Last week, U.S. Secretary of State Mike Pompeo complained about Republicans in Congress who were grandstanding for harsher sanctions on Iran. Now, he has joined the grandstanders, announcing that the Trump administration is stepping up its maximum pressure campaign against Iran by ending waivers that had allowed some states to import Iranian crude oil.
This may have significant consequences for global oil markets. It will have bigger consequences for U.S. power. Trump administration unilateralists, together with their Capitol Hill supporters and anti-Iran lobby groups, such as the Foundation for Defense of Democracies, think they can use sanctions as a tool of regime change. They are wrong. The increasingly desperate efforts of the United States to ratchet up sanctions are likely to backfire, hardening the resolve of the Iranian regime and driving both allies and competitors away from the U.S.-dominated global financial system.
The administration’s sanctions unilateralists are making a fundamental mistake about the nature of U.S. financial power. U.S. clout is not a direct product of its military might or even its large domestic economy. Instead, it is a byproduct of the unique topography of globalization—the system of networks that allows global financial transfers and trade to take place. These networks did not come into being through any grand master plan but instead were the result of an uncontrolled and decentralized process of adaptation to the new opportunities of globalization.
The United States is well placed to control key elements of these networks, such as the dollar clearing system and the SWIFT financial messaging system. This, in turn, has allowed it to press foreign financial institutions and firms into service as instruments of U.S. power: No international bank wants to be denied access to dollar clearing, and it is nearly impossible to carry out global financial transfers without SWIFT.
These circumstances have permitted the United States, with the support of European allies, to penalize countries such as North Korea and to cut Iran out of the world financial system. International financial networks became a massive force multiplier for U.S. power. The United States was able to carry out global coercion on the cheap. When the United States designated foreign businesses, organizations, or individuals as the targets of sanctions, other businesses avoided them as if they were bearers of the plague. No bank wanted to face the unlovely choice between paying massive fines with little hope of legal appeal and being excluded from the dollar clearing system. For a decade or more, it seemed as if the United States had discovered one weird trick for achieving global financial hegemony while imposing most of the costs on foreign banks and businesses.
Now, the United States is trying to do this on an even larger scale. Pompeo announced that he wants zero Iranian oil exports. It is probably impossible for any single state to control global oil markets because oil is a commodity. However, the United States can target the financial institutions that provide payments for Iranian oil, the shipping companies that transport it, insurance companies that underwrite shipping, and the myriad other corporations that support trade in Iranian oil. Even where the United States has no direct levers against these companies, it may have levers against other companies that do business with them, perhaps allowing it to isolate them from the global economy. If shipping insurance on freighters moving between Kharg Island and Shanghai is not provided by a U.S. financial institution, it is probably provided by a company with exposure to U.S. markets. As Pompeo acknowledged in his announcement, “To conduct these transactions, one almost always needs to participate in financial markets. We intend to enforce the sanctions.”
The problem is that weird tricks work until they stop working. There is plenty of reason to believe that the United States is overplaying its hand. There is no immutable law declaring that foreign states and businesses have to use U.S.-dominated global financial networks to carry out their business. As the political risk of using these networks increases, their attractions are dwindling remarkably quickly. The graveyards of economic history are filled with the corpses of once indispensable international financial arrangements.
It is unclear whether the United States has the clout to actually deliver on its threats. The countries with waivers include China and India, as well as Greece, Italy, Japan, South Korea, Taiwan, and Turkey. China in particular is less integrated into the global financial system than most other large economies. It is hence less susceptible to pressure and more likely to react angrily to any efforts to target its businesses. The Trump administration has already partly backed down from a sanctions fight over the Chinese telecommunications giant ZTE and is embroiled in a politically complex sanctions dispute over Huawei. Large-scale actions against Chinese energy importers or the domestic banks that work with them would represent a dramatic escalation and invite substantial retaliation.
Efforts to punish European banks, which conduct many of the transactions for Chinese firms, would be nearly as risky. Even before the most recent escalation, European states had started to explore ways to escape the reach of U.S. economic power. Most notably, Germany, France, and the United Kingdom announced in January that they would develop a special purpose vehicle known as the Instrument in Support of Trade Exchanges (INSTEX), which allows for the clearing of Iranian transactions without using U.S. dollars or financial networks. Just days ago, Turkish Foreign Minister Mevlut Cavusoglu announced that Turkey is looking into establishing a similar INSTEX system to circumvent U.S. pressure.
It is unlikely that either the renminbi or euro (let alone the lira) will replace the dollar as a global reserve currency anytime soon. However, these efforts slowly chip away at the zones of U.S. control. U.S. officials have hinted that they may use sanctions to bring European allies to heel, specifically targeting businesses or even perhaps government officials who are associated with the new arrangements. If the United States delivers on these threats, it is more likely to alienate its allies than to cow them. Why should they trust a country that harshly punishes them for trying to maintain an agreement with Iran that the United States itself negotiated before its unilateral withdrawal?
The United States is not only alienating allies but reshaping the incentives of private actors. The head of Barclays’s Americas sanctions office has noted that even if the dollar is unlikely to be displaced, there is growing “comfort with processing certain types of transactions” in other currencies to circumvent U.S. sanctions. Last week’s unrelated decision by the administration to waive Title III of the Helms-Burton Act, allowing U.S.-based individuals and businesses to sue foreigners over the expropriation of Cuban property, may dramatically accelerate the flight of foreign businesses from contact with the United States. As private financial institutions experiment with ways to go around the U.S.-led financial system, they are gnawing away at the supports of U.S. financial power.
Over the years, the United States benefited from spreading a fear of contagion. When states or businesses or individuals incurred the displeasure of U.S. financial authorities, they were treated by others as though they had the plague. They worried that pariah status might be catching (even accidental or innocent contact with a sanctioned party might be interpreted in unfortunate ways), and hence they avoided all association. This sometimes turned out to be a nuisance for U.S. policymakers. For example, businesses rarely took advantage of sanctions exemptions that were supposed to allow the export of freedom-enhancing technologies to Iran for fear that they might accidentally do something that the United States would punish. However, in general, this fear increased the efficacy of sanctions, by discouraging businesses from trying to game the rules.
If the United States continues along its current path, the fear of contagion may start to have quite different consequences. Instead of leading states and businesses to minimize contact with the targets of U.S. sanctions, it may lead states and businesses to minimize their contact with the U.S.-led global financial system and to start to construct their own workarounds. Over time, those workarounds might even begin to accumulate into an effective alternative system. Financial arrangements such as SWIFT and dollar clearing were responses to the incentives and profit opportunities of globalized financial markets. Now, U.S. unilateralism is changing those incentives and profit opportunities in unpredictable ways.