from Macro and Markets

Have Sanctions Become the Swiss Army Knife of U.S. Foreign Policy?

Headquarters of Sberbank, one of the Russian institutions under U.S. sanctions REUTERS/Sergei Karpukhin

July 24, 2017

Headquarters of Sberbank, one of the Russian institutions under U.S. sanctions REUTERS/Sergei Karpukhin
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Sanctions

Russia

Venezuela

North Korea

The Congress takes an important, positive step to reinforce Russian sanctions, but are we at risk of overusing the sanctions tool?

Senate and House negotiators have reached agreement on a bill that would significantly constrain the president’s ability to ease Russian sanctions, and the legislation is expected to reach the president’s desk with veto-proof majorities this week.  While an important step in U.S.-Russia relations, and in some ways the most concrete policy change emerging from the Russia scandal to date, it is but one of a number of recent or prospective decisions by the Congress and Trump administration expanding the scope of sanctions, and perhaps not even the most consequential.  Sanctions have been a centerpiece of economic statecraft in both Democratic and Republican administrations, and especially after 9/11 with a new focus on financial sanctions in countries as diverse as Russia, Iran, and North Korea.  Yet now more than ever, sanctions policy appears to have become a policy of first resort.  The critical question is whether we are getting the balance right, and whether their extensive use presents long-term risk to the global economy.

Consider the following recent sanctions news:

North Korea.  In late June, the U.S. Treasury announced sanctions against the Chinese Bank of Dandong, a Chinese shipping company, and two related individuals for their involvement in providing illicit trade and finance to North Korea. The announcement by the Treasury’s Financial Crimes Enforcement Network (FinCEN) of sanctions against Bank of Dandong for acting as a conduit for illicit North Korean financial activity, and is a foreign bank of primary money laundering concern, was most notable. Such a “secondary sanction” aims to leverage the strength and role of the U.S. financial system to pressure a target (in this case, the North Korean government) by sanctioning a business or individual outside the United States (and the target country) that does business with the target. By imposing these sanctions, the administration aims to sever Bank of Dandong from the U.S. financial system, disrupting North Korean financial flows.

This was a modest first step. The companies involved are small, and there is a reasonable expectation that new companies will spring up to replace the disrupted business.  Further, for U.S. firms that might be willing to do business with North Korea through intermediaries, the announcement is a clear sign that there could be material costs to supporting the North Korean government. The most significant effect of the measure may be in the signal to the Chinese government to do more.

Secondary sanctions are not often used, in part because the perceived extraterritoriality of their use can cause problems for U.S. relations with the country whose institutions have been sanctioned. While the measures announced in June seem narrowly targeted and purposely limited in scope, and Treasury Secretary Mnuchin went to length to state that China was not the target, there are a number of ways that secondary sanctions could be extended, including larger Chinese financial institutions or expanding the sectors affected by the sanctions, with significant economic and political implications.

The move comes at a time of significant uncertainty for U.S.-China relations. There is little doubt that U.S. policymakers are growing increasingly frustrated with the ineffectiveness of current North Korean policy. Recent presidential tweets complaining of lack of Chinese pressure on North Korea, a Taiwan arms package, the failure of U.S.-China talks last week to make progress on economic issues, and the possibility of substantial U.S. tariffs on steel imports all underscore that the economic détente following April’s Mar-a-Lago summit may be coming to an end.

Venezuela.  The Trump administration is preparing to extend sanctions, promising “strong and swift economic actions,” if the Maduro government goes ahead with a controversial plan to establish a new “Constituent Assembly” that would rewrite the constitution, stripping powers from the democratically elected (and opposition controlled) National Assembly.  While sanctions are already in place against individuals associated with human rights abuses or drug trafficking (including the freezing of assets of eight members of Venezuela’s Supreme Court in May), the Trump administration may be readying a dramatic escalation in sanctions unless the Venezuelan government reverses course on the constituent assembly.  This could include broad sanctions aimed at limiting the development and exportation of oil (though there might be carve-outs in this case limiting the effect on U.S. refineries that currently import Venezuelan crude).

My preference though, and perhaps even more effective, would be tough limits on Venezuela’ ability to issue new debt.  Such restrictions, which could prohibit both U.S. companies’ holding/purchasing new debt or the financing for such debt moving through the U.S. financial system, would severely constrain the government’s ability to continue to meet its debt payments.  At a time when the government is defaulting on nearly all its commitments to the Venezuelan people, it has reinforced its position by continuing to make payments on international bonds through increasingly expensive and ad hoc deals.  Now, however, the Venezuelan government appears to have exhausted its liquid and usable foreign exchange reserves, and faces substantial payments in October and November on debt owed by the state oil company PDVSA.  On its face, intensified financial sanctions at this time could be a powerful catalyst for change, and perhaps with a lower humanitarian toll than would be the case with a complete cutoff in oil revenue and a collapse in imports.

Russia. The legislation now in the Congress toughens U.S. sanctions policy on Iran, North Korea, and Russia, but the focus of attention has been on the measures that would allow Congress to block efforts by the Trump administration to ease sanctions on Russia. Notably, the president would be required to send Congress a report explaining why he wants to suspend or terminate a particular set of sanctions, and lawmakers would then have 30 days to decide whether to allow the move or reject it. Given the broad set of existing sanctions in place (earlier Russia sanctions did not employ secondary sanctions but did enact broad sectoral sanctions on energy and finance), such a decision would seem to protect one of the most comprehensive sanctions programs on the books.  The bill has veto-proof majorities in both houses, even as some have raised constitutional concerns that the requirements in this proposed sanctions legislation (that Congress sign off on significant Russia policy alterations) could unduly constrain future presidents’ foreign policy authorities.

Regarding other countries, the bill reportedly prevents those out of compliance with North Korean sanctions from operating in American waters or docking at U.S. ports, and adds restrictions against products produced by North Korean forced labor. For Iran, the sanctions package imposes penalties on those involved in Iran’s ballistic missile program and anyone who does business with them.  This seems in line with administration policy. While adhering to the July 2015 Joint Comprehensive Plan of Action (JCPOA), the administration appears ready to institute an economic pressure campaign to confront Iran over its conventional weapons program and support for militants.

To be sure, I see a reasonably strong case for the more expansive use of sanctions in each of these cases.  Particularly in the case of Venezuela, strong financial sanctions limiting the capacity of the government to continue to finance debt payments, particularly when those deals make the future recovery of the county more difficult, should be a top priority.

But has the pendulum swung too far?

Facing a growing array of foreign policy challenges, one consistent feature of the new administration’s stated approach has been its willingness to move quickly to impose bilateral economic impediments to trade and finance, including sanctions. While a compelling case can be made in each instance for the use of sanctions, it’s hard not to conclude that sanctions have become the go-to weapon of choice, a Swiss army knife with a ready attachment just right for any foreign policy challenge.

No doubt, sanctions have been a growing force in diplomacy for some time. The 9/11 attacks quickly renewed interest in sanctions among policymakers and, backed by a series of executive orders, as well as legislation (Section 311 of the Patriot Act), brought about a new focus on financial sanctions and an effort to harness the power of sanctions to disrupt financial flows across borders.  In cases as diverse as North Korea, Iran, and Russia, financial sanctions found a new rationale and value as a driver of American foreign policy. So it would be wrong to suggest that the aggressive use of financial sanctions is in any sense new.

The question though is whether the pendulum has now swung strongly in favor of the greater use of sanctions. In Russia in particular, the use of “smart” and “asymmetric” financial sanctions by the Obama administration sought to impose substantial costs on the Russian government while limiting the damage to U.S. firms and the global financial system more generally. That meant that, when assessing a tightening of sanctions, the potential longer-term costs to global markets—such as derisking by firms, retaliation, and longer-term costs of disrupted trade and finance, were carefully weighed. Reports at the time suggest that the Obama administration took serious their responsibility to preserve and open, robust global trade and financial system.

If, as many have argued, we are in midst of a consequential shift in our politics, from left-right to one where the debates revolve between advocates of more open and closed economic policies, I wonder whether this administration, or those that follow, will find it easy to get the balance right.  Reports on recent trade deliberations within the Trump administration suggest that, while there are many advocates for open markets, it is clearly understood that the most critical decision makers on trade have a more protectionist leaning, and a willingness to use unilateral action to address grievances. Could the same be true on sanctions? Without a strong advocate of open markets at the table when the decisions are made, the risk is that sanctions become seen as an easy option without significant economic costs. Without these checks and balances, the risk of their overuse is profound.

There is a certain irony here.  On the Russia sanctions, the Trump administration does not want to lock in sanctions, but Congress rightly insists on its review. Beyond Russia, there seems to be a greater willingness by the administration to sanction trade and investment to achieve economic and foreign policy objectives, causing concern for those of us who see great value in U.S. leadership and support for an open, integrated global marketplace. There are economic costs, if confidence in the reliability of markets is lost, which can add up over time as sanctions are repeatedly employed.

As argued earlier, in each of these current cases, an expansion of sanctions looks to be the best of a difficult set of choices.  But looking forward, we should be concerned that the pendulum will swing too far, that sanctions become too easy an option. There are some things for which a Swiss army knife is the perfect tool, but for appendicitis I’d rather see a doctor.

 

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