Addressing the Billions Underserved

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The Futility of Taming the Shadow Economy

Black money is that which is unaccounted for on balance sheets, tax returns or income statements.  Put differently it is the shadow economy that is not counted in official statistics, definitely has not been taxed at the point of sale or criminal in nature, be it drugs or arms running, ransom to kidnappers, bribes taken by politicians and officers, etc.  All of this will fall under the official term money laundering or tax evasion.

In 1996, the IMF came up with the hazy estimate that 2-5 % of the global economy is involved in money laundering of one form or another. Singapore (AMEX:$EWS) and India (AMEX:$INDY) just announced yet another plan to combat money laundering through their financials systems.  In particular Singapore has been very aggressive as their prominence in the global financial community has increased in trying to vote this kind of money off their island.  Another recent move to dramatically raise both the fines and the level of oversight of their two casinos was clearly aimed at deterring this activity flowing through their economy in an obvious attempt to attract capital fleeing the increasingly corrupted U.S. and European banking system.

HSBC (NYSE:$HBC) is facing a serious inquiry into its failures to control the flow of money from countries currently under sanctions by the U.S. government and staring at potential fines of $1 billion Dollars.  Wells-Fargo (NYSE:$WFC) has already paid big fines over this. Of course, the grandstanding by the U.S. Senate’s Sub-Committee on this subject in an election year, singling out a Hong Kong bank for money laundering while JPMorgan (NYSE:$JPM) and Bank of America (NYSE:$BAC) are at the center of the LIBOR scandal as well as other price-fixing schemes, outright theft of customer funds in the in case of MFGlobal and Peregrine Financial, and robo-signing mortgage documentation without any criminal prosecution for actual theft and fraud. 

Difficulty in the Beginning

The whole problem of money laundering is a natural consequence of a solution in search of a problem in many ways.  Governmental edicts create a dislocation in the flow of goods based on the cost of the intervention itself.  The Iranian sanctions are but one example.  Whether the U.S. government likes it or not there is a demand to trade with Iran and people will always find a way around such sanctions, allowing the money to flow, albeit in a more circuitous manner than it would otherwise. 

Prohibitions of any kind create first huge profit margins for the prohibited item/market morphing the economics of the problem to match or exceed the level of violence implied by the enforcement of the edict/prohibition.  The more stringent the enforcement of the prohibition the more likely the situation will devolve into violence and chaos. 
So, while the IMF’s anti-money laundering division, the FATF, may have estimated that the amount of money laundering going on at that time was $1.5 billion annually, the truth is that the number is much higher than that now with the level of escalation that has taken place in the form of drug law enforcement in the U.S., capital controls, etc.  The crisis in Europe has caused hundreds of billions of Euros to be pulled across the borders of Greece, Spain, Portugal, etc. into relative safe-haven countries like Switzerland who no longer wants coming in any more than the Italians want the money leaving. 

Yet, by definition, people attempting to preserve their wealth in the face of a bank collapse would be considered a money launderer.  Anti-money laundering and Know Your Customer laws enacted in the U.S. make the transportation or moving of large amounts of cash 1) reportable to the government and 2) difficult as banks essentially treat their customers as criminals, asking what they need it for, giving thumb prints, outright refusing, delaying the transaction, etc. 

Fruitless Exercise

In a 2011 article from Business Insider John Walker the CEO of Crime Trends Analysis in Australia was quoted as saying,

“I do not believe that anti-money laundering has had any significant impact on rates of global crime, except to have forced changes in the way that the proceeds of crime are laundered.  If I had money to launder right now, I would take advantage of the lack of oversight of international trade prices – particularly in services.  The Global Financial Integrity Project led by Raymond Baker focuses on flows of finance illicitly removed from developing countries, concluding that for every dollar of aid ‘given’ to developing countries, there are $10 going the other way due to corruption, multi-national company tax evasion and straight out fraud.”

The irony, of course, is that the U.S. is at the center of forcing banks to heel, when politically convenient, over what are essentially manufactured crimes, and also the most likely source f the most black money in the first place by far.  Walker’s estimates are that more than 40% of the money laundering originates there.  Considering the size and scope of the War on Drugs this should not surprise anyone.

The Problem with the Solutions

According to a former Indian Finance minister India's black money is almost half of its GDP.  In that sense accurate assessments of India’s GDP growth are almost impossible.  In a white paper by the Department of Industrial Policy and Promotion, India, it was shown that Mauritius and Singapore accounted for almost 51% of the entire FDI received by India between FY01 & FY11, and that the money was routed this way to avoid taxes and/or to hide the identities of the investors many of whom were Indian citizens.

Other studies have shown that the problem is righting itself, at least as a percentage of GDP in the BRICS (AMEX:$BKF) nations over the past half century which makes perfect sense since both China and Russia, for example, have moved from oppressive Communist societies to much more economically open and diverse economies.  Bluejeans are no longer prohibited in Moscow and Beijing.

As I said earlier, for many of the sources of black money, much of this a solution in search of a problem.  As these economic and fiscal crises continue to unfold in the West the banks will continue to be scapegoated, and likely forced to kowtow to even more insane forced buying of government securities which is what it means to be a primary dealer these days.  The explosion of economic growth, however, when these prohibitions/subsidies are unwound will be far higher than can be calculated, as all of the money that is currently working inefficiently to get around the government edict/enforcement system will be freed to work unencumbered to the benefit of everyone.

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Peter Pham is an author, international fund manager, and a registered financial director by the Cayman Monetary Authority (CIMA). In 2013 he published his first book entitled, The Big Trade: Simple Strategies for Maximum Market Returns. He currently manages the portfolio of a global hedge fund and runs an asset management company, Phoenix Capital.  (read more)

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