Text size

When wielded effectively, U.S. sanctions have weakened targets like Iran and North Korea without impacting the global economy. But against authoritarian heavyweights like Russia and China, this may no longer be the case. America’s policy options are narrowing.

The U.S. began using sanctions as a serious deterrence tool after 9/11. The Patriot Act gave the executive branch tools to pressure foreign financial institutions that threatened the integrity of the U.S. banking system. In particular, Section 311 allows the U.S. Treasury to monitor and prohibit correspondent banking with financial entities that sponsor terrorism.

Correspondent banking allows a financial institution in one country to do business in the currency of another. Since the dollar is the world’s pre-eminent reserve currency, most nations need dollar-denominated corresponding banking rights to conduct the great bulk of international trade. Financial institutions that don’t have access to correspondent banking are blocked from transacting in the dollar. The thinking was that, if Washington could deny access to correspondent banking for certain bad actors, it could incentivize them to act with instead of against the U.S.

These sanctions have proved successful in the past. In 2011, the Obama Administration imposed 311 designations on the Central Bank of Iran, making it very difficult for Iran to sell its oil abroad, since most energy transactions are conducted in dollars. Isolating Iran from global markets was instrumental in forcing it to negotiate with the U.S. over its nuclear-weapons program.

Despite that victory and other similar ones, Iran might have marked the peak of these tools’ effectiveness. Newer potential American adversaries are far more economically influential than past sanctions targets. Using a blunt instrument like Section 311 against them could lead them to disrupt U.S. markets.

Russia and China are using sophisticated measures to counter or work around sanctions. The Kremlin-controlled Russian Direct Investment Fund has actively courted investment from other sovereign wealth funds, including from the Gulf States. Given tighter energy cooperation between Moscow and Riyadh, such investment has reduced, if not mitigated, the effects of certain Western sanctions. Russia’s Central Bank has also offered to provide correspondent banking access should Washington revoke these privileges with future sanctions.

At the same time, China is developing potent countersanctions by weaponizing access to its market. When South Korea installed a U.S.-operated missile-defense system in 2016, China responded with informal restrictions. State media encouraged Chinese consumers to boycott South Korean products, while politicized regulatory enforcement targeted South Korean firms operating in China. Beijing has now formalized its new tools in an Unreliable Entities List, which it can use to punish foreign firms, like Qualcomm or HSBC, that it sees as enforcing Washington’s policies.

Broad-stroke penalties have made and will continue to make countries feel hostage to the dollar. The less U.S. sanctions appear tied to matters of national security and more to politics, the more other economic powers will take steps to circumvent U.S. markets and undercut the dollar’s reserve-currency status.

Instead, the U.S. needs targeted solutions that achieve American interests while having little impact on our markets. Targeted solutions currently exist. The Treasury has the legal authority to seize funds stored in offshore accounts. Civil asset forfeitures can single out specific foreign correspondent accounts denominated in dollars instead of cutting off entire financial institutions.

Capital markets restrictions may also be an option, as pioneered against Russia in 2014. Rather than fully severing correspondent banking services, the U.S. and European Union barred specific state-linked Russian firms from euro- or dollar-denominated debt and equity. If deployed on a targeted basis, these measures could carry less collateral damage than a 311 designation.

Finally, the Federal Reserve can ramp up its efforts against money laundering and terrorist financing. In 2018, the Federal Reserve Bank of New York investigated a local branch of ICBC, a state-owned Chinese bank. After finding violations, the Fed reviewed the bank’s dollar clearing transactions and took on greater oversight of the bank’s operations.

Blunt U.S. financial sanctions have had major successes, but they may also have reached the apex of their effectiveness. Without careful calibration, 311 sanctions pose serious macroeconomic risks for markets. As such, there needs to be a new Economic Patriot Act codifying more scalpel-like tools and sanctions. These can protect U.S. interests globally without any negative downstream effects. In a world that is becoming ever more connected, these new tools will enable the U.S. to protect and keep favor of its allies while punishing only truly bad actors. Keeping the rest of the world on the side of the dollar will be important to maintaining its global reserve-currency status and preserving U.S. leverage.

Michael Greenwald is a director at Tiedemann Advisors. From 2015 to 2017, Greenwald served as the U.S. Treasury attaché to Qatar and Kuwait.