Drug trafficking and the financial crisis

Dec 02, 2011 12:00 AM

by Victor Ivanov

Director of the Federal Drug Control Service (FDCS) of the Russian Federation, Victor Ivanov, gave this speech, titled "Worldwide Drug Trafficking as the Key Factor of the Escalating Global Financial and Economic Crisis," at the Centre for Strategic and International Studies, in Washington, DC, on Nov. 18, 2011.
The speech has been translated from Russian and subheads added.


Mr Chairman, dear colleagues,

Thank you for your invitation to deliver a speech at your think tank, a well-known worldwide leader.

Yesterday I came from Chicago, where a regular round of consultations and talks of the [counternarcotics] working group took place within the Obama-Medvedev Russian-American Bilateral Presidential Commission. Gil Kerlikowske, Director of the Office of National Drug Control Policy in the Executive Office of the US President, and your humble servant are co-chairmen of this group.
For two years we have been engaged in close cooperation on specific projects, planning and implementing joint operations and, certainly, discussing the most burning issues: primarily the need to eradicate opium poppy crops in Afghanistan, whose heroin is actually flooding both Russia and the European Union.

To give you an idea of the scope of this phenomenon, I'll cite only one estimate: just one year's output of Afghan heroin is sufficient to kill 10 mm drug addicts.
Taking an opportunity to speak today to a well-prepared audience here, at this think tank, I'd like to draw your attention to my view of one of the most intricate and, probably, key challenges in drug policy.

Analysis has shown that about 10-15 % of drugs are intercepted, while the share of drug money confiscated is less than 0.5 %. This means that the entire revenue from the global drug economy freely enters into circulation and becomes part of global money flows, taking advantage of the capabilities of the legal financial system.
Meanwhile unscrupulous banks, which practice large-scale financial operations beyond their ability to answer for the liabilities they assume, seek to secure the liquidity they need by resorting to the criminal attraction, or, to be more precise, the absorption of huge amounts of criminal money, the greater part of which is drug money.


Figure 1

Here (Figure 1) we have revealing official estimates made by Antonio Costa, former Under-Secretary-General of the UNO and Executive Director of the ODC, that during the global crisis in 2008-2009 about 352 bn narcodollars were injected into major world banks to avoid critical shortages of liquidity; later this money was used for interbank loans.
This is not surprising, since, according to the IMF, major American and European banks lost over $ 1 tn due to "toxic" assets from January 2007 to September 2009, and over 200 major mortgage companies, and plenty of other financial institutions, have gone bankrupt.

The problem? The financial system
It is quite symbolic that this high-ranking international official emphasized that it is not a problem with individual banks, but with the general setup of the whole financial system. Mr Costa knows what he is talking about: he is an experienced international banker who, among other things, for ten years prior to his work at the UNO was Secretary General of the European Bank for Reconstruction and Development.
Assertions about the leading role of criminal "dirty" drug money in the global crisis are also confirmed by abundant other evidence, including data at the disposal of our service.

No wonder more and more experts, as well as participants in the "Occupy Wall Street" movement, are beginning to talk about the emergence of so-called "financial terrorism". At the same time it should be emphasized that periods of crisis merely aggravate and expose the liquidity problem, making it more evident.
It is also obvious, and analytically confirmed, that the existing financial system, which operates using a great and growing number of financial instruments such as options, futures, swaps, and other derivatives that inflate the so-called "financial soap bubble", can no longer exist without injections of "dirty" money.

This analysis is fully confirmed by the expert appraisals presented in the research report published one month ago by the UN Office of Drug Control and Crime Prevention, "Estimating Illicit Financial Flows Resulting from Drug Trafficking and Other Transnational Organized Crimes".
The report states outright that nowadays dirty money can very easily enter into legal financial flows; at the same time "investment" of such money gravely disrupts the real economy and substantially impedes economic growth. The report estimates the total flows of dirty money of transnational organized crime at over a trillion dollars, or 1.5 % of the global GDP, and no less than 70 % of this money is laundered through financial institutions.

The most profitable sector of this "black" economy, according to the report, is the illicit drug trade that accounts for a minimum of half of all global criminal flows ("accounting for half of all proceeds of transnational organized crime").
The economic toll of drug circulation on society is truly enormous. The report's estimations document that the economic damage from drug trafficking is double or triple the value of the drugs. Thus, while the US cocaine market is estimated at $ 35 bn and the market of heroin and other drugs at $ 15 bn, direct damage to the US economy from drug trafficking is $ 150 bn in monetary terms!

Taking into account the fact that similar drug markets are active in the European Union and China, the major trading and economic partners of the United States, this large-scale adverse effect is reproduced in the form of a negative synergy.
And since Europe is the largest market for Afghan heroin, as well as representing half the market for Latin American cocaine, the result is that the real sector of the economies of the world's leading countries is collapsing faster and faster. Dirty drug money, in combination with a speculative "bubble", are simply exhausting the economy of creation and development.

The case of Wachovia Bank
Here it would be appropriate to mention investigations into the financial operations of Wachovia Bank in 2004-2007, which have been widely discussed in the world mass media.
According to the Observer, in early 2010 the bank signed an out-of-court settlement with American regulators, and paid about $ 150 mm in exchange for the dropping of charges that it had assisted in money-laundering. This resulted from a 22-month investigation by US Drug Enforcement Agency officers who established that in 2004-2007, Mexican drug cartels made transactions through the bank using electronic transfers, traveller’s checks, and cash.

According to federal prosecutor Jeffrey Sloman, "Wachovia's blatant disregard for our banking laws gave international cocaine cartels a virtual carte blanche to finance their operations by laundering drug proceeds."
The most disgusting and essential thing was that the bank was found guilty of transferring $ 378.4 bn (the amount is equal to one-third of the Mexican GDP) to dollar accounts at so-called currency exchange offices in Mexico.

There are other, similar cases in which banks did not inform the financial authorities about such operations. Besides the Wachovia case, the US drug police also reported about criminal transactions through another major bank, Bank of America. In one case they tracked transactions related to sales of 22 tons of cocaine, and in a second case, of 10 tons of this drug.
Other banks also came under suspicion and were fined, including the American Express Bank and HSBC.

What is behind this phenomenon? The very nature of the current global financial system.
Today the role of the different types of ersatz money, various derivatives, securitized bonds, futures, etc. that constitute the so-called financial speculative "soap bubble" is already quite obvious.


Figure 2

Figure 2 clearly shows cumulative registered financial liabilities in the amount of $ 600 tn. Since secured liabilities account for just $ 10 tn of the total amount, it is quite obvious that unsecured liabilities, or the "financial bubble", are 10 times greater than secured ones. Indeed, these facts have been thoroughly investigated and described many times; unfortunately, they have become commonplace.
It is the increasing volume of unsecured liabilities that underlies the surging crisis we face. Naturally in this situation the real economy is extremely weak, since it is affected by the "soap bubble" swelling on top of it.


Figure 3

Figure 3 shows it in the immensely overblown upper part, on top of the rather narrow sector of the real economy.
Almost nobody, however, pays attention to a kind of a paradox: how, under conditions where the economy is slackening and essentially crisis-ridden, banks manage to procure liquidity and service their liabilities.

The problem is even greater, in that the "bubble" is compounded by a heavy encumbrance in the form of unrecoverable military expenses (see Figure 4).


Figure 4

Studies have shown that the persistent lack of liquidity and attempts to stay afloat during a crisis promote not only tolerance toward criminal money, but also an attitude of encouraging the availability of such money.
Furthermore, this circumstance, i.e., the possibility of continuously replenishing greatly needed liquidity, is what, in many respects, functions as the moving spring of the ongoing financial and economic, and social, demand for drug production.

Figure 4 is a kind of an X-ray of the mechanics of the current financial crisis.
Drug money and the global drug traffic are actually not just valuable elements, but, as donors of liquidity which is so scarce, they are a vital and indispensable segment of the whole monetary system.

The overlooked 6 % of world trade
It should be emphasized that the degree of impact of hydrocarbons (oil and gas) on the global economy is common knowledge: They account for about 6 % of total world trade.
The impact of the narcotics market, which is estimated at approximately the same size, is not looked at by economists and politicians. Yet the development of adequate solutions should be based on a deep understanding of the specifics of global drug trafficking.

So far, unfortunately, anti-drug policies have been dominated by local or, at best, regional or interregional efforts.
To elaborate adequate solutions and understand what is going on, one should have a better idea of global drug streams. Yet the primary capacity of a drug stream is beyond the local and regional levels: It is at the top, global level of drug crime, as shown in Figure 5.


Figure 5

This is also confirmed by analysis of the distribution of the drug mafia's financial proceeds from sales of Afghan drug products, corresponding to these same levels.
This slide of an example, the structure of Afghan drug trafficking proceeds (Figure 6), shows that the distribution pyramid for its proceeds by level is inverted, compared with the pyramid for the distribution, by level, of offenders and their criminal transactions.


Figure 6

The structure of distribution of profits from global cocaine production, with total proceeds in 2009 of around $ 84 bn, shows the same pattern. While Andean coca farmers earned about $ 1 bn, the bulk of the income of $ 35 bn was concentrated in North America, with another $ 26 bn in Central Europe.
That [North America and Europe] is where, naturally, almost 80 % of the illicit proceeds of the cocaine trade are laundered, while just one tenth of the income, a portion of the funds obtained in other regions, are laundered in the Caribbean.

At the present time there are two obvious components of global drug trafficking, or drug streams, as shown in Figure 7: Latin American cocaine and Afghanistan heroin.


Figure 7

The direction, intensity, and extraordinary capacity of these two components of the traffic require that they be specified more precisely as "streams".
The impressive, devastating capacity of these drug streams is particularly visible from the situation in the drug transit countries, which, falling under their influence, enter into endless social and political turbulence, since their budgets are smaller than the value of the drug streams crossing their territories by a factor of two or three, and sometimes by orders of magnitude.

I don't think it is appropriate here to go into the details of the current semi-civil war in Mexico, which is being literally ripped apart by avalanching drug streams.
Let us have a look at Central Asia. The budgets of the nations of Tajikistan and Kyrgyzstan, located on the Northern Route of Afghan heroin, are several times less than the financial capacity of the Afghan drug trafficking that passes through their territories.

Unfortunately, the globalization of drug crime and the emergence of global drug streams that sweep away everything in their path have also become commonplace for the countries of the Balkan peninsula.
Suffice it to point out that, as a result of the well-known events, the geographic region of Kosovo has turned into the main drug transit cluster in Europe, an epicentre where, on the one hand, two global drug streams intersect -- cocaine comin