The New Cold War
America, China, and the Echoes of History
Late last month, the European Union and China announced that they intended to set up a special global payments system to allow companies to continue to trade with Iran despite U.S. sanctions. Some of the sanctions are already in place, but the bulk will to go into effect in November, thanks to the U.S. withdrawal from the Iran nuclear deal earlier this year.
The announcement marks a small but notable step toward the fragmentation of the global economic order. Friends and foes of the United States were already seeking paths away from the traditional, dollar-dominated financial system. The Trump administration’s policy on Iran provided additional incentive to those who strive to undermine U.S. economic primacy and the effectiveness of U.S. economic statecraft. Washington should take note of the danger.
In May, U.S. President Donald Trump delivered on his promise to leave the Iran deal, also known as the JCPOA, and reimpose unilateral, aggressive economic sanctions on Iran. The most forceful of these measures will snap into place on November 4, dropping an axe on Iran’s core banking institutions, oil sales, and conduits to the global financial system. The measures will prevent Iran from using the prevalent global payment system. They will also cause most of the international businesses that buy Iranian oil and conduct other commercial transactions with Iran to cease such activity.
Traditional U.S. friends and allies are angry that the Trump administration’s choice to spurn the accord includes punishing them if they continue business with Iran. “[The EU] cannot accept that the U.S. decided the regions with which European companies can or cannot do business,” Belgian Prime Minister Charles Michel said recently.
At first shrill and chaotic, Europe’s outrage at Trump’s take-no-prisoners Iran policy has now found a bold and practical course of action. A core group of creative European civil servants has devised several economic mechanisms meant to demonstrate the EU’s continued support for the nuclear deal, deliver Iran its economic benefits, and assert Europe’s ability to take its own policy path.
In August, the EU formally revived a 1990s-era blocking law that allows it to protect or compensate European companies exposed to U.S. sanctions. Then, in September, Federica Mogherini, the EU high representative for foreign affairs and security policy, outlined EU plans to establish a so-called Special Purpose Vehicle (SPV), a financial institution that is technically not a bank and which would process payments between Iran and its international trading partners. In August, German Foreign Minister Heiko Maas said it was “essential that [Europe] strengthen European autonomy by establishing payment channels independent of the U.S. … and an independent SWIFT [payments] system.”
Setting up this new payments system and getting companies to use it will be a tricky business, and time is not on Europe’s side. The nuclear agreement has been profoundly hobbled by the U.S. withdrawal, and there is reason to doubt whether Iran will continue to adhere to it. In September, Iranian Foreign Minister Javad Zarif said that Iran might restart its nuclear program. That may mean Europe’s efforts will be wasted. But at the moment, Europe’s most urgent goal may be less to keep Iran in the nuclear deal than it is to chart an independent economic course.
The United States has long been able to use sanctions to impose devastating economic consequences on faraway countries. The EU never much worried about this when U.S. interests were closely aligned with its own. Now Europeans are facing down a barrage of tariffs, while the Trump administration expresses hostility toward NATO, attacks the International Criminal Court, and prepares a new round of potentially damaging sanctions. President of the EU Commission Jean-Claude Juncker asserted European independence from the United States when he explicitly established the goal of undermining the dollar’s dominance in global markets.
In the short term, this is just tough talk. EU politicians cannot force European businesses to keep buying Iranian oil or supplying Iran with auto parts. These sorts of transactions would trigger U.S. sanctions, which would freeze those businesses out of the global dollar payments system and the $20 trillion U.S. economy, a likely death sentence for any global company.
When the sanctions take effect in November, few companies will take advantage of the blocking law, as it provides only meager protection and compensation. The same is true for the SPV, which cannot protect the companies that use it, or the banks that serve as the gateways between the SPV and the formal financial system, from sanctions. The United States might well sanction the SPV itself if it hosts activities prohibited by U.S. sanctions law. Dozens of big European companies, including Airbus, Maersk, Peugeot, Siemens, and Total, have already announced that they intended to break off business with Iran.
Small and medium-sized firms that do not do much business in the United States will be able to continue doing business with Iran. They may use the blocking statute and the SPV. But they do not account for enough Iranian trade with the world to keep the Iranian economy from contracting. Already, inflation is rising in Iran, and businesses are preparing for a shortage of hard currency when the sanctions hit in a few weeks’ time. In 2012, when harsh sanctions were imposed on Iran, its oil exports fell by over one million barrels a day. A drop of that size today would cost Iran (at current oil prices) more than $80 million in daily revenue, almost half its earnings from oil exports.
Against this backdrop, it’s easy to dismiss Europe’s efforts as so much wishful thinking. The preeminent British banking association, UK Finance, for example, has cast significant doubt on the practical utility of the blocking law, saying it presents significant risks and legal complexity. Moreover, there is no chance that the SPV will displace the Belgium-based global payments system SWIFT, a pillar of the world financial system. European trade with Iran amounted to $787 million in 2017, less than three percent of total European trade. By comparison, nearly $5 trillion passes through the SWIFT system every day. Much of the scant European commerce with Iran will likely drop off following the reimposition of U.S. sanctions, but even if it all migrated to the SPV it would not reduce SWIFT’s usefulness, reliability, or profits.
Yet to write off the European effort to set up an alternative payment mechanism would be short-sighted. U.S. economic primacy is not immutable, and the conventional financial architecture and payment system will not necessarily last forever. In fact, the fragmentation of the global economic system is likely to be a major theme of the coming decades.
As the United States pushes away its allies, they will push back. The EU economy is too big to sanction: it comprises 22 percent of global GDP, carries out one-sixth of global trade, forms the largest single market for goods and services, and its predominant currencies—the euro and the pound—are the second and third most used for global payments, respectively. If China and Russia get involved in the SPV, as Mogherini has suggested, then the project will be even better resourced and the players even more able to tolerate the threat of sanctions.
China has ambitions that could make it particularly useful to the EU’s efforts: It seeks to elevate its currency while investing in projects around the world, and it rejects many of the international norms on commercial practices, developing its own unique national standards in sectors where there is already international guidance and establishing its own courtsto settle commercial disputes for countries involved in the Belt and Road Initiative.
The current effort to bypass U.S. sanctions is unprecedented in its creativity. It is also more elaborate, multinational, and mainstream than prior attempts at sanctions busting. And the political will behind it looks sustainable, as the United States shows no signs of letting up on its aggressive policies.
In the near term, the SPV is unlikely to grow very fast or to host very large companies. It may only serve as an accounting system for legal, unsanctionable trade with Iran in food, medicine, and medical devices. Some small businesses with limited ties to the United States might also participate, testing the waters on prohibited trade with Iran. This would allow policymakers to improve the SPV so that it can be expanded or replicated later.
But eventually, the SPV, or a similar mechanism it inspires, may succeed in creating a regularized and functional, if limited, way to make payments outside the conventional banking system. Such a vehicle may come to provide liquidity to people, companies, and states that struggle within the conventional financial system, whether because they are corrupt rogues or because they simply lack access to normal banks because banks find it too costly to perform the due diligence for customers in war-torn places or jurisdictions with weak banking oversight.
The benefits Iran might reap from the SPV or a similar payment facility are probably limited. That is because many of the country’s firms are corrupt and non-transparent, and business with Iran is generally perceived as risky. But the SPV, more than providing a truly workable system of its own, will likely provide a blueprint for future bespoke payment systems that seek to avoid U.S. jurisdiction and conventional payment platforms.
Some non-Western countries have already made efforts to avoid the traditional major currencies and payment systems, whether out of nationalism, a desire to evade sanctions or taxes, or a quest for efficiency. Russia is exploring creating a cryptocurrency and China is developing an expansive payment system that doesn’t involve Western banks or payment processors at all. Venezuela infamously launched an oil-backed cryptocurrency, the Petro, earlier this year. (No one really used it.) But none of these will undermine the dominance of the dollar and the euro currencies or drive cracks in the global payment architecture until they bring tangible economic benefits to their users and get some G-7 economies and major companies on their side.
The SPV is just one of many mechanisms that will redirect trade flows, supply chains, banking relationships, and payment processing to the detriment of U.S. economic power. Nevertheless, it is worrying that the United States itself is accelerating this trend. By imposing sanctions in a unilateral, belligerent manner, the United States is encouraging other nations to build independent economic channels. Such efforts can draw those countries closer together as they seek to counterbalance the United States. And foes of the United States can then use those channels to avoid U.S. sanctions, which will have lost their bite.
The day after Mogherini announced the EU’s plans, U.S. Secretary of State Mike Pompeo quipped that the SPV “is one of the most counterproductive measures imaginable for regional and global peace and security.” He didn't know how right he was.