How the Pentagon Aims to Stop China's Cyber-Hacking of America

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Given the deficit fears and budget skirmishes that are focus of the moment down in Washington, it's tough to get excited about defense-related investments right now.

Defense outlays are destined to shrink.

But there's one area where spending is slated to go up …

And I mean go way up.

I'm talking, of course, about defense-related spending that will promote cybersecurity and combat cyber-terrorism.

Here at Money Morning, we've talked a lot about the massive surge in cybersecurity spending that's destined to unfold in the years to come. Much of our focus has been on private-sector spending – although we also said the Pentagon and the rest of the federal government would also be factors.

Over the weekend, the Pentagon gave us a hefty reminder of why we're watching the cybersecurity sector so closely.

On Sunday, defense officials said they were working on a big expansion of their cybersecurity forces – with two key objectives.

First, with the number of attacks on America's computer networks growing constantly, defense officials want to be able to counter the incursions that could cripple our economy, as well as our national security.

And, second, the Pentagon also wants to be able to take the battle back to America's digital enemies.

"The threat is real and we need to react to it," William J. Lynn III, a former deputy defense secretary who worked on the Pentagon's cybersecurity strategy, told The New York Times.

That strategy would require a 444% increase in the U.S. Department of Defense's Cyber Command - boosting its ranks from 900 now to an estimated 4,900 when the expansion is completed, The Washington Post reported this weekend. And those folks would be divided into three groups, each with a different mandate, including:

  • The "national mission" force, which will protect the computers systems that support America's power grid and other critical "infrastructure."
  • A "cyber-protection" force, which will maintain the security of the Pentagon computer systems.
  • And a "combat mission" force, which plan and execute attacks on U.S. adversaries.

Back in October, U.S. Defense Secretary Leon E. Panetta warned that America – having become the choice target of overseas hackers – was headed for a "Cyber Pearl Harbor." Some of these hackers are operating under the stewardship of militant/extremist groups, or even "aggressor nations."

When it comes to those aggressor countries, I bet you can name the prime suspects without even thinking: If you said China, Russia and Iran, you hit the bulls-eye.

The worry is that one of these groups could pull the plug on the U.S. power grid, stall our transportation system, overtax our financial system, or infiltrate a government agency. Any one of those could have catastrophic implications for the country and its economy.

And these fears aren't overblown. Insiders say that a digital boxing match is already underway – one The Times described as "an emerging shadow war of attacks and counterattacks already under way between the United States and Iran in cyberspace."

A case in point is last August's computer attack on state-run Big Oil player Saudi Aramco, an incursion that infected and even made useless more than 30,000 computers. By October, the U.S. intelligence community had become convinced those attacks had come from Iran.

While there's no "hard" evidence these attacks were sanctioned by the Iranian government, Panetta is said to have become especially concerned about this particular incident.

Here's why. Back in 2011, Iran's military created a "cyber warfare" corps of its own. The United States and Israel had launched cyber-attacks against Iran's nuclear-enrichment facility at Natanz. Iran created the "cyber-corps" unit in response – and claim that was the unit that "commandeered" and landed the U.S. state-of-the-art Lockheed Martin RQ-170 Sentinel unmanned aerial vehicle (UAV) back in December 2011. (The U.S. military disputed the claim and said the UAV crashed because of a malfunction.)

If the thought of cyber-warfare-savvy Iran has you spooked, try this on for size: That country's capabilities are said to be nothing compared to the digital-hacking muscle that China and Russia possess. And those two countries are believed to be the source of a large number of the hack attacks on U.S government agencies and private-sector companies.

(Just this week, The New York Times revealed that its computer systems had repeatedly been penetrated by Chinese hackers, who were stealing reporters' passwords and hunting for insights into the newspaper's hard-hitting expose of the $2 billion in wealth amassed by the family of China Premier Wen Jiabao. Beijing has vehemently denied the allegations, but Times Chief Information Officer Marc Frons told The Guardian newspaper that "this is business-as-usual from what we can tell for aspects of the Chinese government. It is really spy versus spy. I don't think we can relax. I am pretty sure that they will be back.")

Indeed, China's military-backed "cyber-espionage" efforts pose "an advanced persistent threat to U.S. national and economic security," the Project 2049 Institute, an Arlington, Va.-based think tank that focuses on Asian security issues, said in an October report. Groups operating from Chinese territory have been "waging a coordinated cyber espionage campaign targeting U.S. government, industrial, and think tank computer networks."

The report concludes that China's military cyber activities are housed under the "Third Department," a general-staff-level component of the People's Liberation Army (PLA) that is Beijing's version of the U.S. National Security Agency (NSA). The Third Department has strengths in such areas as signals-intelligence (SIGINT), high-performance computing, and linguistics and code-breaking. It also conducts "cyber reconnaissance," which can involve breaking into foreign computer networks in preparation for future battle or conflict, the think tank report concludes.

I remember reading Forbes piece in mid-2011 that said that cyber warfare would be a "bust" for defense contractors – and, by extension, for investors. It was a well-thought-out piece, and the arguments made some sense as far as they went. Trouble was, the author was looking at the "market" from the wrong vantage point. And, as we've seen, the situation has changed substantially since May 2011 – with the situation having become much graver.

As an investor, you don't look for the one or two big defense contractors who are poised to profit from this … you look for the technology providers who are best-positioned to capitalize on the spending that has to take place to make these initiatives possible. This approach allows you to also factor in cyber-security spending of all types – including private sector spending – and throughout the world. That's expected to grow from $60 billion in 2012 to $86 billion by 2016, says a recent forecast from researcher Gartner Inc.

That figure includes worldwide spending on security infrastructure, including software, services and network-security appliances used to secure enterprise and consumer IT equipment. The $60 billion spent last year represented an 8.4% increase from the $55 billion spent in 2011.

"The security infrastructure market is expected to experience positive growth over the forecast period, despite risks of further economic turbulence," Gartner Research Director Lawrence Pingree said.

"Results from the 2012 annual Gartner CIO Survey show increased prioritization for security compared with 2011 and results from Gartner budgeting surveys published in June 2012 underline the fact that organizations globally are prioritizing on security budgets."

The fastest-growing security segments will be IT outsourcing (managed security services), secure-Web gateway (appliances), and security-information and event-management (SIEM) emerging as the fastest-growing security segments. Demand for cloud-based security will also experience frenetic growth, Gartner said.

Whenever there's a big trend, we look for ways for you to profit from it. And you can bet that we'll continue to do that with cybersecurity.

In the meantime, however, you might want to take a look at EMC Corp. (NYSE: EMC), a stock that we profiled in the special-investment-research report "Big Trends Equal Big Profits." Our June 29 report focused on the big gains we're expecting to see in Web traffic in the next few years – a reality that will drive the need for storage (EMC's core competency) in a big way.

Although it's a big-cap stock, it's awfully cheap right now. It's a market leader in data storage and data security. And in addition to a specific focus on cybersecurity via its RSA business unit (formerly RSA Security Inc., which it bought for $2.1 billion back in 2006), EMC is also involved in such growth niches as cloud computing.

And we believe the market is seriously undervaluing this company. If you want proof, just look at how quickly the stock rebounded from an early week sell-off. EMC reported earnings that beat expectations, but offered guidance that said 2013 looked "challenging." The stock initially dropped, but has since gained it almost all back.

Indeed, Web researcher Trefis.com puts the target price at nearly $41 – or 67% above its trading price yesterday.

Private Briefing will be back with additional recommendations as we uncover the best ones.

If you'd like to join the thousands of investors we've already helped to make big money in the markets, just click here.

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About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.

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  1. Denise | February 1, 2013

    The Obama administration has already sold these countries rights to everything that they could ever want or need.

  2. Thomas Hegarty | February 1, 2013

    Clearly there is a chink in the armour here alright.
    A relatively cheap way of waging a potentially devastating attack.
    Let's not forget for a single moment how completely and too reliant, society has become on electronics, from switch gear in telephone exchanges for 'phone and wi fi connections, satellites for GPS used by civilian and military to the service tills using automated stocking controls in supermarkets, never mind the stock exchange !
    Emergency services, ambulance and fire for instance could be instantly made impotent.
    Not only from cyber attack, a near to hand cosmic ray burst would fry all of that and more !
    Just hope it never happens. (Apparently indicators have been found to show that it has indeed happened in earths not too distant past ! )
    The other thing to be aware of, is that not all of that money will be directed to looking outwards, a great deal of it will be looking inwards at thee and me. All in the name of "Terrorists," "Cyber Attacks," "Alqaeda," in your case, "Homeland Security," protecting the public. You'll hear things like " If you've nothing to hide, you nothing to fear!" Sure, we can trust you, can't we ?
    We can all see China has a huge military force, land sea and air. I know they don't have planes on their 'carriers…yet! They do have their own space station (Didn't see that in the press?) They will be well equipped to use muscle in the furtherance of their hunger for natural resources. Who in the west, will have the strength or the will to oppose it ?
    Those disputed islands of the Chinese mainland and Taiwan, are going only one way ! That is where the resolve of the west as a whole will be tested first.
    America has become so vulnerable to the dollar being dumped by the Chinese never mind a cyber attack as well.
    In London, the Chinese have bought into major institutions here. You would have to assume that the internal workings of these institutions would be laid bare at the same time and their weaknesses too. Whose fault is that then, if you willing to whore your company out for money and don't give a damn where it comes from ?

    • (Admin) Bill Patalon | February 1, 2013

      Good stuff, Thomas …

      William Patalon III
      Exec. Editor
      Money Morning & Private Briefing

    • Joe Aerospace Engineer | June 13, 2013

      1. This Chinese stealing of secrets has been going on at least since the Clinton administration and certainly during Republican administrations, so lets try and work FOR this President and not be UNPATRIOTIC and work against him!

      2. We should pass a law that prohibits the sale of classified information to another military power. But that's not enough. Something smarter and more secret is afoot !

      3. Our President knows the importance of cyber attacks and that is why he smashed IRAN with a cyber attack. The one they sent us back was a Whuuss!…We are already ahead of China on all of this too. China may not even know it, which is laughable!

      GEORGE W. BUSH SOLD SECRETS TO ISLAMIC NATIONS.

      For DENISE…. Mr.Bush Sold Military Secrets to Islamic Nation, DENISE– SORRY TO CONFUSE YOU WITH FACTS –

      Turkey has been an active member of the F-35 project since 2002 — the Bush years, for those who've forgotten. In 2007 — again, the Bush years — Turkey signed the "memorandum of understanding" that would allow it to actually purchase completed F-35s. Could this be where the F-22/F-35 fuselage look alike came from? It began by supplying fuselages and engine intakes. If Turkey is indeed a traitor to our cause, it's the former president, not the current one, who has much to explain. And don't forget our most cherished ally- SAUDI ARABIA, the bosom buddies of the Bush bunch!

  3. fallingman | February 1, 2013

    They may WANT to expand the cyber security/attack forces from 900 to 4,900, but I'd like to know where the people with the requisite skills are supposed to come from. China? Do we plan to outsource, because those people don't exist, at least not those with names like Bob and Charlie and Chelsea.

    Seriously, to acquire that number of suitable, qualified people, they'll have to do two things together…cannibalize from utility companies, banks, etc. and clone some existsing hackers.

    Good luck with that. I'm sure neither should be any problem for the geniuses at the Pentagon.

    • (Admin) Bill Patalon | February 1, 2013

      Fallingman:

      That is, in fact, an issue. And a big one. I am working on a folo on this and that's a key point that I make.

      Bill Patalon

    • DD | February 1, 2013

      Fallingman – I agree with you that China is probably nowhere near qualified to do all the cyber attacks on the scale that the US is making out they’re doing and these people don't really exist. It's nothing but US fear mongering and only an idiot would believe this.

      And even if China were cyber attacking the US, so what!
      Look at all the countries the US has cyber attacked and drone attacked etc., in years gone by. What turns around comes around! The US hypocrisy, lies and deceit is sickening!

  4. DD | February 1, 2013

    The US only needs to look in the mirror to see who's behind most cyber attacks that happen anywhere on this planet and it sure as sht is NOT coming form China.

    What most American's fail to realize is what this country reckons China is doing, was done by the US prior.

    USA = Hypocrisy at its best and then some!

    Wake up you sheeple people and make the Gvt et al accountable for their ongoing lies and deceit.

    Suggested reading the “Creature from Jekyll Island” by G. Edward Griffin

  5. fallingman | February 1, 2013

    Mr. Hegarty…spot on. And thanks for the comments DD. I actually think the Chinese have quite an advanced capability. I was making a lame joke. But to your main point, I too think the real threat rests in Crystal City and that the "external threat" thesis is completely overblown. As kids would say…"You started it." Well, that's what I would say to the Pentagon.

    And yes on Creature!

    My concern…and I really shouldn't even state it here…is that the next false flag event will be of a cyber nature and will result in an even greater assault on our rights and privacy and an even more intrusive and imperial central state.

    So easy to blame on others when all this stuff is invisible.

    Thanks Mr. P for broaching the subject. It's a touchy one, but very important IMO.

  6. Leslie Belden | February 1, 2013

    If this is suddenly a big fear, then we're a day late and a dollar short! It's looking more like Pearl Harbor all the time, if we've been ignoring the clear signals until now.

    • DD | February 1, 2013

      Leslie – Yes, the thing about Pearl Harbor is that, is was NOT a surprise attack at all. FDR knew PH was going to get attacked by the Japs well in advance but did nothing about it or even try to prevent it, hence, he let it happen. It was just one of many ‘ulterior motives’ to get the US into WWII at the behest of the wealthy elite.

      The are many lies that are deep and twisted and people need to get educated and demand the truth; because it's Main Street that end up paying with their lives etc due to the deceit of the Gvt and elites.

  7. Gerald Arbeau | February 1, 2013

    The solution should be that "NOT EVERYTHING" has to be always connected to the WWW! My business computers that have my customer data base info is not connected to the web/internet or has email. I use a separate computer for banking that is not the computer I use for email and web surfing. Heck, Even our local police files and medical records that should be connected for other communications are not shared information! There is something wrong with the mentality of those that think "passwords" make safe the huge secrets of potential harm of leaked information. Where do these "smart keepers" of our potential harmful information get there common sense from???? There is no reason the national power grid should be so vulnerable except for stupidity of not having safety measures in place, to disconnect at times where irregularities will trigger indicator gauges at many places on the grid before the catastrophe explodes. Even most homes have limit built in circuits to eliminate this.

  8. JOHN LAFRANCE | June 13, 2013

    We are doing a great job in cyber stumping China! I am former aerospace and I am not worried.

    Don't believe otherwise!

    Go Drones!

    Go NSA!

    and incidentally…..

    Mr.Bush Sold Military Secrets to Islamic Nation – Esquire

    Check out the facts. Bush sold secrets to Turkey, and they in turn sold them to Iran and China. And of course, you will never hear this on FOX NEWS.

    To Patalon 3, Don't ask for shares if you don't like odd names!

    and please give equal time to the truth, not just to a bunch of road hog tree stump Republican Couch Potatoes in love with themselves and their own lies!

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