Marcus Noland has published two fascinating charts on recent changes in North Korea’s palace economy. According to one, North Korea has begun posting a current account surplus by squeezing its poor, and by taking in foreign exchange from mysterious (but probably Chinese) sources.  That would certainly explain some of its recent, more aggressive behavior — a well-funded North Korea is menacing; an underfunded North Korea is relatively, if temporarily, conciliatory.  Judging by North Korea’s aggressive WMD development and investment in white elephants (gray ones, too) and perks for its elite, the regime doesn’t appear to be starving, even if its people are.  Noland also posts another fascinating chart showing his estimate of the share of North Korea’s income earned through illicit activities, which he estimates at between 5 and 20 percent of its export revenues.

Obvious questions arise about how we can really know such things, but it’s unlikely that anyone in America knows better than Marcus does.  Assuming his charts are correct, enforcement efforts have had considerable success, yet a staggering share of North Korea’s revenues continues to come from illicit sources. It’s now incumbent on us to identify these new revenue sources for the sake of our own national security; indeed, it may also alter our estimates of the “illicit” share of North Korean exports.  Both charts present challenges to the potential effectiveness of sanctions, but not insurmountable ones under anti-money laundering (AML) principles.  It all depends on how widely you’re willing to target North Korea’s income, because our time for playing whack-a-mole has run out.  A strategy that isn’t comprehensive and that doesn’t reach North Korea’s foreign enablers is, by default, a license to proliferate.

How an economist analyzes those challenges is apt to differ from how a lawyer addresses them.  This is why I enjoy my side of this public conversation so much.  Please don’t confuse what follows with criticism.  What it is, is eagerness to devour and parse the research. So having said that, here’s a short list of what else I wish I knew.

First, how do we define “legitimate?” For example, are the Siberian logging revenues legitimate, given that some of the escaped loggers say they aren’t being paid?  That would make any    transaction to facilitate these arrangements “trafficking in persons,” which is a predicate offense for money laundering under 18 U.S.C. 1956(c)(7)(B)(vi), and therefore subject to criminal prosecution, along with the seizure and forfeiture of any proceeds or instrumentalities of the transaction.  The same predicate offense may well describe North Korean gold, coal, iron ore, and copper, probably its largest “legitimate” exports, if they are mined with forced labor (for which North Korea’s mining industry is deservedly notorious).  If the products of this newly announced Chinese-owned garment factory in North Korea (HT) are labeled “Made in China,” importing them into the United States could violate the country-of-origin labeling laws, this executive order, and consequently, the International Emergency Economic Powers Act, which would make the merchandise subject to seizure and forfeiture, and any movement of funds to facilitate that importation (you guessed it) money laundering, under 18 U.S.C. 1956(c)(7)(D).  Drive it past me, and I can probably find a broken taillight that anyone else would be ticketed for. I have never accepted “North Korean exceptionalism,” the idea that we must judge North Korea by a lower standard.

Second, one of the reasons why estimates about illicit revenues are invariably imprecise is the problem of commingling of legitimate and illicit funds.  If a North Korean attache’s diplomatic pouch contains $100,000 in supernotes, $100,000 in dope revenues, and $800,000 in proceeds of North Korean restaurants, how much should the authorities seize?  The answer, under AML principles, is $1 million, because commingling is usually a sine qua non for money laundering, and lawmakers eventually decided to vastly improve enforcement, and save law enforcement officers much annoyance, by empowering them to seize the whole lot.

Third, it’s important to distinguish between proceeds of prohibited activity and instrumentalities of prohibited activity.  Even if you accept the legitimacy of the labor and pay arrangements Kaesong, how do we know that its proceeds aren’t used for WMD development? (My view is that only Jang Song Thaek, Kim Jong Un, and a few people in Bureau 38 really know, and that as North Korea threatens South Korean civilians, and South Korea’s President prepares to visit the United States, for South Korea to revive the idea of importing Kaesong-made products into U.S. markets tariff-free is just crazy talk.)  If those proceeds are misused for WMD programs, they become instrumentalities. Under AML principles, instrumentalities can be seized and forfeited, along with whatever other funds they’re commingled with.

What this means is that, even assuming the accuracy of Noland’s estimates, well-crafted sanctions could and should reach much more than 5 to 20 percent of the regime’s income, and thereby suffice to vaporize its surplus and shock it into instability. After all, the money isn’t being used to better the North Korean people.

If the administration is really serious about stopping North Korean proliferation, it needs a new sanctions law, similar to the Iran sanctions acts of 2010 and 2012, which targeted Iran’s main source of income, its oil industry, as an instrumentality for its proliferation and a means to put political pressure on its regime.  As the Financial Action Task Force has been telling us for years, North Korea lacks the financial transparency needed to ensure that its income does not facilitate illicit activity.  We also know that North Korea prioritizes weapons development over providing food, heath care, and education for its people, and even over feeding some less-favored units of its military. North Korea can’t continue to develop its WMD programs or maintain its system of domestic terror without foreign money, particularly from China, but also from South Korea, the Middle East, and a small amount of European trade.

When it comes to investments, aid, and loans to North Korea, we would be well justified, and arguably compelled by Paragraph 8(d) of UNSCR 1718 to shift the burden.  As such, North Korea’s donors, lenders, investors, and insurers should be required to “ensure” that the end use of their funds is not some banned purpose.  If not, those funds should also be subject to blocking, seizure, and forfeiture.

Correction: A previous version of this post contained an image of an incorrect location for Bureau 39. I will try to post an image of the correct location later.

Via the Chosun Ilbo, and according to “a diplomatic source:”

The U.S. government is considering labeling North Korea as a money-laundering state to pave the way for sanctions after Pyongyang’s latest nuclear test.  [....]

Article 311 of the Patriot Act was created following the Sept. 11, 2001 attacks and authorizes the U.S. Commerce Department to identify an individual, financial institution or state as a “primary money-laundering concern.” This would ban the target from transacting business with any system that handles U.S. dollars.

This measure is much tougher than the freezing by the Bush administration in 2005 of around US$25 million held in some 50 North Korean bank accounts at Banco Delta Asia in Macao.

Theoretically, yes.  But it won’t be tougher in practice if North Korea is designated and the Chinese and South Korean entities that continue to fund the regime aren’t.  The key to effective economic pressure against North Korea is to cut its financial lifelines to its foreign enablers.  Yes, the North Koreans will always be able to use old money laundering tricks to evade sanctions, like shifting its transactions to bulk cash and stored value cards, and by “structuring” transactions (splitting big transactions into small ones) to avoid reporting requirements.

A drug cartel or a small terrorist organization can operate like that for years, but no one has ever tried to finance a police state, govern 23 million people, or feed and maintain a million-man mechanized army that way.  Sanctions don’t need to be 100% airtight to work; even sanctions that are 30% effective would create a massive shock to the palace economy, disrupt its system of gifting and patronage, impede WMD development, and force the regime to excommunicate large segments of its Inner Party.  That’s potentially destabilizing for a regime that’s recently purged a number of senior officials to consolidate its power base.

There is no such thing as a perfect plan, and the idea of pressuring North Korea through international financial sanctions is no exception.  Like money launderers everywhere, the North Koreans have adapted to get around anti-money laundering controls.  Reuters has an excellent, must-read report on North Korea’s use of bulk cash transactions to avoid the scrutiny of banks and law enforcement.  The report features an interview with Kim Kwang Jin, who defected and revealed his role in an international re-insurance scam.

North Korea has also responded by splitting its income streams via more banks.  South Korea claims that it’s difficult to associate specific accounts with illicit activity, which is always the case with money laundering.  That’s the whole idea of such classic money laundering methods as “structuring” — dividing large payments into smaller ones to evade reporting requirements — and “co-mingling” — mixing illicit funds with the proceeds of “legitimate” activity.  The usual law enforcement approach to such tactics is to impose special measures on all of the suspected launderer’s income and assets.  That approach shifts the burden to those handling the suspect’s transactions to establish the legitimacy of the origin and use of the funds.  It was also the clear intent of Paragraph 8(d) of UNSCR 1718.

All of which suggests that an appropriate U.N. sanction would be to ban bulk cash transactions with North Korea, its nationals, and its agencies.

I’ve often marveled at the inventiveness of the North Koreans at coming up with new schemes to bring in money. What’s more, I wouldn’t hold any of it against them if they were using it to feed their hungry people.  The example that sticks with me is the recent scam in which North Koreans hacked into popular South Korean online games, created algorithms to autoplay them, collected online credits, sold the credits for cash online, and gave the proceeds back to the regime to use for God-knows-what.  The New York Times thinks God-knows-what means “nuclear weapons programs and to smuggle Rolex watches and other luxury goods, which he doles out to buy the allegiance of the party and the military elite,” but with North Korea, no one ever really knows where the money goes.

One source of illicit North Korean income that has probably dropped off is the drug trade.  This piece, which discusses the cross-border meth trade between North Korea and China, doesn’t say whether the trade is state-sanctioned, but I tend to suspect most of it isn’t, except for the involvement of corrupt officials.  Japan’s crackdown on remittances and trade with North Korea badly damaged the state’s capacity to earn through the meth trade, and a lot of the chemists behind the trade turned pro.