Saturday, June 02, 2007

A Drop in the Bucket

The Federal Reserve Board Debunks Allegations of Large Scale Laundering of North Korean Supernotes

In my previous post about alleged North Korean counterfeiting, I wrote that the U.S. Secret Service had reported that only $50 million in Supernotes had been seized over the last 15 years. This meager haul provides little evidentiary or logical support for the idea that North Korea was funding its current account deficit through counterfeiting.

The counterfeiting allegation is an important part, perhaps a central pillar, of the hardline case for aggressive action against the North Korean state.

It’s difficult to make the case for North Korea as a “Soprano state” relying on hundreds of millions of dollars in profits (not revenues, mind you) from criminal activity to finance its current account shortfall through counterfeit cigarettes, narcotics, and pharmaceuticals trafficking alone.
With the allegation of counterfeiting—and the picture of North Korean printing presses cranking out hundreds of millions of dollars of fake US currency every week—these difficulties would seem to evaporate.

Also, in contrast to illicit production of cigarettes and drugs--which could be plausibly if not convincingly blamed on rogue elements inside the North Korean economic and security apparatus--the massive effort, expense, and difficulty of counterfeiting and distributing Supernotes in large quantities could only be undertaken with the knowledge of the North Korean government.

Finally, while North Korea’s other alleged criminal activities primarily impact China, Japan, and other Asian countries, Supernote counterfeiting can be considered a direct affront, even a threat, to the United States.

Indeed, counterfeiting another nation’s currency has been declared a casus belli under international law by David Asher, architect of the Illicit Activities Initiative against North Korea--although I have as yet been unable to find an independent citation supporting this position.

In light of the insignificant quantity of Supernotes seized, I wrote that conspiracy theorists would need an alternate explanation to justify an aggressive campaign against North Korea: that there were hundreds of millions in undetected Supernotes out there, and this theory would necessarily require collusion by some big financial guns:

...especially since the only way to pass a significant, obviously suspicious wad of hundreds of millions or billions in US currency, even if the bills were perfectly undetectable, would be with the collusion of Chinese or Russian banks—and their governments.

I don’t know if Mr. Asher would take such a big step [as confronting China on the pretext of an investigation against BDA] on the shaky assumption that North Korea was grinding out hundreds of millions of dollars in absolutely undetectable supernotes. I suppose we’ll have to await the publication of his memoirs to learn his true feelings on the subject and whether I am pummeling a straw man on this subject.

Well, impatient readers need wait no longer...and straw men can retire unmolested to their hayricks.

David Asher, architect of the anti-money laundering campaign against Banco Delta Asia and North Korea, apparently does not believe the North Korean government can produce undetectable Supernotes.

However, he does make the assertion that detectable Supernotes can circulate in the world economy undetected—and through the vagaries of the world financial system and the connivance of bankers—leaving the door open for continued allegations that the Chinese are assisting the North Korean in injecting significant amounts of counterfeit currency into the global market.

Unfortunately for Mr. Asher, this position has been authoritatively debunked by the U.S. government—four times.

In remarks to a Heritage Foundation seminar in April 2006, David Asher stated:

As the Secret Service has now revealed, the Federal Reserve Bank has come into the possession of roughly $48 million of these notes in the last fifteen years. Some argue that this shows that counterfeiting is just a drop in the bucket. Let me argue against this view.

First, although supernote definitely can be detected, it is of such high grade that much of it circulates undetected. Largely this is because it has been primarily distributed in the economies of Asia, the former Soviet Union, Africa, and the Americas where the dollar functions as a parallel currency and major money center banks that process currency are few. Another reason for the low amount of detected circulation is that the banks themselves only lose money if they allow the notes to be turned over for processing back to the US. They receive no compensation for being honest. The dirty little secret among bankers and bank tellers appears to be that if they unwittingly accept supernote deposits they should then recirculate them along with genuine currency. They can do this because to almost everyone the notes appear genuine and can be passed as “real.” Thus, for these reasons there could be a lot more of the notes out there than we can document.

I would say that Mr. Asher is taking the logically risky tactic of starting with a negative—that trade statistics provide no clear evidence about how North Korea is covering its current account deficit—to make a dubious assumption—that North Korea is counterfeiting currency—and, in order to deal with the objection that very little counterfeit currency has been detected, takes that second negative—the absence of counterfeit currency—to posit a new interpretation of currency flows in which large amounts of counterfeit currency are knowingly injected into a parallel global cash economy by venal bankers.

Mr. Asher’s chain of reasoning is logically shaky and also contradicted by analysis by people who probably know more about it that he does: the Federal Reserve Board.

In connection with introduction of the new, difficult to counterfeit US currency—the NCD or New Currency Design—the Federal Reserve Board and the Treasury Department undertook a massive, multi-year effort to understand the nature and vulnerabilities of the international demand for US currency.

A 2002 paper entitled Estimating the Worldwide Volume of Counterfeit U.S. Currency: Data and Extrapolation, by Ruth Judson and Richard Porter, was prepared for the Division of Monetary Affairs of the Federal Reserve System, and later formed the basis for a series of three reports to Congress by the Treasury Department.

It analyzed the statistics on counterfeit confiscations and analyzed the worldwide flow of US$ cash. The authors concluded that there was no significant “parallel economy” insulated from the big money center banks.

Contra Mr. Asher’s apparently undocumented assertions concerning his understanding of the world currency markets, I particularly enjoyed this passage:

Locations visited by the authors of the current paper included Argentina, Bahrain, Belarus, Bolivia, Bulgaria, Chile, China, Colombia, the Dominican Republic, Ecuador, El Salvador, Egypt, Greece, Hong Kong, Latvia, Lithuania, Mexico, Panama, Peru, the Philippines, Poland, Romania, Russia, Saudi Arabia, Singapore, South Africa, Switzerland, Taiwan, Turkey, United Arab Emirates, the United Kingdom, and Vietnam. Other team members visited Brazil, Cambodia, Indonesia, Japan, South Korea, Paraguay, and Thailand.

Believers in the North Korean counterfeit story may try to extract some comfort from the fact that the Fed team didn’t visit Macau.

However, the point of the report is that it is impossible for counterfeit currency injected into an open economy such as Macau’s to be quarantined from the banking system.

Consider the circulation lives of $100 notes. Genuine notes circulate, return to Reserve Banks, and sometimes recirculate; their average lifespan is about eight years. In contrast, counterfeits end their lives when they are detected, which at the very latest is on their first (and only) trip to a Federal Reserve Cash Office....we assume that on average counterfeits could remain in circulation at most for one year, with a few months being much more likely.

The authors make the interesting point that cash is exchanged, on the average, once a week, and the probability of a note finding its way to a bank after 22 weeks of circulation is 95%. They conclude:

Based on what we observed, it was apparent that currency does not endlessly recirculate in any of the markets we visited. Currency is used for a wide range of transactions, but even in gray or black market economies it will eventually find its way into a commercial banking institution, most likely after being used in relatively few transactions.

In sum, we find it unlikely that counterfeits can circulate for long outside the banking system and thus outside reasonably sophisticated counterfeit detection for very long. These figures suggest that notes are unlikely to circulate outside banks for much more than a year.

...We believe that an estimate in the neighborhood of $40 to $50 the most plausible and is consistent with a relatively short average lifespan for a given counterfeit note.

I recently corresponded with individuals familiar with the issues addressed in this report, and they advised that they have not come across any new evidence that would lead them to question its conclusions concerning the magnitude or character of counterfeit US currency circulation in the world economy.

In a footnote, the North Korean counterfeiting conspiracy theory is addressed:

For years, stories have circulated that some government(s) hostile to the United States had obtained plates to print currency and were going to produce a flood of counterfeits in an effort to destabilize the dollar. It was argued that these counterfeits could circulate endlessly and freely within the bounds of such countries. We have no way of confirming or denying such stories. If “closed” countries (e.g. North Korea) do indeed have many counterfeits in circulation, it is impossible to know as long as the system remains closed. The evidence and model we present here apply to open markets and economies.

In other words, the existence of North Korean counterfeits could be concealed from the world financial system—if they are only circulated in North Korea. So, if North Korea is counterfeiting vast quantities of US currency, maybe Kim Jung Il is doing it to build a palace from bricks of hundred dollar bills; an offense against good taste, perhaps, but hardly a casus belli.

Bottom line is, Mr. Asher’s allegation that Supernotes of the type that have already been detected are circulating in large quantities thanks to the vagaries of the international cash system and the cupidity of bankers is extremely implausible.

And, parenthetically, where are our counterfeits coming from?

The number one source of counterfeits (measured by counterfeits seized) for the last four years running: Colombia.

How ‘bout that!

Counterfeiting is apparently an attractive business for narcotics traffickers, using similar distribution networks but with decreased risks and legal penalties. The main markets are in Latin and South America, where use of the dollar is widespread (Ecuador and El Salvador went so far as to dollarize their economies), but packages of counterfeit bills also end up in the U.S.

The 2006 report provides the enticing news that a large number of Supernotes entered the Peruvian economy in early 2005, but provides no information on the amount or their origin.

The 2003 report also describes a high level of Chinese expertise in detecting counterfeits:

During its visit to China, the ICAP team learned that People’s Bank of China statistics indicate that mainland Chinese banks have been receiving between $4 to $6 million in counterfeit U.S. dollars annually. While the ICAP team was not able to substantiate these figures by the usual means of directly inspecting the suspect notes, they could determine that the PBOC had a well-developed process for handling, archiving, and maintaining statistics on counterfeit U.S. currency. Furthermore, Secret Service representatives on the team examined a small sample of counterfeit notes provided by the PBOC in Shanghai and determined that the majority were of high quality.

For perspective, China accounts for about 20% (second behind Russia) in overseas holdings of U.S. currency, in other words about $50 billion.

As to whether North Korea is involved in Supernote production, even if it is not passing a significant number, the 2006 report on counterfeiting states:

The U.S. Secret Service has determined through investigative and forensic analysis that these highly deceptive counterfeit notes are linked to the Democratic People’s Republic of Korea (DPRK) and are produced and distributed with the full consent and control of the North Korean government.

I would like to think of the U.S. Secret Service as unpoliticized, interested in genuine enforcement issues, and conservative in its conclusions.

So I find the statement attributed to the Secret Service that the DPRK is involved in Supernotes persuasive, despite the seemingly immense technical and logistical difficulties involved in making Supernotes in North Korea, let alone continually redesigning them to track changes in the legit currency.

Well, maybe the Supernotes aren’t being made in North Korea.

And a not-too-convoluted parsing of the statement might beg the question, why didn’t they say the Supernotes are produced in North Korea? Instead they said the notes are “linked” to the DPRK and “produced and distributed with the full consent and control of the North Korean government”.

Maybe somebody in another country is cranking out some Supernotes for North Korea.

I’d vote Russia instead of China, simply because the Chinese seem to have their spooks under control, while the lid came off in Russia and there might be some skilled and connected forgers over there who would be willing to run off small orders of Supernotes for Kim Jung Il.

Or maybe the U.S. government is confident about North Korean involvement in Supernotes because it provided them some detectable, traceable Supernotes in a sting, which would be...funny, but not the kind of smoking gun the international enforcement community would be looking for.

In any case, the Treasury Department reports Supernotes remain a drop in the bucket. Since 1996, only $22.4 million have been confiscated while being passed, while $50 million worth have been seized.

$75 million in $100 notes represents a stack of currency smaller than a refrigerator.

Kim Jung Il may have more stashed in his palace. Maybe when there’s an opportunity—like the faulty currency-checking system that existed in Peru for a few months—he takes a desperate risk to pass some Supernotes through a criminal gang.

Nevertheless, the bottom line is, it can be said with considerable confidence that Supernotes are not a significant source of revenue—or focus of money laundering—for the North Korean government.

This state of affairs leads believers in the North Korean counterfeit story to an awkward place.

It’s a place where the investigations of the U.S. government itself—hey, the Treasury Department itself!—indicate there is no significant flow of Supernotes into the world economy.

It’s a place where the only argument for massive North Korean counterfeiting would have to rest on their ability to forge undetectable supernotes.

That’s a place no Treasury official committed to protecting the viability of the US dollar as a world currency is willing to go.

That’s a place no American diplomat interested in preserving his or her credibility is willing to go.

Heck, it doesn’t even seem to be a place David Asher wants to go, as his apparent acceptance of the detectability of Supernotes (see above, “supernote definitely can be detected “) seems to indicate.

And that leaves his allegations of significant North Korean counterfeiting of supernotes...nowhere.

So I would pronounce the story of collusive money laundering of counterfeits by Macau banks—and a large part of the justification for the BDA action and the effort to confront China over alleged complicity in laundering of hundreds of millions in North Korean Supernotes—DOA.

Without the counterfeiting angle, Mr. Asher must now rely on counterfeit cigarettes, counterfeit pharmaceuticals, trade in endangered species, weapons sales, and provision of money laundering services to support his business model of North Korea financing an annual current account deficit of $500 million through illicit activities—and justify his allegation that Chinese banks in Macau are laundering hundreds of millions of dollars of illicit North Korean proceeds.

With an important element of his seductive narrative of the North Korean criminal state largely discredited, the burden of proof is shifting to Mr. Asher to demonstrate that the move against Macau banks was inspired by compelling evidence of extensive money-laundering of North Korean criminal proceeds—and not lazy, unproven assumptions of criminality exploited to disrupt North Korea’s legitimate access to the international gold markets, South Korean financial aid, overseas cash remittances, and its bona fide government and personal forex accounts.


David said...

Given that HSBC was the bank that verified the dollar deposits for BDA, and that they didn't detect any fakes, it would appear that Asher is saying that they knowingly pased fakes as genuine notes.

I wonder if HSBC and its lawyers are aware of Asher's accusation by implication?

Don't you think that it would be a worthy journalistic endeavour for someone to ask HSBC about Asher's accusation?

David said...

Re Asher's counterfeiting accusation being declared dead, I am minded of the Monty Python "Dead Parrot Sketch".

Asher has become Michael Palin's shop keeper, attempting to sell a dead parrot to a sceptical world!

Beautiful plumage!