Thursday, October 31, 2019

Is the strength of U.S. sanctions due to U.S. dollar hegemony?

I often hear the idea that the U.S. dollar is the means by which the U.S. implements sanctions. And since the U.S. dollar pervades all corners of the globe, the U.S. government's sanctions are uniquely powerful. For instance, Reuters reports that Russian resource giant Rosneft is shifting all its contracts over to euros in order to "shield its transactions from U.S. sanctions."

Another version of this idea was recently floated by David Marcus, the head of the Libra payments project:
"The future in five years, if we don’t have a good answer, is basically China re-wiring” a large part of the world “with a digital renminbi running on their controlled blockchain,” Marcus said. He warned about the prospect of “having a whole part of the world completely blocked from U.S. sanctions and protected from U.S. sanctions and having a new digital reserve currency” with no alternative."
The shared assumption of both the Rosneft and David Marcus quotes is that the U.S dollar is the primary pathway for projecting U.S. sanctions. By going out of their way to adopt a different currency, euros or renminbi, a nation or corporation can sidestep the sanctions threat.

But that's not quite right. Sure, the U.S. dollar is the world's reserve currency. However, the U.S.'s ability to apply strong and effective sanctions has very little to do with the U.S. dollar itself.

To see why, we need to visit how sanctions work. If the U.S. doesn't like a particular company, say Rosneft, and wants to cripple it, it starts with primary sanctions. The government tells U.S. companies to stop dealing with Rosneft on threat of fine.

But the real story begins with secondary sanctions. Here, the U.S. government tells Americans that on top of breaking ties with Rosneft, they must stop doing business with all other foreign entities (European, Canadian, Japanese, etc) that does business with Rosneft.

A foreign company now has a choice. If it is a European refiner, it will have to choose between continuing to buy crude oil from Rosneft or no longer accessing U.S. markets. This means being shut off from U.S. energy exports, doing without Texan oil & gas technology, forgoing U.S. repairs and refinery parts, being exempt from Silicon Valley tech expertise, being excluded from purchasing American assets, and having its existing U.S. subsidiaries threatened. There are also financial repercussions. It will lose access to New York's capital markets and the dollar payments system.

Given a choice between Rosneft or America, which will our refiner choose?

As I wrote a while back at Bullionstar, their are additional costs to being blacklisted by the U.S. government. Blacklisted executives would have to face the possibility of "no longer being able to send their kids to Ivy league schools, travel to Las Vegas for holiday, or seek medical care at Johns Hopkins or the Mayo Clinic." They wouldn't be able to visit the U.S. for business purposes, or explore U.S. job opportunities. I doubt that Russia has enough good job opportunities, universities, vacation spots, and high end hospitals to compensate.

This impressive list of penalties is why the U.S. government's secondary sanctions are so powerful. Almost every foreign company will prefer to give up Rosneft and keep doing business with America.

Now, Rosneft might nudge and wink at its European customers and say "hey, let's just deal in euros. That way we can get around the sanctions. We'll keep doing business together and you won't lose access to the U.S."

But using euros doesn't change the economic calculus facing our refiner. Even if it does business with Rosneft in euros rather than dollars, it is still doing business with Rosneft. And the moment that the U.S. justice department catches a whiff of this (say one of its bankers rats it out), the European company will be blacklisted. And that means losing the entire list of goodies that is associated with access to America. The risk is simply too high.

Fancy payment options like bitcoin or gold don't solve this either. Say that Total, a big European refiner, buys Rosneft oil with bitcoin. Total execs hopes that a bitcoin payment might prevent its bankers from tattling on it to U.S. authorities. But it's very difficult to camouflage the opposite side of that trade--massive movements of crude oil back to Europe. There are just too many bodies involved in that sort of operation. A large law-abiding organization like Total can't take the risk of being discovered. And so, bitcoin or not, it will disconnect Rosneft.

To summarize, what makes American secondary sanctions so effective isn't U.S. dollar hegemony. It is the impressive amount of technology, wealth, goods, services, and experience generated by American companies and individuals. When firms are threatened with losing access to this treasure trove, they will make whatever sacrifices are necessary to keep it.

As for Libra, in an effort to sell his new payments system to American regulators, David Marcus conjured up a world "completely blocked from U.S. sanctions" thanks to a new digital renminbi. But even if firms have the ability to make transactions in digital renminbi, this doesn't change the fact that America's home-grown economic bounty is massive, and foreigners value that bounty above any other, U.S. dollar or not. There are other reasons for regulators to welcome Libra. But bolstering U.S. sanctions isn't one of them.

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