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Central American University - UCA  
  Number 227 | Junio 2000



Money Laundering and Investment: A Few Clues

Discovering how drug-trafficking profits are laundered and invested is complicated, risky and increasingly difficult. How has financial globalization facilitated these illegal operations?

François Chesnais

Starting at the end of the 1960s, certain platforms for "dirty" money began to be set up in offshore tax havens and financial centers—the same countries that act as a base for the geographic expansion of Eurodollars, out of range of their central banks.
There appears to be certain a correspondence in time and space between setting up the mechanisms and institutions of financial globalization and the use of increasingly refined ways to launder capital generated by drug production and sales.
The rapid rise of narco-dollars between 1985 and 1995 paralleled the financial deregulation and liberalization processes, which have increased the purely financial ways of ensuring capital growth, utterly unrelated to the production of goods and services.

Financial globalization: Three processes in one

Financial globalization is the name given to the intensification of interconnections between banking systems and national financial markets that has led to the appearance of a global financial space. This space is becoming increasingly unified and is overwhelmingly dominating the majority of national systems, although its structure remains completely hierarchical, with the United States still the nucleus and main beneficiary. The process is the result of a radical break with the old system of regulated financial operations and control over capital movement that had been in force in some countries since the crisis of 1929 and in others since the Second World War.

Authors classically identify three elements that set financial globalization in motion: monetary and financial deregulation or liberalization, the establishment of contacts among the different national financial markets and dis-intermediation [or in more lay terms the ability to directly access stock and money markets without going through a broker]. There is in fact a profound interaction and relation among these three processes. Financial globalization affects both the domestic de-compartmentalizing of different financial functions and types of markets (foreign exchange markets, credit markets, stock markets and bond markets) and the external interpenetration of national currencies and financial markets and their integration into globalized markets to which they are for the most part subordinated.

Searching for a needle in the financial hay stack

The volume of transactions related to drug production and sales has been the subject of a great many discussions. Estimates vary between US$100 billion and $500 billion a year during the first half of the 1990s, but while this is a lot of money, it is an insignificant part of the total volume of financial transactions made during the same period. Between 1982 and 1992, net international financing (bank credits, Eurostocks, international bonds) registered by the International Payments Bank rose from $1.23 trillion to $4.94 trillion. The stock markets have entered more slowly into the globalization process, but for several years now the growth of stocks issued by foreign companies has exceeded that of stocks issued by resident companies in most of the stock exchanges. The other market compartments have experienced a similar progression.

The markets in foreign exchange [the term used for the "hard currencies" universally acceptable as payment] are the global financial market compartment that has experienced the greatest growth. During the 1980s, trading volume in these markets increased tenfold and the daily volume of operations currently stands at $1.2 trillion. It is thus understandably difficult to identify the flows of "dirty money" within this overall volume once they penetrate the world financial system at any point.

In theory, the main function of foreign exchange markets is to expedite payment for international trade exchanges. But the latest survey by the International Payments Bank, done in 1992, estimates that transactions related to merchandise trade represented just 3% of the total daily transactions carried out in those markets. Foreign exchange transactions, what H. Bourguinat terms the international economy of speculation, got underway in successive stages starting in the 1960s. The volume of transactions in this segment of the market largely reflects the size acquired by the long and overlapping chains of operations and the complex and fragile pyramid of credits and debt—mainly hedging operations in the futures market—that link the main operators: banks, pension and investment funds and specialized investment houses.

As to the location of the globalized market centers, one of the main characteristics of financial globalization is that it has put the most prestigious centers—both old and new—such as City of London, Zurich, Geneva, New York, Chicago, Los Angeles, Frankfurt, Tokyo and Singapore in contact with the most "modern" and murky ones—the offshore tax havens and financial centers used by the big banks and corporations for their "gray-area" operations. The illegal activities that generate "dirty money" exploit every possibility offered for laundering and investing capital in these financial centers, such as Bahrain and particularly various states in the former British and Dutch Antilles, the Bahamas, Bermuda, the Cayman Islands and Hong Kong.

The logic of drug production and use

The era of globalization is not simply one of increasing interpenetration of national economies. It also involves, among other things, accentuated financing aimed at squeezing greater profit from available capital, with capital gains increasingly important; reduced profitability from productive activities; higher unemployment levels and the emergence of a dual society in the advanced capitalist countries. On the international scale, it is also an era in which an infinite number of countries and even whole continents are marginalized from world trade.

The end of the long growth period of the "glorious ’30s" and entry of the global economy starting in 1974-1975—a time of more or less successive economic recessions separated by weak recoveries—have made production and sale of industrial and agricultural products—and even of non-financial services—less remunerative and more chancy. An increasingly optimized supply generated by technological changes born out of microelectronics has run up against an effective demand whose growth is weakening as the new technologies greatly reduce the demand for employment in industries with an important labor component. Certain economic agents and social groups have reacted to this situation with "forward flight"—financing the placement of their capital—while others have increased their relations with illegal economic activities. The economic rationale underlying the two alternatives is not as removed as we might think. According to a 1995 analysis by the Geopolitical Drugs Observatory: "As the wide social support enjoyed by cocaine production and sale in Colombia and Bolivia shows, these are perfectly rational activities—even a reflection of survival—from the viewpoint of certain social groups and several poor countries whose traditional export markets have collapsed since the 1970s."
Moreover, the fact that this potential supply of products with narcotic effects is finding an increasing demand in the rich countries—peasants and miners from the Andean highlands have historically known how to regulate their social use locally—appears to be closely linked to the globalization of capital and the part played by finance, with its entourage of devastating social and human consequences. The social sectors being condemned to permanent unemployment and confinement to urban ghettoes by the endemic world crisis born of globalization are the same ones that provide drug trafficking with its biggest market. It is no coincidence that this criminal and deadly trade appears to be most dynamic in the main citadels of financial globalization, such as New York, Los Angeles and London.

Studying the laundering circuits

The Financial Action Task Force on Money Laundering (FATF), created during the 1989 meeting of the Group of Seven, the world’s seven most powerful countries commonly known as G-7, published a widely disseminated report during its first year of existence. Since 1991, when it became a permanent task force, the FATF has published short annual reports with more limited distribution. An examination of these reports reveals a growing awareness of the modifications that financial globalization has contributed to the techniques for laundering dirty money. The 1991 report still treated banks and other financial deposit institutions as the main agents transferring funds both within the G-7 countries and internationally. Over the years, this vision has broadened and become increasingly complex. Other areas began to be studied, including the growth of non-banking financial institutions and the role of businesses previously outside of the financial sector that now have easier access to it. As a result of de-compartmentalization and internationalization, the financial system has enabled dirty money to be hidden, moved and laundered, sometimes far from its geographical and social place of origin.

Three phases: Penetrate, export and repatriate

In the 1991 report, which detailed the terms of reference for its assigned mission, the FATF recalled that money laundering was classically considered to consist of three stages: when the money in cash penetrates the national formal or informal financial system; when it is sent abroad to be integrated into the financial systems of "haven countries"; and when it is repatriated through apparently valid transfers.

An examination of the FATF’s work reveals that these definitions are now too academic. In particular, the introduction of foreign subsidiaries of companies and the growing importance of offshore financial centers had already begun to break down the separation between the first two stages even before the financial globalization phase really started up.

The toughest operation has always been, and to a certain extent still is, injecting the huge sums of money to be laundered into the financial system. According to the FATF, the financial system includes a formal sector, basically the banks, and an informal sector. Traditionally, money laundering seeks out financial systems located abroad according to a number of different factors, one of which is size. In the United States, for example, the sheer number of financial institutions increases the possibility of penetration and dissembling the operations. The kind of lax legislation that exists in the tax havens is another factor, as is the custom of banking secrecy in such countries as Switzerland and Luxembourg. These three advantages for money launderers can be found in both the banks and the informal financial sector.

In the case of banks, the traditional and dominant laundering method has been to make cash deposits. This operation requires the conscious complicity of some of the bank staff or the ability to convince the financial establishment of the legitimacy of a strong cash income or the purchase of a cashier’s check. The case of the infamous Bank of Credit and Commerce International (BCCI), which built its fortune on fraud and narco-dollar laundering, as well as of many other US banks, has shown us that this is not just a theoretical problem. Other banks whose central offices or branches have been denounced include the First Bank of Boston (central service for foreign exchange transactions), Chase Manhattan, Irving Trust, Bank of America and Hutton, an important Wall Street brokerage firm.
The employees directly involved were tried and sentenced, but the banks themselves were simply fined, in amounts that pale in comparison with those they helped launder. Although several top BCCI officials were arrested and tried for money laundering in 1988, it took a fraudulent bankruptcy to bring about an investigation, which resulted in the bank’s judicial liquidation in 1991.
The high-ranking protection the BCCI enjoyed in the United States and the United Kingdom has been the subject of various impassioned investigations. Among the financial systems of the central countries, accusations focus on two countries in particular: Switzerland and the United States. A whole range of respectable banks could be implicated through their branches in the offshore tax havens and financial centers.
States that have created a legal framework protecting financial secrecy in order to attract capital not only form part of the unrestricted "world payments system," but have also been important springboards of financial globalization, even though its growing importance has shrunk their own role.

"Smurfing," tax havens and specialized lawyers

The FATF states that in the last ten years, various member countries of the G-7, particularly the United States, have taken measures to make it harder to make sizable cash deposits in banks. Security services offer more systematic attention to important cash deposits thanks to an automatic declaration system for such deposits or one that makes the declaration of suspicious operations obligatory.

In countries with such controls the launderers have to break up their income into amounts that are below the established limit in order to get around the declaration. This is known as "smurfing."
Before financial liberalization and deregulation facilitated laundering in the central financial systems, tax havens represented the best place to deposit the financial profits of drug trafficking in banks outside the country of origin. FATF defines a tax haven as a country whose banking system is not sufficiently regulated and which authorizes the installation of "mailbox" companies.
This kind of legal system is found, for example, in small countries that want to create a "financial services industry" to provide complementary employment for the population and needed additional national income, through the sale of banking licenses, for example.

In the tax havens, the initial phase of laundering has always required affiliates to transport the funds in cash as well as the intervention of in-country brokers. The classic example of this is the specialized lawyer who acts in the name of clients that hide behind the professional secrecy of those representing them.
The deposits are often made in the name of a company, thus dissimulating the identity of the real owners. Those responsible for signing for the firm or who receive the payments do not necessarily know the owners’ names or the origin of the funds. Nowadays, the central instruments in money laundering and fiscal fraud are offshore "shell" companies.

More sophisticated ways to invest dirty money

A quick reading of the FATF’s annual reports suggests that while considerable progress has been made in controlling the penetration of funds into a certain number of countries that have imposed stricter measures, these advances have been almost cancelled out by financial globalization. The Group’s official 1994 report points out that, since globalization, "There were further indications of the existence of joint ventures of drug traffickers and financial professionals, which resulted in increasingly sophisticated money laundering methods." Such methods are used not only for circulating and laundering money within the financial sphere, but also during the penetration stage. The liberalization of the movement of capital, the multiplication of overseas bank branches and subsidiaries and deregulation have all provided a field of action for the depositing of funds abroad that far outstrips the circle of states with tax havens. In 1995, the FATF confirmed the increasingly frequent recourse to second-line banks and to accounts opened in the name of foreign companies. The use of representative offices of foreign banks for laundering purposes has also been detected.

Financial liberalization and deregulation have allowed a notable increase in the circuits of penetration during the first stage of laundering on the "informal" level. Since 1993, the FATF has talked of "the trend towards greater use of non-banking financial institutions as a means of getting the proceeds of crime into the financial system…. The use of bureaux de change, casinos, financial brokers, life insurance and postal money orders were all mentioned."
The 1995 report again underscored the launderers’ general tendency to abandon the banking sector and seek out non-banking financial institutions and non-financial activities.

Bureaux de change: The first non-banking "laundries"

The oldest and most commonplace non-banking institutions used in money laundering are bureaux de change, exchange houses that accept money in one currency and return its equivalent in another. Although this operation does not resolve the problem of having the money in cash, it does achieve an initial transformation of the money that helps to further complicate detection of its origins. The liberalization of currency exchange along with the growth in mass tourism and in international transactions has led to a considerable increase in the number of exchange houses and of the amounts they handle, thus facilitating the laundering process.

The buyers of checks against cash, which mainly guarantees this service outside banking hours, can also work in reverse: selling checks at an advantageous price against cash. The staff of these offices, who generally work with precarious contracts, are generally more open to corruption than bank workers, who constitute an organized and highly unionized sector in many countries. Today, manual exchanges play an important role in the penetration stage and some modest establishments have been used to transfer large sums of money.

More doors opened by competition and the removal of controls

Financial deregulation and liberalization have also allowed other non-banking financial institutions to increase the number and variety of their operations, so they can receive and relocate money with fewer controls. The professional ethics of these institutions are much more lax than the traditional institutions. Financial brokers have gone into this market as well as into others.

There is little tangible proof of laundering through stock brokerage firms, but according to the 1995 report this is more because of the difficulty of discovering laundering activities in this sector than the fact that they are not used so much. In the insurance sector, single premium insurance bonds of one kind or another are an increasingly popular laundering mechanism. Laundering has always sought out non-financial firms that handle large cash funds, and while the specialized services traditionally monitor casinos and companies that trade in gold and precious gems, there has been an increase in these kinds of businesses.
One of the effects of deregulation and liberalization—especially in countries where the "neoliberal revolution" has developed further—has been to open up the previously regulated and therefore controllable financial sector to competition. This has given companies that do not traditionally belong to this sector a lot of maneuvering room to carry out financial operations.
When this happens, according to the FATF, "at least certain financial activities can be conducted by any business in conjunction with its mainstream operations. An example is the provision of bureaux de change facilities by travel agencies. If no measures were taken in this area, there would be a potential loophole in the anti-money laundering framework which could be exploited by criminals." The same considerations are valid for financial dis-intermediation, which allows certain non-financial businesses direct access to the financial markets and therefore to the international money circulation networks.

Electronic transfers and "shell" companies

Once the dirty money has managed to penetrate the globalized financial system somewhere, be it in the formal or the informal sector, it is extraordinarily easy to move it to the international scale. Financial globalization first facilitates the "layering" process, defined as "conducting a series of transactions to hide the illicit origin of the money." This aspect has both a technical and a legal dimension. Financial globalization allows the possibilities offered by technological advances in the area of telecommunications to be exploited to the maximum. First telegraphic transfers and now electronic transfers have made the international circulation of funds easier than ever before, and financial deregulation and liberalization have increased the effect. But it is not just a question of technology. Globalization has also led to an unprecedented expansion of the most refined combinations authorized by the legislation covering corporations, such as the ex nihilo creation of "shell" companies or the use of existing companies for the same ends.

The seriousness of this aspect is emphasized in the FATF’s latest report: "Bearing in mind the propensity to use ‘shell corporations’ in capital laundering operations, the aim is to ensure that the real owners of these companies are identified and that the operational services that investigate laundering crimes have access to this kind of information. As the Group’s work has advanced, we have confirmed the importance of applying the principle of transparent ownership to all companies, as not only shell companies but practically all legal entities are susceptible to being used in the mechanisms for laundering capital."
Evidently it is completely illusory to think that the fight against money laundering could lead to any serious treatment of the question of business secrecy, a subject that so many companies and politicians consider an inherent part of free enterprise.

"Drying" the laundered money

Investing laundered money has become child’s play for financial specialists. Financial globalization has increased the possibilities of investing such capital because it is now "clean" both in the country of origin and everywhere else. It is known that illegal capital has a predilection for certain large-scale service activities, particularly wholesale and retail trade—currently located in the big commercial areas, malls or centers—as well as tourism, the leisure industry and real estate sectors.
"Association with finance professionals," particularly brokers and stock-market companies, leads to the assumption that most drug trafficking profits are invested within the financial sphere—in the framework of mutual funds, for example. The same is true of any other capital mass when the aim is to keep it as money and invest it so it remains within the financial sphere in the globalized markets. Hence, once dirty money has been laundered and invested it acquires a convincing aura of respectability

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