The Dollar Underpins American Power. Rivals Are Building Workarounds
le 4 juin 2019
U.S. allies, looking to buck American control over international trade, are developing alternate systems that don’t rely on U.S. currency.
The catalyst was the Trump administration’s decision last year to reimpose trade sanctions on Iran after pulling out of the 2015 nuclear-weapons deal. The U.K., Germany and France didn’t support the sanctions, which include a ban on dollar transactions with Iranian banks. So they are fine-tuning a system to enable companies to trade with Iran without using dollars.
India wasn’t happy either. Iran is a longtime trading partner, and India wants Iranian oil. India began using a similar alternative system in November, and shipping records show it already is being used by international companies to trade with Iranian businesses subject to sanctions.
China and Russia, also eager to break free of U.S. control, are promoting their own alternatives to the global bank-transfer system, which the U.S. effectively controls, and are striking deals to trade with yuan and rubles instead of dollars.
Global trade runs on dollars, giving the U.S. extraordinary power over nearly every entity that imports or exports anything anywhere. That clout has long frustrated America’s enemies, making them vulnerable to U.S. trade sanctions.
The new arrangements won’t change the dollar’s dominance in global trade, but they will diminish the U.S.’s power to impose its policies, including sanctions, around the globe. They also could make it easier for criminals and terrorists, who have long tried to sidestep the dollar, to move money outside of U.S. oversight.
The White House declined to comment about efforts by other countries to bypass dollar-denominated trading. A senior administration official said the U.S. is working to make sure oil is readily available in dollar-denominated markets from sources other than Iran, and to “bring Iran’s oil exports to zero.”
In congressional testimony in March, Treasury Department undersecretary Sigal Mandelker said that “those who engage in activities that run afoul of U.S. sanctions risk severe consequences, including losing access to the U.S. financial system and the ability to do business with the United States.”
Jacob J. Lew, Treasury secretary under President Obama, says the U.S. is at risk of losing some of the power it has long wielded. The world, he says, now has “pathways” for those who “need to or want to avoid the U.S.”
The dollar’s status dates back to the end of World War II, when the U.S. economy was the world’s most robust and dollars were plentiful. The currency’s liquidity, and the efficient U.S. banking system anchored by the Federal Reserve, mean trading in dollars is much less expensive and more convenient than using other currencies, says Craig Pirrong, a University of Houston professor who studies payment systems.
Here’s how it works: A Canadian lumber company sells boards to a French buyer. The buyer’s bank in France and the seller’s bank in Canada settle the payment, in dollars, via “correspondent banks” that have accounts at the Fed. The money is transferred seamlessly between the banks’ Fed accounts because their status as correspondent banks means they are seen as safe counterparties.
The use of these accounts, the U.S. says, means every transaction technically touches U.S. soil, giving it legal jurisdiction. Because using most other currencies is relatively inconvenient and expensive, many countries and companies will do whatever the U.S. requires to maintain access to dollars.
Tensions over the Iran nuclear deal have ratcheted up recently, with Iran threatening to abandon some of its commitments if it doesn’t realize certain economic benefits. The foreign ministers of the U.K., Germany and France, in a joint statement, expressed concern and rejected Iran’s ultimatum. An unraveling of the deal could affect Europe’s plans for rolling out Instex, the name of its new system.
Europe’s Dollar-Free System
A new system called Instex is designed to facilitate trade between Europe and Iran without sending money across borders.
A company in Europe agrees to sell medicine to a buyer in Iran.
Another European company agrees to import pistachios from Iran. Companies notify Instex in Europe and its Iranian counterpart.
Both parts of Instex then pay the local exporter with cash from the local importer. The money never crosses any borders, avoiding U.S. scrutiny. If the numbers don’t match, Instex uses funds from other transactions or from its own capital.
India’s system is being used already. Although it is supposed to facilitate trade involving only nonsanctioned entities and goods, a Wall Street Journal review of Indian customs records shows it is allowing companies to trade with Iranian entities named on the U.S. sanctions list.
On Jan. 24, Punjab Bevel Gears Ltd., a parts manufacturer in Ghaziabad, India, sent nearly $71,000 of tractor components to Iran Tractor Manufacturing Co. Treasury classifies the company as a “specially designated global terrorist,” and says it can sanction any company anywhere in the world that trades with the Iranian company. Iran Tractor didn’t respond to a request for comment.
Mohan Singh, who handles exports for Punjab Bevel Gears, says his company got paid through India’s payment mechanism. He says he wasn’t concerned that the buyer is on the sanctions list because “the Indian government has allowed export to Iran. That’s what we are doing.”
The European effort may be the most serious threat to the U.S. dominance. “I want Europe to be a sovereign continent, not a vassal, and that means having totally independent financing instruments,” French Finance Minister Bruno Le Maire said at a press conference last year. In an op-ed around the same time, German Foreign Minister Heiko Maas wrote that it is “essential that we strengthen European autonomy by establishing payment channels independent of the U.S.”
Planning in Europe began after the U.S. threatened action against Swift—the Belgium-based system that banks use to communicate with each other about money movements—unless it cut off Iran’s banks. In response, Germany, France and the U.K. decided to set up Instex, an acronym for Instrument in Support of Trade Exchanges.
The system, which isn’t yet operational, will be based on the euro, the second-most-used currency in international trade. Initially, it will allow for trade with Iran of goods not covered by new U.S. sanctions, such as consumer products and medicine. It is needed because U.S. sanctions bar dollar transactions with Iranian banks, even on deals for unsanctioned goods. Once operational, Instex’s members could expand it to cover any trade with Iran.
Vice President Mike Pence told a conference in February that European countries were trying to “break American sanctions against Iran’s murderous revolutionary regime.” Officials in Europe say they needed to create Instex to honor earlier deals with Iran.
The system aims to bypass the dollar by using the same mechanism underlying the age-old hawala money-transfer system popular in the Middle East and Asia, under which people pay cash in one office and a recipient draws the equivalent funds at a distant locale without money actually moving.
This is how the Instex system would handle the sale of medicine by a German company to an Iranian buyer: The German exporter wouldn’t get paid by the buyer, but by another European company that is separately importing goods from Iran. Similarly, in Iran, the buyer of the medicine would pay the exporter of the other goods. No dollars at all would be involved, which means the U.S. would have no jurisdiction.
Instex incorporates a “sovereign shield” that puts government officials who can’t be prosecuted by the U.S. in the top positions, which protects individual bankers from U.S. pressure.
While the European initiative is focused on bypassing the Iran sanctions, China’s effort is broader. It has struck deals under which countries including Turkey and Pakistan have agreed to sell goods to China in exchange for yuan. Last year, it did a currency swap with Nigeria to reduce the need for dollars in bilateral deals. And it established a yuan-based system that enables Serbians to use their local credit cards in other countries.
In 2013, less than 7% of trade between China and Russia was in yuan and rubles, the bank ING Groep reported last year. In 2017, it was more than 18%. If China trades in yuan with sanctioned entities, the U.S. would have trouble detecting and stopping it.
China’s effort to develop nondollar payment systems is significant because it is the world’s second-biggest economy, with a huge role in global trade. China’s Cross-border Inter-Bank Payment System, which started in 2015, is operated by the People’s Bank of China. So far, it is used only in yuan transactions and is using Swift, the global payments system, for communicating about transactions. Many who study international trade expect it to evolve into a system that allows widespread yuan-based trade without using Swift.
Even if such alternative systems catch on, the dollar is likely to dominate international trade for years to come. In 2016, the most recent year for which data are available, the dollar was involved in 88% of the daily trades in the $5 trillion-per-day foreign-currency market, according to the Bank for International Settlements, an international institution owned by central banks.
The euro is handicapped by political uncertainty in Europe, and the yuan by Chinese restrictions on currency flows and unease about that nation’s economy. Further bolstering the dollar’s standing is its role as the world’s main reserve currency, held by central banks globally. That creates a strong incentive to keep the currency stable and liquid.
“The rest of the world can’t do without the U.S. dollar,” says Daniel Drezner, a Tufts University professor who used to advise the U.S. Treasury.
The U.S. has used that power to force foreign countries to abide by its laws on money laundering and corruption. After the 9/11 attacks, it used its control of the dollar to increase surveillance of global money flows and curb financing for terrorist organizations. That began a shift toward using the dollar to further U.S. policy goals.
North Korea, Syria and al Qaeda were mostly cut off from the global financial system by U.S. sanctions. Policy makers used the U.S.’s control of the dollar to try cutting off funds for despotic regimes, would-be nuclear powers and rivals intent on undermining elections in democratic countries.
Yet tensions have arisen over big U.S. fines against companies seen as important in their own countries. France’s Société Générale last year paid $1.34 billion to settle claims it violated U.S. sanctions against Cuba, Iran and Sudan. Petróleo Brasileiro SA, Brazil’s state-controlled oil company, agreed last year to pay $853 million to U.S. and Brazilian authorities and additional money to investors for allegedly paying kickbacks and inflating costs on projects in Brazil. This year, Russian telecom MTS agreed to pay $850 million to resolve charges that it bribed Uzbek officials.
Even with the risk of fines, though, the high cost of alternative transactions meant avoiding the dollar was hardly worth it. Even bitcoin has failed to catch on as a large-scale substitute because of the cryptocurrency’s volatility.
India’s alternative system is similar in concept to Europe’s, though it is used now only for trade involving Iranian oil, for which the U.S. gave India a temporary waiver. In April, the U.S. said it would end the waiver. India has stopped direct purchases of Iranian oil, at least temporarily, the Journal reported this week.
A Journal review of customs data on more than 5,000 shipments from India to Iran in January shows hundreds going to Iranian entities whose owners are subject to U.S. sanctions. American and European companies have used the system to sell goods despite the sanctions.
Ajay Sahai, CEO of the Federation of Indian Exporting Organizations, says India is on track to export some $3.5 billion in goods to Iran this year, about 25% higher than last year. He says he hopes the Indian government can “convince the U.S. of our need to import oil from Iran” so that Indian exporters can continue selling to Iran. While the system is designed to facilitate only trade involving nonsanctioned entities, Mr. Sahai says Indian exporters must rely on the word of the Iranian counterparts for how products will be used, presenting a risk of goods being sold to parties who are subject to sanctions.
One U.S. company’s use of the Indian system shows that even companies complying with sanctions need to find ways around bank policies of not doing business with Iran.
On Jan. 9, the Indian subsidiary of Pennsylvania-based medical-supply company Colorcon Inc. got paid the equivalent of about $9,000 for drug ingredients shipped to an Iranian firm called Sobhan Oncology. Sobhan is owned by companies whose owner is controlled by Iran’s supreme leader, according to Kharon, a Washington company that uses open-source data to reveal networks of sanctioned entities.
The Treasury Department has said that Sobhan Oncology’s parent is involved in “generating revenue for the Iranian leadership” and “assisting the Iranian Government’s circumvention of U.S. and international sanctions.”
Colorcon is allowed to trade with Iranian companies because the goods it sells are covered by a license allowing food and medical exports. And while it isn’t allowed to trade with entities sanctioned for things like terrorist connections, it is allowed to sell to companies that, like Sobhan’s owners, are only sanctioned for being owned by the Iranian government.
Colorcon’s lawyer, Janet Kim, says “the practical reality” is that most banks won’t process such transactions because of their fear of doing any business with Iran. So Colorcon got paid through India’s payment mechanism. In theory, says Colorcon General Counsel Bruce Reed, the company could have received payment in dollars, or any other currency. In practice, though, “it appears that the only one that’s effectively trading now is rupees,” he says.