Dreaming of Financial Independence

In a recent article in Germany’s leading daily business newspaper, Handelsblatt, and in a broader article considering the current state and future prospects of transatlantic relations in the age of US President Donald Trump, Germany’s Foreign Minister Heiko Maas asserted that it is ‘essential that we strengthen European autonomy by establishing payment channels independent of the US’. Maas’s comments were made in the context of the re-imposition of sanctions on Iran by the US following President Trump’s decision to withdraw from the Iran nuclear deal, and the resulting threat posed to EU companies that continue to do business with Iran. The threat of being sanctioned themselves or suffering related financial penalties is indeed quickly proving to be a powerful incentive for reversal for those companies that have invested in Iran since the nuclear deal was implemented in January 2016; and will certainly dissuade most others still contemplating economic ties with Tehran.

Despite Germany’s position as a signatory to the nuclear deal and the country’s commitment to the continuation of the deal, Maas was quickly put in his place by Germany’s Chancellor Angela Merkel. She dismissed his views as an expression of his own opinion that had not been discussed with her in advance. There are of course plenty of well-rehearsed reasons as to why it would be a seemingly impossible task to develop a financial system for international trade that does not touch the US payments system, however fleetingly, in order to evade the reach of US law enforcement. Banks such as HSBC and BNP Paribas have felt the full legal and financial force of this connection in recent years. Global commodities such as oil are priced in US dollars; almost all foreign exchange transactions involve the US dollar (even if it is not US dollars you are buying or selling); approximately 50% of global trade is still conducted in US dollars and nearly two-thirds of global currency reserves are held in US dollars (in contrast about 20% are in euros and 1% in Chinese renminbi).

There are, thus, a great many practical reasons why the creation of such an insulated financial system is impractical, if not impossible. But the fact that a leading politician from a G7 country has mooted the idea, suggests that a system that was once considered axiomatic and integral to global finance might face challenge sooner than expected.

Following the Second World War, the US dollar rapidly became central to global finance. The signing of the Bretton Woods agreements in 1944; the loss of faith in the other reserve currency – the British pound – following the Suez crisis in 1956; and the ending of the gold standard in 1971 established US dollar hegemony. The stability provided by the US dollar as a store of value and reliable unit of exchange has created a virtuous and reinforcing cycle.

But this dominance has also encouraged the US to use its financial power to support its role as the global guarantor of security, particularly since the end of the Cold War. Financial sanctions issued by the UN Security Council became a progressively more popular tool to support international diplomacy. However, where – as is increasingly the case – international consensus cannot be reached, the central role played by the US dollar in the economy of most countries has allowed the US to issue unilateral sanctions with considerable effect.

As sanctions techniques have evolved and been refined, individuals and corporate entities have also found themselves in the crosshairs. The rate at which sanctions have been issued by the US Treasury’s Office of Foreign Assets Control (OFAC) has risen gradually over the past 15 years. Under President Trump, that rise has accelerated. In 2017, nearly 1,000 names of people and entities were added to the OFAC list representing a 30% increase over President Barack Obama’s final year in office and close to three times the number issued in his first year in office in 2009. Importantly, these Trump administration sanctions are hurting allies as well as foes. It is therefore no wonder that means of immunising economies from the reach of OFAC are being studied in capital cities around the globe.

In an oft-referenced and prescient speech in March 2016, then US Treasury Secretary Jack Lew cautioned that sanctions should be used wisely, with clearly articulated goals and relief available when objectives are met; and cautioned against ‘the risk that overuse of sanctions could undermine [the US] leadership position within the global economy, and the effectiveness of […] sanctions themselves’.

Which brings us back to the idea floated by Foreign Minister Maas. Is payment independence from the US entirely fanciful?

Consider the state of global finance and international payments 10 or15 years ago. The ability of any one country to challenge the US was vanishingly small. Today there is a veritable industry of alternatives being developed. Russia claims to have developed a payments system that removes its reliance on SWIFT, the standard global payment messaging service, for domestic, and potentially international, payments; China’s UnionPay offers a widely accepted and increasingly popular credit card alternative to US-based Visa and MasterCard; countries are establishing bilateral payment channels to avoid the need to transact through US dollars in the currency markets or are agreeing to trade US dollar-based commodities in other currencies; cryptocurrencies and other forms of new payments technologies are seeking to circumvent traditional payment methods; and barter trade also provides opportunities for continued commerce.

Maas’s views might not yet be shared by the German leader, but they are shared by many others fearful of the propensity of the Trump administration to reach erratically for sanctions at an ever-increasing rate. None of the alternatives are as efficient as relying on the US dollar-based payment system but a growing number of countries that fear the vulnerability of their exposure to the US dollar are certainly being encouraged to consider their alternatives.

Tom Keatinge is Director of RUSI’s Centre for Financial Crime and Security Studies.

The views expressed in this Commentary are the author's, and do not necessarily represent the views of RUSI, the Ministry of Defence, or any other institution.