Unless I mis-understand, isn't this basically money laundering? Or rather, I suppose, bitcoin laundering?

Yes--assuming that exchange A is still on-line, which maybe isn't such a good assumption...

It is pretty much impossible to take down all bitcoin exchanges. If some are taken down, others will pop up. Decentralized systems like Bitcoin are very resilient. This the same reason why the Internet has not found a way to "take down illegal peer-to-peer file sharing".

While this is true, one or more countries ruling btc illegal could quite effectively stop it becoming mainstream and destroy its value.

By the time this happens (if it happens), I postulate that Bitcoin will be too mainstream to be stopped. And in the history of man, when people want something illegal (drugs, weapons, prostitution, etc), no law will "destroy the value" of these things and even less stop people from wanting them.

This would restrict BTC to the black market though.

The black market would be a niche use and probably a sustainable one but nowhere near the size of mainstream use people seem to be hoping for. If (for instance) the US government decides the businesses can't accept it, online or offline, then it would severely limit the growth potential for BTC in the US.

In some ways I'm surprised someone hasn't already gone after the exchanges for allowing people to convert back and forth between BTC and then gamble with it.

You can't get high snorting a Bitcoin. In that sense, it's very much different than drugs, weapons, gambling, prostitution, or even file-sharing.

Actually yes, "people can get high from bitcoins". Bicoin is the exclusive currency of payment on Silk Road (illegal drugs, weapons, etc). If Bitcoin is ever made illegal, it will continue to be used precisely to buy illegal products that people will always desire.

I doubt it. No one will use bitcoins anymore because they won't have the network effect required to extract value from currency. You can say you have Six Bajillion Bonkers Bucks, but unless a critical mass of others accept Bonkers Bucks as a valuable currency, it's worthless.

People want money because it's a token by which they can gain control and power over things. If bitcoin stops becoming this, no one will want it anymore. Bitcoin is nothing by itself, and if you can't get it into dollars, no one will want it anymore because there won't be enough people with enough respect for an independent bitcoin to yield up the control or power currency holders are trying to acquire.

Drug dealers use bitcoin because it facilitates online transactions without requiring the endorsement of a credit card company, payment processor, merchant bank, and so forth, and because they can cash that currency out for U.S. dollars, which they use to give themselves control and power.

No one wants bitcoins of themselves. I run a software firm and have tried to offer my employees partial payment in bitcoins, and none of them wanted it. If these guys don't even want to get into that game, what do you think the normal person will say?

Or sell for other currency and not convert to USD, as one reason for holding bitcoin is to avoid USD exposure.