The Hindu Business Line : Capitalism is increasingly operating outside the rule of law

"Responsible business interests should understand that they have much more to gain from supporting and extending rather than subverting and weakening legal structures," cautions Raymond W. Baker in Capitalism's Achilles Heel. Satyajit Das promises a `wry and wickedly comic exposé' that is played out every day in trading rooms around the world in Traders, Guns & Money. Racy reads for the weekend, suggests D. MURALI.

With 4,884 press citations about `money laundering', India ranks fifth, according to the May-July 2006 Money Laundering Global Media Benchmark, from Factiva (www.factiva.com). The first four slots go to China (9,859), Russia (8,512), Japan (5,438), and Canada (4,950). These numbers indicate the extent to which money laundering issues are mentioned in the media of FATF (Financial Action Task Force) countries, and quantify the coverage of high-profile money laundering cases.

What is money laundering? `Situation analysis' in the Benchmark explains: "Organised crime groups generate huge sums of money by drug trafficking, arms smuggling and financial crime." These operations generate `dirty money,' but that is of little use to the crime biggies, says Factiva. Why so? Because "it raises the suspicions of law enforcement and leaves a trail of incriminating evidence."

In the face of such deterrents, criminals find an escape route: They change the colour of money, by `laundering' it. In simple, this is done by routing money through ostensibly legal operations. Thus, illegal profits get disguised, and the criminals aren't exposed. Annual turnover of global money laundering is estimated at `somewhere between $600 billion, or $1.5 trillion,' or 2 and 5 per cent of world's GDP (gross domestic product).

Dirty money is the focus of Capitalism's Achilles Heel, by Raymond W. Baker, from Wiley (www.wiley.com). Free-market system isn't performing at the top of its game, he says in the opening chapter. "An assortment of frauds, thefts, corrupt practices, accounting irregularities, earnings restatements, asset write-downs, tax shenanigans, and allegations have corroded the reputations of dozens of companies and sapped the net worth of untold numbers of shareholders and retirees."

Baker classifies dirty money that crosses borders into three, viz. criminal, corrupt, and commercial. "The criminal component includes proceeds from a boundless range of villainous activities including racketeering, trafficking in counterfeit and contraband goods, alien smuggling, slave trading, embezzlement, forgery, securities fraud, credit fraud, burglary, sexual exploitation, prostitution, and more."

Bribery and theft by foreign government officials constitutes the `corrupt' component. And the third component, the `commercial' evades taxes and `almost always disappears from any record in the originating country'. Disturbingly, all the three forms use the same subterfuges to roll through international channels: "False documentation, dummy corporations, shell banks, tax havens, offshore secrecy jurisdictions, mispricing, collusion, kickbacks, numbered accounts, wire transfers that disguise transactions, and more."

A simple game

If you thought that conveying illicit funds from country to country is `a highly complex and specialised process,' Baker dispels the myth, with `the dirty-money user manual'. It lists `proven' and `effective' tools! Such as, underpricing imports. For instance, "Oil has been piped out of Russia at a fraction of its value and resold in Europe at world-market prices, with the difference ending up in Cyprus bank accounts of the owners or executives of Russian producing and marketing companies."

A simple game, that is. And it seems to work for Chinese toys too. "The big toy companies in the US and Europe don't necessarily have to pay the kickbacks; these can be handled by wholesalers who buy, mark up, pay the kickbacks into hard-currency accounts, and resell to the multibillion-dollar brand-name companies and retail chains." A win-win, because consumers in the developed world get things at a low price, and the distorted system produces `several Chinese dollar millionaires with their money safely stashed in foreign banks.' To know how one can overprice exports and yet stay in the business, there is an example from closer home. Baker describes the modus operandi thus: "The Indian seller makes an agreement with his foreign buyer to overprice the export. With the overpriced invoice the seller goes to the Indian authorities and collects, say, the inflated 20 per cent subsidy."

The reference is to export incentives that are `a percentage of the value stated on commercial invoices to encourage exports from the country'. What happens at the other end? "The cooperating buyer can pay the overpriced amount in return for a credit against future shipments or not pay the full invoiced amount after asserting some spurious claim."

Who has fashioned all these wile ploys? "Western business and banking sectors have developed and promoted the mechanisms for bringing in dirty money from other countries for more than a century," declares Baker. There are newer tricks too. Offshore banks can help their customers through credit cards issued in banks' name, without the customers' name or signature appearing anywhere. Electronic banking is another route vulnerable to exploitation.

Banks are not the only conduits for transferring illicit resources. "Securities firms, brokerage houses, commodity traders, insurance companies, money changers — they're waiting to offer you services that rival the banks in creativity and subterfuge," informs Baker.

"In the aftermath of 9/11, many people learned about the `hawala' system, known in Pakistan and in India as `hundi' and in China in a slightly varied from, `chop'." The system is many centuries old, and it "takes money in one place and hands it over in another place without ever passing through the banking system". The system is perhaps alive and kicking. For, one of the many leads that the 7/11 investigators are currently pursuing is the hawala trail that funded the perpetrators of the Mumbai blasts.

"Illicit, disguised, and hidden financial flows create a high-risk environment for capitalists and a low-risk environment for criminals and thugs," reasons Baker. "Responsible business interests should understand that they have much more to gain from supporting and extending rather than subverting and weakening legal structures."

A call that comes in conclusion, even as "capitalism is increasingly operating outside the rule of law."

The business of trading is a `beautiful lie'

More overwhelming than dirty money is `the dazzling world of derivatives' that Satyajit Das leads us to in Traders, Guns & Money from Pearson Education (www.pearsoned.co.uk). "A wry and wickedly comic exposé of the culture, games, and pure deceptions played out every day in trading rooms around the world, usually with other people's money," the back cover teases.

The book is a record of Das' time in the industry. "No qualifications were required; I just bluffed my way in," he writes in the preface. In the next about 300 pages, Das puts together "tales about the products, the people and the strange goings-on in the business."

Phases of investment madness

Prologue speaks of three phases of `investment madness in emerging markets', in the words of experts that Das listens to. First, there is growth, attracting a lot of foreign investment and relocations of production facilities. "Cheap brown people to do dirty jobs for nothing. You dig up, cut down everything you can. The locals deregulate everything." In the second phase, "living standards improve for the fortunate," and property prices go crazy. The third phase sees costs rise to uncompetitive levels. "Alas, the capitalist caravan must move on."

You may pay heed to `worldly investment wisdom' that comes in this form: "If you arrive at a country and discover limousines waiting to transfer foreign investors and their investment bankers to five star hotels, then generally speaking it is time to sell."

Chapter 1 has a dangerous title: `Financial WMDs — derivatives demagoguery'. Don't forget that Warren Buffett had called derivatives `financials weapons of mass destruction'. In a section on `secret subtexts', Das explains how derivatives are typically cash settled. "This means that the farmer does not need to deliver the wheat. Instead, at the agreed delivery date a calculation is done."

The business of trading is a `beautiful lie', something we like to believe, says Das. "In most businesses, the nature of the product is a known known," he explains, drawing inspiration from Donald Rumsfeld's notorious quote unleashed during a Department of Defence news briefing in February 2002. "The derivatives sales process is more complex. You may not know that you need the product — an unknown known. You probably haven't got the faintest idea of what a double knockout currency option with rebate is or does — a known unknown. What should you pay for this particular item? Definitely, unknown unknown." So, now you know!

To make money, sheer luck can help, concedes the author. Besides luck, there are only two ways, he says: Inside information or overwhelming force. "Trading thrives on information — `information', `disinformation', `misinformation', `inside information'." It helps to know that the trader wants to know what everyone else is doing `but doesn't want others to know what they are doing'.

Another snatch of Rumsfeld-speak that Das cites is, "Anyone who knows anything isn't talking and anyone with any sense isn't talking. Therefore, the people that are talking to the media, by definition, are people who don't know anything and people who don't have a hell of a lot of sense." That pretty much describes the exchanges between traders and the financial press, sums up Das.

Reads to rev yourself up this weekend.

http://BookPeek.blogspot.com

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Capitalism is increasingly operating outside the rule of law