In general, capitalist economies depend on the movement of capital (money) as a means of maintaining growth and generating profits. In a free-market or laissez-faire capitalist model, there would be no restrictions on the movement of money – no taxes, trade tariffs, or financial regulations at all – and prices for goods and services would be entirely determined by market forces.
Instead, thousands of different regulations, taxes and tariffs influence and control the movement of money. These financial instruments play various roles – they may control interest rates on loans, redistribute wealth in the form of benefits and healthcare to poorer sections of society, allow governments to control prices so that the cost of basic necessities remains affordable, or introduce trade tariffs to protect valuable industries.
Thus, a truly free market does not exist in the world today. Individual countries and regions vary in the extent to which they regulate business, but all nations today impose taxation and regulations to some extent.
Due to financial red tape, conducting business transactions can be complex, slow, and subject to scrutiny from various financial authorities. But within this complexity, there are almost endless opportunities to bend or break certain rules, or just make up new ones entirely – as essentially occurred with the subprime mortgage scandal and the system of credit default swaps.
Then, if the rules get broken or bent too far, it can cause instability that can ripple out and wreak incredible economic devastation, culminating in recessions or even depressions. This has happened a remarkable number of times throughout history.
In 2008, the financial manipulation of the mortgages and securities market caused the failure of the two largest US mortgage lenders, Fannie Mae and Freddie Mac, causing a domino effect within the banking industry – and ultimately a global recession.
In severe recessions, spending and investment practically grinds to a halt. With businesses and governments unwilling to spend or invest, the amount of liquid capital in the system rapidly declines. Profits go down, wages and jobs are cut, and governments generate smaller tax revenues – and desperate measures such as quantitative easing, bank bailouts and austerity may be implemented.
But there is a form of capital that remains relatively unaffected in these situations, largely because it is not subject to taxes, regulations, or interest rates. This is illegal or “black” capital, generated from illicit economic activities including drug smuggling, human trafficking, prostitution and gambling. A 2009 UNODC report estimated that together, these “black” industries were worth $2.1 trillion that year, or 3.6% of global GDP.
Of the illegal industries, the single largest sector is drugs. In fact, drug capital alone may make up almost 1% of total world GDP. The UNODC estimated that $321 billion was spent on drugs in 2003; the same year, total GDP was estimated at $38.7 trillion, indicating that 0.83% of the total world GDP was generated from drugs.
According to some economists, this liquid, illegal money may be fundamental to the maintenance of the current global economy. Antonio Maria Costa, former head of the UN Office on Drugs and Crime, stated in 2009 that the proceeds of crime represented “the only liquid investment capital” available to banks in danger of collapsing during the 2008 crisis.
“Inter-bank loans were funded by money that originated from the drugs trade and other illegal activities… There were signs that some banks were rescued that way”, Costa stated.
Without it, he argues, the financial crisis of 2008 could have led to an all-out global collapse of the banking industry. Instead, although numerous major banks failed, others scraped through thanks to the availability of illegal money.
But where exactly does this liquid, illegal capital come from, how is it moved around the world, and how do banks have access to it?
First, let’s talk about liquidity. Capital is liquid when it can be easily moved around and exchanged. Thus, physical cash is the most liquid asset of all. Money held in bank accounts and bonds is often also classed as cash, because it can be quickly and easily converted into physical cash if needed. It’s liquid capital, but not quite as liquid as a bundle of banknotes.
At the other end of the scale, we have illiquid investments such as houses, art, money locked up in long-term savings accounts, business assets – things that can’t be easily exchanged for cash, and that are subject to lengthy procedures to become accessible.
Next, let’s discuss legality. All money, when it comes into being, starts off as “white”, legal money. It’s only after it is illegally obtained that it becomes “black” money – so when money is stolen, spent in illegal transactions such as drug purchases, or fraudulently withheld from the tax office, it becomes black money.
Black money is the most liquid capital of all – it is overwhelmingly in the form of hard cash, and it changes hands without being delayed or diminished by red tape and taxes. In this respect, the black market is arguably closer to a “free” market than any legal, regulated market.
Although some drugs may be purchased with stolen money, the vast majority of money spent in illegal drug transactions is in the form of small cash amounts that come directly from the end consumer, from wages, salary, savings, inheritances or benefits legally available to the consumer.
Cumulatively, this sum of money is not trivial by any means – a 2014 report estimated that the US population spends $100 billion annually on drugs for personal consumption. As previously mentioned, an estimated $321 billion was spent on drugs throughout the world in 2003; of that, $214 billion was spent at the retail level. It’s important to note that these figures are estimates, as tracing the movement of black money is extremely difficult, given the secretive nature of illegal industries and the risks involved in studying them.
Suffice it to say that the average consumer, as well as plenty of small-time illegal retailers, hardly needs to consider the movement of drug money once it has left their hands. For the consumer, the drugs are purchased and that’s that. For the low-level dealer, the profits generated can be spent as disposable cash in small amounts that won’t attract the attention of the financial authorities. Thus, a substantial chunk of cash slips in and out of the black economy at this level.
But the small-time retailer purchases their product from distributors further up the chain, who ultimately will be dealing with amounts of cash too large to use without attracting attention. Individuals or organizations at this level now have to think about how to “clean” their money, so it can get back into the white economy with a good explanation of its movements and existence.
Without that, expensive cash purchases could attract the wrong attention – attention that could lead to long, secret investigations, arrests and prosecutions, and the seizure of money and assets.
Therefore, a system that allows money to be cleaned and safeguarded in return for an agreed percentage is a necessity for any sensible dealer. Hence, the existence of money “laundering” – literally, the cleaning of money.
Money laundering also serves another important benefit – with the right setup in place, money can be transferred between countries and individuals with remarkable speed, by utilising the white legal network but remaining effectively outside of it.
The money laundering industry is the most important bridge between the black economy and the white, and may process as much as 2.7% of total world GDP per year (an estimated $1.6 trillion in 2009). Money laundering businesses may be “front” companies that are set up for the sole reason of cleaning money for criminal organisations, or may be otherwise legitimate businesses with a clandestine sideline in money laundering.
It’s in this latter category that we find the most damning evidence of the involvement of “white” businesses in the “black” economy – such as certain major banks, which have repeatedly been exposed for illegally profiting from drug money.
In 2009, it was discovered that two major banks, HSBC and Wachovia, had managed accounts for the Mexican Sinaloa Cartel, laundering hundreds of billions between them. Wachovia laundered approximately $420 billion for the Sinaloa Cartel between 2003 and 2008 – and on Wachovia’s behalf, workers at Mexican branches of HSBC routinely took delivery of and handled this money.
In 2010, after a 22-month investigation, Wachovia was punished with a “deferred prosecution” along with fines and forfeitures totalling $160 million – just 2% of its profits that year. By this time, Wachovia had been bought by Wells Fargo, and had ceased its money-laundering activities apparently for good.
HSBC, on the other hand, continued to profit from money-laundering activities for several more years. It is reported that cartel members deposited hundreds of thousands of dollars every day at HSBC branches, with no questions asked by the bank.
In 2012, HSBC was fined $1.9 billion for its money-laundering activities – among the biggest banking fines in history, but a tiny fraction of its annual profits. It was also hit with a five-year deferred prosecution – but as the New York Times put it:
“Federal and state authorities have chosen not to indict HSBC, the London-based bank, on charges of vast and prolonged money laundering, for fear that criminal prosecution would topple the bank and, in the process, endanger the financial system.”
These cases exposed a deeper undercurrent of complicity between big banks and drug traffickers that stretches back decades, if not centuries. The extent to which major banks have cooperated in the laundering of profits from criminal organizations is endemic, and has arguably underpinned almost two centuries of Western-driven capitalism.
What’s behind this complicity between banks and illegal drug runners, and why do governments and judicial systems apparently work to protect the relationship? If the aim truly is to eradicate the global drug trade, the correct approach would surely be to expose and sever it.
To fully understand the complex relationship between banks, governments and drug businesses, we first need to look at the history of the global drug trade, with its roots stretching back to the European colonial period.