Financial sanctions a potent weapon

Financial sanctions a potent weapon

LONDON - The United States counted the cost to the Russian economy even as it issued Moscow another warning this week that it faces more sanctions over the growing unrest in eastern Ukraine.

At a congressional hearing on Tuesday, US Assistant Treasury Secretary Danier Glaser ran through a list that included a 13 per cent fall in the Russian stock market and capital flight of some US$100 billion (S$125 billion) to US$130 billion this year.

The Russian central bank had to shell out nearly US$50 billion to support the rouble while Rossiya Bank - linked to President Vladimir Putin - has lost US$1 billion in deposits since March.

Moscow was warned that if it continued to meddle in Ukraine through its support of pro-Russia separatists, the sanctions will bite harder. These would come in calibrated doses in response to Russia's actions, but "we will use the full range of sanctions authorities at our disposal", Mr Glaser said.

Russian leaders may have scoffed at the sanctions threat initially, but over the past decade, financial warfare has become a potent weapon in Washington's arsenal. If the US wanted to, it could do Russia serious harm within weeks.

Until fairly recently, sanctions were dismissed by foreign policy experts as a failure: The "bloqueo", as the blockade which the US imposed on Cuba half a century ago is known, has certainly impoverished that country but done nothing to dent the Cuban regime's hold on power.

Sanctions entrenched the rule of Iraqi leader Saddam Hussein, spawning a vast web of corruption. By the time Mr George W. Bush moved into the White House in early 2001, sanctions were regarded as a diversion from real policymaking.

Today, however, financial sanctions are viewed in Washington as "a 21st century precision-guided munition", in the words of former CIA director Michael Hayden.

The US operates no fewer than 24 different sanctions programmes against countries, commercial entities or specific business sectors. The pain of a freeze on foreign currency holdings and other related measures had been credited with persuading hostile North Korea and Iran to get back to the negotiating table.

The success of this financial weapon came about because of two inter-related developments. The first was the creation by the US Treasury Department of a specific financial intelligence capability, or "Finint" as it is called in the spooks' trade, to complement "Humint" (human intelligence) and "Sigint', as the art of electronic intelligence is known.

Finint built up a huge databank of information on the financial dealings of hostile governments which allowed a US president to target sanctions where they hurt most. And America's domination of the global financial system did the rest.

Once a country or a specific financial institution was sanctioned by the US, banks around the world rushed to comply even if they were not legally obliged to do so, for the simple reason that, if they ignored the US sanctions, they could end up being excluded from trading on US territory or with US-based banks for years.

As Mr Juan Zarante, a former Bush administration official who created the new sanctions regime and recently published a book entitled Treasury's War points out, America's new weapon "does not come from the classic trade-based sanction or law, nor did it derive from a UN sanctions resolutions. Instead, it came from the sheer domination which the US exercises over the global financial system".

By incapacitating even one or two key banks, the US would effectively make doing business with a country "toxic to the private sector", he explains. "All financial activity would be rejected like an infection by the antibodies we had built up in the international financial system."

The way new financial sanctions work was not initially apparent even to US administration officials. And it was most certainly not understood by foreign governments: Mr Zarante reveals that before imposing financial sanctions on North Korea a decade ago, the US gave China ample warnings through secret diplomatic channels, but the Chinese had still "not anticipated the gravity of this action or its ripple effects, including within the Chinese financial system".

Yet they soon would: a few months after the US action, none other than the Bank of China joined the financial sanctions on North Korea, since it had no other options if it wanted to defend the Chinese banking system from the risk of US penalties.

The sheer potency of the sanctions sometime stuns even US officials. When Washington eventually decided to allow North Korea to withdraw its money frozen in overseas accounts, the US had to spend months trying to find a bank willing to execute the transaction, since nobody wanted to touch such business.

The US primacy over finance means that global payment systems such as MasterCard and Visa invariably have to apply American sanctions, regardless of the fact that most of their operations are outside US jurisdictions. The customers of Bank Rossiya thought that they were safe because most of their deposits are physically inside Russia, until they discovered that all their credit and debit cards suddenly no longer worked.

America's ability to influence Swift, the global system which is the backbone of financial transactions between all banks, is even more significant. Just ask the Iranians, who thought that they may be able to evade US-imposed trade sanctions by selling their oil cheaply to China and India, only to discover that, even if they found willing buyers, they could not get paid, unless they were prepared to carry banknotes in suitcases across borders.

But the US ought to be wary of being too enthusiastic about the use of this instrument. The more it abuses its dominance of the global financial system, the more the pressure will grow to establish parallel structures which are outside its control.

That won't be easy, since the biggest ingredients in the creation of a new payment system are credibility and business volume, and both take time. Still, if the will is there, parallel payment structures could be created.

The US may end up encouraging precisely the trends it seeks to avoid: a growing backlash against existing financial rules and structures, one which is already aided by the growth of new "virtual" currencies available electronically, such as bitcoin.

US officials claim to understand these dangers: financial sanctions should be used "sparingly" and only "in conjunction with other tools", cautions Mr Juan Zarante. But the temptation is hard to resist. So the sanctions on Russia will grow. And so would the search by America's opponents to escape from Washington's financial clutches.

jonathan.eyal@gmail.com

This article was published on May 9 in The Straits Times.

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