveys  the damage that decades of Communist rule have done to the people of Cuba including a prostrate economy, widespread poverty and political repression. Falcoff  argues that it will be difficult, perhaps impossible, to reverse the decades-long devastation and that to expect an instantly revitalized dynamic Cuba to emerge is unrealistic.

For more on Obama’s move to change the diplomatic relationship with Cuba, read Roger Noriega’s recent piece on the matter.

Follow AEIdeas on Twitter at @AEIdeas.

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Where will Hollywood’s surrender take us?http://www.aei.org/publication/will-hollywoods-surrender-take-us/ http://www.aei.org/publication/will-hollywoods-surrender-take-us/#comments Thu, 18 Dec 2014 18:49:38 +0000 http://www.aei.org/?post_type=publication&p=825426 What if Golden Age Hollywood were like today’s Tinsel Town?

Charlie Chaplin would never have made The Great Dictator. Hitler’s threats would have led to it being pulled from circulation; one of the greatest anti-Nazi propaganda pieces would never have seen the light of day just before we went to war.

Sony Pictures has now confirmed that it is canceling the Christmas release of The Interview, a comedy starring James Franco and Seth Rogen, due to North Korean–directed threats against theaters. The majority of America’s main theater-chain owners caved to the outrageous and unrealistic warnings from a hitherto unknown group called “Guardians of Peace.” Not since the fatwa against Salman Rushdie and The Satanic Verses has the West so cravenly surrendered to intellectual terrorism.

And now, American business finds itself on the front lines.

The U.S. government has confirmed that North Korea is behind the attacks that have crippled Sony Pictures. For the past week, Sony’s internal computer systems have been ripped apart, with e-mails, financial details, film copies, and scripts tossed across the Internet. With that, an impoverished nation run by the most isolated regime on earth has made the gigantic American entertainment industry cower.

The truth is, we’ve been heading this way for a long time, starting with our response to Islamist assaults on those whom they believe blaspheme Mohammed. Now, we’re moving to another level.

The Kim-family regime in North Korea, now run by third-generation owner Kim Jong Un, is more or less a mafia that happens to rule a state. Next to Iran, North Korea is the world’s largest purveyor of state-sponsored terrorism. It traffics staggering levels of fake American dollars, tobacco, drugs, and of course, nuclear technology. It has tied down 30,000 U.S. troops on the Korean peninsula for years, and given China a perfect foil to use against U.S. interests in Asia. It has kidnapped Japanese citizens from their homes and sunk South Korean naval ships.

Yet this week was Pyongyang’s biggest coup so far. The multi-billion dollar U.S. entertainment industry has been brought to a shuddering halt by a government whose oppressed people might as well live in the Middle Ages.

Every terrorist organization and disruptive state will be looking on with envy at the North Korean victory and hastily scribbling notes.

A new type of asymmetric warfare, threatening the free flow of ideas (no matter how stupid) strikes at the core of Western liberties. There are innumerable ways in which copycat hostage takers can emulate North Korea, since everything today can be done from the shadows.

An academic conference on Chinese suppression of Tibet or Xinjiang separatists? Threaten to blow up the auditorium. A book exposing Vladimir Putin’s Mafioso approach to government? Blackmail the publisher with pictures of his children. What about a university that offers classes on North Korea? Take down its computers, destroy its academic records. A chain that opens up stores in an enemy of Iran? Sabotage its logistics, threaten to poison its products.

How about the producers of intellectual content in this brave new world? Expect more self-censorship — if Hollywood’s A-listers think they may be blown up for poking fun at the villains.

James Franco has been photographed accompanied by large new bodyguards already. Would Theo van Gogh, shot by an Islamist several years ago for his work, have told the truth if he knew what lay ahead? Knowing what his fate was? Let’s hope he would have.

Yet how many voices will be silenced by that fear: You know what? It’s really just not that worth it.

There has not yet been any type of government thinking about this type of threat, what the response should be, or how the free flow of ideas can be managed in a world of constant cyberwarfare.

The shadows of the cyberworld reveal more opportunity for mischief and evildoing every day. They are the ultimate badlands, but, like the train carrying in the ruthless gang in High Noon, they matter only as much as we give up our safety and security to them.

America’s entertainment industry has surrendered in the badlands’ first public battle. That choice ensures that there are many more to come.

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The oil price collapse may end the ‘Texas Miracle’ — at least for nowhttp://www.aei.org/publication/oil-price-collapse-may-end-texas-miracle-least-now/ http://www.aei.org/publication/oil-price-collapse-may-end-texas-miracle-least-now/#comments Thu, 18 Dec 2014 18:08:11 +0000 http://www.aei.org/?post_type=publication&p=825418 The energy sector gives, and the energy sector takes. The stunning drop in oil prices looks like bad news for the “Texas Miracle.” (Texas is responsible for 40% of all US oil production — vs. 25% five years ago — and all of the net US job growth since 2007.) This from JPMorgan economist Michael Feroli: “As we weigh the evidence, we think Texas will, at the least, have a rough 2015 ahead, and is at risk of slipping into a regional recession.”

So perhaps a minor key replay of what happened in the Lone Star State back in 1986 when oil prices also collapsed. The oil patch bust caused Texas unemployment to rise, housing prices to fall, and, eventually, a nasty banking crisis. On the positive side, natural gas prices have not fallen along with oil — unlike in 1986 — while the Texas  employment share from oil is less today than back then. But there are reasons to worry as well:

While these are all valid, they are not so strong as to signal smooth sailing for the Texas economy. Financially, oil is a fair bit more important than gas for Texas, both now and in 1986, with a dollar value two to three times as large. Moreover, while energy employment may be somewhat smaller now, we are not talking about night and day: the current share is about 3/4ths what it was in 1986. (And given the higher capital intensity there are some reasons to think employment may be greater now in sectors outside the traditional oil and gas sectors, such as pipeline and heavy engineering construction).

As we weigh the evidence, we think Texas will, at the least, have a rough 2015 ahead, and is at risk of slipping into a regional recession. Such an outcome could bring with it the usual collateral damage that occurs in a slowdown. Housing markets have been hot in Texas. Although affordability in Texas looks good compared to the national average, it always does; compared to its own history, housing in some major Texas metro areas looks quite dear, suggesting a risk of a pull-back in the real estate market.

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It’s always Christmastime for farmershttp://www.aei.org/publication/always-christmastime-farmers/ http://www.aei.org/publication/always-christmastime-farmers/#comments Thu, 18 Dec 2014 17:28:36 +0000 http://www.aei.org/?post_type=publication&p=825406 It is Christmas time once again and in my part of the world, southwestern Montana, the snow has arrived and will be with us until early March.  Most nights the temperature will fall well below 20 degrees Fahrenheit; some days the thermometer won’t rise above zero.

That’s winter time in the Northern Great Plains and the eastern Rocky Mountains, where cabin fever is a real phenomenon and ranching becomes truly hard work. In this world, cattle can be inconvenient. They need water and calories in places where they can feed and drink, and cows often calve on bitterly cold February and early March nights.

Ranching is also risky in the winter time; herds can be decimated by blizzards and what seem like mile high snow drifts. And ranchers, on the whole, are genuine risk taking entrepreneurs who, for the most part, neither seek nor receive substantial federal bailouts. Most of them also know that country of origin labelling is a bad economic idea that has reduced the prices they are paid by meatpackers and feedlots. The National Cattlemen’s Beef Association, for example, has recently argued that the US should “reform” and essentially terminate that program rather than appeal a recent WTO finding that the program violates US WTO commitments.

The federal support ranchers do get is modest and comes mainly in three forms. They receive relatively small scale disaster aid payments for excessive cattle losses caused by bad weather or disease and moderate compensation for loss of feed on the lands their cattle graze in the summer because of exceptional drought.

Ranchers also have access to federally subsidized cattle price related insurance products that are generally poorly designed and, happily from the taxpayer’s perspective, rarely used, and a heavily subsidized rainfall index insurance product associated with forage production that is more extensively exploited. But livestock insurance programs account for less than 2% of the more than eight billion dollars in annual average taxpayer funded subsidies that underwrite the US federal agricultural insurance program.

In addition, through publicly funded research and development programs, USDA and the nation’s Land Grant and other universities generate much of the science on which new medical, production and land management technologies are developed that improve the efficiency of the livestock industry. The result is that meat prices at the supermarket are lower than would otherwise be the case, though that may be hard for some to believe given the current record high prices we are paying for hamburger. The reason for these current high prices is complex, but derives from recent increases in global demand relative to global supply for meat based protein.

Many crop producer organizations have a different view about how their world should be managed, as do milk producer organizations.   The corn, wheat, soybean, peanut, rice, milk and cotton lobbies have been highly successful in obtaining substantial subsidies from the federal government over the past sixty years.  And, having enjoyed those subsidies, like Oliver Twist with respect to his daily allotment of oatmeal (but with much less justification), they want more.  By and large, they were successful in getting their “more” in the 2014 farm bill.

Of course, the difference between Oliver and most of the farmers served by those organizations is that poor Oliver was genuinely poor, in fact starving. In contrast, as was recently pointed out in The Economist, most federal crop subsidies go to farm households that have much higher incomes and are far wealthier than the average US household.

So, as at every Christmas time, we should genuinely be thankful for all the farmers and ranchers who help us enjoy better lives. But we should also expect Congress and the administration to deliver federal farm policies that focused on real needs and do not spend tax payers’ funds on programs that, for the most part, transfer incomes to the relatively wealthy in ways that waste society’s scarce resources.

Follow AEIdeas on Twitter at @AEIdeas.

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Dodd-Frank change won’t increase risk of taxpayer bailoutshttp://www.aei.org/publication/dodd-frank-change-wont-increase-risk-taxpayer-bailouts/ http://www.aei.org/publication/dodd-frank-change-wont-increase-risk-taxpayer-bailouts/#comments Thu, 18 Dec 2014 16:56:50 +0000 http://www.aei.org/?post_type=publication&p=825403 ...]]]> Did the government sell out to Wall Street by repealing a provision of the Dodd-Frank Act in order to pass a spending bill? “A vote for this bill is a vote for future taxpayer bailouts of Wall Street,” Sen. Elizabeth Warren warned in a passionate speech on the Senate floor. Setting polemics aside, the repeal of Section 716, the so-called swaps push-out rule, will do little to increase the risk of a taxpayer bailout of Wall Street. But it will reduce the costs of banks’ swap businesses.

The provision requires bank holding companies to push out certain swaps trades from their insured depository bank to a non-insured subsidiary. The rule mainly applied to “uncleared credit default swaps, equity derivatives and commodities derivatives,” according to Federal Deposit Insurance Corp. vice chairman Thomas Hoenig.

Many other kinds of swaps were permitted to stay within the insured depository institution, including those that are hedges for the bank’s risk exposures; those that reference interest rates, currencies, precious metals, loans, and qualified debt instruments; and credit default swaps that are cleared using a regulated clearinghouse. If a bank failed to move the banned swaps, it lost deposit insurance and the ability to borrow from the Federal Reserve.

Banks’ goal in pushing for the repeal of this provision was mostly to reduce the cost of their swaps businesses — not to increase the benefits they receive from taxpayer safety nets. Derivatives trading is expensive, requiring employees with specific skills and tailored systems and risk controls. Duplicate swaps operations within the same bank holding company is money poorly spent.

Perhaps banks’ biggest cost savings will come from jettisoning the requirement that banks shift dealer-to-dealer credit default swaps to a regulated clearinghouse. The forced migration of dealer-to-dealer credit swaps would have generated substantial new collateral requirements because clearinghouses require collateral for initial margin that is not needed under bilateral dealer collateral agreements. It would also have imposed large new daily liquidity needs.

When it comes to systemic risk and the potential for taxpayer bailouts, however, the repeal of the swaps push-out rule changes little. With or without the rule, the government protects the swaps contracts of the largest institutions.

Swaps contracts receive special treatment in bankruptcy. Counterparties are allowed to immediately close out their swaps positions and seize and sell the pledged collateral of the bankrupt counterparty rather than wait for a recovery through the judicial bankruptcy process.

If a large swaps dealer defaults without government intervention to prevent bankruptcy and stop contracts from terminating, a huge volume of collateral will be seized and dumped on the market. To prevent this massive “asset fire sale,” financial regulators grant swaps and other derivatives special treatment in their post-Dodd Frank resolution plans.

Swaps contracts that remain in the insured bank are fully protected. If the insured bank fails, the FDIC resolution process typically guarantees a failing bank’s derivatives contracts, including swaps. Legally, the FDIC has 24 hours to decide whether or not it will guarantee a failing bank’s derivative contracts. But in practice, the FDIC always protects derivatives — usually by transferring them to a healthy acquiring institution.

Swaps booked in a holding company subsidiary outside of the insured bank are also protected as long the swaps are written by a SIFI. Under the FDIC’s single point of entry plan for exercising its Dodd-Frank orderly resolution powers, the FDIC will take over the SIFI parent holding company and use its assets to guarantee all the obligations of the company’s subsidiaries in order to keep the subsidiaries open and operating. The protection not only prevents “asset fire sales,” it also prevents swap defaults from triggering bankruptcy proceedings in other countries that would bollix the FDIC’s orderly liquidation plan.

Some have claimed that because the repeal allows banks to write dealer-to-dealer credit default swaps in the insured bank, rather than shifting them to clearinghouses, it extends the government safety net. But this claim ignores the fact that the government plans to insure all swaps cleared through regulated clearinghouses.

All regulated clearinghouses are now designated as systemically important financial market utilities. This gives swaps clearinghouses access to the Federal Reserve lending safety net — just as if they were in an insured bank. And should a clearinghouse default, the FDIC will use its new orderly liquidation powers to transfer clearinghouse swap contracts to a solvent counterparty, preventing contract close out and protecting counterparties.

On balance, the repeal of the swaps push-out rule is unlikely to impose more risk to the financial system or to taxpayers. It is true that the repeal may generate more swaps activity than if the provision had been allowed to stand. But the increased activity will be attributable to the operational cost savings afforded by the change, not because the repeal added to the taxpayer-backed safety net. In fact, big banks’ swaps contracts are backed by the government either way.

Paul H. Kupiec is a resident scholar at the American Enterprise Institute.

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The Pentagon’s to-do listhttp://www.aei.org/publication/pentagons-list/ http://www.aei.org/publication/pentagons-list/#comments Thu, 18 Dec 2014 16:26:05 +0000 http://www.aei.org/?post_type=publication&p=825399 President Barack Obama has nominated former Deputy Secretary of Defense Ashton Carter to replace Chuck Hagel as secretary of defense. Carter is a sensible pick and is expected to be swiftly confirmed by the Senate. Once in office, he will face a mounting list of challenges with only a narrow window to act before the 2016 election cycle consumes Congressional attention.

While Carter can be certain that unexpected events will consume his time and attention as secretary – just as Russia, Ebola and the Islamic State group have for others in recent years – there are clear and predictable problems to tackle on day one. A recent hearing on the findings of the blue-ribbon National Defense Panel points to several key items that need to be on the Pentagon’s to-do list over the final two years of the Obama administration:

1) Convince the president and work with Congress to overturn the Budget Control Act’s defense cuts.

Testifying before the House Armed Services Committee, former Obama Pentagon official Michèle Flournoy called automatic spending cuts “a threat to national security” and argued that restoring defense spending to more stable, predictable levels would send an immediate signal of America’s commitment to both friends and foes alike. While Pentagon leaders have consistently opposed sequestration, the commission’s report makes a compelling case that the entirety of the Budget Control Act for defense – approaching $1 trillion over a decade – should be overturned.

If confirmed, Carter should begin showing Congress how budget reductions beyond sequestration have harmed the force and make the case for returning to the path laid out by then-Secretary of Defense Robert Gates in his 2012 Future Years Defense Program. There is a lack of understanding by policymakers about how bad the drawdown is hurting capacity and readiness and how much is required to reverse course. It goes beyond simply halting sequestration to restoring defense budget growth that is slightly above inflation to keep the Defense Department afloat.

2) Outline today’s readiness crisis and propose a readiness supplemental spending bill.

The Joint Chiefs are increasingly describing in animated and dire terms the near- and long-term readiness challenges across the armed forces. This problem has been accruing for years and began before the Budget Control Act but worsened considerably after. As noted during the same hearing, Marine Corps Commandant Gen. Joseph Dunford recently warned that half of all Marine Corps forces currently at their home bases are at “a degraded state of readiness.” Flournoy cautioned that similar circumstances exist across the services and that in the case of a major operation, uniformed personnel would be sent into harm’s way without proper training or equipment.

The National Defense Panel called for an emergency readiness supplemental aimed at triaging the military’s readiness crisis. This solution is smart because it avoids the intractable politics of artificially linking defense and non-defense spending as equals like in other budget proposals. Passing legislation for urgent priorities, such as taking care of America’s military, is something Congress would be more than willing to undertake were it outside of legal budget caps, which this would be. Carter would need to be clear that this would only be a shot in the arm for the force and not a long-term solution to budget unpredictability, instability and inadequacy.

3) Create a genuine partner in Congress on Pentagon reform efforts.

Throughout the Congressional hearing on the findings of the National Defense Panel, Flournoy further emphasized the importance of comprehensive reform in how the Pentagon conducts its daily operations. Even with additional funds, the Pentagon must look to maximize the value of each dollar and keep faith with those in uniform. While this includes providing generous compensation and benefits, it also includes ensuring that service members have the best equipment and cutting-edge training when they head into battle. As those in the department have argued, these two contracts are increasingly at odds. But scaling back infrastructure or overhead or even the number of civilians or how service members are paid need not be all pain and no gain. Elected officials must be convinced that new promises can be made with future enlistees that give more benefits to a larger number of those serving. They must also believe that smart trimming of excesses like unused infrastructure can support fielding more combat power and a greater number of jobs gained than lost as a result.

4) Revisit the Pentagon’s force-sizing construct.

The framework used to generally size and build the U.S. military has gradually been squeezed in recent decades even as the force has been asked to do more while getting smaller. During the 1990s, the Pentagon articulated a two-war standard, which called for a military large enough to fight and win two major operations nearly simultaneously. The National Defense Panel differed slightly from the Pentagon’s latest 2014 strategy by not only calling for a military sized to win one protracted campaign and fight a holding action in a second theater (as the Pentagon calls for), but to also conduct a host of other regular and ongoing missions including counterterrorism, homeland security and deterring aggression elsewhere.

Former Pentagon and State Department official Eric Edelman, testifying alongside Flournoy, noted that most Pentagon plans today are based on the assumption that the U.S. will fight and win short wars. Yet the recent past is full of anything but short operations. If the need to mobilize for a future conflict should arise, the Pentagon would be largely unprepared. The need to think through a mobilization scenario – along with the taxing demands of everyday presence, deterrence and counterterrorism mission requirements means that the Pentagon must give serious thought to altering its force-sizing construct to reflect a more realistic batch of scenarios and missions. Otherwise, Carter will struggle to reconcile how a smaller, older military can still meet even the reduced goals in the president’s 2012 strategic guidance before an already skeptical Congress and chiefs who are ready to say publicly they simply cannot meet the current strategy.

5) Continue the Pentagon’s promising launch of a “third offset” strategy.

Recently, Pentagon officials have articulated the need to develop a “third offset” strategy to combat America’s declining military technological superiority. The initiative is designed to cultivate creative plans and programs that will help maintain America’s military preeminence for the next generation. Yet previous offset strategies relied on substantial technological innovations such as nuclear weapons and the information technology revolution. As former Ambassador Edelman argued during the hearing, in the absence of higher budgets, the Pentagon may lack the resources to invest in the types of technologies that could deliver a true breakthrough advantage in the future. While understanding that technology has its limits when it comes to warfighting, the next secretary of defense must balance short- and long-term interests and invest in innovation. The need to shore up readiness, buy back some capacity cuts that have gone too far and still invest in capability and innovation is another reason Carter should seek a return to 2012 defense spending levels. All three priorities are unaffordable under current plans, period.

There is plenty for the next secretary of defense to tackle head on and no time to lose. If confirmed, Carter would surely hit the ground running. Yet if he is to have a successful tenure at the Pentagon, he will have to address these items and more. He should shamelessly steal a few solutions from the National Defense Panel to allow the Defense Department to begin rebuilding as soon as possible.

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