How Does Illegal Drug Money Affect the Economy?

The money that fuels illegal drug trade is one of the only truly “liquid” forms of capital in the world, making that same money an important aspect of the entire global economy. To what degree do governments, banks and businesses perpetuate the war on drugs precisely by prohibition?

According to some economists, the global trade in illegal drugs is a fundamental, essential part of the prevailing economic model – and the war on drugs is a means to maintain the trade, rather than to eradicate it.

However contentious the topic is, the illegal drug trade plays an enormous role in the current global economy. Despite how much the war on drugs is presented as a means of eradicating illegal drug trade, international law and money laundering are drivers of the illegal drug economy. In this way, banks and governments are implicit in the passage of illegal drug money and its effects on the global economy.

Markets & the movement of capital

In general, capitalist economies depend on the movement of capital (money) as a means of maintaining growth and generating profits. In a free-market or laissez-faire capitalist model, there would be no restrictions on the movement of money – no taxes, trade tariffs, or financial regulations at all – and prices for goods and services would be entirely determined by market forces.

Instead, thousands of different regulations, taxes and tariffs influence and control the movement of money. These financial instruments play various roles. They may control or affect interest rates on loans and redistribute wealth in the form of benefits and healthcare to poorer sections of society. They allow governments to control prices so that the cost of basic necessities remains affordable, or introduce trade tariffs to protect valuable industries.

Thus, a truly free market does not exist in the world today. Individual countries and regions vary in the extent to which they regulate business, but most nations today impose taxation and regulations to some extent.

Due to financial red tape, conducting business transactions can be complex, slow, and subject to scrutiny from various financial authorities. But within this complexity, there are almost endless opportunities to bend or break certain rules, or just make up new ones entirely. This is essentially what occurred with the subprime mortgage scandal and the system of credit default swaps.

Then, if the rules get broken or bent too far, it can cause instability that can ripple out and wreak incredible economic devastation, culminating in recessions or even depressions. This has happened a remarkable number of times throughout history.

In 2008, the financial manipulation of the mortgages and securities market caused the failure of the two largest US mortgage lenders, Fannie Mae and Freddie Mac. The subprime mortgage crisis caused a domino effect within the banking industry – and ultimately a global recession.

The collapse of the mortgage industry caused a global recession (© Mark Warner)

In severe recessions, spending and investment practically grinds to a halt. With businesses and governments unwilling to spend or invest, the amount of liquid capital in the system rapidly declines. Profits go down, wages and jobs are cut, and governments generate smaller tax revenues. Desperate measures such as quantitative easing, bank bailouts and austerity may be implemented.

Drug money may be 1% of total world GDP

But there is a form of capital that remains relatively unaffected in these situations, largely because it is not subject to taxes, regulations, or interest rates. This is illegal or “black” capital, generated from illicit economic activities including drug smuggling, human trafficking, prostitution and gambling. A 2009 UNODC report estimated that together, these “black” industries were worth $2.1 trillion that year, or 3.6% of global GDP.

Of the illegal industries, the single largest sector is drugs. In fact, drug capital alone may make up as much as 1% of total world GDP. The UNODC estimated that $321 billion was spent on drugs in 2003. The same year, total GDP was estimated at $38.7 trillion — indicating that 0.83% of the total world GDP was generated from drugs.

According to some economists, this liquid, illegal money may be fundamental to the maintenance of the current global economy. Antonio Maria Costa, former head of the UN Office on Drugs and Crime, stated in 2009 that the proceeds of crime represented “the only liquid investment capital” available to banks in danger of collapsing during the 2008 crisis.

“Inter-bank loans were funded by money that originated from the drugs trade and other illegal activities… There were signs that some banks were rescued that way”, Costa stated.

Without it, he argues, the financial crisis of 2008 could have led to an all-out global collapse of the banking industry. Instead, although numerous major banks failed, others scraped through thanks to the availability of illegal money.

Legality & liquidity of money

But where exactly does this liquid, illegal capital come from, how is it moved around the world, and how do banks have access to it?

First, let’s talk about liquidity. Capital is liquid when it can be easily moved around and exchanged. Thus, physical cash is the most liquid asset of all. Money held in bank accounts and bonds is often also classed as cash, because it can be quickly and easily converted into physical cash if needed. It’s liquid capital, but not quite as liquid as a bundle of banknotes.

At the other end of the scale, we have illiquid investments such as houses, art, money locked up in long-term savings accounts or business assets. These are assets that can’t be easily exchanged for cash, and that are subject to lengthy procedures to become accessible.

Next, let’s discuss legality. All money, when it comes into being, starts off as “white”, legal money. It’s only after it is illegally obtained that it becomes “black” money. Therefore, when money is stolen, spent in illegal transactions such as drug purchases, or fraudulently withheld from the tax office, it becomes black money.

Black money is the most liquid capital of all – it is overwhelmingly in the form of hard cash, and it changes hands without being delayed or diminished by red tape and taxes. In this respect, the black market is arguably closer to a “free” market than any legal, regulated market.

How drug capital flows through the system

Although some drugs may be purchased with stolen money, the vast majority of money spent in illegal drug transactions is in the form of small cash amounts that come directly from the end consumer. The money comes from consumers’ wages, salary, savings, inheritances or benefits legally available to the consumer.

Cumulatively, this sum of money is not trivial by any means. A 2014 report estimated that the US population spends $100 billion annually on drugs for personal consumption. As previously mentioned, an estimated $321 billion was spent on drugs throughout the world in 2003. Of that, $214 billion was spent at the retail level. It’s important to note that these figures are estimates, as tracing the movement of black money is extremely difficult. Given the secretive nature of illegal industries and the risks involved in studying them, exact figures are generally hard to come by.

It suffices to say that the average consumer, as well as plenty of small-time illegal retailers, hardly needs to consider the movement of drug money once it has left their hands. For the consumer, the drugs are purchased and that’s that. For the low-level dealer, the profits generated can be spent as disposable cash in small amounts that won’t attract the attention of the financial authorities. Thus, a substantial chunk of cash slips in and out of the black economy at this level.

But the small-time retailer purchases their product from distributors further up the chain, who ultimately will be dealing with amounts of cash too large to use without attracting attention. Individuals or organizations at this level now have to think about how to “clean” their money, so it can get back into the white economy with a good explanation of its movements and existence.

Without that, expensive cash purchases could attract the wrong attention – attention that could lead to long, secret investigations, arrests and prosecutions, and the seizure of money and assets.

Money-laundering – The bridge between the “black” and “white” economies

Therefore, a system that allows money to be cleaned and safeguarded in return for an agreed percentage is a necessity for any sensible dealer. Hence, the existence of money “laundering” – literally, the cleaning of money.

Money laundering also serves another important benefit. With the right setup in place, money can be transferred between countries and individuals with remarkable speed. Essentially, a system like this utilises the white legal network but remaining effectively outside of it.

The money laundering industry is the most important bridge between the black economy and the white, and may process as much as 2.7% of total world GDP per year (an estimated $1.6 trillion in 2009). Money laundering businesses may be “front” companies that are set up for the sole reason of cleaning money for criminal organisations. Alternatively, they may be otherwise legitimate businesses with a clandestine sideline in money laundering.

It’s in this latter category that we find the most damning evidence of the involvement of “white” businesses in the “black” economy. For example, certain major banks, which have repeatedly been exposed for illegally profiting from drug money.

Banks – The world’s biggest money launderers

In 2009, it was discovered that two major banks, HSBC and Wachovia, had managed accounts for the Mexican Sinaloa Cartel, laundering hundreds of billions between them. Wachovia laundered approximately $420 billion for the Sinaloa Cartel between 2003 and 2008. And on Wachovia’s behalf, workers at Mexican branches of HSBC routinely took delivery of and handled this money.

In 2010, after a 22-month investigation, Wachovia was punished with a “deferred prosecution” along with fines and forfeitures totalling $160 million – just 2% of its profits that year. By this time, Wachovia had been bought by Wells Fargo, and had ceased its money-laundering activities apparently for good.

HSBC, on the other hand, continued to profit from money-laundering activities for several more years. It is reported that cartel members deposited hundreds of thousands of dollars every day at HSBC branches, with no questions asked by the bank.

In 2012, HSBC was fined $1.9 billion for its money-laundering activities. It was among the biggest banking fines in history, but a tiny fraction of its annual profits. It was also hit with a five-year deferred prosecution – but as the New York Times put it:

“Federal and state authorities have chosen not to indict HSBC, the London-based bank, on charges of vast and prolonged money laundering, for fear that criminal prosecution would topple the bank and, in the process, endanger the financial system.”

These cases exposed a deeper undercurrent of complicity between big banks and drug traffickers that stretches back decades, if not centuries. The extent to which major banks have cooperated in the laundering of profits from criminal organizations is endemic, and has arguably underpinned almost two centuries of Western-driven capitalism.

What’s behind this complicity between banks and illegal drug runners, and why do governments and judicial systems apparently work to protect the relationship? If the aim is truly to eradicate the global drug trade, the correct approach would surely be to expose and sever it.

To fully understand the complex relationship between banks, governments and drug businesses, we first need to look at the history of the global drug trade, with its roots stretching back to the European colonial period.

Colonialism, drugs & the balance of power

Drugs have been traded between countries for centuries, and laws have been passed banning their sale or consumption for perhaps as long. The early history of the drug trade is patchy, but from the 17th century onwards there is plenty of evidence of a flourishing international trade – as well as plenty of efforts to stamp it out.

British, Portuguese, French, Spanish and Dutch interests had been competing for control of key Asian territories and trading routes for over a century by the 17th century. Among their territories, the Portuguese had control of Goa, and the Dutch controlled Bengal – which happened to be two very important opium-producing regions.

It’s important to note that at this time, the European governments were only indirectly involved in this emerging international trade network. The principal actors were the merchants of the East India Companies – collectives of traders with indirect support from their respective governments.

By the late 17th century, the Portuguese and British East India Companies were transporting opium to Canton (Guangzhou – the principal Chinese seaport at the time) from Goa, while the Dutch East India Company had established a monopoly on the opium trade between Bengal and China.

The Chinese empire was an important regional power, with which Europe had an imbalanced trading relationship. The Chinese exported vast quantities of valuable goods to Europe, but had little need for European products in return. However, opium sales represented a highly effective means of acquiring Chinese silver to offset the European deficit, and at first, the Chinese were happy to buy it.

Then, due to concerns over rising addiction numbers and declining silver revenues, China passed a law banning the sale of opium in 1729. However, this did not stop the trade, merely pushing traders to implement more subtle methods of getting their products to China.

The private armies of the British East India Company fought and won important wars in 1757 and 1764 that allowed it to take control of Bengal, Bihar and Orissa – major opium-producing regions of India. This period marked the true beginning of Company rule in India, which was to continue until the establishment of the British Raj in 1858.

In 1773, the British Crown granted the Company a monopoly over the opium trade in Bengal. The Company then commenced selling opium to private merchants in Calcutta (Kolkata) in order to avoid openly flouting the Chinese ban on opium sales. These merchants would then transport the bulk of the opium directly to China.

The opium wars & China’s defeat

The Company was fully aware that its continued trade in opium past 1729 was illegal under Chinese law. However, it pursued the trade, and for a short time even took opium directly to Canton in Company ships. However, this ceased when Company directors in London criticised the practice for “jeopardising legal forms of Sino-British trade, as opium was contraband in China”.

Over the next few decades, the Company increased its efforts to control and penetrate the Chinese market, and the trade in opium became ever more crucial to its ongoing efforts in Asia.

Despite partially relaxing the ban in the decades after 1729, new increases in addict numbers and heavier silver losses motivated China to issue new bans on opium consumption (1796) and imports (1800). Then in 1834, the Company lost its Crown-granted monopoly (due to widespread British protests in favour of free trade) over opium, and competition began heating up.

This period saw increasingly devious and aggressive attempts to control the trade. The Company issued written orders to the private merchants it traded with, ostensibly banning them from smuggling opium to China, while secretly requiring them to transport it.

During this time, merchants would typically ship opium to warehouses situated on islands close to Canton. In 1839, Chinese officials inspected these warehouses, and confiscated and destroyed 20,000 chests (around 1,400 Imperial tons) of opium.

At this stage, the Company appealed to the British government for assistance. The British government, understanding that the opium trade was now essential to maintaining a British trade presence in Asia (and healthy revenues for Britain itself), sent a fleet of warships up the Pearl River Estuary towards Canton – and the first Opium War (1839-1842) began.

By this time, the laissez-faire economic philosophy of Adam Smith was greatly popular in Britain, and Chinese restrictions on the opium trade were held up as an example of unfair trade restrictions. It was a jaw-dropping hypocrisy, given that the East India Company’s monopoly had been lifted just five years previously.

By 1865, the British, with support from the French and the Americans during the second Opium War (1856-1860), had taken control of Hong Kong, Shanghai and Nanjing, and fully opened them up to trade. The opium trade into China was now fully established, and with the signing of the “Unequal Treaties” of Nanjing, imports were made fully legal under Chinese law.

These treaties, along with widespread social instability caused by protracted war and steadily climbing addiction rates, brought the mighty empire of China to its knees. What would follow would become known as its “Century of Humiliation”, and its subjection to European colonial powers. With the last great non-Western power defeated, the era of Western rule had begun in earnest.

Drug banking in the colonial period

But where do banks come into this sordid history of drug smugglers, governments and war? We’ve seen evidence that major banks have a crucial role in laundering drug money in today’s world. But if the entire formation of the modern capitalist system depends on the complex relationship between governments, businesses and banks, then banks must also have had a role stretching back centuries.

Indeed, when looking at the history of banking during and immediately after the Opium Wars, we come across a familiar name – the Hongkong & Shanghai Banking Corporation, now known to the world as HSBC.

Established by British businessmen in 1865, after the second Opium War, the bank served the needs of British traders in China – at a time when 70% of the trade was in opium. In fact, certain founding members (particularly Dent & Co and Thomas Sutherland of P&O) made their fortunes directly from the opium trade, while it was illegal under Chinese law. During this time, opium was considered to be the most valuable commodity in the world.

Several other banks were involved in handling the proceeds of opium at the time, including Barings Brothers, Jardine Fleming Bank Ltd, and Hottinguer & Company. These banks handled opium money until around the end of the First World War, when the trade became internationally illegal – at which point their role in handling drug money either ended or became clandestine.

The emergence of modern money laundering

As the drug trade became illegal throughout the world, it was not eradicated. It simply went underground, just like British trade into China after the Chinese bans on opium. As the risks of operating as a drug smuggler became higher, so too did the potential rewards, and mafias and cartels quickly became established. Governments that had previously been open in their support distanced themselves from the drug trade, and a new era of anti-drug rhetoric emerged.

Now that drug revenues were internationally illegal, the need for money laundering came into force in a big way. By the US Prohibition era of the 1920s, vast amounts of illegal money would be laundered. After all, one of the most lucrative commodities of all time – alcohol – was by then prohibited in the US. The illegal revenues pouring into the coffers of the emerging American mafia were staggering.

The art of money laundering was in its infancy at this time, and in fact, money laundering itself would not become officially internationally illegal until the 1980s. Thus, when Al Capone was imprisoned in 1931, it was not for bootlegging or money laundering, but for simple tax evasion.

However, this signalled to other mobsters that the authorities may be paying attention to their own business dealing, and the money laundering business began to pick up speed. Prominent Jewish mobster Meyer Lansky soon began transferring illegal cash to Swiss bank accounts, which were protected by the Swiss Banking Secrecy Act of 1934. He would ultimately set up his own offshore Swiss bank and a vast and complex money laundering system to accompany it.

Since then, banks have repeatedly been shown to still have involvement in the illegal drug trade. Examples include the Bank of Credit and Commerce International, the Nugan Hand Bank, the Federal Reserve’s Miami branch – all active during the 1970s and 1980s, when the cocaine trade in Latin America was taking off.

Now, money laundering systems have evolved to become highly complex and intricate, comprised of vast webs of banks and businesses stretching across dozens of countries. Drug money is used to purchase gold, diamonds, clothing, footwear, agricultural equipment and various other legitimate goods, and the paper trail is almost impossible to follow.

The battlegrounds of the war on drugs

International laws are now in place prohibiting money laundering and the trade in drugs. In addition, there exist several treaties that render illegal any open attempt by a government to interfere with another sovereign nation’s market using military force.

But while colonialism may officially have ended, certain patterns perpetuate themselves – continuing to enrich the ex-colonial powers by transferring wealth from the “developing” world. Drugs still represent a huge source of wealth; businesses that smuggle drugs continue to channel vast amounts of money into the “Western” economy; governments still involve themselves in wars that perpetuate the trade, and major banks and other “white” businesses continue to facilitate the process.

Since the balance of power has shifted from Great Britain to the USA, the primary battlegrounds of the war on drugs have shifted too, from Southeast Asia to Latin America. Now, the world’s most valuable commodity is no longer opium, but cocaine.

The ambiguous concept of the “narco-state”

As colonialism ended and former colonies achieved national independence, the world saw another fundamental socioeconomic shift. Colonial powers were losing their grip on revenues from their former colonies. Plus, the colonies themselves were in a new, uncertain stage of life, with a desperate need to become financially self-sufficient.

Although the major Western powers were losing outright political power in their former territories, they still held vast economic power, built up over centuries of unfair trading practices. For many such territories, their largest trading partner today is still their former colonist – and invariably, trading relationships remain vastly unequal. In fact, this phenomenon has been labelled “neo-colonialism” or “post-colonial colonialism”, and its effect on the world is profound, especially in Africa.

For some of these former colonies, dominions and mandates, drugs destined for international sale still make up a vast chunk of the national economy. In certain countries, participation in the drug trade has had an enormous and visible effect on the development of their economies. This is how we come to the concept of the “narco-state”, although (as so meticulously pointed out in The Myth of the Narco-State, P.A. Chouvy, 2015) the designation is dubious and has never been clearly defined.

However, there are various clear similarities between major drug-producing nations. They are typically “developing” countries, with widespread poverty. They are often politically unstable, and prone to unrest and violence. They typically have weak governments that may enable, encourage, or even directly profit from the illegal drug trade to varying degrees. Often, a mafia or cartel system will have developed, and will benefit from a deep level of infiltration into law enforcement and government.

Major drug-producing countries usually also have an intricate financial system in place to internationally launder drug trade profits. Typically, they also have a long history of exploitation and subjugation by a colonial power. They are heavily dependent on foreign aid, leaving them open to financial bullying and manipulation at the international level. Countries that fit this description are usually situated in Africa, Asia and Latin America.

Demonising drug producing nations is a key propaganda tool

There is a huge and ceaseless global market for drugs, and a “moral” argument in keeping them illegal. This moral argument is highly compelling, and is a key part of the rhetoric ostensibly “justifying” the war on drugs.

Since prohibition times, drug-producing states have been labelled as narco-states, scapegoated, and subjected to military aggression from major powers, particularly the US. This military aggression is fêted as an attempt to eradicate the illegal trade in drugs, but there is now a great deal of evidence to suggest that it in fact perpetuates it, and gives narco-traffickers ever more power and influence.

In May 2001, the terrorist group known as the Taliban imposed a ban on opium production in Afghanistan, which had a profound effect on the global opium market – dramatically reducing availability and increasing prices. Months later, the US invaded – and the Taliban reversed their policy on opium, sending production skyrocketing over the following years.

Afghanistan’s opium production has long been linked with the funding of terrorist organizations, particularly the Taliban, Al Qaeda and now ISIS. For example, it has been widely reported that ISIS receives $1 billion per year in illegal drug revenues.

The dubious link between drugs & terrorism

However, upon looking closer, there are obvious flaws with the argument. Certainly, some of the profits generated by the illicit trade in drugs go towards financing terrorist groups, but it is thought to be a small fraction of total funding.

ISIS, according to the Centre for Analysis of Terrorism, made $2.4 billion in 2015 – of this, $800 million came directly from taxing the citizens living in the territories they control, and a further $600 million came from oil. The remaining $1 billion came from a mixture of sources including kidnapping & ransom, antiques, donations, agriculture, phosphate mining and natural gas. Any revenue earned from drugs apparently comes from taxation of drug producers rather than management of drug production.

Yes, terrorist groups can benefit from the stealth and liquidity of drug capital, but it’s clear that they are far from the main beneficiaries, and that drugs make up a negligible proportion of total funding. The Taliban may be an exception here, with up to 40% of their funding arising from Afghan heroin (possibly over 60% at the peak of the trade). But the Taliban’s total annual revenues are less than a quarter of ISIS revenues, and it is thought that they receive greater total amounts directly from Pakistan and the Gulf states.

The main beneficiaries of the drug trade

With a trade worth over $320 billion a year, even if ISIS (the “world’s richest terrorist organization”) did make $1 billion annually (and the evidence suggests they do not), terrorist organizations are not big players in the international drug trade. The main beneficiaries are the drug cartels themselves, along with the banks and businesses that do business with them.

Just for comparison – it’s thought the Sinaloa cartel makes $3 billion per year, and the Latin American cartels combined may make as much as $64 billion annually, almost entirely from the trade in cocaine (with small percentages deriving from other illegal drugs).

The entire global financial system continues to benefit from the illegal drug trade, keeping drug-producing countries trapped in a cycle of unbreakable economic dependence. This is furthermore facilitated by vast quantities of international aid, which keep drug-producing nations subject to the economic whims of their international creditors.

“Count The Costs”, an international organisation offering an “alternative World Drug Report”, states:

“Globally, in excess of $100 billion a year is spent on fighting the war on drugs – roughly the same as the total spent by rich countries on overseas aid. The US, and other countries, have diverted development aid from where it would be most effective, blurring it into military spending for its allies in the war on drugs – most significantly in Latin America.”

This points to the deeply flawed and unequal nature of our current economic model. It also suggests that what is required to actually end illegal drug smuggling is the establishment and maintenance of an economic system that does not depend on a pool of illegal cash to turn to when the usual mechanisms fail. A sustainable economy must not be based on the unsustainable exploitation of weaker nations.

Currently, we are experiencing fundamental changes to the global economy, and some economists believe that the era of Western economic supremacy is drawing to a close. As this transitional phase continues, we are likely to see radical changes within the drug trade. The current trend towards legalising and regulating the world’s most valuable cash crop – cannabis –  may be an aspect of this fundamental change.

  • Disclaimer:
    While every effort has been made to ensure the accuracy of this article, it is not intended to provide legal advice, as individual situations will differ and should be discussed with an expert and/or lawyer.

Comments

5 thoughts on “How Does Illegal Drug Money Affect the Economy?”

  1. Developing nations consume vast quantities of recreational drugs. In America the drug of choice was alcohol. Although opiate use was not unknown (Nantucket). With development that use rate declines. The alcohol temperance movement was a reaction to that use rate despite the fact that alcohol consumption was already in decline. And we now know why.

    Addiction is a symptom of PTSD. You can look it up. – That is why even in America we have a residual of opiate addicts.

    The fear that opiate use will greatly spike if it is legalized is unwarranted. We no longer get large amounts of PTSD just from living. Our residual amounts of PTSD are from child abuse. Dr. Lonny Shavelson found that 70% of female heroin addicts were sexually abused in childhood.

  2. It seems to me that nearly all really big money is earned through human suffering and death; I guess it is one of those things that can be counted on – war, climate change, disease, cancer, forfeiture

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    Sensi Seeds

    The Sensi Seeds Editorial team has been built throughout our more than 30 years of existence. Our writers and editors include botanists, medical and legal experts as well as renown activists the world over including Lester Grinspoon, Micha Knodt, Robert Connell Clarke, Maurice Veldman, Sebastian Maríncolo, James Burton and Seshata.
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