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March
25, 2004
An Interview with Michael Hudson
An
Insider Spills the Beans on Offshore Banking Centers
By STANDARD SCHAEFER
The oil industry created the practice of countries
(SHIPS?) flying "flags of convenience" as a means of
avoiding income taxes nearly a century ago. Since the 1960s the
U.S. Government itself has encouraged American banks to set up
branches in Caribbean hot-money centers and more distant islands
as a means of attracting foreign money into the dollar. The initial
aim was to help finance the Vietnam War by turning America into
a new Switzerland for the world's hot money.
This policy succeeded in turning the
United States into a flight-capital center for third-world dictators,
Mexican presidents and Russian oligarchs. The former Soviet Union
now finances a substantial portion of the U.S. balance-of-payments
deficit with the flight capital that neoliberal "reformers"
facilitated by backing the kleptocrats. The result has grown
into a full-blown system enabling multinational corporations
to evade taxes everywhere, including the United States itself.
It enables domestic investors to globalize their operations by
 setting up offshore affiliates
Enron-style in the Cayman Islands, Dutch West Indies or some
small and newly notorious Pacific Island of their choice.
The permissive regulatory system relating
to these offshore beachheads of tax avoidance has evolved to
a point that enables U.S. and European investors to shed taxes
simply by hiring a lawyer to set up a boiler-place office and
finding an accounting firm willing to take its records at face
value--which is good enough for the tax authorities to accept
in these days of downsized fiscal operations. The resulting plunge
in the ratio of corporate tax obligations to national income
has been a major factor in America's soaring federal budget deficit.
Businesses--and especially the financial sector--establish dummy
companies and adjust their transfer pricing (e.g. on sales
of raw materials to refineries, and of refined or semi-manufactured
products to their final distributors in the industrial nations)
so as to take all their profits in these tax-free enclaves.
Flight capital would not leave countries
without having somewhere safe to go. A rising number of tax-avoidance
islands have made use of the fact that they are small enough
to adopt whatever tax code they wish. Lawyers acting on behalf
of financial and business lobbies in North America and Europe
have drawn up laws to turn these banking centers into what Prof.
Hudson calls anti-states.
* * *
SS: In earlier interviews you described
how the economy has been "financialized" in ways that
free companies from taxation. What role do offshore tax havens
play in this?
MH:Companies set up trading companies
in tax-avoidance islands and declare whatever income or capital
gains they earn on real estate, stocks or other investments to
be made by these shells. This has led to the quip that taxes
have become purely voluntary for modern businesses.
SS:How does this affect the domestic
U.S. economy?
MH:Un-taxing business income--and financial
income in particular--leaves individual taxpayers to bear the
fiscal burden through wage withholding for Social Security, Medicare
and pension-fund contributions. Consumers also bear a rising
burden through the sales tax and other local taxes.
SS:Do the statistics confirm this?
MH:Offshore tax havens enable multinational
companies to give an impression that they do not earn any income
on business done in countries where taxes are levied at European
and North American rates. The reality is that U.S. companies
make a lot more money than they report. However, offshore banking
centers free them from having to pay taxes on this income, or
on capital gains. That's why we're running such high budget deficits
today.
SS: I understand you have had a forty-year
experience with these offshore banking centers and tax-free enclaves.
MH: I was taught the ropes in the course
of my work as a balance-of-payments economist, and later as a
mutual-fund manager. My first clue to how these enclaves were
set up came when I worked for the Chase Manhattan Bank in 1965-66
and was assigned the task of writing a report on the oil industry's
impact on the U.S balance of payments. After reading the usual
books about how the cartel operated worldwide, I still had difficulty
making my way through the oil industry's income-and-expense statements
and the statistics published by the Department of Commerce.
My main problem was to find just where
oil companies made their profits. Was it at the production end
where crude oil was drilled out of the ground, at the processing
stage where the oil was refined, or at the distribution end where
it was sold to its end-users to heat buildings, run cars, fly
airplanes and make into petrochemicals and plastics?
David Rockefeller arranged for me to
meet one afternoon with Jack Bennett, the treasurer of Standard
Oil of New Jersey (the old Esso before it changed its name to
Exxon). "The profits are made right here in the Treasurer's
office," he explained, "wherever I decide." He
showed me the broad leeway a vertically organized global conglomerate
enjoyed in being able to assign "transfer prices" do
as to report the overall profit at whatever point taxes were
lowest on oil's statistically labyrinthine journey from wellhead
to gas station.
Taxes were lowest (in fact, non-existent)
in Panama and Liberia, where the oil industry's tankers duly
registered their flags of convenience. Standard Oil priced its
crude oil low to these shipping affiliates, and sold it at a
high, nearly retail price to refineries and marketing outlets
in the industrial oil-consuming nations.
SS:How can someone use the statistics
to trace what is happening?
MH:It is not easy to find transactions
with these flag-of-convenience countries in the U.S. balance-of-payments
statistics. Instead of being listed as bona fide countries in
Africa or Latin America, they appear under a rather obscure column
heading called "international." Cursory viewers tend
to overlook it, as it does not indicate a specific country or
region. Some people may imagine that it even refers to venerable
international organizations such as the United Nations, IMF or
World Bank. But what "international" means is, quite
simply, "international shipping" registered under flags
of convenience. Quite properly, it doesn't really belong to a
foreign nation's economy at all, because it is a legal fiction
that U.S. companies simply make use of to produce tax filings
on an unrealistic "as if" basis.
SS:You're saying that the statistics
are translated into a language of unreality.
MH:A carefully structured unreality--and
one that has real-world consequences, to be sure. The essence
of this game is that Esso and other oil majors were able to "game"
the world's tax systems by selling their crude oil at so low
a price to their tanker companies as to leave little income for
Saudi Arabia, Venezuela or other oil producing countries. This
discouraged them from taking control of their mineral wealth,
especially as they had no tanker fleets to move this oil. The
corporate shipping affiliates turned around and sold their oil
to their downstream refineries. These generally were located
safely offshore in different political jurisdictions (e.g.,
Trinidad for Venezuelan oil). The oil was transferred at so high
a price that despite the heavy capital investment in these facilities,
the refiners and distributors reported losses year after year,
decade after decade.
SS:How could the tax authorities in Europe
and America not catch on to what was happening?
MH:That's where the political lobbying
power of major vested interests came into play. Their ability
to avoid having to declare earnings on which taxes would be due
reflected the passivity of tax collectors in Europe and North
America where most downstream facilities were located. One might
think that such governments would have imputed a minimum tax,
on the principle that any investment must expect to earn at least
a normal rate of return; otherwise it would not be made or kept
in place. Turning a blind eye to this logic, governments accepted
the profit-and-loss statements as company accountants submitted
them. They permitted the profits from oil drilling, refining
and marketing to disappear down the statistical black hole of
international shipping.
Mining companies followed a similar accounting
practice with their shipping fleets and refineries. These oil
and mineral companies were among the largest multinationals.
SS:You are saying that profits fell statistically,
but not really. What does this mean for the theory that market
prices allocate resources efficiently by reflecting supply costs
and demand?
MH:The development of tax shelters in
flag-of-convenience countries to record corporate profits hardly
can be viewed as a merely marginal phenomenon. For nearly a century
it has played a central role in the U.S. and European economies.
But the prices are fictitious rather than a result of being based
on actual costs or on supply and demand. Only the immense political
power of these extractive sectors could have induced their governments
to remain so passive in the face of the fiscal drain they entail--a
favorable tax treatment denied to other taxpayers.
Gradually, however, other sectors learned
to emulate the strategy of avoiding taxes by using offshore banking
centers.
SS:Apart from transfer pricing, were
other accounting gimmicks used?
MH:Parent companies consolidated their
oil fields in the Near East, Africa and South America into their
domestic U.S. balance sheets by organizing them not as corporately
distinct foreign affiliates but as "branches." This
technicality allowed them to take the full U.S. depletion tax
credit against their income. Depleting the resources of other
countries was treated as if they were part of the American economy--except
that the profits were taken in Liberia and Panama.
SS:Did you have any conflicts working
for Chase and the oil companies to produce this report?
MH:I was given free rein. I was told
to come up with the best statistics possible. They made it clear
that if the answers were not what they and the oil industry expected,
they would not publish my report, but at least they wanted to
know what the statistical situation was. I accepted the assignment
on these terms.
How the Russian and
U.S. Governments nurtured offshore capital-flight dollar centers
SS: How did these flag-of-convenience
tax havens evolve into offshore financial centers independent
of corporate shipping operations?
MH:The common denominator is tax avoidance,
but the proliferation of offshore banking centers has taken on
a life of its own, based on flight capital and hot money.
SS:Did this also occur as a result of
corporate tax maneuvering?
MH:That was not the main motivation.
Switzerland and Liechtenstein would have sufficed for the level
of flight capital and criminal savings that characterized the
1950s. In order for modern-type hot-money havens to emerge, an
institutional set-up had to be created to hold dollars or other
hard currencies outside their countries of origin--somewhere
that would provide the same degree of "privacy," "confidentiality"
and hence immunity from the authorities that Switzerland provided
with its notorious bank secrecy laws.
The oil and mineral companies did not
break the laws or do anything illegal, and hence did not need
this kind of privacy. They simply wrote and amended the tax laws
to insert loopholes in their own favor. The actual money was
kept in their home offices. But offshore banking centers aimed
at a different source of deposits--those which needed to be kept
outside the reach of U.S. or European authorities.
SS:So how did the offshore vehicles for
dollar deposits develop?
MH:Actually, the great catalysts were
the Soviet and U.S. Governments themselves. The story starts
with the creation of the Eurodollar market during the Cold War
years.
In the late 1950s the Soviet Union had
a problem. It needed bank accounts denominated in U.S. dollars
to defray its various spending programs in the West. But as the
Cold War heated up, it feared that the U.S. Government might
confiscate its U.S. bank accounts (much as Chase Manhattan would
do to Iran after the Shah was overthrown). Russia therefore approached
a number of British banks and suggested that they establish accounts
enabling Soviet agencies to keep their dollar receipts denominated
in U.S. dollars (rather than converting them into sterling),
and to use these dollar accounts to pay dollars various suppliers
in the West (not to mention more nefarious agents). British banks
agreed, and the Eurodollar market was born--a market for dollar
deposits held outside of the United States.
SS:So a great finance-capital innovation
was established by the Soviets themselves. Did they realize what
they were dong? And by trying to evade U.S. control, did they
end up helping or hurting U.S. global interests?
MH:Nobody grasped the implications at
first. As so often happens, this financial innovation bred a
train of unanticipated consequences. U.S. multinationals found
it helpful to hold dollars offshore to facilitate their own transactions,
especially as they began to buy European and other foreign firms
and establish their own overseas branches.
U.S. banks set up branches in London
and other money centers to serve these companies. When monetary
policy was tightened during the Vietnam War years, these banks
found the easiest supply of money to come from their foreign
branches. Bank regulatory agencies had not foreseen this development,
and had not imposed any requirement that head offices set aside
reserves against the deposits that came from these foreign branches.
So Eurodollar deposits became a great source of deposits for
the large international U.S. banks to lend out when money was
getting tight as a result of the Vietnam War's balance-of-payments
drain.
How the U.S. Government
urged Chase to set up branches in hot-money centers
SS: What was the most remarkable experience
you had with these institutions?
MH:The Vietnam War was pushing the balance
of payments into deficit, draining the gold supply that backed
the currency. Gold had been America's lever of international
financial power since World War I, and now it was flowing out
to pay for the war in Southeast Asia.
The Johnson and Nixon administrations
knew that if fighting the war meant less consumption at home,
voters would oppose the war. So they pursued a guns-and-butter
policy, promoting heavy domestic consumption and deficit spending,
leaving little to sell abroad. The United States was not willing
to permit key economic sectors to be sold to foreigners to balance
its international payments, although this is what it directed
other debtor countries to do after 1980.
U.S. officials sought to attract foreign
exchange in any way they could, but their options were limited.
One great possibility remained: attract foreign flight capital.
This could be done without raising interest rates at home, but
providing a safe haven for foreign hot money. Therefore, what
U.S. geopolitical strategists were willing to accept were foreign
bank deposits, regardless of where they came from.
In balance-of-payments terms, foreign
money being converted into dollars and kept in foreign branches
of U.S. banks would do just as well as money in U.S. banks, as
long as these deposits were held in dollars rather than in foreign
currency.
SS:Was this an explicit policy?
MH:Pretty explicit. This was at a time
when so much hot money was going to Switzerland that its franc
was becoming the world's hardest currency. American financial
strategists sought a policy to support the dollar in much the
same way. The State Dept. and Treasury approached the nation's
leading international banks with a proposal to do something that
they would have feared to do without official inducement. They
were to establish and expand their own branches in the world's
major capital-flight centers--and perhaps to help establish some
new ones. Not only would this attract foreign flight money, it
would keep at home the substantial sums were being sent abroad
by U.S. tax evaders.
In 1996 a former State Dept. employee
who had become a Chase officer asked for my opinion of a memorandum
outlining the common interest between U.S. economic diplomacy
and the nation's international banks with regard to establishing
offshore branches aimed at attracting some of the world's hot
money away from Switzerland and other flight-capital centers.
The US is probably the second major flight
center in the world, but with little probability of rivaling
Switzerland for the foreseeable future. Like Switzerland, flight
money probably flows to the US from every country in the world.
It is handled almost exclusively by the major New York and Miami
brokers, lawyers, and leading commercial banks. Officers of CMB
International Department and Trust Department confirm that CMB
Home Office itself handles a reasonable amount of foreign flight
money. However this is insignificant relative to the total potentially
available.
There is general consensus among CMB
officers and both US and European experts in the field that US-based
and US-controlled entities are badly penalized in competing for
flight money with the Swiss or other foreign flight-money centers
over the long run. This is because of the following interrelated
factors:
(a) The demonstrated ability of the US
Treasury, Justice Department, CIA, and FBI to subpoena client
records, attach client accounts, and force testimony from US
officers of US-controlled entities, with proper US court back-up.
(b) The restrictive US investment and
brokerage regulations and policies, which limit the flexibility
and secrecy of investment activity.
(c) The US estate tax and US withholding
tax on foreign investments.
(d) The role of the US as a major contestant
in the Cold War, and resulting likelihood that investments through
a US entity may be exposed to any hostility or freeze of assets
occurring as a result of the Cold War.
(e) The generally held (and partly unwarranted)
view of many sophisticated foreigners that US investment managers
are naïve and inexperienced in manipulation of foreign funds,
especially in foreign markets.
Despite the above limitations, the US
has brought appeal to flight money holders in other respects.
These include: The largest and most active securities markets
in the world, assuring both liquidity and diversification. Ease
of transfer and mechanical handling of investments, partly through
US banks' worldwide network. The world's leading reserve currency,
the US dollar. In recent years, the unmatched financial stability
and one of the highest levels of economic growth of any major
industrial nation. Finally, negligible probability of revolution
or confiscation, and low probability of inconvertibility.
The memo cited Beirut, Panama, Switzerland
and other centers from which the U.S. Government invited Chase
to attract international flight capital by placing its services
at the disposal of the existing and prospective patrons of dictators,
drug dealers, criminals and even Cold War adversaries.
Chase and other major U.S. money-center
banks responded by setting up a network of offshore centers to
turn America into a high-level Switzerland.
SS: Did this actually occur, and did
the government go along with it?
MH:The government and banks were well
aware of the fact that crooks are the most liquid people in the
world, for the simple reason that they fear to hold property
in plain sight of the authorities--except in cases where their
actual ownership can be laundered through a maze of dummy companies
and name-plates on legal folders in the offices of the offshore
lawyers who make their livelihood by managing such financial
stratagems. The major American accounting firms, law firms and
investment advisors soon got into the business of advising corporations
and wealthy clients how to set up offshore bank accounts in the
name of paper companies.
SS:This would seem to be a bombshell.
Have you ever published this?
MH:I showed it to the Canadian economics
professor and journalist Tom Naylor, who reproduced it in 1987
in his book Hot Money, pp. 33-34. The book has been translated
into many languages and reprinted numerous times. It is about
to be reprinted again this year by McGill-Queens University Press
up in Canada, and in fact I'm writing an introduction to the
newest edition. But there hasn't really been much discussion,
because the topic of hot money remains outside the concerns of
most academic economists.
SS:Was there any debate over whether
this was the right thing to do?
MH: Yes, a series of Congressional hearings
were held, and many excellent reports were included. But right-or-wrong
morality didn't play much of a role. One of the main policy issues
was simply whether the government should impose a 15 percent
withholding tax on foreign holdings of Treasury securities, on
the ground that this would probably be the only tax revenue it
would recover. Government spokesmen (WHO, WHAT DEPARTMENTS?)
convinced Congress not to impose the tax, on the ground that
this would discourage foreign hot money--and also U.S. hot money,
for that matter--from holding Treasury bonds. The United States
needed every market it could create for its bonds at this time,
to stem the gold outflow. So the foreign withholding tax was
abolished.
SS:In other words, the Treasury permitted
domestic U.S. tax avoidance to occur in order to get a balance-of-payments
inflow into the dollar, and to hold down domestic interest rates.
MH:Yes. The I.R.S. already had permitted
tax avoidance to occur under pressure from the large multinationals
such as the oil and mining companies. Vertical integration enabled
them to administer transfer pricing in a way that minimized their
global tax liability. Refraining from taxing the interest paid
on U.S. Treasury bonds favored U.S. hot money.
By the late 1960s the United States was
well on the way to making America the leading haven for the world's
flight capital. Citibank, Chase and others established or expanded
operations for their "private banking" subsidiaries
offering "confidentiality" to clients ranging from
Mexico's leading politicians to Russia's kleptocrats in the 1990s.
SS:But the price was to give international
law-breakers a better tax treatment than law-abiding and tax-paying
citizens.
MH:Yes, and there's a reason for that.
The striking thing is that the most liquid savers in today's
society are criminals and tax evaders. They have a good reason
to avoid real estate or other tangible property. It is too visible
to prosecutors and tax authorities. That is why balance-of-payments
statistics classify capital movements as "invisibles."
Prestigious accounting firms and law partnerships busy themselves
devising tax-avoidance ploys and creating a "veil of tiers"
to provide a cloak of invisibility for the wealth built up by
embezzlers, tax evaders, a few drug dealers, arms dealers and
government intelligence agencies to use for their covert operations.
SS:So all this made finance capital more
cosmopolitan and less subject to national regulation and government
control.
MH:Yes, and by the late 1980s U.S. money
managers were incorporating offshore mutual funds to tap global
capital markets.
How hot-money centers
turn capital flight into a market for government debts
SS: What was the effect of these tax
havens and banking centers on the economies of other countries?
MH: Just as the U.S. authorities hoped,
the world's hot money found it most convenient to go into dollarized
offshore banking centers.
SS:Can you give an example of how this
worked?
MH:In 1989 I was hired by the Boston
money-management firm of Scudder, Stevens and Clark to spend
a few months of my life organizing a sovereign-debt fund, that
is, a fund investing in the bonds of third world governments.
This was the world's first such fund, and it started what would
become a torrent of issues in the 1990s. But at that early stage
Scudder was unable to find American clients willing to put $75
million into a region where they had been burned badly in the
aftermath of Mexico's 1982 insolvency.
On the other hand, that traumatic event
had pushed borrowing rates up to nearly 45 percent annually for
Argentine and Brazilian dollar-denominated government bonds,
and about 25 percent for Mexico's dollar-denominated medium-term
tesobonos. These rates enabled the fund to be more successful
in finding foreign buyers. Incorporated in the Netherlands Antilles
(Dutch West Indies) as the Sovereign High -Yield Investment Co.
N.V., its shares were listed on the London Stock Exchange. The
underwriter, Merrill Lynch, sold them mostly to well-connected
Argentine families through its Buenos Aires office, with the
balance taken mainly by Brazilian and other Latin American buyers.
Their money was invested in the high-yielding
bonds of their own governments. The irony was that the exorbitant
interest payments being made in 1990 were largely due to Argentine
flight capital and to Brazilian families operating offshore as
a "Yankee fund." The fact that it was set up offshore
meant that no U.S. investors were allowed to buy its shares.
The biggest investors were political
insiders who had bought into the fund knowing that their central
banks would pay their dollar debts despite the high risk premiums.
While these local oligarchs appeared in the statistics as exploitative
"dollar creditors" to their countries, domestic demagogues
blamed the Yankees, the IMF, the World Bank and British bankers
for enforcing financial austerity on their countries. Yet the
dollar debt of Argentina in the early 1990s was owed mainly to
Argentineans operating out of offshore banking centers. The major
beneficiaries of foreign-debt service were their own flight-capitalists,
not bondholders in North America and Europe.
To Argentina, a "foreigner"
was likely to be a local oligarch operating out of an offshore
account invisible to their government (which consisted largely
of their own families). One finds the same phenomenon in Russia
today, where a "foreign investor" tends to be a Russian
with an offshore account operating out of Cyprus, Switzerland
or Liechtenstein, perhaps in partnership with an American or
other foreigner for political camouflage.
SS:How did the fund do?
MH:In its first year of operation it
became the second highest-performer worldwide. (An Australian
real-estate fund was in first place.) Global investors soon got
into the act as they watched Latin America's financial oligarchy
recycle its own dollarized flight capital back to its countries
of origin via offshore enclaves.
However, the fund with which I had been
associated was limited to only a five-year duration, because
in 1989 it seemed to me that this was all the leeway available
to keep siphoning off third-world income until a new crisis loomed.
By the time this period was up, in 1994, Mexico's tesobonos
had become such an investor favorite that their interest
rate fell below 10 percent. The country was selling off its telephone
system and other public enterprises whose sale proceeds temporarily
were filling the central bank's foreign-exchange reserves--the
PRI dictatorship's last act in office before it lost the presidency.
But Mexico teetered on the brink of default
in that year's peso crisis, just a dozen years after it had triggered
the Latin American "debt bomb" of 1982 by announcing
that it could not service its foreign debt. The Clinton administration
"rescued" Mexico, or rather, Treasury Secretary Robert
Rubin rescued its creditors.
SS:So ultimately, speculators in third
world dollar bonds lost.
MH:They weren't the only ones. The process
involved flight capital being turned into a legacy of foreign
official debt. Argentina even was convinced to join the ranks
of Panama and Liberia by dollarizing its economy. Rather than
creating domestic credit itself by running budget deficits as
other nations do, its government issued an enormous volume of
bonds payable in dollars. Their interest rates fell below the
10 percent level as investors in the creditor nations wanted
to believe that the secret of monetary solvency had been found.
Foreign dollars were borrowed to finance domestic policies.
Meanwhile, the decline in interest rates
resulting from the rise in "confidence" in Argentina's
folly provided rich capital gains for investors who had bought
the bonds at so low a price that they yielded four or five times
as high a return. But what is confidence, after all, but an opportunity
to play the confidence game--a game at which financial underwriters
have honed their skill for centuries! The Scudder fund and other
early investors sold off their bonds to the new mutual funds
and other buyers inexperienced with international risk during
the bubbling '90s when everyone tried to top the returns of others,
regardless of where the long run was leading.
This promoted a needless foreign indebtedness,
whose collapse today threatens to split Argentina away from other
nations. Then in 2001 the debt pyramid collapsed, and the bonds
have now plummeted. This wiped out a substantial portion of "bad
savings" that were the book-keeping counterparts to these
bad debts.
Some policy alternatives
SS:How much money in these centers is
illegal flight capital and savings out of tax evasion?
MH:The remarkable thing is the extent
to which investors have made the use of these centers legally.
In sponsoring the Eurodollar, for instance, the British government
encouraged the creation of tax-avoidance entrepôts on some
of the islands located in the otherwise inhospitable English
Channel and North Sea. By the simple act of registering ownership
of their real estate in one of these islands, British property
owners are permitted to avoid paying capital gains taxes, as
these are not charged on "foreign" investors.
SS:What's the difference between a tax
avoider and a tax evader?
MH: It's legal to make use of existing
laws to minimize one's tax liability. A tax evader is someone
who violates the law by making false statements or engages in
complex financial operations that have no economic function except
to avoid paying taxes.
SS:So Britain's logic was much the same
as America's in the 1960s: It needed the money, regardless of
where it came from. The cost ended up making it easier to avoid
taxes.
MH:The logic was that sterling needed
foreign investment to support its exchange rate. The main effect,
however, was to provide tax favoritism to large domestic investors
as opposed to home owners or small investors who did not establish
foreign accounts. A British investor can set up a dummy corporation
in these enclaves and avoid paying taxes on resale gains on their
land and buildings, stocks and bonds or other assets.
It is all perfectly legal, as any country
has the right to levy--or not to levy--taxes on wealth, capital
gains or income. Inasmuch as capital gains tend to outstrip the
growth of earned income, the economic role of such offshore centers
is central to global wealth accumulation. As global asset-price
inflation gained momentum during the 1980s and '90s, the attractiveness
of such centers has increased proportionally. This means that
economists hardly can analyze the growth and polarization of
national and global wealth without taking into account the web
of financial claims and liabilities associated with these centers.
SS:But there is a growing overlayer of
illegality, isn't there?
MH:Certainly, but it's been merged into
"invisibles" as far as economic statistics are concerned,
and economic theory too for that matter. Crime is one of the
key sectors for which no estimates are made. Yet it is perhaps
the most liquid, as dictators and kleptocrats, embezzlers and
drug dealers fear to tie down their assets in visible form. The
newest additions to the world's rentier class, they have
become a fount of liquidity for today's economies.
Russia has suffered $25 billion in flight
capital annually since 1990. Its IMF bailout loan of August 1997
disappeared into an obscure bank in Britain's Channel Islands,
from whence it was forwarded to Cyprus, Switzerland and the United
States. Most IMF lending to Africa and Latin America has been
fully absorbed by capital flight, subsidizing it under the euphemism
of "currency stabilization." What is being stabilized
is mainly the rate at which this flight capital is exchanged
for hard currency (if one still can call dollars a hard currency).
SS: How might governments counter this
ploy to tax this money?
MH: That is what is being debated in
Russia these days. It seems that the only kind of tax that can
be collected from multinationals today is to tax what is visible,
not what is invisible--that is, invisible to the national economic
statistician and tax-collecting office. Russians are discussing
a rent tax levied in the form of an excess profits tax on oil
and mining exporters.
SS: If we look at the balance sheets
as they stand, the offshore banking centers appear as net creditors,
and the rest of the world's countries are net debtors?
MH:Not quite. The "savers"
who have accounts in these offshore banking centers have claims
on them that, in turn, represent the liabilities of these
enclaves that offset their claims on the rest of the world. But
the financial claims held by these havens are owed in turn to
their offshore "savers."
What is missing from the data that should
be there are the claims by these "savers"--the tax
avoiders, criminals and so forth--on these offshore havens, classified
in terms of their country of origin. These surreptitious savings
get lost in the IMF's "errors and omissions" line.
This is because the Dutch West Indies, for example, may owe money
to a Panamanian shell, which owes money to an Isle of Man shell,
and so on. The ultimate hot-money claimants are hard to identify.
Deposit inflows to these enclaves find their balance-sheet counterpart
in their own rising indebtedness to tax avoiders and dodgers
in Europe, North and South America, Asia and Africa. But the
statistics are silent as to just who these invisible savers actually
are and where they really reside.
An Argentinean or Russian exporter sells
at a fictitiously low invoice price, asking the buyer to deposit
the difference in an offshore bank account. Needless to say,
the Argentinean or Russian will not declare this holding, so
it doesn't appear in the official accounts. But it exists in
reality. This is why the world's reported debts exceed the locatable
savings by an "errors and omissions" margin.
SS:How exactly does this false invoicing
work?
MH:In two ways. The simplest is for importers
to claim to pay more for imports than their true economic price.
This is what the oil companies do when they price crude oil so
high to their refineries that the refineries have no room to
report a profit, decade after decade.
The mirror image of this fraud occurs
when exporters claim to receive less than they actually are paid.
The margin is what they are able to embezzle. The buyer typically
pays the difference to a "private" account in one of
the offshore banking centers, facilitated by one of the U.S.
or British or Canadian banks set up for this helpful purpose.
This is the meaning of bank "privacy." It is how Russian
exporters of oil, aluminum and other raw materials conceal their
actual income from the Russian government. It explains the emergence
of so many post-Soviet multi-billionaires benefiting from "unexplained
enrichment."
SS:Doesn't the Russian government still
raise most of its taxes from oil and other raw-materials exports?
MH:Yes, but it fails to tax the actual
income. If it did, Mr. Khodorkovsky and other kleptocrats would
not have suddenly risen to join the ranks of the world's wealthiest
individuals in merely a single decade, and would not now be under
prosecution for criminal tax evasion. It is significant that
the financial press in the West writes anguished editorials accusing
this of representing nothing less than brown-shirted fascism,
nationalism and totalitarianism. Bush administration hacks such
as Secretary of State Powell publicly express their worry that
this threatens the very foundations of "private enterprise."
This show how little they think of punishing tax evasion in their
own countries.
SS:I assume that we'll get to cover these
machinations in greater detail in our up-coming interview on
Russia after its March 14 presidential election. Returning to
the topic of offshore banking centers, are you describing a technique
that has been developed simply by individuals, or has it been
institutionalized on a higher, economy-wide plane?
MH:The largest accounting and law firms
of North America and Europe have got a rising proportion of their
income for providing advice to companies seeking to make use
of these tactics. The primary users are money managers and leading
corporations to conceal their profits (or losses, in the case
of Enron and Parmalat) from oversight by the authorities in their
own countries. By the 1990s, Enron, Parmalat and other giant
corporate criminals were able to organize the largest financial
frauds in history by using structured finance involving hot-money
havens.
SS:Isn't there a U.S. law against arranging
a complex business practice solely for the purpose of evading
taxes?
MH:The law is indeed on the books, and
the IRS has complained specifically that the KPMG firm has organized
systematic tax-evasion schemes. But the neoliberals have placed
their own ideological administrators in these agencies, men who
have bragged to me that they simply refuse to regulate to "kill
the beast," that is, government, which is supposed to be
the economy's guiding brain. Their non-action has corrupted the
national legal and regulatory system by disabling it. Power is
being wielded by campaign contributors whose wealth has convinced
politicians to give tax evaders the right to blackball any regulatory
agency who shows himself or herself to be too conscientious in
applying the law, above all the tax code.
SS:What about New York Attorney General
Eliot Spitzer?
MH:He obviously recognizes what is going
on, and seems to have been astounded to discover how far the
rot has spread. What he found while bringing criminal charges
against Arthur Andersen in the Enron case was that every major
accounting firm was engaging in the same fraudulent practices.
This created a practical problem for him. Was he going to close
down every accounting firm by applying the law across the board?
If he had done this, who would have audited
the books of America's companies? It would have crashed the stock
market and the entire economy. So he settled for fining the banks
and financial and accounting firms a very small portion of their
gains, leaving their partners with their comfortable retirement
takings and making them promise to stop breaking the law in the
future.
On the other hand, I think that even
if he closed down these firms--and remember, I used to work for
Arthur Andersen and found it thoroughly venal already in the
1960s--the system would have healed itself almost overnight.
The existing firms as such would have been wiped out and many
of their leading partners would have gone to jail--probably not
more than a few hundred--or at least would have lost their retirement
payoffs. But most of the remaining accountants would have gotten
together to create new firms, free of the taint of corruption
that has characterized Deloitte Touche in the Parmalat case,
KPMG for its tax-evasion schemes, and the other accounting firms
right down the board.
SS:How deeply can the problems be traced?
MH:The path leading to this state of
affairs was opened up at the close of World War II. U.S. diplomats
brought pressure on the International Monetary Fund to free capital
movements, at a time when it was clear enough that most capital
flight would be into the dollar, out of economies that were regulated.
Euphemized as "economic reform" and "freedom of
choice," the move toward financial decontrol cleared the
path for the development of offshore havens. That was part of
the fatal flaw built into the DNA of the postwar Bretton Woods
system.
The U.S. Government remained in control,
and as I explained earlier, when the Vietnam War pushed the balance
of payments into deficit, the government encouraged the large
money-center banks to set up branches in these island enclaves
to act as enablers facilitating global theft, fraud and other
criminal activity. It has been through their user-friendly operations
that the non-criminal world--the world of honest men and women,
industry, commerce and even sovereign governments--has become
increasingly indebted to lawbreakers, just as taxpayers are increasingly
indebted to tax avoiders.
Much of America's net foreign debt, along
with that of countries such as Argentina, is owed to these flight-capital
centers. This has become the meaning of "globalization"
in its financial dimension.
I pointed out above that deposit inflows
to these havens are matched in the official statistics by other
countries' "errors and omissions." The world's most
important economic phenomena that determine exchange rates today
have been relegated to the unseen "black" economy--not
only crime, but what is becoming the dominant mass of corporate
and personal wealth. It is more "invisible" today than
ever, in order to avoid the eyes of prosecutors and tax authorities.
What is remarkable is that neoliberals
praise rather than denounce this phenomenon. The upshot has been
to create a situation in which, if one must own land, other tangible
assets, or financial securities, the best way to avoid taxation
or seizure is to register them in the name of offshore proxies.
The next step for these offshore entities
is to loan this money back to oneself, charging enough interest
to absorb the erstwhile taxable revenue. Operators large enough
to set up their own insurance company can charge off the remainder
of their income as tax-deductible insurance payments to their
offshore entity created for this purpose, along with the usual
skimming charge for management fees to owners and senior managers.
Financially sophisticated operators send
their money offshore and then borrow it back, paying enough interest,
insurance and management fees to themselves to absorb their earnings
and thus render themselves free of taxes. These payments expensed
to oneself appear in national income and tax statistics as a
cost of doing business, while balance-of-payments statistics
report them as an international outflow for "services"
under the rubric of "invisibles." So statistics become
increasingly fictitious.
SS: You have described how the rise of
these centers has led to economic statistics losing their value.
How can the economy be analyzed and quantified under these conditions?
MH:Financial havens help income and capital
gains disappear from the statistics of national economies as
flight capital, only to reappear as debts owed by victimized
economies to "foreigners" operating out of these enclaves.
Their balance-of-payments transactions appear as "errors
and omissions." Most economists know that this is a euphemism
for "short-term capital movements," which itself is
a euphemism for capital flight and tax evasion.
The basic perception is that what one
can avoid reporting to national authorities will not be regulated,
taxed or prosecuted. Strategy along these lines reflects decades
of lobbying by the world's wealthiest companies and individuals
to disable their governments' ability to tax them. Accounting
firms, law firms and global banks help them by using "structured
finance" to conceal their income and wealth--as well as
their debts and financial fraud. The more crooked the client,
the larger the fee that can be charged for the advice being orchestrated
to guarantee privacy. In a society where crime pays better than
most honest professions, financial and banking expertise is for
hire. The experts will happily go to work for Enron and Parlamat,
salving their conscience by believing that this is all part of
the free market impelling civilization forward and leaving Communism
by the wayside in the world economy's struggle for existence
between competing systems.
The symbiosis between offshore banking
centers and oligarchic, kleptocratic and criminal wealth can
be traced in the lawsuits that have graced the front pages of
the international press in recent years. The largest bankruptcies
in recent years have involved machinations via such centers.
In Parmalat's bankruptcy the legal defense by the company's auditors,
Deloitte and Touche, is that they had no reasonable way of knowing
that the $4 billion in alleged deposits in an offshore Bank of
America hot-money account did not really exist. Other poster
boys for this predatory universe of flight capital are the offshore
entities created by Arthur Andersen and Citibank for Enron, the
Swiss banks renowned for serving Idi Amin and other warlords,
and the Bank of New York and its brethren that helped Russia's
oligarchs embezzle $250 billion in the 1990s.
Once the fiscal ploys are spelled out
in detail, attentive readers may recognize that what is being
described is how today's multinationals typically are structured
to extract revenue and minimize (that is, to avoid) taxes. Economists
since John Maynard Keynes have used the word "leakage"
to describe funds withdrawn internationally from the domestic
income stream. The term implies that money is being lost, and
of course it is lost to the tax collector. But it does not simply
disappear. Placed in the world's anti-government centers, flight
capital takes on a creditor power that is indebting North America,
Europe, Asia and Africa, siphoning off their financial surplus
in ways that remain invisible to most statisticians and economists,
politicians and voters.
SS: You paint a discouraging picture.
What is the point in trying to tax corporate and financial income
at all, if transactions with these islands are not simply closed
down?
MH:A choice is indeed being forced. If
these tax-cheating havens are not closed down, the only people
left to tax will be the middle class and employees.
Companies now file two sets of annual
accounts. One is for their stockholders, and another is for the
tax collector. The tax account shows no profit, because companies
don't want to pay taxes. The report to stockholders shows a maximum
profit, because companies want to boost the price of their stock.
Voters have elected politicians whose electoral campaigns are
paid for by lobbies who are hired to mobilize support for this
policy, while academic chairs are endowed to hire well-meaning
fools or "useful idiots" to teach this anti-government
philosophy as representing positive "reform" rather
than depicting it as outright parasitism.
The public is being misled in two ways.
First of all, governments are given tax returns that show profits
as shrinking, through artificial book-keeping that becomes the
basis for official statistics. Meanwhile, stockholders are being
given stories of fictitiously high profits, at least in the cases
of Enron and Parmalat.
The clients of this floating island world
use a system that has been put in place by pillars of business
integrity representing the global economy's core, not merely
a peripheral underworld constituency. These enclaves belong at
the center of economic analysis, yet they usually are treated
as an anomaly rather than as an integral organ of modern wealth
accumulation.
SS: How might these offshore centers
be shut down? The law says that you cannot punish or fine people
following the laws that apply in their own day. You cannot lay
down penalties retroactively.
MH:You don't have to. Laws against fraud,
embezzlement and tax evasion have been on the books for many
years, although many of these laws have not been seriously enforced.
One of the easiest laws to enforce is the principle of "unexplained
enrichment." This is, by the way, how the world's great
fortunes were created--and what Putin is applying against Mr.
Khodorkovsky.
Banks in the United States, Canada, Europe
and Asia would agree not to recognize deposit transfers from
these centers. Companies and brokerage houses would refuse to
pay dividends to addresses in them. Countries would lay down
rules for legitimization of ownership of these deposits, corporate
shares or other financial claims.
One standard question no doubt would
be to ask how one came to obtain holdings in these centers. Was
this wealth obtained out of one's normal income? If not, how?
A broader solution would be simply not
to recognize banking and creditor claims from these centers.
This would be a start repudiating the world's bad debts.
SS:This would have to be done suddenly,
of course. We'd better leave this broader context for a future
interview.
Professor Michael Hudson is an independent Wall Street financial economist.
After working as a balance-of-payments economist for the Chase
Manhattan Bank and Arthur Anderson in the 1960s, he taught international
finance at the New School in New York. Presently, he is Distinguished
Professor of Economics at the University of Missouri (Kansas
City). He has published widely on the topic of US financial dominance.
He has also been an economic adviser to the Canadian, Mexican,
Russian and US governments. His books include Trade, Development,
and Foreign Debt (Pluto, 1992, 2 vols.). He is the author of
Super
Imperialism.
Standard Schaefer is an independent economic journalist, a cultural
historian, literary critic, poet and short-story writer. He teaches
at Otis College of Art and Design. He is the non-fiction editor
of the New Review of Literature. He can be reached at
ssschaefer@earthlink.net.
©2004 Hudson and Schaefer, from
book-in-progress.
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