A mixture of unintended consequences and indifference has left China playing a significant role in America’s fentanyl crisis. This has become a point of heated contention between Beijing and Washington. U.S. politicians accuse China of deliberately stoking the U.S. drug crisis; China responds that it has done its part and the United States is scapegoating.
But the actual story of Chinese regulation is far more complex and messy—and shows how powerful the profit motive is and how regulatory effects can have unintended consequences. The Chinese government regulates the production and distribution of fentanyl and its precursor chemicals, but stopping the trade is a challenge. Policies aimed at boosting China’s chemical and pharmaceutical development and exports have instead created a vast cottage industry of hundreds of thousands of small chemical plants and active pharmaceutical ingredient (API) manufacturers—and with it, a vast money laundering industry that takes advantage of the advanced real-time settlement capabilities of China’s banking system.
Understanding how to control fentanyl requires understanding how to make it. Fentanyl has many variants with similar sounding names that are chemically distinct but cause similar reactions in the body; the variants are merely different icing on the same cake.
Since its creation in 1959, researchers have developed at least three different manufacturing methods for fentanyl, each relying on different precursor chemicals as part of the process. Criminals have continued to adapt these processes to use a broader set of more readily available precursor chemicals—like using margarine because you’re all out of butter. The potential manufacturing methods are limitless. Criminals seeking to profit from fentanyl and governments seeking to control its supply are locked in a never-ending competition, with each new countermeasure spurring further innovation to circumvent it.
For many years, Chinese regulators attempting to uphold the country’s traditionally strict anti-drug policies faced a challenge as new variants of fentanyl emerged faster than they could be administratively added to the list of controlled substances. Between 2012 and 2015, only six new fentanyl variants emerged, but there were 63 new variants in 2016 alone. In response, the Chinese government placed all variants of fentanyl on the controlled substances list as of May 2019.
Since 2019, the supply of fentanyl from China directly to the United States has “decreased substantially,” as the U.S. Drug Enforcement Administration (DEA) noted in its 2020 National Drug Threat Assessment. However, fentanyl precursors—the chemicals used to manufacture fentanyl in Mexico and other Central American countries—have continued to originate from China, according to the U.S. State Department’s 2023 International Narcotics Control Strategy Report.
The Chinese government tightly regulates the manufacture of narcotic drugs and closely monitors their distribution as bulk APIs and finished dosage forms. As of December 2023, just two companies had licenses to produce and sell three fentanyl-related APIs (fentanyl, remifentanil, sufentanil). In total, only seven companies have licenses to sell fentanyl-related medical products in finished dosage forms. Hubei-based Yichang Humanwell Pharmaceutical is the dominant player in the industry, with $292 million in fentanyl-related domestic sales in 2022.
The company’s most significant competition comes from U.S. conglomerate Johnson & Johnson and imports of its fentanyl patches. Yichang Humanwell does not export fentanyl to the United States. According to its last statement on fentanyl exports in 2017, all of Yichang Humanwell’s foreign customers were national official procurement agencies, locally authorized distributors, or factories with production licenses from the government of the importing country in Ecuador, the Philippines, Sri Lanka, Turkey, and Vietnam.
By law, Chinese narcotic drug manufacturers such as Yichang Humanwell can only sell their products to three designated national wholesalers: Sinopharm, Shanghai Pharmaceuticals, and Chongqing Pharmaceutical. These national wholesalers distribute the drugs to authorized regional wholesalers, which supply hospitals and other medical institutions in their regions. Even the disposal of patches after use is closely monitored.
The high degree of industry concentration and tightly controlled distribution channels make it unlikely that substantial amounts of fentanyl manufactured in China are diverted into the illicit drug trade.
The source of fentanyl sold on America’s streets is not China but instead clandestine labs in mainly Mexico that synthesize fentanyl from precursor chemicals bought from small-scale producers in China and other countries. In 2022, more than 160,000 small Chinese businesses manufactured chemicals with relatively little oversight from the government. API manufacturers require a pharmaceutical license and receive some scrutiny, but with more than 1,600 producers spread across almost every province, it is difficult for the government to enforce compliance.
In 2021, the Chinese government identified about 20 percent of China’s 579 chemical industrial parks as “high risk” or “relatively high risk,” citing a lack of planning, low barriers to entry, and insufficient supervision. Most of China’s chemical and API manufacturers are small private firms with only modest capital investments and flexible operations.
Nearly all U.S. government enforcement actions related to fentanyl and taken against Chinese persons have involved the manufacture of chemical precursors, such as the four Chinese chemical companies and eight executives indicted last yearor the 28 members of a Chinese smuggling network sanctioned last October. In both cases, the companies involved were small private operations, located in provinces known for constructing some of China’s largest chemical industrial parks—Jiangsu, Fujian, Hubei, Hebei, Henan, and Anhui.
Chinese provinces compete fiercely with one another to attract the pharmaceutical manufacturing industry—accidentally undercutting regulation as a result. Four companies sanctioned by the U.S. government are in Hubei, where the provincial government named fentanyl specifically as a priority in its 2021-25 implementation plan for developing an API production base. At the national level, policy has encouraged the consolidation of the API supply chain into more easily supervised industrial parks.
China is the top API exporter globally, and small-scale producers still form the backbone of its industry. China’s comparative advantage is most significant in heavily polluting low-value APIs, where raw materials are the biggest cost. Industry consolidation is essential for China to climb up the value chain but remains a distant goal for Beijing. Intense competition among small-scale producers operating on thin profit margins will likely continue to drive some firms to opportunistically sell chemical precursors for synthetic drugs such as fentanyl and methamphetamine to whoever in the world may demand them and for whatever purpose.
In 2017, when the Chinese government placed two common fentanyl-related chemical precursors under control, Chinese producers switched to selling three other still unregulated chemicals used to make fentanyl—4-AP, boc-4-AP, and norfentanyl. These compounds were added to the United Nations’ list of controlled substances in November 2022, and the DEA has controlled the chemicals in some form since May 2020. Chinese authorities are likely to follow suit sometime soon, but criminals will discover new precursors in turn.
The U.S. government has pressured China to adopt “know your customer” (KYC) rules for Chinese chemical exporters, but China is unlikely to agree, at least for now. Implementing KYC rules would be cost-prohibitive for smaller Chinese producers and expensive to enforce. In 2022, then-Chinese Ambassador to the United States Qin Gang said KYC rules “far exceed[ed]” China’s obligations under the U.N. anti-narcotics conventions.
So far, the Chinese government has only warned producers to be “cautious” about exports of precursor chemicals controlled by the DEA to Mexico and other countries. Practically, this warning has had little effect. China’s small-scale chemical manufacturers can adapt their operations as quickly as drug cartels find new production methods.
China’s small chemical manufacturers make it easy for foreign buyers to place orders and make payments using messaging apps, such as WeChat, that support instant payments. Buyers only need to verify their identity when opening a WeChat account, a step that can be easily circumvented. For buyers seeking total anonymity, some companies will accept cryptocurrency as payment, even though such transactions have been illegal in China since September 2021. Many small Chinese chemical companies seem to be inviting shady businesses by advertising “stealthy” sales of known precursor chemicals for making illicit drugs.
Researchers at Elliptic, a blockchain and crypto analytics firm, found that more than 90 China-based chemical companies they interacted with were willing to supply fentanyl precursors, many of which mentioned prior shipments of the same chemicals to Mexico and were willing to supply fentanyl itself. They also found that 90 percent of these chemical companies accepted cryptocurrency payments, mostly using bitcoin, with a minority in tether, a so-called stablecoin.
China occupies key positions both upstream and downstream of the fentanyl crisis playing out on America’s streets. Chinese companies are the largest suppliers of chemical precursors used to make fentanyl. China also serves as the base of operations for criminal money laundering organizations that facilitate the sale of fentanyl. In congressional testimony in March 2021, U.S. Navy Adm. Craig S. Faller, then-head of U.S. Southern Command, described Chinese money laundering organizations as the “No. 1 underwriter” of transnational criminal organizations.
In 2021, a Chinese national was sentenced to 14 years in U.S. federal prison for laundering money on behalf of Mexican drug cartels. U.S. prosecutors said the case reflected a “recent phenomenon” in which Chinese criminal organizations had come to “dominate” international money laundering. These money launderers seek to take advantage of a deep-rooted culture of informal money lending among extensive networks of small Chinese-owned businesses in the United States, Mexico, and Canada. Many of these businesses are cash-based and import commodities and products directly from China. In many Spanish-speaking countries, these businesses are so prevalent that they have given rise to a new slang term to describe any discount corner store that sells seemingly everything imaginable.
The typical Chinese trade-based money laundering scheme involves at least four groups: 1) the Chinese criminal organization that brokers the deal; 2) local businesses that import goods from China; 3) wealthy Chinese nationals seeking to circumvent capital controls and move their wealth overseas; and 4) drug traffickers with excessive amounts of cash in small denominations of U.S. dollars.
The first two parties have a simple profit motive for participating—the money launderers earn an average commission of 1-2 percent, and the businesses obtain cheaper import financing than any bank offers. The last two parties have nearly offsetting problems—wealthy Chinese have capital in the Chinese banking system but no way to get it out and converted into dollars, and drug traffickers have dollars that they cannot legally spend. The money launderer’s goal is to execute a three-way swap among all the other parties, ending with dollars in the hands of the wealthy Chinese and clean money in the bank accounts of drug traffickers.
Chinese money laundering organizations are cheaper, faster, and safer than their competitors. According to Thomas Cindric, a veteran agent of the DEA’s Special Operations Division, Colombian money launderers typically charge between 13 and 18 percent commission for their services. By comparison, Chinese launderers typically charge a bargain price of only 1 to 2 percent and even as low as half a percent in some cases.
Chinese criminals use the same basic money laundering model as other criminal organizations. They distribute the money to their network of partners operating cash-based businesses, where it is mixed with cash from legitimate sources and deposited in small batches into the banking system. What sets the Chinese apart is their turbocharged speed and capacity to absorb enormous flows of dollars. This is only possible because Chinese money launderers leverage their access to the Chinese banking system to match the supply of illegally obtained dollars with black market demand for overseas dollars from wealthy Chinese. To legally buy dollars, Chinese residents must fill out a form, apply at the bank, and await a response. Upon approval, they are still limited to only $50,000 annually in overseas wire transfers.
The Chinese government zealously guards its monopoly over selling China’s domestic currency—the renminbi, usually known as the yuan—for foreign hard currency, such as the U.S. dollar. This is partly out of fear that allowing individuals to convert their money freely could lead to capital flight that harms the economy. Capital flight has deepened thanks to China’s recent economic downturn, worsening relations with the United States, and Chinese President Xi Jinping’s “common prosperity” policies, giving Chinese elites many reasons to think their fortunes may be more secure abroad.
Last August, Shanghai police detained five people, including a prominent executive at an “immigration services” firm, as part of a crackdown on the black market for foreign currency. Many similar advisory firms act as white-glove, discreet intermediaries for wealthy Chinese to employ the services of criminal money laundering organizations.
As soon as the handoff of dirty money is confirmed, money launderers get to work by executing a series of mirror transactions in the Chinese banking system using the RMB their Chinese clients transfer to them for conversion into dollars. The money launderers use mule accounts and shell corporations to obscure the origins of the funds and break up the volume into small amounts. Transfers between bank accounts of 50,000 yuan (about $7,000) or less are settled almost instantaneously—even across different banks—using the High Value Payment System operated by the People’s Bank of China, China’s central bank. The whole process can be done using only mobile banking apps and takes as little as three hours to complete.
The money launderers aim to create a new RMB bank deposit, untraceable to their clients, that can be drawn on to pay for goods exported from China to the country of residence of the original owner of the dirty money. In this trade-based money laundering model, the importers of the goods are members of the same network of small Chinese-owned businesses used to place the dirty dollars. These cash-based small businesses sell the imported goods into the local economy. The proceeds from these sales are transferred to the original owner of the dirty money as clean bank deposits in the local currency, which can be legally spent or converted into another currency as desired. Elsewhere, the money launderers’ Chinese clients collect their desired U.S. dollars—formerly dirty money but now cleaned—thus completing the circular flow of money.
Authorities in the United States and China have had difficulty combating this model of money laundering because it does not utilize cross-border payment systems such as SWIFT, which anti-money laundering compliance teams closely monitor. Within the Chinese banking system, the transfer amount that triggers filing a report with authorities is relatively high—500,000 yuan (about $70,000) per day for a personal account. By contrast, U.S. banks generally file reports whenever daily aggregate transactions exceed $10,000. Even detecting the influence of trade-based money laundering on economic data isn’t easy. One sign may be the growing gap—about $500 billion annually—between China’s official trade surplus and the implied level of trade surplus according to customs receipts.
One prevalent yet less sophisticated approach of money laundering is known as the Vancouver model, named after the Canadian city that the children of many Chinese elites call home. In this model, Chinese clients seeking to move their wealth offshore deposit RMB into bank accounts controlled by money launderers before flying to Vancouver.
On arrival, the clients collect Canadian currency—usually dirty money from drug sales—and immediately go to a casino to exchange it for chips. After placing a few small bets, the clients redeem the chips for semi-clean money that still must be sheltered by using it to settle pre-negotiated all-cash real estate purchases. A 2019 report commissioned by the government of British Columbia estimated that up to 5.3 billion Canadian dollars (about $4 billion) in real estate transactions in the province in 2018 were related to money laundering activity, pushing up housing prices by as much as 7.5 percent.
So far, arrests and punishments have done little to deter Chinese criminals from engaging in money laundering. In October 2021, Xizhi Li, a Chinese national and naturalized U.S. citizen, was sentenced to 15 years in prison for laundering at least $30 million for drug cartels through a dingy Guatemalan casino. For every kingpin like Li who is punished for his actions, dozens more criminals think the payoff is worth the risk.
Washington and Beijing often trade heated words over the subject, but both sides share an interest in stopping the illegal fentanyl trade. The harm done to China’s international image by its association with the fentanyl crisis vastly outweighs whatever related profits may accrue to its chemical manufacturing industry. U.S. law enforcement agencies need the cooperation of local government officials and police in China to curb the supply of chemical precursors to drug cartels that operate with impunity in Mexico. Neither government benefits from tolerating international money laundering activity associated with drug trafficking because it also enables official sector corruption.
China views fentanyl as a problem that can be dealt with over time, whereas the United States views fentanyl as a crisis that demands action now. The first-ever U.S.-China Counternarcotics Working Group meeting last January shows that both sides are ready to discuss a substantive solution. But Washington will have to do more than nicely ask for Beijing to reconsider its priorities; concessions in other areas of importance to Beijing will have to be on the table. Potential incremental steps include an extension in how long a Chinese company can remain on the U.S. Commerce Department’s Unverified List before moving to the more severe Entity List and more flexible export end-use checks for Chinese companies and individuals. The Chinese government could potentially reciprocate by updating China’s list of controlled precursor chemicals to match the list contained in the U.N. Convention Against Illicit Traffic in Narcotic Drugs and Psychotropic Substances.
The U.S. and Chinese governments have the infrastructure and tools in place to work together to deal a severe blow to the illicit fentanyl trade. The price of winning China’s cooperation in this matter pales in comparison to the terrible price already paid by the American people.
The post How China Trapped Itself in America’s Fentanyl Crisis appeared first on Foreign Policy.
