The Central Bank Power Shift from West to East, Game of Thrones Style

(This piece is a version of my article appearing in Jim Rickard's Strategic Intelligence newsletter this month. It gives you an idea of what's to come in Artisans of Money (abent the Game of Thrones comp.)) Enjoy.

“When you play the Game of Thrones, you win or you die.” – Cersei Lannister

I was late to Season 6 of Game of Thrones (while buried in writing my next book Artisans of Money.)  If you have never watched Game of Thrones, a) do so immediately and b) here’s the nutshell. The show, based on the book series, depicts a land in which several kingdoms are duking it out for the Iron Throne, the symbol of absolute power.  Think the board game “Risk” except with dragons, magic, an army of the dead, and lots of blood.

While I was watching, I couldn’t help noticing that its backdrop is a dead ringer for central banks’ strategy.  The Fed clings to status quo. Other central banks are vying to knock it down, or at least loosen its grip on them. But the Fed behaves as if it has no idea there are other powerful central banks that want to grab and harness its power. It carries on refusing to acknowledge that there may come a time, sooner rather than later, where its power is attacked.

The ramifications of such an attack will impact the standing of the U.S. in the world.  The Fed can carry on being oblivious, but Game of Thrones illustrates the struggles playing out right now.

In the Game of Thrones world, emerging queen, Daenerys Targaryen is biding her time and building her army. She is creating alliances in Meereen, an ancient country in the East (her awesome fire-breathing dragons in tow).  She’s playing the long game, strategically planning when to elevate the fight against the ruling queen in the West, Cersei Lannister.

The most important part of Daenerys’ story is not that she is determined to rule the seven kingdoms and take possession of the Iron Throne. It’s that she knows she can’t do it alone. So she aligns reinforcements, smaller power bases.

These smaller partners may or may not have allegiance to her based on the legitimacy of her claim to power — but they have all been wronged by the Lannister’s. This family, currently led by Cersei Lannister, is extremely wealthy and powerful, but hasn’t managed to lead the western kingdom, Westeros, to wealth and power. In fact, the people in Westeros are becoming increasingly frustrated and scared of their rulers.  (You see the similarities?)

Not only has Cersei managed to create enemies out of the smaller families that surround her, she recently massacred a large portion of the city she rules to protect her own interests. She is losing her power domestically and globally, but continues to think and act as if she will rule forever. We’ll see what happens next season.

The Fed’s State

In this situation, the Lannisters are representing the U.S. and the Fed specifically. The Fed remains in denial about the true state of the domestic and global economies. In its realm of hubris, it has no idea of the steps other central banks are taking, or want to take, to reduce their exposure and reliance on not just the U.S. dollar, but on U.S. political, monetary, financial and regulatory policy in general.

Case in point. After the Dow dropped 250 points on September 9^th, on September 12th, Asian markets nose-dived on the possibility that the Fed might raise rates (though it said nothing of the sort — the “rate tease” is a manifestation of deliberate Fed obfuscation and media boredom).  This is a pattern that plays out every month, with varying degrees of intensity, or volatility.

Enter three of the Fed’s giants, led by Lael Brainnard. During her speech at the Chicago Council on Global Affairs, she backtracked on any tightening talk saying, “the case to tighten policy preemptively is less compelling.”

That calmed markets. That day. It reminded them nothing is changing any time soon. U.S. stock markets rejoiced. Bubble-baiters bought. The Dow soared 1.3%. Elsewhere in the world though, no one wants their market whipsawed by Fed speak.  Certainly not the People’s Bank of China.

The PBoC’s approach has been to send out anti-Fed policy sound-bites through elite officials. These clips are picked up by national and international media and then spread to the general public.  
On September 13^th, for instance, Yi Gang, a deputy governor from the PBoC, told a central banking conference in Vienna, “We’re still very cautious on this (zero-interest rate) monetary policy." He warned, "We have to be very careful and look at the limitations and uncertainty of a zero-interest rate policy, because in China we still have a decent growth rate.” What he basically said was “the Fed’s policy is a joke and we’re not laughing.” (I’ll have more quotes like this in Artisans of Money.)

In the Game of Monetary Policy, the Fed whacked the idea of “free markets” in the face. (For the record, I don’t believe they ever existed, because the theoretical implication is full information transparency and equal access, and that’s just not been the reality – ever.) The ECB chucked an arrow in its heart. The BOJ sliced off its head. Markets are sustained artificially. The Fed has become, as you’ll read more about in my book, the chief Artisan of Money. Central banks are bankrupt of new ideas to keep the system afloat.

Or are they? While the Fed cut rates to zero, bloated its book to $4.5 trillion, and pressed the rest of the developed world to follow, global skepticism bubbled over. First the Chinese, then Latin America. Then the IMF. Then the Chinese again. Central bank elite took turns bashing Fed policy, mostly under media radar,  and calling for an alternative to the U.S. dollar associated with it. This is the equivalent of financial warfare. The U.S. and Fed struck first.  It will take time, but the blowback is in motion.

The U.S. dollar was attached to a financial crisis fueled by big bank recklessness and Fed apathy, followed by a Fed policy that devalued money itself.  Many other countries had no choice but to follow the Fed’s lead and directives, but that doesn’t mean they were happy about it. As in Game of Thrones, the smart choice is to forge strategic alliances with other houses or be slaughtered.

The IMF is one of the houses that will be a crucial player in the new power constructs.

The IMF Power Play

The IMF, created by the U.S. and Europe, has been seeking a broader role in the monetary politics wars. For all the media dissection of every word Janet Yellen utters about rates, the IMF knows the Fed is lost. Its policy hasn’t worked. The Fed ignored this and raised rates last December, despite warnings from managing director, Christine Lagarde. Market punishment was swift and the damage was global. The move caused renewed fear and anger from nations that had already suffered at the hands of the Fed and the big U.S. banks it sustains.

The U.S. has the largest voting block within the IMF, which is located blocks away from the White House, but IMF leadership understands how the winds of change are blowing. If the BRICS and a few more developed states were to act as a voting block (or increase their voting power, as they’re attempting), they could potentially dislodge the strong influence that the U.S. has within the IMF.  

It was the U.S. voting block that gave Lagarde her job in 2011, and allowed Europe to maintain its 70-year stronghold on the IMF. As a result, Lagarde’s opposition, Augustin Carstens, head of the Central Bank of Mexico, lost that country’s first bid for the role.

In Game of Thrones, this is the story of Tyrion Lannister. He’s Cersei’s brother, but has been loudly critical of her leadership. Originally, he tried to guide his sister towards better practices. She didn’t listen to him. Now, he has joined forces with Daenerys and is helping her rise to power. His loyal alliance with Daenerys has led him to ascend the ranks again, from another angle. He is well-connected throughout the seven kingdoms. He is strategic. He knows the strengths and weaknesses of all the players. He is formidable despite his size (or in central bank terms, the volume of reserves). 

This is the Fed and the IMF.  That entity was spawned to augment U.S. central bank and government power in the wake of WWII. Powerful, but not as powerful. Since the financial crisis, the IMF has been strategically chipping away at the Fed’s power base. Like the PBoC, the IMF has been both criticizing and warning about the impact of Fed policy on other nations. By disparaging the Fed, it is amassing its own power. Its international influence has never been higher.

Under Lagarde, the IMF is doing more than funding development projects and supplying overall currency directives to the world, as was its original mandate.  It is reconstructing new alliances amongst countries not involved in its creation. In doing so, it is building its own power by elevating their allies.

On October 1, for the first time in 43 years, the IMF will add China’s currency, the Renminbi (denominated in yuan), into its Special Drawing Rights basket (SDR).  In doing so, the IMF, at the zenith of its own power, has tipped the scales away from the U.S. and the Bretton Woods crew that created the SDR in 1969.  The expanding SDR basket is as much a political power play as it is about increasing the number of reserve currencies for central banks for financial purposes.

The SDR Factor

China’s power ambitions go well beyond the SDR. They include international diplomacy, sustainable energy dominance, and becoming a focal point for alliances through Europe,  Russia and the ASEAN states.  The ASEAN–China Free Trade Area (ACFTA) is a prime example of why the SDR for China and the region is important as China expands its influence. So are new trade and financial pacts with Russia where the yuan and ruble exchange in deals without involving U.S. dollars. In addition, Russia and China are both starting to amass gold which could return as the 6^th component of the SDR someday.

When the SDR was created as a global reserve asset, it was to supplement the international supply of gold and the U.S. dollar. Once the gold standard was demolished and countries began accumulating international reserves, there was less of a need for this global reserve asset.  It lay dormant, along with the power of the IMF. But in the wake of the financial crisis, it sprang back to life as another liquidity source for member countries.  The IMF sprang back to power as well.

The SDR was initially defined relative to gold (0.888671 grams of fine gold — the equivalent of one U.S. dollar.) After the collapse of the Bretton Woods system in 1973, the SDR was redefined as a weighted basket of four currencies — the U.S. dollar, euro, Japanese yen, and pound sterling.

In 2015, when the yuan was approved, a new weighting formula was adopted. It assigns equal shares to the currency issuer’s exports plus a composite financial indicator. That means the more prevalent the currency in the world, the bigger its weight. If more Yuan are used in the world, its position in the SDR grows. In another crisis, it could take on the U.S. dollar and Euro, and by extension the Fed.

The SDR weight of the yuan is just 10.92 percent compared to 41.73 percent for the U.S. dollar and 10.92 percent for the Euro.¹  That’s not a bad opening gambit. The next official weights review is in September 30, 2021. But in a crisis, there is latitude for this to happen much sooner.

As China continues to play host to global events (Olympics, G20, etc.) it also is in pursuit of greater regional influence. With the largest economy, and now showing its capability as having a globally recognized reserve currency, China is adding another layer of strength to its position.  While the associated confidence measure will not be the death of the dollar, it indicates that the dollar is not the only option to turn to in times of panic, or increased trade or financial growth.  The intrinsic power of that position attacks not only the dollar but the overall power of the U.S.

Competing Central Bank Kingdoms and their Power Bases

Currencies reflect both political and economic clout. Even if SDR’s themselves aren’t that voluminous yet, the shift in the make-up is meaningful. The Fed has already lost ground in the process. The IMF and PBoC have gained it. In the middle, there is an increasingly shaky, EU.

The ECB was established after the creation of the Euro in 1998 to oversee other member European central banks. It has more power than any of them because it sets rates for the EU, which dictates the cost of their money and how it flows.

Former Goldman Sachs executive and former Bank of Italy Governor, Mario Draghi is the current President of the ECB. He has followed the Fed’s policy to a letter — despite grumblings from other EU power brokers (and reality) that negative interest rates have solved nothing and instead aided to the fractiousness of the EU experiment itself.  In 2012, facing an acute European debt crisis, he promised, “the ECB is ready to do whatever it takes to preserve the Euro.” The Euro has fallen precipitously since.

If Draghi’s words are weak, his actions are weaker. The ECB is offering to pay banks that borrow money from it, plus, giving them 85 billion Euro each month through its ongoing QE program to purchase their debt. From a battleground standpoint, that smacks of desperation.

The ECB just announced it would give banks three years to write off bad loans — meaning they have lots of bad loans. Deutsche Bank is just one mega example. The ECB has failed to mitigate any risk. Its alliance with the Fed hasn't helped Draghi build his power, just retain it, and it certainly hasn’t helped the EU as a whole.   

Within the wider European Area, the Bank of England, under governor Mark Carney, retains legacy power. That power has waned though, and increasingly so since the Brexit vote. If Britain leaves the EU for real, then the Bank of England’s actions are less relevant to the EU.  This elevates the power of the ECB and the Euro. But as noted, those are already weak to begin with.

If the Bank of England follows the course that Brexit has laid out, the SDR could see a further reduction of the pound weighting, and Euro weighting, which would push up the weighting of the yuan by sheer math. This shift is symbolic now, but power can start in that realm.

The Bank of Japan, before governor Haruhiko Kuroda took the helm, had run-ins with the Japanese minister of finance over its negative rate policy and bond-buying programs. The Japanese stock market lies in a constant state of tension. Because the BOJ is on the same monetary policy plane as the Fed, Japan’s markets have similarly become used to monetary adrenalin shots. Globally, this has led capital, seeking a fix in times of instability, to Japan and to the yen.

But lately Japan’s markets have also been reacting more viciously whenever the possibility of a Fed tightening hits, or lack of fresh BOJ easing measures, emerge.  The alliance of the BOJ and PBoC has not been fleshed out yet, but I believe that’s only a matter of time. Old fights might be discarded if economic or financial survival is imperiled, which is what these sharper market moves foreshadow. (There have already been new trade and lending deals emerging between the two.)

People’s Bank of China: Dragon Rising

This dragon’s about to take flight. The People’s Bank of China governor is Zhou Xiaochuan, who has held that post longer than any other G20 central bank leader. The PBoC holds more U.S. treasuries than any other central bank and is ready for battle. Zhou understands global paradigm shifts. He’s the only Chinese person on the G30 and on the board of the BIS.  He’s been the leading figure pushing the yuan into the SDR basket by slowly allowing it to float with the market, despite allegations of ongoing currency manipulation. He has a good personal relationship with Lagarde.

As China’s position has grown, so has Zhou’s voice, albeit without giving too much away, (something for which the U.S. has been critical.) Keeping some card close to his chest is a strategy. “The central bank has a clear and strong desire to improve its communication with the public and market," he told Caixin, a major publication in China. "At the same time, it's not easy to do a good job in communication.”

China wants to keep internal inflation down. This is why it would prefer a strong, not a weak currency. This negates the charge that China is trying to devalue or manipulate the yuan for better trade profits perpetuated by Donald Trump and Hillary Clinton. This is true to a minor extent due to economic pressures, but barely.  (It was, after all, the Ming Dynasty back in 1455 that ended the printing of paper money in order to control inflation.)  

The stronger the yuan, and the more prevalent it is globally, the more the PBoC challenges the Fed and the more control the China bloc gains over the U.S. In Chinese culture and the Game of Thrones, the Dragon symbolizes life and expansion. (Side note: I confess to having a Dragon obsession.) It’s a fitting symbol for the rising power of China and the yuan.

The Current Central Bank Hierarchy

The Fed is the world’s most powerful central bank. The ECB is a close second. Third, is the Bank of Japan. Fourth, for now, is the People’s Bank of China.  That will change.

The PBoC has crafted its own techniques to support China’s economy through monetary policy. Although, at the recent G20 meeting, Xi Jianping told reporters that the age of monetary and fiscal stimulation is over and new strategies must arise, he did so by claiming the global growth mantel. As he said, “In light of the pronounced issue of lackluster global economic growth, we need to innovate our macroeconomic policies and effectively combine fiscal and monetary policies with structural reform policies.”

The Fed’s power is resting on the dollar’s dominance. That dominance, in turn, was established by political design based on military prowess following two world wars — which were financed by elite U.S. banks. 

The U.S. Treasury market is the world’s largest and most liquid. Central banks holding U.S. dollars are really holding U.S. Treasuries.  They are lending the U.S. money, and we pay them for it with interest. But when rates are zero, we are paying them nothing to lend us more money. This is why growing debt is so easy under current Fed policy.

Just like Cersei Lannister, the Fed thinks it will retain its power simply because it currently has power, even though everyone is wary of her and the house she represents. In contrast, Daenerys is not so disliked. Like China, she is clever and building alliances. They are playing the long game patiently and strategically.

Bad Bad Contagion

The Fed re-assembled in Washington on September 20-21, after a mini-break. Prior to that, they were in “black out” mode. During that time, I discovered a new report while sleuthing around the Fed’s website.  It’s about 45 pages of mathematical equations, beyond which lies some scary thoughts.

In this September 2016 report, to which main stream reporters paid none to minimal attention, Fed economist, Juan M. Londono addresses the notion of “contagion.” The Fed’s own research team is ahead of its management. Bad contagion, Londono notes, is the “confluence of unexpectedly low stock returns across several international stock markets simultaneously.” His findings revealed that, “episodes of bad contagion are followed by significant and meaningful deteriorations to financial stability indicators.”  

If stock markets crumble, so do economies. The elites running central banks in those economies don’t want that happening on their watch. The only way to avoid the collapse is to distance themselves from the Fed and the dollar. Even David Reifschneider, deputy director of research for the Fed, noted, “there could be circumstances in the future in which the ability of the FOMC to provide the desired degree of accommodation using these tools would be strained.” (Translation: The Fed is running out of bullets,. Or losing its power over other central banks.)

This doesn’t mean the dollar will tank like a stone immediately as some people predict — the power base that supports it won’t go down without a fight. (Nor will the Lannister’s—Season 7 will be bloody.)  But once the fight starts in earnest, it will accelerate off its own momentum.

Stock markets have reached historic highs on a steady diet of fabricated money. Contagion is real, because the associated polices are interdependent. Having gone down with the U.S. economic ship in 2008, why would any country want to endure that again?

During the past eight years, the Fed has led a global race to the bottom of responsible monetary policy while exuding bi-polar verbiage as to its effectiveness. This blind continuity of Fed policy is the clearest indication of its lack of success. The inability to articulate an exit strategy is another.

The third, is the denial that other central banks and countries want to distance themselves from the Fed. For the moment, the leader in that regard is the PBoC. The Dragon is re-entering the fight now that the stakes are highest. The swords are drawn. The battles of the East and West are on.

Writing, Exploring, And My Pulling a Thoreau this August

One of my favorite quotes of Henry David Thoreau is this:

“You must live in the present, launch yourself on every wave, find your eternity in each moment.”

That quote captures the spirit of “carpe diem”, seize the day - except the idea is to seize every day, every experience, every awakening, and every awareness. It’s following the human impulse to explore the unexplored, question what doesn’t ring true, dig beneath the surface of what you think you know to formulate your own reality, and embrace the inherent ‘now’ of life.

Earlier this week, a composer friend of mine asked me why I became a writer. And not in that ‘why did you leave banking to become a writer’ sort of way, deeper than that. I think we all embark upon circuitous life routes that, if we are paying attention, coalesce to move us ever closer to that thread that renders us authentically us by virtue of its consistent presence. We possess a core “self” with which we are most at peace, and around which we feel most natural. That self can have a tendency to hide, conform when it seems most comfortable or expedient to do so, cling to what’s ‘safe’ regardless of whether that safety is merely a manifestation of fear and not a grasping of a bolder life. Seeking eternity or clarity in a single moment is a way to be free of that fear. Liberated. It is never easy, but always spiritually rewarding.

I started writing as soon as I began reading, sooner if you count drawings.  Kids don’t need to be told “write what you know”, it’s intrinsic. Everything we know is all we can imagine. We can envision the most complicated worlds and the simplest interactions between animals or people or objects without any filter. When you shove aside the noise, the infinity of ways to stay ‘plugged in’, the ugliness, the vapidity, you can experience a momentary clarity whose value can not be quantified. I moved on to mathematics and music and later banking, yet the pull to explore, to be guided by my curiosity, to find the story, to probe its elements, to tell the tale, remained a constant thread. The more I explore the less I know, but the more I want to know. 

This year, I’ve traveled to Mexico City, Guadalajara, Monterrey, Rio de Janeiro, Sao Paulo, Brasilia, Porto Alegre, Beijing and Shanghai, and many cities in between, as well as throughout the United States. I’ve traveled on high speed railways over Chinese countryside, participated in anti-impeachment demonstration in Brazil and had numerous coffees with students and farmers and small business owners in Mexico. I fell a little bit in love with the essence of each new location and the people in it. Though I arrived to gather and share information and conduct interviews -  I left with the knowledge that each discovery, personal connection and historical fact, became an extension of me and my story. I’ve met the most compelling people in my travels, and been blessed with an outstanding international team of researchers helping me.

For the month of August, I am going off grid to compose a 50,000-word narrative out of about 500,000 or 1,000,000 words of notes for the first half of my new book, Artisans of Money. The journey to this book, for which I spent time walking the Great Wall of China last month, as I did decades ago when I started in banking, showed me that traversing the same wall can invoke a tremendously altered perspective, not because of age, but due to a different and more open relationship with awareness and engagement.

The copy for the book so far says it’s about the rise of central bank power and control of money flow in the post-crisis era, or as I call it, the “Artisanal Money Era”, and how this influence pervades national and global economies and governments, and impacts ordinary people.  But what I want to explore beneath that theme is the essence of how the world has changed. I want to delve into the motivations of the people and countries intrinsic to the largest shifts, as they repel and attract each other. I want to get to the core of who and what provokes the most critical transformations or clings to the status quo.

Everything is connected, not every connection is apparent. For me, behind them all, lies a saga that will uniquely capture my experience and analysis. By Labor Day, I hope to emerge with the first half of my book (because book deadlines are what they are) that centers on the US, Latin America and China, before moving on to travel and exploration for the second half which focuses on Japan, Europe with other places along the way. I look forward to foregoing every detail of the US election for a month. This US election - stripping away the name-calling, personality selling, and rhetoric -  is (largely but not only) about two people trying to prove their authenticity to the public. I’ll take up writing about that this fall, as I also continue along the Artisans path.

Meanwhile, I will be convening with nature, notes, and that wonderful struggle of finding and telling the story.

Have a meaningful and inspirational August, my friends!

Love, Nomi

Gimme Shelter (From the Tax Man) Disappearing Money and Opportunistic Candidates

This article orginally appeared in TomDispatch. The latest Panama Papers May 9th disclosures underscore the broad and ongoing global connections between big banks and tax havens. A swath of politicians on both sides of the aisle remain enablers and users...

There’s a pile of money hiding offshore. It’s true that jobs are also leaving the United States because American companies find it convenient to cut labor costs by moving manufacturing abroad, the economic issue you’re hearing most about in this election season. But the stunning amount of money that continues to flow across American borders (and those of other countries), and eventually disappears into the pockets of the corporate and political elite, ultimately causes even more damage to our finances and our lives.

While the two leading candidates for the presidency, Donald Trump and Hillary Clinton, have indeed suggested cosmetic fixes for a situation that only grows more extreme with the passage of time, they have themselves taken advantage of numerous tax “efficiency” strategies that make money evaporate. Of course, you shouldn’t doubt for a second that they’ll change their ways once in the Oval Office.

As with so much in our American heritage, there’s a history to the “offshore” world, too. Finding places to shield money from tax collection first became commonplace among upper-crust industrialists, bankers, and even public servants back in the 1920s. Treasury Secretary Andrew Mellon, a millionaire mogul who served presidents Calvin Coolidge, Warren Harding, and Herbert Hoover (and had a knack for cutting taxes on the wealthy), left office under mounting congressional probes into his tax evasion strategies.

Fast-forward about a century and tax dodging has been woven into the fabric of the lives of the affluent and corporate worldwide in an extraordinary way. According to an April 2016 Oxfam report, the top 50 U.S. companies are hoarding more than $1.4 trillion in cash offshore.

What’s more, for every dollar that these firms spent lobbying Congress for “favorable” tax treatment (a collective total of $2.6 billion between 2008 and 2014), they received $130 dollars in tax breaks and $4,000 in subsidies from the U.S. government. These companies, including Pfizer, Goldman Sachs, Dow Chemical, Chevron, Walmart, IBM, and Procter & Gamble, created “an opaque and secretive network” of more than 1,600 company subsidiaries located in tax havens that they decided to disclose. (Because of the weak reporting requirements of the Securities and Exchange Commission, there could be thousands more.) According to a March 3rd report from the Citizens for Tax Justice, the Fortune 500 companies are now saving $695 billion in federal income taxes on a total of $2.4 trillion in offshore holdings.

Americans can’t afford to ignore such tax games, since we’re the ones who, in effect, wind up paying the taxes these firms don’t. For government policymakers, such tax evasion is a grim matter of attrition, since the U.S. (and other countries) plunge ever deeper into debt thanks to such antics and then find themselves cutting services or raising taxes on us to cover the gap between the money they’re losing and the taxes they’re collecting. 

Not only are such firms unpatriotic, they are parasitic and while they’re at it, they use similar techniques -- let’s not call it theft (though it is) -- to avoid tax payments in the poorest places on Earth. As Oxfam reports, “the biggest burden” of tax havens “falls on the poorest people.” In the process, they only increase already oppressive levels of inequality globally.

Tax “secrecy” specialists -- people working in the money-hiding field -- help rich individuals, multinational corporations, political leaders, terrorists, and organized crime groups divert cash and capital, sometimes in staggering amounts, from local economies into an obscure, complex, multi-layered global financial network that operates outside any national or international regulatory or tax system. Given this, isn’t it a little surprising that the top candidates for the presidency barely pay lip service to the impact of such hidden money?  What toothless policies they have proposed to deal with the phenomenon will do little or nothing to change it.

The Panama Papers

U.S. trade agreements generally include rosy promises about partnering with regional economies around the world to encourage the flow of goods and services across borders. At the same time, they generally are focused on the obliteration of barriers that in any way restrict money from flowing out of the United States or into the embrace of other nations. The free movement of capital, or financial globalization as it’s called, has been a bedrock Washington policy for a century and, since the 1980s, places like Panama -- a renowned tax haven -- have abetted this process.

A month ago, the International Consortium of Investigative Journalists released a trove of documents, 2.6 terabytes of them, including “more than 4.8 million emails, 3 million database files, and 2.1 million PDFs.” These were turned over by an undisclosed source (“John Doe”), communicating through encrypted channels to avoid repercussions. Now known as “the Panama Papers,” they reveal how elite multinational companies, the super rich, and government figures have engaged in tax-dodging practices engineered by a single Panama City-based law firm, Mossack Fonseca (MF).

In addition to public officials and billionaires, more than 500 global banks, their subsidiaries and branches, have registered at least 15,600 shell companies there using MF’s services. That word “shell” is descriptively accurate since such “companies” rarely have employees and are commonly no more than a post office box providing a façade through which books can be doctored, taxes dodged, losses concealed, and money-laundering and other criminal actions carried out.  And keep in mind that MF, which acts for approximately 300,000 companies, is only the fourth largest provider of such offshore services globally. 

One mega-bank that used its services extensively was HSBC, which created an astonishing 2,300 shell companies with that law firm’s help. We’ll return to HSBC.

Mossack Fonseca’s official mission, it claims, is “to deliver quality, reliable and comprehensive services to our worldwide clients in the legal, trust, investment consultancy, and digital solution fields.” That’s code for helping select establishment outfits and dubious enterprises to avoid paying taxes on profits, investments, or money made from buying and selling real estate, luxury yachts or planes, oil wells, weapons, or drugs, among other things.

Secrecy is its calling card. Tax havens, or locales amenable to tax dodging, whether in the Caribbean, Central America, Switzerland (still the world’s top location for financial secrecy), or for that matter the state of Delaware, exist to circumvent tax laws. Period. And these operations are so shady that even the functionaries working in the shadows to establish such secret accounts are barely aware of exactly who owns them, where the money came from, or where it’s going. For regulators, prosecutors, and tax collectors, the opacity is far worse.

You don’t necessarily have to be rich or powerful to access the services of such offshore firms and banks, but it helps. Some havens take anyone ready to put up a minimum of $25,000, while others demand staggering sums. Western Samoa, for instance, requires a cool $10 million to get started.

The most alarming aspect of the Panama Papers revelations was not MF’s clientele or even its secretive practices, but that what it does is completely “legal.” Nor was this the first such disclosure. In November 2014, for instance, the “Luxleaks” scandal involving a whole “menagerie of Luxembourg-based tax schemes,” as the Guardian put it, was disclosed by two whistleblowers from the accounting firm PricewaterhouseCoopers. (Luxembourg is a major European tax haven.) Citigroup, Deutsche Bank, Facebook, HSBC, JPMorgan Chase, and Microsoft were on the list of its more than 350 multinational “tax avoiders.”

Avoiding vs. Evading Taxes and Corporate Inversions

Avoiding and evading taxes are technically considered different kinds of acts, the former being legal in the U.S., the latter not. According to the Internal Revenue Service, “Taxpayers have the right to reduce, avoid, or minimize their taxes by legitimate means.” Tax evasion, on the other hand, involves an “act to evade or defeat a tax, or payment of tax” by “deceit, subterfuge, camouflage, concealment, attempts to color or obscure events, or make things seem other than they are.”

The line between the two is obviously thin and vague, but both practices result in the same thing: paying fewer taxes or hiding money.

The subject of tax avoidance and evasion has generally gotten little traction on the campaign trail in election 2016, the exception being corporate “inversions.” These happen when, for example, an American company merges with a foreign one in a tax haven, and so gets a lower tax rate by re-incorporating (filling out some paperwork) there. This, too, is “legal,” although it represents the purest form of corporate tax evasion.  Perhaps you won’t be surprised to learn that the practice began in Panama about 30 years ago.

In 2014, companies with household names like Apple, Microsoft, Pfizer, and General Electric avoided paying a collective $90 billion in taxes through inversion strategies. Apple led that list, holding $181.1 billion offshore.  That’s a lot of iPhone sales.

The Leading Candidates and Hidden Money

Tax havens are, in essence, perfectly “legal” criminal facilities designed to steal money from the rest of us. The two leading candidates in this election season, however, aren’t talking about closing down tax havens for good (which would piss off lots of rich people, banks, drug cartels, and terrorists). They are instead focused on getting companies to voluntarily repatriate, or return, profits made abroad for taxation purposes or on closing tax “loopholes” that allow money to disappear.  Neither, however, offers much detail as to what that means. 

Both do share one thing, however, when it comes to tax havens: Hillary Clinton and Donald Trump have companies registered at the same address (also “shared” by 285,000 other companies) in Wilmington, Delaware. In other words, they make use of the “Delaware loophole,” which allows for the legal shifting of earnings from elsewhere in the country to the ultimate tax haven state in the U.S.  Neither, as Rupert Neate of the Guardian has written, has been willing to offer any explanation for this. That’s the political beauty of loopholes: closing one is different from eradicating an entire practice but suffices as a promise.

Hillary

Hillary has gone after tax havens before. In 2004, as a New York senator, she vowed to close tax loopholes for “people who create a mailbox, or a drop, or send one person to sit on the beach in some island paradise and claim that it is their offshore headquarters.”  She introduced no bills to do so, however.

She has spoken out against corporate tax inversions, too. She wants Congress to prevent them by imposing what she calls a “commonsense 50%” threshold on them; in other words, as long as a company keeps at least half of its operations in this country, it would be considered a U.S. company for tax purposes, no matter the inversions. She also has favored an “exit tax” to ensure that multinationals pay a “fair” share of U.S. taxes owed on earnings stored overseas. Both of these suggestions would put some modest limits on offshore tax dodging (after the fact), but not come within a country mile of banning it.

On such subjects, she can sound strong indeed at appropriate moments. InFebruary 2016, for instance, she said, “We need to go after a company like Johnson Controls that is trying to avoid paying taxes after all of us bailed it out by pretending to sell itself in a so-called inversion in Europe.” It evidently didn’t matter to her that the same automotive parts company set to merge with Tyco International (based in Ireland to dodge taxes) had donated money to the Clinton Foundation charity as recently as December 2015. (Johnson Controls denied Hillary’s claims that it had received a bailout during the financial crisis.)

Hillary, lest we forget, joined the board of directors of the the Clinton Foundation, the family charity, in 2013. She resigned in April 2015 to run for president. Now, keeping it in the family, her husband, Bill, and her daughter, Chelsea, remain standing members of the board. Spawned from the William J. Clinton Foundation, founded in 1997, the charity has raised $2 billion, has about 2,000 employees (including at times members of Hillary's political team), and boasts an annual budget of $223 million.

Like many gilt-edged couples, Hillary and Bill Clinton have themselves utilized onshore and offshore tax loopholes. In 2010, they used a common tax-dodging technique by placing their multi-million dollar home in Chappaqua, New York, in a “residence trust.” After he left office, Bill spent five years as an “adviser” to billionaire (now-ex-pal) Ron Burkle’s investment fund, Yucaipa Global, which had funds registered in the Cayman Islands and Dubai. That alliance netted Bill at least $15 million.

Hillary’s bedrock thinking on money flowing out of the U.S. and into the offshore world can best be seen in her support for the 2012 U.S.-Panama Trade Promotion Agreement when she was secretary of state. The agreement removed “barriers to U.S. services, including financial services,” which actually simplified the process of squirreling money away in or through Panama by allowing it to flow freely into that country.

The Clinton Foundation inhales donations from people using tax havens (including Panama). Although Hillary denounced Mossack Fonseca’s dealings on cue after the Panama Papers story broke, a number of individuals and multinationals that have contributed to the foundation used MF to establish offshore accounts, according to McClatchy. These include Canadian mining billionaire Frank Giustra who features in the foundation’s $25 million top-tier donor bracket, and two firms tied to Ng Lap Seng, the Chinese billionaire implicated in a major donor scandal involving the Clintons and the Democratic National Committee.

Similarly, in a speech she gave at the New School in July 2015, Hillary highlighted the “criminal behavior” of global bank HSBC. In 2012, the behemoth financial institution agreed to a record $1.92 billion settlement with the Department of Justice and the Treasury Department for enabling drug cartel money laundering and violating U.S. sanctions by conducting transactions for customers in Iran, Libya, Sudan, and Burma. She vowed, “On my watch, it will change.”

Yet, in 2014, the Clinton Foundation accepted between $500,000 and $1 million from that bank. 

The Panama Papers are but one conflicted instance in which Hillary’s stated beliefs, her actions, and the generosity of her friends and acquaintances came together in a contradictory fashion. The evidence suggests that tax-dodgers will, in fact, be able to breathe a sigh of relief if she becomes president.  Her actions are likely to -- if you’ll excuse the expression -- trump her words when it comes to curtailing the behavior of offshore scofflaws in significant ways.  And speaking of Trump...

The Donald

Consider the fact that The Donald won’t even disclose his tax returns. His indignantly delivered explanation is that they are “under audit.” Under the circumstances, don’t hold your breath. Perhaps he doesn’t make nearly as much money as he claims -- or maybe he has an embarrassing tax haven habit. Who knows?

Ironically, Mossack Fonseca’s Panama City headquarters is located a mereseven-minute drive from the Trump International Hotel and Towers in Panama City. (If you’re interested, its website is pitching a bargain on rooms at “15% off our currently available Best Unrestricted Rate.”)  That decadent complex is one of many sketchy enterprises to which Trump lent his name for licensing purposes. According to his (unaudited) personal financial disclosurereport filed with the Federal Election Commission, the deal earned him $5 million. In true Trumpian style, lawsuits and battles surround the endeavor.

Under the tax plan he’s touting in his presidential campaign, U.S. businesses would see a reduction in their maximum tax rate from 35% to 15%. This lower rate (“one of the best in the world”) would, he claims, render corporate inversions unnecessary. The Donald apparently hopes that corporate America will be so eternally grateful to him that they’ll move their money back onshore and pay taxes on it voluntarily (though most of them already don’t pay the top tax rate here anyway).

Trump’s views on a “repatriation tax holiday” that would let companies bring home their overseas stashes on a one-time basis for little or nothing have shifted over the course of his candidacy. Last year, he proposed the repatriation of hidden funds without penalty or taxation of any kind. Now he’s advocating a more populist one-time 10% tax on them.

Although a key promise of his tax reform plan is to end the practice of stockpiling money in offshore accounts by American companies, he has personally invested in many of the companies that do so. As CBS News noted, in October 2015, Trump owned stock in 22 of the top 30 Fortune 500 companies ranked by their number of offshore subsidiaries. It’s a group that has engineered 1,225 tax-haven subsidiaries holding $1.4 trillion. Of course, Trump has a keen understanding of the practices that disguise or shelter money from taxes. As he explained to supporters in Iowa this January, when it comes to his own business enterprises, "I pay as little as possible. I use every single thing in the book."

Bernie

As far as we know, Bernie has no personal experience with tax havens and has a far more structured plan than either of the leading candidates to combat their money-sucking, tax-dodging prowess. His policies would prevent American companies from avoiding U.S. taxes through inversions, block them from escaping taxes by establishing a post office box in a tax haven site, and end the practice of letting corporations defer paying taxes on profits from offshore subsidiaries.  

In the real world, financial speculation, crime, and tax evasion -- sorry for this word again -- trump the highly touted goal of “free trade” when it comes to tax havens. Bernie understood this well when he voted against the Panama “free trade” agreement of 2011. In a Senate speech on the subject, he presciently noted that “Panama is a world leader when it comes to allowing large corporations and wealthy Americans to evade U.S. taxes by stashing their cash in offshore tax havens. And the Panama free trade agreement would make this bad situation much worse.”

He was right then and he remains right today. Unfortunately, no one was listening or interested in acting on his warning -- certainly not Hillary, who, as secretary of state, characterized the agreement as “an example of the Obama Administration’s commitment to economic statecraft and deepening our economic engagement throughout the world.”

In practical terms, Sanders went significantly further than Hillary by formulating actual legislation on the subject. Last April, he introduced theCorporate Tax Dodging Prevention Act of 2015 in the Senate. Among other things, it aspires to “prevent corporations from sheltering profits in tax havens like Bermuda and the Cayman Islands and would stop rewarding companies that ship jobs and factories overseas with tax breaks.”

Regarding inversions, he would treat companies as American for tax purposes if they were majority-owned by U.S. interests and operating in this country. Even his plan, however, would fall short unless it made inversions illegal -- and too many companies are invested in not letting that happen.

Ted

Ted would abolish the Internal Revenue Service and enable people and companies to file taxes on a postcard, so there’s no real point in further analysis of his “positions” on tax havens.

Missing Money Costs

As of 2014, according to Gabriel Zucman, University of California economist and author of The Hidden Wealth of Nations, at least $7.6 trillion, or approximately 8% of global financial wealth, was “missing” somewhere offshore. His analysis demonstrates that the sorts of tax-dodging practices we’ve been discussing put governments across the planet in the red by approximately $200 billion annually. Tax avoidance by major U.S. companies costs governments an additional $130 billion per year since nearly a third of their profits are hidden offshore.

The U.N. estimates that tax dodging by multinational companies costs developing countries $100 billion a year, an amount “equivalent to what it would cost to provide basic life-saving health services or safe water and sanitation to more than 2.2 billion people.”

There are, in other words, harrowing costs to tax dodging. When the wealthy and powerful hide money from governments or speculate with it in sneaky ways, it destabilizes economies and enables the commission of crimes that place a further burden on ordinary people. When money flows from the economic necessities needed by the less privileged to the top fraction of a percent of the world’s population and is then hidden offshore, essentially “disappeared,” it’s a net drain on and a blow to the world economy. This impacts jobs and the quality of our future. Unfortunately, the leading candidates in this election year aren’t championing a major change for the better.