Money Laundering is Not What You Imagine It to Be

Money laundering is the process of transforming the proceeds of funds of indeterminate origin, likely criminal, into legitimate money or assets.  Nowadays, it refers to many other forms of commercial crime, or regulatory irregularities.  There is also the phenomenon of reverse money laundering.  Reverse money laundering is the process of disguising a legitimate source of funds for use in illegal enterprises.

According to the United States Treasury Department, “Money laundering is the process of making illegally-gained proceeds appear legal.  Typically, it involves three steps: placement, layering and integration.  First, the illegitimate funds are furtively introduced into the legitimate financial system.  Then, the money is moved around to create confusion, sometimes by wiring or transferring through numerous accounts.  Finally, it is integrated into the financial system through additional transactions until the “dirty money” appears “clean.””

Many countries treat fund movements in breach of international sanctions, or even their own currency control regulations, as money laundering.  Some even define money laundering as obfuscating sources of money, either intentionally or implicitly.  Some places consider it money laundering to move funds generated from activities that are a crime in that jurisdiction, even if it was legal where the actual conduct occurred.  Thus, “money laundering” is not always money laundering.  And this is problematic.

Although it is impossible to reliably estimate, it is thought by those of us in the industry that perhaps 10% or more of the global economy is involved in laundering.  The International Monetary Fund estimated it conservatively at 5% in 1996.  20 years later, that estimate seems hilariously small.

The biggest money launderers are not crime bosses or even individuals.  They are governments.  And governments have a lot of reasons to launder vast amounts.  Rogue states such as North Korea, and quasi states such as ISIS, need to trade and move funds.  Both they and their customers are laundering.  Some countries use this to acquire or facilitate the movement of hard currency.  Some countries use this to mask their involvement in certain activities, such as China’s building of infrastructure in the South China Sea to stake claims in disputed territories, or to hide the extent of their indebtedness.  At a smaller level, businessmen need to move funds to facilitate business, particularly in places such as Indonesia and Malaysia due to corruption and currency controls.  And then there is illegal cross border trade, such as in Indochina.

Officially, the main concern of governments regarding the billions of US dollars laundered in the black economy is large scale criminal enterprises and terrorism.  The real reason is political control and revenue.  Another reason, of course, is that when it comes to laundering, governments do not like competition.

There are many ways of laundering money, and some methods can move surprising amounts of funds quickly undetected.  For example, used car businesses are a simple way to launder money.  Selling a used car afford many opportunities to inflate the cost to justify movements of funds that come out clean on the other end.  They include:

1. Payments to a vendor by unrelated third parties;

2. False reporting, such as misclassification, and under-valuation;

3. Carousel transactions, which is the repeated importation and exportation of the same shipment; and

4. Double invoicing.

And that is just for the cars.  A lot more shenanigans can be done with car parts and accessories, meaning that a single shipment can be inflated by several degrees, and is useful for the purposes of layering funds on a massive scale.

Other legitimate businesses are also used.  This is for the layering and integration process.  People need to use that money, and need to create a reason for that money to be there.  For it to work, it has to be a cash business so that there is minimal documentation of transactions.  This makes inflation possible.  This also means that they have to pay taxes, but in reality, that is another avenue for tax fraud.

There are many accounting tricks and methods where a company can be used for laundering money, particularly when engaging in a legitimate business as cover for an illegal one.  For example, a trading company can be a front for smuggling.

For something on a smaller scale, there are stored value cards, SVCs.  They are a fast, reliable, and anonymous method for storing cash.  It is unwieldy to move money in the tens of millions, but this is more than adequate to store and carry several hundred thousand dollars.  They are a favourite method in cross border narcotics trades.

A new method uses bitcoins, the virtual currency.  Bitcoin is the currency of the deep web.  Its advantage is that a single bitcoin is worth several hundred dollars.  At the time of April 2016, a single bitcoin was worth over US$400.  Also, this is a peer-to-peer financial transaction with no intermediary, allowing a level of anonymity.  The disadvantage is that, on their own, bitcoin transactions are recorded in a blockchain, a sort of public ledger, meaning that transactions are relatively transparent.  But there are now tools to bypass this as well.

Perhaps the simplest way is to have shell companies.  A shell company is a seemingly legitimate business, but provides no actual services.  The sole purpose of a shell company is to create the illusion of legitimacy by creating a documentary trail to justify illegitimate funds.  These funds are used to purchase assets such as real estate, commodities or even art, and the proceeds cashed out through other entities, or simply kept in a tax haven.  Shell company are also used to purchase assets to mask the identity of the true fund owner.

China uses shell companies to borrow vast sums of money without booking it under their debt.  This allows the government to hide its true public debt levels as a percentage of GDP, by counting it as private debt.  China’s true estimated debt to GDP ratio is almost 300%.

Then, there is the hawala, an informal banking system from ancient India.  The term means “money transfer without moving money.”  The hawala consists of thousands upon thousands of hawaladars, brokers, throughout the world, wherever you find the Indian subcontinent diaspora.  Each of them keeps a detailed ledger of transactions that relies on an honour system to enforce.  An individual, wanting to send money to another person in a different town, region or even another country, simply gives the money to his local hawaladar.  This money does not move. Instead, the hawaladar will communicate to the hawaladar in the recipient’s side.  That hawaladar will settle the balance, minus a commission.  The hawaladars settle up each other separately.  This is a nearly untraceable money transfer in the billions of dollars.  There is no paper trail, and total anonymity.  This makes it perfect for tax avoidance.

In summary, almost all strata of society actively engaged in various forms of money laundering for a variety of reasons, from nefarious to simple tax evasion.  In sum, the amounts are enormous, and the players are very well-connected.  Whenever somebody gets caught, the amounts, which may sum astronomical, are actually a drop in a very large ocean.  The sum total of all currency in circulation is just shy of US ten trillion.  The illicit amount uncovered by a single leak in a single firm in Panama was more than twice that.  How much do you think an actual financial centre such as Singapore or Hong Kong launders, and how much of it is hidden in these places?