Tuesday, November 27, 2012

Fallen Angel Investing


(….it’s all legal)

You’ve seen McKenna’s Gold, The Good, the Bad and the Ugly, Goldfinger and Gold Rush. Deadly metal. A few lives don’t count for the reward. Goldfinger radiates menace....touches on the economic aspects (smart guy).  Gold holdings. Its working like the bomb the guy designed for the movie “Speed” – you can't slow down. Central banks around the world hold huge quantities of gold…it’s a stupid, useless metal relative to its price. By holding it, the price stays up….if they sell it….they’d do what Goldfinger couldn’t.

Indian citizens consume 800 tonnes of imported gold annually (domestic consumption is a multiple of that..2000 tonnes plus when I checked last a long time ago).  At today’s prices, that’s about US $ 46 billion or a little less than 3 % of real GDP. The Reserve Bank of India is concerned. Import duties are up to 4% in a bid to reduce consumption. The govt will earn $ 1.8 billion in revenue at current import levels. Right? Wrong.  $ 1.8 billion is arbitrage window for smugglers to bring in 800 tonnes of gold.  15 years ago, the same govt reduced import duties to a point where smuggling became unattractive business. Organized crime went back to extortion and kidnapping (read the front pages of a random Mumbai newspaper through 1997 and 1998 to verify).

In the US, a recent article in The Economist focused on differential taxes on cigarettes between neighbouring  states. Higher prices should curb smoking. Right? Wrong.  Its created an opportunity to smuggle cigarettes across state borders. Cigarettes are also a versatile trading currency, if you’ve read and watched the prison stories – war and criminal.

Gujarat, the home state of Mahatma Gandhi, has had prohibition in force since independence. It’s the only state that you can get home delivery of your favourite brand anytime you want. The long coast of Gujarat provides plenty of scope for smuggling.  The excellent roads built (I’m told, I haven’t traveled on them) are handy for the powerful cars that smugglers invest in while the L1 quotation supplies (L1 is lowest bidder, for the uninitiated) of cop vehicles can’t keep pace.   So guess who wins the chase in this sequence. It ain’t Dirty Harry.

States within India often have different tax rates for products and services. Result. Cross border smuggling, invoice fudging etc. Just picture armed cops in pursuit of a jeep carrying (gulp!)……..electronic computer parts…..while there’s mob violence unabated in a nearby town. Its like that guy at airport security in the movie "Airplane" telling the passenger with the dog, “Ma’am, I can’t let him go on board..no way….”.  In the background, some guys are walking through with automatics and rocket launchers.  

At an international level, this is called tax planning by legitimate corporations who book taxes in obscure island countries famed for nice beaches and clear blue waters.  And its all legal. The biggest price they pay is being called “the 1%”, “anti-national” and “anti-people”. Terrible stuff. I’m sure the accountants are feeling remorse while they sip their rum cocktail at the beach barbeque on starlit nights.

The “Drug War” led by the United States and United Nations is a colossal disaster.  Drug smugglers running heroin freely in the late 60s, said it was an easy competitive market with low margins. There wasn’t much killing then and much of the shooting was the users in their arms. Organized crime and drug cartels flourished post-drug war to the multi-billion dollar enterprises they are today. Further, their profits have been reinvested in new, higher value added formulations that are good for business.  On the other side, its led to the creation of a huge bureaucracy to combat these criminals – with associated vested interested. “Vested” means stakeholders.  Those employed in these bureaucracies with their large budgets plus those who supply the equipment and services to sustain them – no one wants this war to end. It means they lose business and / or a job. Even Batman struggles with “moving on” ("The Dark Knight Rises") after Gotham’s crime free – and he’s a good guy.

Once a distribution system is streamlined (this includes greasing corrupt law enforcement machinery), it can be used to deliver a variety of products – bombs, weapons etc.  The reported plot to assassinate a Saudi ambassador in the US last year, had the Iranian guy talking to a Mexican  “drug” executive (sic).  (A banker friend once told me that dispensing cash through ATMs is not very different from delivering pizza – aaah, the world of logistics).

When you extend such ridiculous laws to more common features of life in a developing country, it’s hardly surprising that crooked politicians, corrupt administrators and organized crime thrive.  It’s also not surprising that ordinary citizens become criminalized or are forced to bribe – a sustainable (the dream of development practitioners) solution for criminal enterprise. Some examples you may relate to:
i)                    Mandatory food certification – a recent article featured “underground” supper clubs in the USA.  Ingredients bought from the same sources as every home, cooked for those who’d like to eat it and are willing to pay. Its illegal.
ii)                   Street food – ubiquitous in any large city anywhere in the world. Street vending is illegal in most places – you aren’t allowed to sell. Forget that these entrepreneurs are trying to earn an honest living providing food at cheap prices to the citizens of the city, who voluntarily purchase it and consume it. The largest food-related health epidemics in India – adulterated cooking oil normally through “legal” traders (and it ain't Walmart), often cheating on quantities to make the slim margins that enable them to function.
iii)                 Licence / permit systems – an official of the real estate developers association in India has publicly stated that with about a 100 different permissions required from different civic departments, bribery is inevitable. As a result, real estate sales demand 30% of the sales price as cash or “black” money from buyers. And that's a conservative estimate.

Fiscal policies have been the Angel investors of organized crime. They create a huge arbitrage opportunity, enough to justify scale.  Even without scale, it creates huge opportunities for crooked administrators everywhere, including rich countries. When such things happen in parts of the world with poor government and judicial enforcement, it’s the road to disaster.  Militias (look at mineral rich Africa, drug rich northern Burma and Afghanistan etc) thrive. Where it isn’t militarized, crooked politicians love the access to illegal money for political reasons. Real estate dealing in India (and other countries like ours) is a huge source of finance for crooked politicians, many in bed with criminals of all denominations. It’s a secular business - so it meets that aspect our Constitution without reservation.

I wouldn’t be surprised if they’d discovered a shrine in the late Pablo Escobar’s palace with statues of the leading lights of the anti-drug war – the guardian angels who’ve given impetus to the business.

And in case you think these guys are sleazeballs – they make profits in cash for providing services and products, a cash return on investment. Not selling dreams or notional values of promised profits on a piece of paper with a price tag, based on long maths equations that require  a  Ph.D. to decipher. And sink your family’s fortunes and a country’s fortunes overnight…..and its all legal! 

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