Introduction
This week’s column provides a highly condensed, yet hopefully accurate portrayal of the origins of money laundering, which as we shall observe is a uniquely modern phenomenon. As I have previously noted, tax evasion is the major driver of money laundering both globally, and specifically in the Caricom region (other than in Guyana and to a far lesser extent Jamaica and Trinidad and Tobago) where other criminal pursuits are more apparent.
Historically, the crime of tax evasion appears to have been first legally prosecuted by the United States Government as part of its fight against organized crime over eight decades ago (the famous Al Capone trials of the early 1930s). Money laundering however, as a major organized criminal endeavour first engaged widespread media coverage much later, in the 1970s and early 1980s. Indeed it was only in the early 1980s that the first legal cases against money launderers were prosecuted by the US authorities. It is clear that, from the outset, these cases were closely allied to official onslaughts on major organized crime including, murder for hire, racketeering, and trafficking in narcotics, arms, and persons.
With this brief description, which indicates money laundering first seriously engaged the world’s attention through actions undertaken by the United States Government, let us take a closer look at its economic origins.
Economic origins
There is wide consensus among financial, economic, and international legal analysts that the origins of money laundering are rooted in two economic phenomena. One is the historic distortions that were being perpetuated in the global economy during the 1960s and 1970s, well after the profound economic dislocations of World War II. And the other has been the paradigm shift that was occurring (although not sufficiently recognised at the time) in the global economy where a new world order (with very different policy prescriptions than those that had been primary until then) was emerging in the form of globalisation and financialisation.
Underlying, these economic distortions was a severe global capital shortage, which was occasioned by the massive diversion of public and private savings to military expenditures arising from World War II and the Cold War. The ruling regulatory and developmental ideology of that time prioritized state-led, non-market-based approaches to economic policy formulation. Thus in the area of banking and financial regulation, market-based policies were not considered robust enough to be effective (for example, open money market operations, which are principally relied on today) and reliance was instead placed on direct controls.
At the time these included foreign exchange controls (designed to contain international financial speculation); fixed exchange rates; mandated reserve requirements for banks; and regulatory controls on both the interest rates, which banks could pay/charge, as well as on the types of loans that banks could make (sectors, time profile, period of loan, etc). It should be pointed out that these policy prescriptions were pursued eagerly in both rich and poor countries alike. It was indeed the politically correct approach of the time.
It was in these circumstances that the euro-dollar (and later the euro-currency) financial markets emerged and created the platform for the rise of offshore financial centres (OFCs) and the explosive growth of money laundering.
Euro-dollar market
What is the euro-dollar market? With restrictive financial regulations in force, banks based in Europe soon realized that any US dollar denominated accounts, which they could obtain would be beyond the effective regulatory reach of the US Federal Reserve System.
Under existing laws these deposits could be accumulated, therefore, at a premium interest cost and then lent out to investors beyond the reach of either the United States jurisdiction or that of the national authority where the bank was based. Thus was created the euro-dollar financial market. The current formal definition of this market is one for “United States dollar-denominated deposits at foreign banks (or foreign branches of US banks).”
To be sure, it is only because of its origin in Europe that the financial market was termed the euro-dollar market. This name has no necessary connection to either the euro as a currency, or to the Eurozone; indeed it pre-dated both. However, the functions which this market provided could be replicated elsewhere, and not surprisingly, therefore, the market soon spread to other countries and territories that set about deliberately to replicate the opportunities for this type of market to thrive within their jurisdictions.
Parenthetically, readers should appreciate that the euro-dollar market quickly spread beyond the United States dollar and morphed into the euro-currency market. This latter market includes any currency denominated deposit account offered by a bank to a customer, other than the currency of the jurisdiction of the country in which the bank is located. Thus for example, a British pound deposit, held by a bank in Guyana in British pounds would qualify as part of the euro-currency market.
Conclusion
Readers could safely conclude that banks saw the opportunity for attracting deposits which were outside the jurisdiction of both local and foreign banking supervision and regulation through paying premium interest rates. However, the universal rule still applied: the less is the banking supervision (and regulation) in place, the greater is the risk these deposits are taking.
However, because financial markets adopted a ‘no questions asked’ acceptance of euro-dollar and euro-currency deposits, these have become attractive to two groups of economic agents. One constitutes those countries and banking/financial venues outside Europe, which were prepared to compete with Europe for these deposits. And, the other is that group of economic agents seeking to move funds in a clandestine manner; that is, beyond national supervision and regulation.
These two incentives spawned the worldwide emergence of OFCs and alongside these, money laundering on a world scale.
Next week I shall wrap up this discussion on the origins of money laundering.
