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Capitalism’s Financial Secrecy System

T HE FINANCIAL SECRECY phenomenon began to accelerate in the 1960s, driven by two global forces. First, from the late 1950s through the 1960s, 48 countries gained their independence. This affected motivations within both ceding countries and the newly independent countries. Former colonial powers, most importantly the United Kingdom and France, sought to hold on to their mechanisms for shifting wealth out of their traditional possessions. And many citizens of these newly independent countries, not altogether trusting their unstable governments, also wanted to get their money out and needed facilitating mechanisms and structures.

Second, multinational corporations, which were quite few in the immediate post–World War II years, began to spread aggressively across the globe and generated contrivances to move their profits in a hidden manner out of distant ventures or risky environments. Growth in global trade enabled shifts of revenues and profits with little oversight by young, unstable governments.

Thus, the financial secrecy system grew in order to serve these two new interests driving the relocation of income and wealth. This system has continued to develop since its modest beginnings in the 1960s to the point that today by some estimates it handles close to half of global trade and financial movements, much of it invisible to governments, central bankers, tax authorities, law enforcers, and legislators.

The financial secrecy system is specifically designed to shift and shelter illicit money. Illicit money is money that is illegally earned, transferred, or utilized. A key point made repeatedly in these pages is that every significant element of this secrecy system has been developed in wealthier Western countries. The mechanisms through which this system operates are not something done to us; these are mechanisms created and expanded by us specifically serving the new motivation within capitalism: secrecy.

Early on, let it be clear that privacy and secrecy in the financial arena are different. I would like my bank account to remain private, as already provided for in law. This does not mean that it should be cloaked in secrecy. If someone with a name similar to mine is suspected of a terrorist act and authorities need to check possibly relevant account activity of me and others, I have no objection. My financial privacy is not above your personal security.

Three sources generate illicit funds: commercial, criminal, and corrupt. The commercial source of illicit money is usually tax evading through trade and capital movements. The criminal source is from drug dealers, human traffickers, counterfeiters, poachers, and more and includes the activities of terrorist financiers. The corrupt component is funds stolen by government officials. The system created to move and shelter illicit money comprises tax havens, secrecy jurisdictions, disguised corporations, anonymous trust accounts, fake foundations, trade manipulations, hybrid entities, and specialized money laundering techniques. Banks, corporations, lawyers, and accountants have devoted hundreds of millions of man-hours to designing, disguising, complicating, and expanding this system to serve the secrecy motive, the motive to move invisible trillions.

TAX HAVENS/SECRECY JURISDICTIONS

Tax havens enable income receipts and wealth accumulations with little or no taxation or regulatory oversight. Starting from just three or four in the 1960s, there are now some 70 to well over 100 across the globe depending on who is counting.

Decisions under British common law laid the groundwork for the tax haven phenomenon. A 1929 case, Delta Land and Investment Co., Ltd. v. Todd, solidified earlier decisions that enabled companies registered in the United Kingdom to avoid taxation there if controlled elsewhere. The principle of ownership in one place and management in another place meant that taxes could be virtually eliminated in the country of registration and rather easily manipulated in the country of operation.

Curaçao was granted internal autonomy from the Netherlands in 1954, which enabled it to create a low tax environment for companies incorporated there but not doing business there. In 1955, Curaçao was included in a US-Netherlands tax treaty to avoid double taxation: taxing the same profits twice arising from cross-border investments. US and European corporations by the hundreds established nonoperating entities on the island and then routed transactions through these dummy entities in order to curtail taxes.

Every tax haven services illicit money as a significant part of its business. The Cayman Islands became a tax haven in the late 1950s and today caters to institutional clients and hedge funds. The British Virgin Islands has carved out a niche sheltering Chinese flight capital coming in, incorporating as a foreign entity, and roundtripping back to China. Malta handles Russian and European Union money, specializing in the wealth of oligarchs and kleptocrats. Luxembourg allows the formation of tax-exempt holding companies for foreign assets and earlier facilitated the creation of offshore eurobonds attracting stateless capital. China’s 1978 Open Door policy enabled Hong Kong to become one of the fastest-growing tax havens servicing the parent country and other Asian sources of illicit money. Singapore, seeing a great deal of money flowing into its region during the First Indochina War and the Vietnam War, appealed to foreign commercial banks by giving preferential regulatory and tax treatment to Asian Currency Units, tapping wealth floating around hunting for a safe haven. Mauritius services money flowing out of and going back into India, enabling companies to launder money and dodge taxes. Panama leveraged the linkage of its Canal Zone to the United States to become a transit point for ill-gotten gains pouring out of Latin America, a business tapped by Manuel Noriega servicing drug cartels. Bahrain took advantage of Lebanon’s civil war to launder money exiting unstable countries in the Middle East. Even the United States gives preferential tax treatment to foreign nationals in order to attract deposits, making this country the biggest tax haven operating anywhere today.

The important point to grasp is that tax havens exist because wealthier countries want them to exist, sheltering profits for multinational corporations and attracting money flooding in from foreign interests. This reality is a principal feature of the financial secrecy system of moving and hiding illicit money.

Most tax havens also operate as secrecy jurisdictions to the point that the two phenomena are now largely synonymous. This means that in addition to providing tax advantages, these jurisdictions also provide the services of bankers, lawyers, and accountants to receive, hide, shelter, disguise, and transmit funds onward, permitting company owners and account holders to remain entirely anonymous.

Switzerland made bank secrecy a matter of law in 1934, appealing to money streaming across the borders of Europe seeking a hiding place. Banking officials themselves were prohibited from disclosing client identities even to Swiss national authorities.

In recent years, a difference has been recognized between “conduits” and “sinks.” Conduits gather money and send it on to sinks. A recent study examined networks between 98 million firms connected through 71 million ownership relations.¹ Reportedly, the main conduit countries are the Netherlands, the United Kingdom, Ireland, Singapore, and Switzerland. The Netherlands and the United Kingdom were estimated to handle some 45 percent of the billions a year flowing through the financial secrecy system. Netherlands redirects much of its inflow into European holdings, whereas the United Kingdom transmits much of its inflow into temporary holdings in smaller jurisdictions spread across the globe. The study identified 24 sinks as the most active recipients of these flows, 18 of which are related to the British Commonwealth. Smaller sinks ultimately shift their accumulating millions and billions back into wealthier economies.

The Financial Secrecy Index lists 133 jurisdictions offering secret corporate registrations.² This phenomenon, which the founders of the free market system never envisioned, undermines responsible capitalism.

DISGUISED CORPORATIONS

Secrecy jurisdictions permit the formation of entities without revealing ownership.

Panama has more than one million disguised entities on its rosters, most still fully in existence despite the release of the Panama Papers in 2016. The Cayman Islands and the British Virgin Islands are home to hundreds of thousands of disguised corporations.

The United States has been the most prolific secrecy jurisdiction for many years. Interstate commerce is largely regulated at the state level. Following the lead of Delaware, every state in the union passed laws permitting company formation agents to establish entities without identifying the natural persons owning the entities. Created at an estimated rate of two million such undertakings a year, America is a preferred destination for illicit money seeking secrecy and shelter. As of this writing the Treasury Department is drafting regulations that will change this reality, hopefully enabling government authorities to identify each entities’ substantial partners and shareholders.

Often referred to as shell companies, disguised corporations appear in many variations. Front companies do some legitimate business in order to shelter other segments of illegitimate business. Bearer share companies are owned by whoever holds the share certificate, providing an ideal avenue for money laundering. Law firms maintain thousands of “shelf” companies, preregistered and sitting in inventory awaiting the needs of clients. Additional variations providing measures of secrecy include British Nominee Companies, International Headquarters Companies, Dual Resident Companies, Open-ended Investment Companies, Irish Non-Resident Companies, English Limited Partnerships, Cayman Islands STAR Trusts, and more. Protected “cell” companies and “segregated portfolio” companies allow individual participants to “rent” a piece of a multiowner entity. Captive insurance shelters give large and small entities a means of transferring money out of accumulated profits, thus providing mechanisms for income deferral and tax evasion.

ANONYMOUS TRUST ACCOUNTS

Trusts, with a long history in English common law, usually do not require legal registration where established. Identities of settlers and beneficiaries are generally not required by regulatory authorities. The parties to the trust may themselves be disguised corporations, further burying identifications under layers of secrecy. Settlers and beneficiaries may in fact be the same, undercutting the original intent of trust law. With Jersey, Guernsey, the Cayman Islands, the British Virgin Islands, the Cook Islands, St. Kitts and Nevis, Niue, and others active in the anonymous trust business, “flee clauses” have been agreed across jurisdictions, allowing trusts to be relocated instantly if identities of settlers or beneficiaries are sought. Some asset protection trusts can make stolen money safe, beyond legal recovery.

Disguised corporations, anonymous trusts, and other secrecy mechanisms enable transactions that separate sellers and buyers who purposefully intend to remain unknown to each other.

FAKE FOUNDATIONS

You can establish a charitable foundation, donate your money to your charitable foundation, and designate yourself as the beneficiary of the charity of your foundation, escaping taxes and oversight. Panama established the Private Interest Foundation, stating specifically that “the charter or bylaws specify one or more beneficiaries, which may include the founder.”³ Liechtenstein created the Anstalt in 1928, combining the functions of the trust and the foundation and eliminating personal identifications from official records. In the United States tens of thousands of foundations have been created over the last two decades, with a growing record of abuses from secret ownership, high fundraising costs, employment for family members, personal expense reimbursements, and even fraud in distributions.

FALSIFIED TRADES

For the first 150 years of the free market system, equity investments and trading profits were distinct business activities. Equity, such as purchasing shares, was invested. Trade, such as buying and selling, was conducted. In the most basic illustration, trade generated profits that appeared on the income statement. These profits then accumulated as equity in the retained earnings account on the balance sheet. Taxes would be paid and dividends remitted. This straightforward scenario, however, is no longer the case. Equity investments and trading profits are today conflated concepts.

To put it simply, abusive transfer pricing enables multinational corporations to transfer profits within trade transactions between subsidiary and affiliated entities. This transfer pricing obviates the need to accumulate profits, pay taxes, and remit dividends. All these steps can be avoided via the mechanism of transfer pricing in trade transactions. Set the price; move the profit. No earnings accumulating, no dividends, no taxes, no increases in the equity account. This process may very well break laws in one jurisdiction or another, but this is unimportant if the multinational corporation is not caught or enforcement is weak.

The process is straightforward. Instead of selling item X between entities within the same corporation at its accurately calculated, legitimately valued price of $100 as would exist in arm’s-length transactions, it can instead be sold for, say, $50 or $150 depending on the direction in which profits are to be relocated. There are four ways to accomplish this, most easily illustrated by considering transactions between subsidiaries A and B in two different countries belonging to a single parent corporation.

Misinvoicing of the sale of goods and commodities, in other words trading at invoice prices that differ from legitimate values, exploded in the 1960s and 1970s as multinational corporations all over the globe avoided the pesky process of actually accumulating earnings in far-flung investments, paying taxes to foreign governments, going through the unnecessary process of declaring dividends, and remitting profits back to the parent company. However, this misinvoicing of goods and commodities ran into a problem beginning in the 1980s and 1990s as world market pricing data began to become available, enabling foreign governments and customs departments to sometimes recognize misinvoiced merchandise transactions.

So, starting in the 1980s and continuing very aggressively today, multinationals make greater use of intellectual property, services, and intangibles as preferred transactions for misinvoicing. Licenses, royalties, patent rights, management fees, interest expense on intracompany loans, insurance, research and development, advertising, head office expenses, and more are hugely exaggerated in order to eliminate taxes and remittance complications in foreign investments. The shift occurred because it is almost impossible to see an invisible item as misinvoiced, and no good comparative data are available. Virtually every multinational, multibillion-dollar, multiproduct corporation uses trade misinvoicing to shift money across borders. The process has become completely normalized in international business.

Today, multinational corporations’ manipulation of the pricing of intellectual property moves hundreds of billions of dollars invisibly around the world. Techniques used are extremely sophisticated and utterly bizarre, sometimes involving more than 30 interlaced steps and, for fully detailed explanations, beyond the scope of this book.

Tax avoidance schemes surrounding intangible assets are built on four foundations. First, tax havens provide the sinks into which money can go to escape revenue collectors. Second, differing national tax systems can be exploited for available loopholes and pathways. Third, the concept of economic substance, that is, the notion that transactions should have real purpose other than tax or title shifting, is largely unenforced in legal and auditing procedures. And fourth, royalties, licenses, user fees, management services, even depreciation, etc. can be shifted with the click of a computer key.

What has happened since the 1960s is that price and value have become entirely different, entirely separate concepts. In billions of transactions, prices do not conform to values. Value is one thing; price is a fiction used to shift money from one place to another. This new normal sits at the heart of much of capitalism’s operations today.

BLACK HOLES, SANDWICHES, AND MALTS

The story of the financial secrecy system now begins to be a bit complex, exactly as intended by its creators and operators so that legislators, regulators, and citizens will have difficulty grasping its intricacies and therefore will shy away from trying to curtail its machinations. Some brief insights into the construction of trade manipulations, the core of the system, will, however, be useful.

Bermuda, which decided decades ago to make money by moving money, is a common repository of intellectual property rights, sometimes referred to as the “Bermuda black hole.” So, a US company can sell intellectual property, such as the operating system for a cell phone, to its wholly owned, Bermuda-based subsidiary for a low price. This Bermuda subsidiary is in fact incorporated in Ireland but supposedly “managed” in Bermuda. This entity operates as a holding company, holding the intellectual property rights of the parent. This Irish holding entity establishes a second Irish operating entity and licenses this second entity to sell intellectual property rights at a high price to other buyers, including in other countries. These buyers pay the second Irish company for the cell phone and its included operating system (i.e., the intellectual property). This second Irish company accumulates revenues, pays fractional taxes in Ireland, and then remits the revenues to the original holding company subsidiary supposedly managed in Bermuda. Bermuda charges no taxes on corporate income. The net effect is huge untaxed profits for the US parent company accumulating in Bermuda, essentially untaxed revenues generated from business activities in dozens of other countries, and minimal taxes paid in Ireland. The two Irish entities give this scheme the name “double Irish.”

A variation on the scheme adds a “Dutch Sandwich” between the two Irish entities. Because consumers in Europe and elsewhere around the world are buying cell phones with the included intellectual property, it is useful to have another European subsidiary, a shell company in the Netherlands, that collects these revenues and then remits to Ireland. Since both the Netherlands and Ireland are members of the European Union, the Netherlands collects no withholding tax on these revenues. And for US tax purposes, these entities “check the box,” confirming to the Internal Revenue Service (IRS) that they are effectively a single entity and that therefore the royalty payments flowing between them are disregarded.

The “Double Irish with a Dutch Sandwich” generated hundreds of billions of dollars of profits minimally taxed for primarily US corporations since the 1990s. Ireland, under pressure, overturned the scheme somewhat in 2015, with a five-year grace period to users to seek other avenues.

The “Single Malt,” a variation on the “Double Irish,” immediately emerged. Under this scheme, instead of a Bermuda-managed holding company, a Malta-managed holding company can be created. This entity channels intellectual property payments to the Irish operating entity. With treaties between the two nations avoiding double taxation, this mechanism accomplishes the same tax-avoidance purpose, though the mechanism is also under scrutiny as of this writing.

Attacks on the “Double Irish” and the “Single Malt” led Ireland to go a step further to preserve its tax haven status. Most recently emerging is the “Capital Allowances for Intangible Assets” (CAIA) scheme. This scheme permits the purchase price for intangible assets to be amortized over a period of years, in the same way that the purchase price of machinery is depreciated over several years. Intangible assets are defined broadly to include trademarks, copyrights, know-how, patents, designs, software, secrets, and more. Thus, an Irish subsidiary buying intellectual property from its parent can write off the cost of that purchase against taxes across, say, five or more years. If the parent company loaned money to that subsidiary to make the purchase, then the interest on that loan, often exorbitantly high, can also be written off over several years. After those years have run, the same exercise can be repeated with a new round of purchases of newly developed intellectual property. While Irish authorities are careful to say that this is not a tax avoidance scheme, some law firms in the country are allegedly marketing CAIA as exactly that. The mechanism has already distorted Ireland’s statistics, creating huge differences between gross national product and gross national income.

LEGAL OR ILLEGAL?

Are these sorts of trade manipulations of goods, services, intangibles, and intellectual properties legal or illegal? In most countries, such activities are illegal if they undercut taxes or violate anti–money laundering laws of the home jurisdiction but are not necessarily illegal if they undercut or violate such laws in other countries.

Yet even this reality is beginning to change. There is another category of laws that are often violated: laws against schemes to defraud. In the United States, for example, cases are being decided against perpetrators of trade manipulations in which US mails and wires are used in a scheme to defraud another party, regardless of whether that party is domestic or foreign, private or government. As enforcement of such laws progresses within the trade arena, the difference between tax evasion, which is illegal, and tax avoidance, which takes advantage of marginally legal loopholes, will shrink. In other words, when trade manipulations are used to defraud another party, whether American or foreign, whether another private company or a government revenue department, this can constitute a felony offense. More on this in later pages.

Seeing how easy it is for multinational corporations to manipulate trade documentation, local businesses in all regions of the world do exactly the same thing. Agreements are made with suppliers to overinvoice trade transactions, so that upon payment the misinvoiced amounts will then be deposited into foreign bank accounts. Or underinvoice transactions, thus avoiding customs duties and value-added taxes in the importing country. These transactions deprive local economies and local governments of resources needed for infrastructure, health, and education.

Some think that trade manipulations are done only or mainly for the purpose of tax evasion and avoidance. This is largely correct when the activity is between wealthy countries trading in hard currencies. But the motivation is different in transactions between poorer and wealthier countries. Here the motivation is focused less on tax manipulation and more on converting soft currencies into hard currencies. Both multinational corporations and local firms have many ways to manipulate taxes in their developing country operations, so tax evasion through trade is not the primary aim. Getting money out of weak, inflation-prone soft currencies into dollars, euros, pounds, and other hard currencies is by far the more common goal.

Even within the borders of a single nation, businesses use trade mis-invoicing to avoid internal taxes. With state taxes at different levels in America, companies shift profits from one jurisdiction to another to curtail avoidable payments to state treasuries.

Companies can also misinvoice their trades by misstating the volume, weight, quality, or purpose of transactions. In other words, the price can pass inspection while the physical basis of the transaction is manipulated.

Trade misinvoicing has become the principal operating mechanism within the financial secrecy system. The structures of tax havens, secrecy jurisdictions, disguised entities, and more are set up to handle money transferred in a hidden manner predominantly through the nearly invisible process of trade manipulations.

STRETCHING OPACITY

Each of more than 200 legal jurisdictions around the world has its own set of laws. What one country prohibits another may permit. Operators of the financial secrecy system have devoted decades to discovering and exploiting differences in laws and regulations, taking advantage of available ambiguities.

Responsible governments have gone to considerable lengths to avoid double taxation, exchanging treaties by the thousands so that profits taxed in one country are not taxed a second time in another country. But double nontaxation is growing, sheltering profits that are not taxable anywhere.

Lawyers, accountants, and bankers, particularly since the early 2000s, have created an endless range of hybrids, enabling manipulation of tax laws to facilitate evasion or avoidance. A hybrid entity is intended to be fiscally transparent for tax purposes in one country but not fiscally transparent for tax purposes in another country. In normal commercial transactions, one company’s expense payment is another company’s revenue receipt. When using hybrids in cross-border dealings, this distinction can be eliminated. An expense paid by one company can avoid being treated as revenue by another company. Or an expense paid by one company can at the same time be treated as an expense by the other company. In tax circles, the first example is called a “deduction/noninclusion mismatch.” The second example is called a “deduction/deduction mismatch.” These and other mismatches can be created through the use of hybrids in trade transactions, asset transfers, equities, debts, and more. They produce the same outcome: economic activity conducted in the shadows with little or no taxes collected by governments.

Another mechanism for avoiding taxes is the corporate inversion whereby a company sells itself to a subsidiary in a low-tax country. Executive operations can remain in the original country; just the legal headquarters is relocated, and the whole entity now has increased profits at the expense of the government in the original and principal place of business.

Opacity also surrounds lawyers’ pooled accounts. Lawyers can put clients’ funds into accounts they manage along with other clients’ money, disguising their separate identities behind attorney-client privilege. White-shoe firms were found to have handled hundreds of millions of dollars that were stolen from Malaysia, addressed further in a later chapter. One estimate put the amount held in law firms’ pooled accounts for clients at around $36 billion.⁴ This practice is one of the reasons the Financial Action Task Force (FATF), anti–money laundering watchdogs based in Paris, gave the United States low ratings on five categories of regulations on American attorneys.

Other major avenues facilitating opacity and trade manipulation are free trade zones, also called special economic zones. These locations usually provide duty-free and tax-free incentives to investors, supposedly to encourage manufacturing and import-export activities. An estimated 4,300 exist around the world.⁵ The United States has more of them than any other country, nearly 200 according to an industry association, plus by some estimates another 500 subzones.⁶ All over the world these zones freely let goods in and poorly monitor goods out, driving smuggling and tax evasion. Panama, Ciudad del Este (in the Tri-Border Area nestled between Brazil, Paraguay, and Argentina), United Arab Emirates (UAE), China, and nearly 70 other countries have free trade zones. No country is known to adequately monitor such sheltered activities.

MONEY LAUNDERING

In the minds of many, money laundering is associated with organized criminal activity. True, but some of the techniques are used by otherwise respectable people as well.

Cash is king in the drug trade. Deposited into banks in small increments, it remains largely undetectable. Hidden within other physical goods, currency is easily smuggled across borders. Cash is likewise a principal mechanism powering human trafficking, animal poaching, organ sales, antiquity smuggling, and most other avenues for crime.

Asset swaps move ownership across borders. A company registered in one country can simply exchange its shares and become owned by a company registered in another country, perhaps a tax haven, shifting value abroad. Similarly, a service performed in one country can be compensated for with a payment given in another country, all quite opaque to prying eyes. Fake insurance claims move money across borders in international transactions. A credit card can be established in one country and used for illegitimate transactions in another country. Or a bank can take your money into a concentration account, lump it together with other funds, and shift it abroad, giving you access in another country.

Interest rate manipulations illustrate how capital and trade have become interfused. A parent company can loan money to its overseas subsidiary at an extraordinarily high rate of interest, thus allowing trading profits to be extracted through principal and interest payments. A variation on the intent is thin capitalization whereby the capital investment is minimal and the foreign subsidiary is loaded with debt to be paid off at a high interest rate, again using a capital transaction to shift what would otherwise be a trading profit.

Businesses can also use derivatives for the same ends. A parent and a subsidiary can enter into a derivatives contract, structured so that anticipated price or interest rate movements will lead to one side of the contract requiring payment to the other side, moving money across borders.

CAPITALISM’S NEW MOTIVATION

The preceding seeks to encapsulate an understanding of the financial secrecy system as briefly as possible. Two fundamental points are made repeatedly. First, every element of this modern phenomenon used today was developed within wealthier Western countries; not a single element was developed by criminals, drug dealers, corrupt government officials, or others who are often blamed for misusing financial openness. Second, the entirety of the system is designed to move money out of the hands of the poor and into the hands of the rich, out of the caches of criminals and into legitimate accounts, and out of the domains of the corrupt and into the spheres of the respectable. No part of the system provides economic benefits to the vast majority of humanity.

Secrecy is a self-sustaining motivation that drives behavior and functions quite apart from simpler notions of greed. I have known many businesspeople, bankers, lawyers, accountants, and others functioning within the financial secrecy system that I did not regard as personally greedy nor sense that they were intentionally facilitating the greed of others. On the contrary, for them the right thing to do is secrete and shelter money so it will not be subject to confiscation, lawsuits, taxes, spendthrift relatives, pleas for alms, and other demands. For them, the financial secrecy system, whether its patently illegal or thoroughly obtuse mechanisms, is serving a greater good. Such justifications propel trillions upon trillions of dollars across national and state borders, undermining the capitalist system and its contributions to societies.

Or should we just stick with the facts and avoid murkier notions surrounding motivations? Joe Biden, when he was running for president of the United States, said often that in politics it is a mistake to attribute motives to your opponent. In one-on-one encounters, this is normally sound advice. But what is being addressed here is an entire system, a financial secrecy system specifically designed to disguise and move money for the benefit of the few at the expense of the many. Curtailing this reality has to take into consideration what drives this reality. The profit motive in capitalism has been spoken of for more than two centuries. This fully justifies delving into the new secrecy motive now guiding capitalism. Supporting this view is the argument of Paul Krugman, distinguished economist and Nobel Prize winner, who says,

Don’t be afraid to talk about motives. . . . If you’re having a real, good-faith debate, impugning the other side’s motives is a bad thing. If you’re debating bad-faith opponents, acknowledging their motives is just a matter of being honest about what’s going on. . . . [Y]ou deal with the world you have, not the one you want.⁷

In the middle of this financial secrecy world that we have created sits the mechanism of falsified trade. Manipulations of trade, whether by price, quantity, measure, or other devices, are by far the most frequently used instruments within the financial secrecy system. Generating money through manipulating trade transactions then links to every other part of the system via tax havens, secrecy jurisdictions, several kinds of disguised entities, and money laundering methods. Finally, openings left in national laws facilitate movement of money through the financial secrecy system and ultimately into the coffers of the rich, both corporations and individuals.

Other commentators have addressed particular components of the financial secrecy system in greater detail. What has not been emphasized, however, is that every single component of the modern shadow financial system has been developed for the specific purpose of serving capitalism’s new, over the last half-century, secrecy motivation. This is a profound change from the intentions of Adam Smith and other original thinkers and designers of free market ideology. We are experiencing a new motivation within capitalism, a major break in concepts and operations arising across recent decades. What is depicted above did not exist before the mid-twentieth century. This book contributes toward understanding the motivations and mechanisms now operative within capitalism and explains and illustrates the impact these new realities have on prosperity and peace the world over.

Two facets of the shadow financial system predate modern design: the hawala system and Chinese flying money.

Hawala enables money or value to be handed over in one place and handed out in another place with no actual transfer. A hawala dealer in one country will receive money and then cooperate with another hawala dealer in another country to pay out money. Such arrangements are often entered into by family members in one country transferring small amounts to other family members in another country. The hawala dealers on one or both sides of the transaction will take small commissions for their services. They keep track of how much money they have handled for each other, and when balances tip too far on one side or the other they settle accounts between themselves. In settling such imbalances, dealers often resort to the modern financial secrecy system to arrange transfers through trade misinvoicing or money laundering techniques. Sometimes feared by security officials in richer countries as an invisible means of terrorists’ financing, the vast majority of hawala transactions are instead small personal remittances between relatives.

Chinese flying money—fei-chien—operates on very much the same principle. With Chinese cross-border investment, trade, and construction growing exponentially in recent years, the technique is moving huge sums out of partner countries and into Chinese coffers. Construction materials going in and resource exports coming out are manipulated in quantity and value or through outright smuggling in order to shift revenues across borders by cooperating dealers on the two sides of transactions.

As the modern shadow financial system grew in the 1960s, drug dealers in the 1970s realized that these new secrecy systems were ideally suited for shifting their money, and they stepped into the same structures being made available to the corporate and the corrupt to move their disguised proceeds. In the 1980s other transnational criminals, seeing how easy it was for the drug dealers, they too stepped into the same mechanisms to move their money. In the 1990s and the 2000s terrorist financiers, seeing how easy it was for drug dealers and assorted criminal syndicates to move their money, they too stepped into mechanisms available within the financial secrecy system to secure and position resources both within countries and across borders to bankroll their attacks.

Stressing again, every single component of the modern shadow financial system as depicted in figure 1.1 has been developed in wealthier countries precisely for the purpose of serving capitalism’s new motivation: moving, secreting, and sheltering income and wealth in a hidden manner. This is not something foisted upon the richer countries; it is something created by the richer countries. The system is designed to shift money from poor to rich, from criminal to legitimate, from corrupt to respectable. And it does so very efficiently every single day.

Many people believe that bad actors as discussed in succeeding chapters are solely responsible for misusing our good intentions. On the contrary, bad actors are taking advantage of structures we created, in fact structures we frequently operate for the criminal and the corrupt. Secrecy breaks the normally operative laws of supply and demand and undermines theories of growth and equity. We are not dealing with unfortunate outcomes but rather with willful intents.

No short survey such as this can cover adequately all the means available for generating, relocating, and hiding dirty money. What is stressed in preceding pages is the breadth of these activities and the depth to which they have become embedded into the capitalist system’s operations. What is described is not how capitalism was intended to work. What is described is how the system works today using every conceivable mechanism to facilitate the new motivation at its core—secrecy.

Now, step back for a moment in order to grasp the three fundamental forces laid out here that have changed capitalism:

•   Ownership is delinked from control, utilizing multiple entities.

•   Value and price are different concepts, facilitating trade manipulations.

•   Seller and buyer can be disguised, unknown to each other and to regulators.

With these three realities firmly entrenched in capitalism’s modern modus operandi, our economic system is functionally beyond oversight by anyone.

Some halting progress in curtailing the worst of capitalism’s ills is being made, as will be addressed later in this book. But legislators and authorities have not understood a basic truth. You cannot regulate secrecy. You cannot regulate a secret system. Trying to do so is a contradiction in terms. If you do not know what I am doing, how do you stop me from doing it? Law enforcement against money laundering, corruption, tax evasion, and other illicit financial dealings has notably failed because enforcement efforts, laudable as they may be, hardly begin to address the multiple manipulations utilized within the financial secrecy system. What can work and is explained later in the book is transparency and accountability, measures aimed at curtailing the motivations driving the financial secrecy system. Transparency and accountability can eliminate or reduce secrecy far, far more effectively than trying to regulate financial activity while secrecy remains protected.

Most worrisome of all, development of this structure supporting financial secrecy has enabled capitalism to separate itself from democracy, to operate outside competent control of democracy—governments and the people they govern. In this clash, rogue capitalism is winning and embattled democracy is losing, a point driven home in chapters following.

Repeating an earlier point, in order to win the battle for change, it is necessary to understand the elephantine, enigmatic forces opposing change.

This financial secrecy system, this structure that has been created to shift and hide revenues and profits, serving this new motivation within capitalism, this motivation for secrecy, for invisible and unaccountable trillions of dollars of income and wealth, circumventing taxes, driving inequality, impoverishing billions, empowering criminals, enriching despots, what has been done over the last century and especially the last half-century, different from the past, this is without question the ugliest chapter in global economic affairs since the wretched years of lawful slavery. Let us hope that it will not take an equal number of years to change. Like slavery, the costs of ill dealings within capitalism are staggering, to which we now turn.