IFRS, Fair Value Stupidity...and How The Banks Lost $255 Billion

Robert Owen said this: All the world is queer save thee and me, and even thou art a little queer...


The topic today is how well-intentioned changes in accounting practices have created a monster that could devour us all: it's a monster with positive feedback loops, making any crisis much worse than it need be, and perversely also setting the ground for the development of massive bubbles that will implode with severity equal to none.

What is this monster?

IFRS. The International Financial Reporting Standards, the rules for international bookkeeping.

What is the problem?

This (from Wikipedia):

Receivables (debtors) and payables (creditors)

Receivables and payables are recorded initially at fair value (IAS39.43). Subsequent measurement is stated at amortised cost (IAS39.46 and 47). In most cases, trade receivables and trade payables can be stated at the amount expected to be received or paid; however, it is necessary to discount a receivable or payable with a substantial credit period (see for example IAS18.11 for accounting for revenue).

If a receivable has been impaired its carrying amount is written down its recoverable amount (the higher of value in use and its fair value less costs to sell). Value in use is the present value of cash flows expected to be derived from the receivable (IAS36.9 and 59). ...

and what is Fair Value?

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction (IFRS1 App A).....


Now, this all sounds reasonable, but is it?

Hardly.

The key is that receivables and payables, initially valued at what you actually paid for them, are then significantly and constantly revalued.

Not what the company expects to receive for them, as laid out in the contractual agreements signed, but what the company could get for such receivables if they were sold on the market as OTC or exchange instruments.

Most importantly, this effects the valuation of assets, defined as resources controlled by the company and with which the company makes money (in the form of future cash flows).


Now, why is this a problem, and more importantly, how does this form a positive feedback loop that causes any sort of modulation to start excessive swings?

Receivables must always be assessed for the purposes of bookkeeping at their fair market value. No particular need to do this every day or month, but it must be done once a year, at the very least, to determine equity of the company.

What happens when the market for <whatever the asset is> is down sharply? That means that the assets that the company holds must also be revised downward sharply, resulting in a reduction in equity. Given that net profits is equity of the previous year minus equity of today, this means that the usage of fair value leads to a reduction in equity, which must then be written off.

Given the large amount of financial paper held out there, this means that because of IFRS and fair value, and here I am quoting today's Handeslblatt on page 23, banks world-wide have written off no less than 255 billion dollars on value adjustment. The professional organization CFA even says that 55% of responding bankers see the IFRS rules as being responsible for the magnitude of the current problem.

Of course, the IFRS insists that these rules are right and proper, and reflect "reality" better than the old rules, where assets were simply depreciated over time and future receivables discounted to net present value.

The IFRS is wrong, wrong, wrong and did I mention that they are wrong?

If a concern were to be liquidated, then the IFRS interpretation would be correct: however, the IFRS itself says that the fundamental assumption is that when we look at a company, it is always the company as a going concern.

The IFRS interpretation would imply that an investor should "know" the "real" state of the company's finances before making any sort of investment decision, or that the company itself should "know" the "real" state of its receivables, both by acting as if the receivables were to be sold off to realize their current cash value.

That way lies madness.

I cannot underscore this more.

The problem isn't just the current downswing: the real problem will be the next dynamic upswing.

Why?

Because then the companies will revalue their receivables as markets recover and pick up: all of a sudden, companies will report massive increases in profits, vastly improving their equity position, and resulting in a major, major increase in their ... creditworthiness.

Hence companies will be able to increase their borrowings with significantly lower risk premiums.

Which means that the banks will increase their downside risks dramatically when the business cycle turns downward again, forcing them, per IFRS rules, to revalue their assets downwards significantly as the relative risk of the business partner worsens dramatically.

What the IFRS rules really do, in their absurd search for some resemblance of reality, is make it even more difficult for banks and lenders to determine "true" risk: bookkeeping, due to the highly volatile nature of fair value asset revaluation, will make it harder to see the true financial state of the company, as the swings due to asset valuations will overweight these significantly.

This means it will be harder for those who are not financial wizards to actually read a balance statement without being severely misled as to the true profitability of the company.


Now, that is stupidity.


It is what happens when you let the inmates run the asylum: this is the result of not an attempt to make finances more transparent, but rather to satisfy the desires of accountants to give themselves a "better" idea of how the company is doing, and shows how terrible things can happen.

When they don't ask economists how reality actually works. The stupidity of the IFRS and the very, very real damage being done to the economy comes from a fundamental ignorance of how destructive positive feedback loops really are.

If the IFRS simply allowed a secondary valuation of assets, but left straight-line depreciation alone for the purpose of determining profitability, then you'd have at least $255 billion less having been written off. What started out as a sensible internal measure - companies should know if they are facing significant price deterioration for key assets - has become a monster that has the potential for massive destruction.

All in the name of greater transparency. This isn't transparency, it's folly.


But they're accountants. One nasty joke is that economists are only glorified accountants, and I'd even accept that largely, with one caveat: economists are accountants who can actually think.

Sheer and total stupidity, and the destruction of $255 billion.

Even for the US government, that's real money.

Escalatio, Superiority, Usability, Stupidity ... and Danger

After finally having come up a tad for air, I read this.

I'm not going to go into enormous detail, since that'd put most to sleep.


But the author of this, Keir Lieber and Daryl Press, are dangerous fellows.

Not so much because they know so much: that's not what makes them dangerous.


Rather, because they are what is called "owls", dedicated disarmament proponents.


Nuclear strategy and thinking about nuclear strategy has gone way, way downhill from the heyday of the Cold War. Hermann Kahn's "Thinking the Unthinkable" desperately needs to be updated and rewritten for the 21st century, but remains the best work in this area, as does Clausewitz (in my thinking, if you haven't read Clausewitz, then you haven't done your homework...).

There are only two reasons for acquiring nuclear weapons. One is the obvious: to use them in a military conflict when you really, really, but really want to hurt someone, regardless of the price. That's the military side, where nuclear weapons are very, very useful when you want to put a lot of hurt on the greatest number.

But nuclear weapons are and remain also political tools. They serve to intimidate, to scare, to show competence (that your country can build them), and they serve to deter. They are the ultimate threat, one that results in the death of millions and destruction of entire cities when used, hence the problem of believability and survivability.

Believability is that you would actually use them. Given the inclination to paint your opponent in the worst possible, preferably sub-human, colors, the mere possession of nuclear weapons gives credence to the idea that you would use them: after all, they are, despite being very useful militarily, rather a pain to acquire, and aren't the result of any sort of benign accident, but rather must be built (barring the ability to buy them).

So, politicians being what they are, they'll believe their own propaganda and believe that the other side will use them under a set of given circumstances. Knowing that these circumstances are enables you to make your own strategic plans to avoid placing your opponent in such circumstances.

Now, that's not always possible...

Survivability was the underlying principle that led to strategic equilibrium: if you couldn't ensure that the other guys' nukes were destroyed, then you didn't start tossing them. Just one of their arriving really ruins your day as commander-in-chief, and hence if you're gonna have any nukes, you need to have them survivable. Otherwise, if the other guy thinks that he can take them out, and it comes to a push-and-shove situation, he will: just like in the move Aliens, the best option is to nuke them from orbit (i.e. destroy them at no risk to yourself...).


Now, the Cold War is over. The US has reduced its arsenal significantly, but at the same time has applied lessons learned with conventional weapons to nuclear weapons, such as increasing accuracy significantly and improving targeting abilities. This has transformed sub-based missiles, previously the core of deterrence (almost impossible to find and capable of busting lots and lots of cities) into a weapon of relative accuracy. They've also moved the yield way up - quadrupling the yield is the same as making the missile 16 times more accurate - and are now approaching the ability to actually surface-hit the target being aimed at, meaning that you're talking about the ability to take out, literally, any hardened target with a single warhead.

You see, the calculus of deterrence established the fact that it took dozens of warheads to ensure that you could take out a single hardened target. Hence the massive numbers of warheads in the inventory during the Cold War: this has not only been reduced, but has actually not become necessary.

What does this imply for escalation theory (what I call escalatio after Tom Lehrer)?

Two things: one, that this makes planning vastly simpler (one shot, one kill), but that it changes the equations significantly. Under the old rules of deterrence, missile defense was "easily" overwhelmed by a saturation attack, but you also had the warheads to spare. Under the new rules, with few warheads, missile defense becomes paramount, since there is no other way to defend: this is important! Your hardened targets are now easily destroyable - nothing can stand being hit 10 meters away by a surface-detonated 15 kton nuke, let alone a 400+ kt nuke - and either you must deter or you must intercept (the folks up above see a third alternative that simply isn't one: launch on warning, which makes nuclear war random, rather than deliberate. No one is going to seriously switch over to launch-on-warning unless there already is a war going on and they are afraid that there will be an attack on their assets: this would include any sort of non-nuclear attack as well, as the end effect is the same. Basic case of "use it or lose it", but I have yet to see a situation where that would occur out of the blue.

Now, this increase in strategic ability - the ability to reach out and touch someone where it really hurts - under the current conditions reflects the fact that the US has, effectively, created a situation of strategic superiority in any major conflict involving classic use of military force. This, on top of the tactical superiority of US troops, means that under the current circumstances, any major conflict will be shortly resolved in the manner most pleasing to the US, with extraordinarily dire circumstances if someone decides to nonetheless go forward with plans to attack US interests despite this knowledge.

What does this mean for usability? Will it be more likely that the US uses nuclear weapons?

Hardly. The weapons are first and foremost political weapons (and if you don't think that is the case, then you're up against more than 60 years of praxis and theory...), and the actual use of nuclear weapons means one of two things: a) that a President really mucked things up and got the US in a situation where the only real alternative would be a significant strategic defeat and b) that a President really mucked things up by letting an opponent believe that the US lacked the political will to use the weapons. Such are the things of Clancy novels.

The authors ut supra talk about various scenarios as well: given the US ability to take out a relatively small nuclear deterrence force (18 ChiCom missiles, each with a single 4MT warhead) with a very, very degree of certainty, this means that the US can, in all likelihood, prevent the Chinese from, say, attacking Taiwan, because they know that they cannot win in a military conflict, even if it fails to go nuclear. They're worried that this means that the Chinese will start an arms race.

That's stupid.

First of all: if the Chinese were to massively expand their nuclear forces, we're back to the days of the Cold War and all which that implies. Unless they reach technical parity with the US - which is not only conceivable, but even likely - the situation remains as it was during the Cold War, a strategic stalemate.

If they were to gain the same ability as the US, then both the US and China have an incentive to ensure a draw-down, as nuclear weapons then lose importance, rather than gain in importance, since there is no such thing as a hardened target any more, merely targets.

But what is really regrettable is that they don't think that US superiority Is A Good Thing.

I've capitalized that for two reasons.

One, nuclear and hence strategic superiority deters wars. Nothing less, nothing more. If China is convinced that the US would come to the aid of a mass attack on Taiwan, then they won't attack Taiwan, regardless of their desire to integrate Taiwan into Greater China, since the costs would be vastly greater than the benefits. Hence: no war.

Second, if the Chinese leadership believed that the US is a paper tiger and won't go to war over Taiwan, the US can disabuse them of this notion very, very quickly by using highly accurate small-yield weapons that removes the Chinese ability to threaten to destroy LA if US carriers enter the China Sea, meaning that the conflict will be carried out over China, not the US, and that Chinese will die, not Americans.

If you don't see the sense of that for any American government, then I strongly question your reasoning abilities.

Now the authors lack imagination: they see only two paths for the Chinese. Either massively deploy new, mobile weapons and warheads, or shift to launch-on-warning.

That is too short-sighted and not Chinese at all (I won't profess to understand the Chinese government, but I have read The Art of War): if the Chinese know that they can't risk military force, then they will try other means, such as political intrigue leading to a breakdown of any independence movement in Taiwan, or explore non-military solutions to their problems and policy goals.

That is where the authors fail to see that a Pax America doesn't mean an end to conflict, but it does mean an end to wars as we have known them. No country is going to go up against the kind of American military force that took apart the Republic Guard in a matter of hours in the middle of a sandstorm: that way lies destruction.

So if you are opposed to US policies and operations, you go after US interests in other ways: guerrilla war, economic warfare, assassination, covert operations, etc. Which, of course, is what we are currently seeing in the Middle East.


Again: US nuclear and strategic superiority means that no one will challenge the US here: they will challenge the US in many, many other ways, and will ensure that there will be no targets for the US to hit. That is, however, a completely different topic altogether.


What makes these two fellows dangerous is that if the US were to further disarm as they would have it - scrapping the most advanced weapons, rather than the oldest and least useful - this would make war more likely, and not less: it would aid US opponents, reducing US opportunities and tactics, reducing the ability of the US government to take the war to the enemy by using, in their example, 50 low-yield warheads to destroy the Chinese ability to kill 18 US cities with something on the order of 100mn people.

That'd be a better situation?

To quote the authors ut supra: reducing US superiority would weaken ...

... U.S. coercive leverage in crises involving nuclear-armed adversaries, and they would leave future presidents who find themselves in dire circumstances with few palatable counterforce options—meaning options that wouldn't kill millions of civilians. On the other hand, these steps might avert an arms race with China and prevent a dangerous spiraling of events during a crisis.

That is an academic trade-off at best and sheer stupidity at worst.

Giving up the concrete abilities of preventing any sort of war for the mere possibility of avoiding an arms race with China and preventing a war during a crisis is a demonstrably bad idea.

They're not trying to think the unthinkable, but rather arguing for the inarguable.

Market Transparency, Inefficiency and Limitations...

I'm what the foto industry calls "advanced amateur", which means that a) I've got some money and b) I actually bother to read manuals. I used to have my own darkroom, still own a rather expensive Pentax 67 system, and have gone through a couple of digital cameras trying to figure out which one I really want and can justify spending a chunk of money on.

One of the premier makers, of course, is Nikon. Now, Nikon lost me as a customer by insisting that I cough up money for something that was their fault, but I think I'm objective enough not to be snarky about them. I've used their cameras in the past, and they are excellent: you don't get to their status by building junk (of course, the camera I bought my daughter for Christmas from Nikon a few years ago doesn't work either, but that's another story. Their Pro stuff is top-notch).

Now, the web makes markets transparent: you can be in Germany and find out what something costs in the US, for instance, very simply, and you can quickly find all sorts of objective and subjective reviews across the board for virtually any item you want to buy. That's a good thing, informs the consumer, and an informed consumer is the economist's best friend, since they tend to make rational decisions. That's why manufacturers aren't too keen on them, usually, since rational thought and advertising expenditures usually show a negative correlation.

Nikon has a new model out, the D3. Lovely camera, people who have them rave about them.

But let's look at list prices.

In the US: $4999

In the UK: 3399 Pounds Sterling

In the EU: €5180

That gives me...a dollar exchange rate of just a tad less than $1.04 for 1 €, roughly 68 pence gets you one dollar, and the pound is worth roughly €1.52.

And this resembles current exchange rates of ... roughly $1.60 per €, around 50 pence gets you a dollar, and the Pound is ca €1.26.

So, either Nikon is deliberately pricing low in the US, or it is making money hand and foot in the UK and within the EU.

The real story is that it is doing both.

Nikon has a leverage that distorts the true market. If the market were completely efficient, then no one would buy a camera in Europe: they'd buy one in the US, paying more than €2000 less or a discount of no less than 37%.

Now, normally the camera would also be discounted, but in this case - new and desireable - there are little or no discounts available (even online at the best NYC camera stores, B+H and Adorama), but even so: a 37% discount.

Normally, no one would buy their camera in the UK or London.


Unfortunately for the consumer, Nikon can distort its market. The usual justification is that the cost of doing business in Europe is higher, and I will give them that: but 37%? Okay, you do have your VAT driving prices up for the consumer as well, and let's drop 20% of the price right there: that still leaves us with a 17% difference.

It is not 17% more expensive to operate in Europe than it is in the US - remember, we have already factored out VAT - and the question then arises: how does Nikon get away with this?

It's simple: consumer preferences and market fragmentation.

While I'd be comfortable dropping that much money online and having it sent to me, there are plenty of consumers who prefer to go to camera stores and buy brick-and-mortar. Given that photography is both a relatively expensive and a relatively technical hobby, many prefer to have a good working relationship with such a store to get advice, and are willing to pay for it in the form of paying retail. That's fine, that would probabyl explain most of the voluntary decision to go with a high-cost retail channel purchase.

But the rest are screwed: Nikon - and this is nothing unique among international manufacturers - has successfully fragmented what should be a monolithic market. How do they do this?

By controlling the retail channels, via delivery of product and by guarantee limitations. Again, this is nothing new: what is new is that it is now easily visible and that the web allows us to see it in action.

Nikon - and others - control their retail channels very carefully: while they have high-volume discounters who move lots of equipment, their "true" customers, the high-value customers, are the classic photo-shop retail outlets, largely privately owned, with a couple of larger operations that may have shops in a dozen cities or less. This is where folks pay retail and where the highest profit margins are found: if anything, this retail channel is, for Nikon, more profitable than discount channels, despite the larger volume of business.

Delivery is, of course, critical to the retailers: if you don't have the equipment to sell, you can't sell it. Manufacturers police, as it were, these channels to prevent price competition: drop prices too much and you will no longer receive deliveries, and Nikon may refuse to sell to you at all. This is what stops major sales outlets in the US, for instance, in selling more than a handful of cameras to Europeans; if they were to undermine Nikon's price politics in the EU, they'd no longer have equipment to sell. At the prices we're talking about, it would behoove someone wanting to spend that much money to get on a plane, fly to New York, buy the camera, bring it back, pay duty, and they'd still be less expensive than buying it from the corner camera store.

How does Nikon deal with these folks? Simple: warranties. Buy the camera in New York, and you'll have to send it to the US to have work done on it. For a disposable item, not a problem, but for a $5000 camera? Too much risk.


So, I'll end here: you've seen how markets can be transparent, how they can become inefficient for consumers (but very efficient for sellers), and there are always limitations to markets that reflect unique structures and developments.


And I use Olympus equipment, have done so since 1973.

Wiki and the Truth...

This is/was an interesting read on Wikipedia and accuracy.


One of the big problems with the environmental movement is that they are so completely convinced that they are right that they are almost incapable of recognizing legitimate criticism, preferring to stick to their dogma and hiding behind "peer review, peer review" mantra, ignoring the problem of peer review corruption (where peer review becomes meaningless because all in the peer group have a vested interest in maintaining a fiction: don't pretend it doesn't happen).

Peer review corruption is a problem, not merely in this specific case, but for science in general (see this), and while there isn't that much that can be done by those outside of the peer group - which in and of itself is also a problem when, for instance, a peer group fails to spot abuse of statistical methods because there is no professional statistician available within the peer group - there is a case for making the peer review process more transparent and positive.

But the real problem that can be seen in the first link here, to the article on how a Wikipedia author actively refuses to correct something wrong because it would be politically damaging.

To quote a Wikipedia admin involved:

Most of the controversy is contrived to further a political, ideological agenda; I don't see any reason we should help them by perpetuating it.

I dare say that a significant amount of work on anthropogenic global warming fits exactly this description as well: we have seen that Mann et al created data to fit their conclusions by using algorithms that always reported similar results, even fed with random numbers and who, to date, have refused to publish their methodologies; we've seen that there is a systemic upwards bias of reporting stations due to urbanization of the recording stations over time; there is a continuing and ongoing problem with extreme statistical malfeasance when using proxies and creating unitary temperature time series over time; further, that critical voices within the IPCC have been effectively silenced and ignored from day one.

If environmentalists want to receive massive funding for their pet projects based on anthropogenic global warming theories, then they must provide analysis that is at least as believable as the pre-war intelligence research on Iraqi attempts to acquire weapons of mass destruction.


Up to now they have failed to do so.

On Strategy...A Simple Reminder

Been offline the last few days, as reality intruded...as it does every once in a while.

This is for your consideration, a simple reminder of the problems we are facing in the next election cycle. You can download it at the link, I've taken the liberty to quote it here.

Lt. Col. Nathan Freier (that's him here) has written an insightful and relevant opinion editorial from the Strategic Studies Institute of the US Army War College that I think bears greater reading. I'm going to comment on it as well, but this is not a fisking: it is an anti-fisking.

An honest survey of post-Cold War national security policy exhibits a dangerous
strategy deficit. The word "strategy" is overused. The concept, too, is poorly applied. It
is many things to contemporary policymakers except, well—strategy. In the current
environment, strategic communications and strategy have become synonymous.

Here lies the crux: strategy has ceased to be strategy, but rather has become degraded and largely meaningless. Let me expound on that: everyone "knows" what strategy is all about, but because they don't really understand the difference between the two - strategic communications (in the broadest sense) and strategy itself - people confuse the two.

Strategic communications is the carefully crafted but overly general and widely
consumable articulation of key political messages—"assure, deter, dissuade, defeat";
"as they stand up, we'll stand down"; "clear, hold, build"; "phased strategic
redeployment"; etc, etc, etc. It is strategy by façade versus strategy through effective,
deliberate investment of intellectual, temporal, material, and human capital in pursuit
of well-defined outcomes.

Bingo, bingo, bingo: it is what for me is a recurring theme on this blog, that of the confusion between reality and rhetoric, of the problem of modern-day sophists and the culture of deception.

Let's look at his definition of strategy to understand the difference: effective, deliberate investment of intellectual, temporal, material and human capital in pursuit of well-defined outcomes.

This is in contrast to his definition of strategic communications: the articulation of key political messages.

So what is the difference? It's the difference of walking the walk and talking the talk, to put it in a popular phrase. Strategy is laying out the goal and how to get there: strategic communications is about saying what you want.

So far, so good.

Real strategy is the reasoned determination of specific, minimum essential objectives, rationalized with suitable ways to achieve them and the necessary means for success. No careful observer of executive decisionmaking since the end of the Cold War believes the latter high bar to be the norm.

Ouch. Of course not: strategy today is the realm of the amateur. It is, has been, and under the US constitution will remain the perogative of the President of the United States to determine strategy. The senior military should be the ones who listen and understand the President, but form the strategy based on broad goals. They have, however, been usurped by what I am going to cruelly call "wannabes", those that want to be the great strategists, but lack, more often than not, even the roughest idea of military strategy. I think this trend started back with Carter and his "outsiders": he came, after all, to Washington as a deliberate outsider, and promptly alienated his professionals by bringing in politically astute but inept people.

This didn't start with Carter: it's been, in many ways, the hallmark of US presidents since, roughly, the immediate post-revolutionary war period. It's just that during and after Vietnam - where the President (Kennedy, Johnson and Nixon all, if to a varying degree) got his strategic advice from the professional military - it was possible to place the blame for what was, fundamentally, a political defeat at the feet of the military and not only get away with this, but actually further your career by doing so. Having military officers move up into political assignments - Gen. Haig under Nixon - was also a professional error for the entire officer corps, in my (admittedly non-military) opinion: by becoming a bad politician, he helped tarnish the reputation of the US officer corps, reducing the reputation of that group in the eyes of political pundits and hence the public.

A fundamental component of strategy development is rational risk assessment. Risk—viewed as the likelihood of hazard in pursuit of objectives or the likelihood and consequences of failure—injects realism into strategy. Risk calculation offers decisionmakers the opportunity to see that both action and inaction engender costs—lives, money, time, freedom of action, political flexibility, loss of opportunities, etc. Costs accumulate.

Now this I like: professionally, I do risk analysis for industrial development, and it is used by clients for portfolio management (and internally we manage more money than I can even understand...).

Costs do accumulate. Let me take that risk analysis one step further: risk has everything to do with uncertainty. In Rumsfeld's words, they're all the factors: the known knowns, the known unknowns, and the unknown unknowns. The first two you can quantify and account for: the third is, per definitio, unknown. But establishing a risk framework can help enormously in exploring that realm: especially if you have a framework, a model, of known interdependencies and known relationships. If you find something not behaving according to these two, you have discovered that you now know an unknown...

When unaccounted for in decisionmaking, costs quickly and unexpectedly become excessive. Rational risk assessment also allows for the judicious consideration of the prospects and price of failure. Clearly, accounting for both the possibility of failure and the certainty of real cost forces decisionmakers to deliberately consider alternative courses of action. The contemporary temptation to mistake strategic communications for strategy short-circuits the aforementioned process. Rhetoric vice realism defines strategic outcomes. Once embedded in the public narrative of presidents, cabinet secretaries, and sympathetic pundits, these outcomes are not only absolute and nonnegotiable, but also, at the same time, excessively imprecise and
unachievable.

This is fundamentally true in terms of portfolio analysis: it behooves you to get out of high risk and low reward situations, unless you have a specific reason for being there (which of course changes it from high risk/low reward to high risk/high reward).

Identifying risks doesn't prohibit specific policy choices. Rather, it frames them in an
appropriate context. Without prudent evaluation of risk, the nation hazards embarking
down blind alleys with little thoughtful consideration for "Plan B." The conduct of the
Iraq War has been a clinic in this regard. The Iraq War proceeded in the absence of a
governing grand strategy and persistently fails to live up to expectations as a result.

Ouch. But so true: one of the major complaints that can be made against the left in modern America is a constantly shifting set of expectations as what is acceptable. When the US destroyed the government of Iraq during that brief conflict, the military reached its objectives and Bush claimed, properly so, "Mission Accomplished". It's just that this was not the only mission, and that the mission changed as that happened, one from destroying an organized military force to one of learning how to rebuild a country not merely damaged from a brief conflict, but one that had been repeatedly abused and was, effectively, a failed state even before the conflict began.

This is sadly unexceptional in recent American history. It is no accident that American
activism in the post-Cold War era has demonstrated limited enduring success. Intervention
in Somalia, peacekeeping in the Balkans, "Dual Containment," the domestic
response to September 11, 2001 (9/11), the War on Terrorism, confronting the "Axis of
Evil," stabilizing Iraq and Afghanistan, and even Gulf Coast reconstruction all exhibit
one common feature. Each is marked by some significant disappointment or
indeterminacy. The form of each originated less from holistic strategic net and risk
assessment than from political instinct or impulse; and all—though individually either
essential or noble—proceeded without rational consideration of strategic context,
course, and risk.

Perhaps it is the policy of the United States to not have a strategic policy, just as it has been the policy of the United States not to have an industrial policy. But that is the rhetoric: the reality is much, much different.

The United States has pursued "strategy by exception" for 17 years.

To put it slightly differently: the United States has had no real, effective strategy since the collapse of Soviet Socialism. We defined ourselves too much as the opponents of the system, and while Bush 41 talked of a "New World Order" that could have developed into a new strategic mission for the United States, he lost that election and we got Clinton instead, the master of rhetoric and sophistry, the man who had absolutely no clue of the difference between Strategy and strategic communications, despite being quite good at the latter.

Seemingly awash in confidence and resources, American politicos persistently mistake raw capacity for infallibility. Yet, the secure maintenance of American position often benefits
more from careful calculation and premeditation than brashness. The latter, however, is
far more common. Today, there is no real strategy in effect befitting the security of a
singular superpower in an "all-hazards" environment. There is only the façade of
strategy—strategic communications without substance.

It's not so much awash in confidence and resources, but the simple fact that we won the Cold War. We didn't exhaust ourselves doing so, but the problem was that when you have made your career defeating someone, and win, then what do you do? The political pundits and politicians of the day started spending the Peace Dividend - which existed only in their feverish dreams - almost immediately without even thinking about the future. The end of the Cold War meant that the world wasn't safer (OK, the threat of global thermonuclear war was gone, but that was part of the game that was then over), but rather more dangerous. The West and the Soviets had played their power games in the Third World, fueling and dampening conflicts there as desired, but having the money dry up in the wake of the Soviet collapse didn't mean the conflicts were gone, but rather that they were now free from interference.

To re-iterate: the end of the Cold War meant that the world exchanged one danger, one risk, for another, but one that the politicians and pundits ignored entirely, as their focus was on the Great Game as well. Just because the West won the Cold War doesn't, didn't and never will mean that conflicts of all types cease and that a golden era will break out: but that is exactly what the pundits and politicians preached, greedy to get their hands on resources to buy votes.

There is no strategy visible in US politics today.

To be sure, presidents fulfill their legal obligation to articulate the National Security
Strategy on a semi-regular basis. Likewise, the president and individual executive
departments make periodic vision statements in functional areas of responsibility like
National Defense, the War in Iraq, Terrorism, Cyber Security, etc. All, however, are
heavy on themes and messages and light on detail. None can purport to involve the
detailed articulation of achievable, minimum essential ends, the balanced adjudication
of ways and means, and a thorough analysis of the risks associated with action and/or
inaction. Yet, meeting this high standard is critical to securing the national interest in an
era of extreme peril, enormous opportunity, and finite resources.

Bingo. Vision statements are exactly that: visions. These can be the vision of the City On The Hill, or they can be visions from the wrong kind of mushrooms. The leftist rhetoric of how the military prolonged the Cold War by inventing threats appeared to have been vindicated, since the Soviets were shown to be a paper tiger (which the left had, to a certain extent, claimed all along), but this is ignoring the fact that you have to have a real tiger to find out if the other side is real or made of paper.

When their party is in power, partisan gadflies will argue there is more to national
strategy than meets the public eye—strategic communications is simply the icing on a
larger, more carefully prepared national security cake. They should know better. There
is a saying in government—"policy isn't made, it accumulates." The same is true for
strategy. To the extent more substance exists, it is buried under a blizzard of
memoranda and PowerPoint presentations across dozens of government agencies.
None of it exists with the benefit of high-level integration. Today, national strategy is
not the product of reason and grand deliberation. Rather, it results from the incremental,
issue-specific accumulation of small decisions. Few of these decisions can claim origins
in a detailed, risk-informed strategic design. Thus, the second- and third-order
implications of each individual decision lie unconsidered and the prospects of failure or
excessive cost are consistently unaddressed.

This is the triumph of the sophist, the victory of the Cult of Deception: burying reality and wrapping its ghost in a tissue of rhetoric.

We are where we are in the world. Blame the strategy deficit. As America's
ambitious and influential gather for another cycle of national debate and political
renewal, it would serve them well to rebalance the relationship between what is truly
strategy and what is rhetoric without substance. The former is elemental to securing the
nation's position and interests. The latter is a clear path to unmet expectations, excessive
cost, and failure.

At this point, I'll become clearly partisan and say that the only candidate that can even understand this problem is John McCain. And a President Obama would make Carter look like a senior statesman in comparison.