When I lived in Argentina in the mid 1990s, most of our friends still acutely remembered the hyperinflation from less than a decade before. They told stories of grocery shopping and hearing, announced over the loudspeaker, that the prices on everything in the store just went up 10 percent. Such memories are poignant—how could they forget?
Inflation in Argentina today isn’t that bad. At least not yet. But it’s getting there. Private accounts of inflation estimate it’s around 25 percent, though the government’s statistics agencies reports hover around less than half the unofficial reports. Don’t be fooled—the discrepancy is more likely due to the government’s attempt to whitewash the public into relaxing. They’ve even gone as far as trying to prevent anyone who isn’t a government official from publishing a inflation figure that doesn’t line up with the official statistic. No one is fooled though and the International Monetary Fund has even threatened Argentina over publishing such poor data.
Argentines have memories long enough to remember the both bouts of hyperinflation in the 1980s, their country’s economic collapse in 2001-02 and the mass unemployment that followed. They also remember 1989, when the government seized bank certificates of deposit in exchange for bonds and 2002, when they automatically converted dollar deposits to pesos.
The solutions to problems are often implicit in the way they are framed. If I tell you my car won’t start, you might tell me to consult a mechanic. If I tell you I can’t find my keys, well, we have a completely different problem. In public policy, frames often conflate symptoms with causes, other times, such as with the example I gave, they just obscure a possible solution.
But frames turn out to be fundamentally important to the problems’ solution. As Albert Einstein once said, “If I had an hour to solve a problem and my life depended on the solution, I would spend the first fifty-five minutes determining the proper question to ask, for once I know the proper question, I could solve the problem in less than five minutes.”
As a report recently released by Christian Aid shows, this is the case with world hunger. One of every eight people in the world—that’s nearly 868 million people—are hungry. This number has come down a bit over the last few years, down from a high of 1.02 billion in 2009 and 925 million in 2010. Of course, we’re still a long way off from meeting the United Nation’s 2001 Millennium Development Goal of eradicating hunger. Specifically, the organization hoped—and still hopes—to halve, between 1990 and 2015, the number of people who suffer from hunger.
They say necessity is the mother of invention. And when it comes to moving money across borders, criminals sure are inventive. Especially, it would seem, the ones in America and its southern neighbor.
There is a huge volume of drug trade that flows between these two countries—Mexico is a major supplier of the United States’ consumption of heroin and the largest foreign supplier of methamphetamine and marijuana. Since the drugs flow north, the money has to flow south. But since the government of Mexico has become particularly relentless on both cutting down drug trafficking and oversight of money laundering, getting money from the United States to Mexico has become more difficult. For example, former Mexican President Felipe Calderon, who called illicit money “vital for criminals,” crafted a variety of money-laundering laws to help stem the flow of dirty money. Some of his reforms bar cash purchases of real estate and limit cash purchases of items like cars and planes with a price tag that exceeds $10,000.
And given the United States’ intense oversight of its banks, and its keen eye for dirty money, depositing those sums in U.S. banks is more difficult still.
As they say, necessity is the mother of invention, so those criminals have invented some new ways of moving money.
Traditionally, drug traffickers move cash carried in suitcases. Federal authorities estimate that between $18 and $39 billion in illicit cash is laundered across the southwestern border between the U.S. and Mexico every year. And as we step up our scrutiny of banks, expect criminals to increasingly resort to physically moving money.
The U.S. government is not unfamiliar with short-sighted policies, indeed short-sightedness in political systems often seems often more familiar than not. Yet of all the short-sighted policies the United States has engaged in, and especially of those overseas, the recent reports on ghost money in Afghanistan take the cake.
I wish I could say I was surprised.
According to a report by the New York Times, the Central Intelligence Agency has literally been dropping off “bags of cash” at Afghanistan President Hamid Karzai’s office for decades. Karzai called the amounts “small,” but evidence indicates the amounts are anything but—perhaps totaling tens of millions of dollars.
The presidential palace in Kabul said the money has been used “for different purposes, such as in operations, assisting wounded Afghan soldiers and paying rent.” But the truth is that if the means were so honest CIA wouldn’t have bothered delivering it so secretly— often in suitcases. In reality, the agency was using it to buy the loyalty of Afghans and encourage their support in the war against the Taliban. Karzai, in turn, has used it to buy power, fuelling corruption and empowering warlords.
On Tuesday this week, six-term Senator Max Baucus (D-MT) announced he would not seek reelection next year. The decision will end his thirty-six year long and influential career in the Senate; one which included over a decade as the top democrat in the Finance Committee and a co-authorship of the 2010 health care law. In his planned retirement, Senator Baucus will join other senior Democratic senators, including Senator Carl Levin (MI) and Senator Tom Harkin (IO).
In the wake of Senator Baucus’ announcement, the pundits, commentators, and even some Democrats have been calling his legacy “mixed.” Democrats are quick to note all of the times the Senator broke rank, for example over gun restrictions, President Bush’s tax cuts in 2001, and the estate tax. He’s even been quick to speak against the party, just this month saying the implementation of the health care law is headed toward “a train wreck.”
Despite a sometimes controversial career within his party, we should recognize Senator Baucus as one of the pioneers of U.S. legislation aimed at reducing what he has called the “tax gap” – the estimated hundreds of billions in legally owed tax dollars that go unpaid each year. As he puts it: “Offshore tax evasion costs the U.S. jobs and billions of dollars each year, and it puts an unfair burden on the average American taxpayer to make up the difference. In an era when budgets are tight, it’s critical for the I.R.S. to have the resources it needs to root out tax cheats.”
Senator Baucus has pursued many routes to reducing that shortfall, from improving voluntary compliance, to sponsoring a slew of relevant legislation aimed particularly at offshore centers and tax havens, to working with the Treasury to manage the issue. One of his most notable successes in this arena was his work (and coponsorship) of the Foreign Account Tax Compliance Act (FATCA). Along with House Ways and Means Committee Chairman Charles Rangel and then-senior Senate Finance Committee member John Kerry, Senator Baucus cosponsored FATCA in 2009 and Congress enacted it in 2010. The law targets non-compliance by U.S. taxpayers using foreign accounts by allowing the IRS and Treasury to require U.S. taxpayers holding financial assets on foreign soil to report those assets. FATCA also requires foreign financial institutions to report certain information about U.S. taxpayers directly to the IRS. Originally, Treasury planned to work with financial institutions to implement FATCA, but has since modified its approach.
This week the world saw a huge leap forward on automatic tax information exchange and, more broadly, the effort to crack down on tax evasion. As the recent investigation by the International Consortium of Investigative Journalists has shown, governments around the world have a big problem, not only with tax evasion specifically, but also the broader use of offshore vehicles for hiding cash and corruption.
Yet this week, the governments of ten European nations have answered this challenge in stunning fashion. Their efforts have ignited momentum on an effort that could be an integral part of not only reducing tax evasion, but also improving economic development and reducing poverty worldwide. Of course, we’re not there yet, we might even not be past the end of the first quarter. But we could get there.
Here’s where we are: On April 10th, the governments of France, Germany, Italy, Spain, and the United Kingdom announced they will launch the first ever multinational system of automatic tax information exchange. Shortly afterwards, the government of the Czech Republic and Poland, followed by Belgium, the Netherlands, and Romania, also signed up, bringing the number of participating countries to 10.
As Raymond Baker, Director of Global Financial Integrity, noted: “This is a resounding victory for taxpayers and transparency groups; it’s not possible to overstate the significance of this news.”
Sarah Petre-Mears controls more than 1,200 companies across the Caribbean, Ireland, New Zealand, and the United Kingdom. Supposedly. Actually Petre-Mears doesn’t know much about the companies for which she passes resolutions and helps set up bank accounts; all she needs to do is sign her name. Because Petre-Mears is actually just a nominee-director, who keep the real owners of her companies secret by selling their names for use on official company documents, whilst giving addresses in obscure places all over the world.
Walk into Madrid’s famed art museum, Thyssen-Bornemiza, and you’ll find the private art collection of Carmen Thyssen-Bornemisza, which includes Monets, Matisses, and Van Goughs. But technically Thyssen-Bornemisza doesn’t own the paintings you see in the museum named for her family. Instead they are owned by secrecy-guarded companies in Liechtenstein, the Cayman Islands, the British Virgin Islands, and the Cook Islands. Not only does this ownership structure give Thyssen-Bornemisza some tax benefits, but it also allows her some flexibility to move the paintings across borders. She’s not the only one; many other of the world’s biggest art collectors use tax havens to buy and sell art.
We wouldn’t know about the antics of Sarah Petre-Mears and Carmen Thyssen-Bornemisza if it weren’t for an investigation by the International Consortium of Investigative Journalists (ICIJ). After a three year investigation into Australia’s Firepower scandal, a case involving offshore abuse and corporate fraud, Gerald Ryle, ICIJ’s Director, obtained a hard drive with a trove of corporate data, personal information, and e-mails on offshore companies and trusts.
Move over, Cayman. Step aside, Switzerland. The world’s next offshore powerhouse won’t be in the Caribbean or the Alps. It won’t be an island surrounded by water, a peninsula in Asia, or a tiny nation barely larger than a city. It won’t be in New York, Delaware, or London. Because it won’t be anywhere. It will all be a figment of our imaginations—and of course the internet.
I’m talking about internet currencies, and specifically, the largest of them all: Bitcoins. And I firmly believe they will pose the next great challenge for stemming money laundering, corruption, and illicit financial flows.
Bitcion is money, but Bitcoins are issued by complex computer algorithms rather than a government. They exist completely online, using peer-to-peer networks rather than a centralized system. And they serve, like all other forms of money, as a medium of exchange. Like the U.S. dollar or the euro, you can buy and sell them on markets. You can also use them buy things like an upgrade on Reddit, blog services in Wordpress.com’s store, and pizza deliveries from Domino’s through Pizzaforcoins.com. You can use them to transfer money to a friend overseas or you can use them to buy drugs, sell illegal arms, and launder money. I’ll get to those in a second.
Until now, I would have said the challenges that Bitcoins face overwhelmed its potential to replace other currencies as criminals medium of exchange in the future. That’s because it faced three very real impediments: its size, its stability, and its security. Like I said, until now.
In the words of two of my personal heroes: “Economists love incentives. They love to dream them up and enact them, study them, and tinker with them.”
For good reason; incentives make the world go round. They are the reason we get up in the morning, the reason we go to work, and definitely the reason we brush our teeth. They are dictate the speed we drive, the groceries we buy, and the pace of our work. Sometimes they are negative (the prospect of getting a cavity or a speeding ticket) and sometimes they are positive (a raise, or a hug from a child). But they are always at work in hundreds of ways, sometimes conscious and sometimes not.
Politicians like incentives almost as much as economists do. Federal and state governments incentivize all sorts of things, from milk production to renewable energy, and everything in between. The problem is though, that incentives are often difficult to design and, even more importantly, result in a whole new set of incentives that the designer never intended.
These are called perverse incentives and history is replete with them. Take nineteenth century China, for example, when paleontologists looking for dinosaur fossils paid peasants for handing over pieces of dinosaur bone. Later they discovered the peasants were digging up the bones, smashing them into many pieces to maximize their payments, and greatly diminishing their scientific value in the process. Others have pointed out that structuring bonuses for company executives around earnings encourages them to artificially inflate profits and make decisions targeting short-term gains at the expense of long-term profitability.
Yesterday, the nation’s top intelligence official, James R. Clapper Jr., briefed Congress on the most important security threats facing our nation. Clapper didn’t bother to hide his disdain for the annual event, calling an open hearing on intelligence matters a “contradiction in terms.” In a more subtle critique, Clapper also noted that it is virtually impossible to “rank—in terms of long-term importance—the numerous, potential threats to U.S. national security.” In that vein, Clapper said it is the “multiplicity and interconnectedness of potential threats—and the actors behind them—that constitute our biggest challenge.” On that critique, I couldn’t agree more.
One of the starkest examples of these dynamic forces are in Clapper’s testimony on money laundering, illicit financial flows, and the dangers of an opaque financial system. As Clapper notes in his statement for the record, “Criminals’ reliance on the U.S. dollar also exposes the U.S. financial system to illicit financial flows. Inadequate anti-money laundering regulations, lax enforcement of existing ones, misuse of front companies to obscure those responsible for illicit flows, and new forms of electronic money challenge international law enforcement efforts.”
Understanding how these forces weaken U.S. national security is, per Clapper, multifaceted. It’s also quite important.
In December of last year the U.S. Department of Justice discovered that HSBC, a large British bank, “willfully failed” to apply money laundering controls to at least $881 million in drug trafficking proceeds from Mexico and covered up illegal transactions for Burma, Iran, Sudan, Cuba, and Libya. To escape criminal charges, HSBC admitted to wrongdoing and paid a record $1.92 billion settlement. Yet despite this massive offense, not a single person went behind bars as a result.
This wasn’t just a failure of the system or the anonymous bureaucracy of a massive corporation. The investigation revealed that senior HSBC officials were complicit in the illegal activity. They did not go to jail. According to court documents, individuals at HSBC went out of their way to allow the bank to act as a financial clearing house for these criminals. They will did go to jail. Other bank officials at HSBC made a “knowing calculation” that they would rather do business with criminals and “make a profit from those illegal transactions” than fulfill their obligations under U.S. law. They did not go to jail.
While critics pointed out the hypocrisy and inconsistency of this message, U.S. government officials called the fine a success. For example, U.S. Attorney Lynch, one of the architects of the settlement, said: “That’s a very short-sighted view, I think, because in this case they’re obviously paying a great deal of money, but they also have to literally had to turn their company inside out.”
In the last few years—and particularly since Vladamir Putin retook power—Russia has increasingly retreated to Cold War tendencies. Russia’s relationship with the United States has soured over its ban on American adoptions of Russian children, a clash over its missile defense problem, and USAID’s democracy promotion efforts. This week, in perhaps the most obvious flashback of all, President Putin announced his nation requires an immediate and massive military upgrade by 2016. And the former KGB agent plans to spend $750 billion over the next seven years to accomplish it.
Yet Russia’s existential threat is not from the United States. No, that threat comes from within.
Two weeks ago, Global Financial Integrity released a report on illicit financial flows from Russia. In the report, authors Dev Kar and Sarah Freitas detail the cross-border flow of illicit funds to and from Russia over the period 1994 to 2011. Usually, I would focus on the illicit outflow component of the report. Yet in this case, I think there is another interesting story to tell—and that’s about the inflows.
Illicit inflows to Russia ranged from a low of $11.1 billion in 1994 to a high of $80.6 billion in 2007. In 2011 they were $58.7 billion. As the report points out, there is no reason to believe “that money brought into a developing country through illicit channels will be declared as taxable income or can be used for economic development” because an investor has no incentive to smuggle in capital from abroad if it represents a genuine return of funds. In fact, rather than adding to a productive capacity, that money can “drive a speculative real estate boom, create a housing bubble and push the country towards economic instability.”
When I lived in Argentina in the mid 1990s, most of our friends still acutely ...
May 22, 2013
Do you care about stamping out corruption, money laundering and tax dodging? The Financial Transparency ...
May 21, 2013
The solutions to problems are often implicit in the way they are framed. If I ...
May 15, 2013
Below the jump: a fantastic infographic on how money is hidden by large U.S. corporations ...
May 13, 2013
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