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Posted on 4 Oct 2018 by BullionStar

Sanctions Busting, European Style

This blog post is a guest post on BullionStar's Blog by the renowned blogger JP Koning who will be writing about monetary economics, central banking and gold. BullionStar does not endorse or oppose the opinions presented but encourages a healthy debate.

U.S. officials were infuriated last week when Germany, the UK, and France unveiled plans to create a European payments channel to help Iran to avoid U.S. sanctions. Even more surprising was their chosen allies: in announcing their sanctions busting plan, the Europeans were joined by Russia and China.

There has been very little detail provided on the proposed payments channel. The press release describes it as "a Special Purpose Vehicle, to facilitate payments related to Iran's exports (including oil) and imports." Nor did EU High Representative Federica Mogherini's comments after the press release contain much information about the special purpose vehicle's technical specifications, other than to say that it would be "opened to other partners in the world."

Despite the lack of particulars, I'll make some educated guesses in this post about the intended role of the Special Purpose Vehicle (SPV) and how it will be designed. I think that the SPV will probably be able to carve out some space for the rest of the world to engage in Iranian trade, but we shouldn't overestimate its power. The U.S., after all, wields an incredible amount of economic might and under Trump hasn't been shy about deploying it.

Trump leaves the Nuclear Deal

The background for the creation of the new European payments channel is the Trump administration's recent departure from the Iran nuclear deal, officially known as the Joint Comprehensive Plan of Action (JCPOA). This was a deal signed by the France, UK, Germany, U.S., Russia, and China, or the E3+3, in 2015. The JCPOA promised to normalize Iran's economic relations with the rest of the world in return for fully-audited limitations on Iran's nuclear efforts.

The U.S.'s exit from the JCPOA this spring brought with it a re-imposition of the same harsh U.S. sanctions leveled on Iran prior to the deal. The most damaging of these, oil-related sanctions, will go into effect on November 4. Oil is by far Iran's largest export. Without the ability to export oil, Iran can expect to be stuck in an autarkic limbo.

In response to the U.S.'s re-imposition of sanctions, many multinational companies that had previously recommitted to Iran after the JCPOA's passage have been exiting, including Total, Daimler, Maersk, and Mitsubishi UFJ. Nevertheless, Iran continues to keep its end of the deal, the International Atomic Energy Agency verifying that it is implementing its nuclear-related commitments. But the economic damage that the U.S. is creating threatens to undermine the remaining five signatories' pledge to normalize economic relations with Iran. If Iran ceases to get enough economic benefits from the JCPOA to justify its promise to give up on nuclear weapons, it may simply walk away.

The E3+2's new payments channel is an attempt to counteract some of the negative economic effects of the Trump administration's sanctions and thus keep Iran in the deal. To gauge the effectiveness of the tool, we first need to touch on how U.S. sanctions work.

Blacklists: Economic Weapons of Mass Destruction

The U.S. has been using a set of blacklists to sever Iran from the global economy. These blacklists were devastatingly effective during the previous round of Iranian economic sanctions (2010-2015), and given the current parade of multinationals leaving Iran, they have not lost any of their potency.

Some of these blacklists designate specific individuals, companies, and organizations owned or controlled by Iran as offenders. The National Iranian Tanker Company (NITC), for instance, has landed on one of the U.S.'s lists, as has Bank Melatt, one of Iran's largest banks. Another set of blacklists targets activities. For instance, buying Iranian oil has been blacklisted, as has the sale of automotive goods to Iran.

Any foreign institution that does business with blacklisted entities, or engages in blacklisted activities, will be sanctioned by the U.S. The punishment for this involves a restriction of access the U.S. economy. This might mean no longer being able to business in the U.S., having its access to U.S. currency curtailed, or being cutoff from U.S. financial markets and banks.

For instance, a European bank that facilitates Iranian oil purchases may find that it can no longer open a correspondent account with U.S. banks. These sorts of accounts are vital for facilitating U.S. dollar payments. A European auto parts firm that sells suspension systems to Iranian automakers might find that it can no longer buy products from U.S.-based car parts companies. Because losing access to the U.S. economy is so much more damaging than being unable to transact with Iran, many companies have chosen to comply with U.S. sanctions and have left Iran.

The only companies that will risk doing business with blacklisted organizations or deal in blacklisted commodities are those that have no connection to the U.S., and thus little to lose. Government-owned enterprises might qualify. For instance, Chinese and Indian state-owned refineries have little need to access the U.S. market, and can therefore serve as natural buyers of blacklisted Iranian oil.

This option has its limits however. If Iranian oil traders were to sell exclusively to Chinese and Indian buyers, they can expect to be paid with Chinese yuan or India rupees. But Iranians need to import a broad variety of products and services, many of which China and India simply cannot offer. The result would be large amounts of sterile yuan and rupees accumulating unspent in Iranian accounts.

A European tool for countering U.S. Blacklists

This is where a European payments option may come in handy. Large European firms simply cannot afford to export to Iran or buy Iranian oil. The biggest refiner in Europe, for instance, is France's Total. Because it has 6,750 employees in the U.S. and millions of American customers, Total has too much at stake to risk offending American rules. But as Iran sanctions veteran Richard Nephew points out, European small & medium size enterprises (SMEs) may step up as a group of "willing to be sanctioned." These European SMEs might not have U.S. subsidiaries nor depend on U.S. supply chains, and little to lose from being sanctioned. If so, they would be able to provide Iran with the sorts of goods and services that India and China cannot export.

To complete this European connection, Indian and Chinese firms would have to open euro denominated accounts in Europe. They could then buy a portion of their Iranian oil imports with those euros. These euros would flow into Iranian accounts, only to be spent  at European SMEs, say to buy manufactured goods, which would be sent back to Iran. The SMEs could then draw down their euro accounts to pay their employees and suppliers.

The recently announced European SPV could be a way to formalize this trading circuit. All three groups - Indian & Chinese state-owned refiners, Iranian oil merchants, and European SMEs - would establish euro denominated accounts at the SPV. The SPV would act as a euro-based clearing house between these various parties, matching buyers with sellers. In theory this clearing function could also be provided by private European banks, but in practice they would be wary of playing such a role due to concerns about being punished by the U.S. A newly-constituted SPV that has no U.S. function or appendages needn't share those concerns.

The effectiveness of this payments channel depends on how many European SMEs would be willing to participate. In our interconnected world, many SMEs will have some sort of existing U.S. connection, whether these be American suppliers or customers, and may not be willing to jeopardize this relationship. If a limited number of SMEs sign up to use the SPV, only a small amount of oil trade will be settled in Euros, and Iran will find that the SPV does not provide them with much shelter from sanctions.

It is possible that European governments could incentivize SMEs to join the SPV arrangement.  The European Union's ‘blocking statute’, for instance, would allow SMEs to recover damages that might result from sanctions. The blocking statute was originally proposed by the EU in 1996 to counteract an American trade embargo on Cuba and sanctions related to Iran and Libya

However, if an SPV were to become too successful, that would doom it. An SPV that attracts large amounts of European exporters would encourage Trump to advance the front lines of his sanctions war and attack the SPV participants themselves. He would go about this by blacklisting all European SMEs that are directly engaging in SPV-backed Iran trade. European suppliers to these black-listed firms would suddenly face immense pressure to stop doing business with their black-listed customers. Even if blacklisted SMEs have no direct U.S. dependencies, odds are that their domestic suppliers will have some sort of vital connection to U.S. supply chains or customers. If they wish to retain this connection, these firms will have to immediately dissociate from SMEs that engage in Iran trade.

Additionally, European banks would face pressure to freeze the accounts of black-listed SMEs for fear of being cut off from the U.S. banking system. This combination of a collapsing supply chain and an exile from the banking system would leave blacklisted European SMEs incapable of doing business not only with Iran, but everywhere else too. In short, they could go bankrupt.

One way or the other, American dominance of the global economy necessarily limits the ability of any European SPV to successfully bust U.S. sanctions. It is certainly possible that the creation of a new payment channel encourages some round-trip trades, say between India/China, Iran, and European SMEs, that wouldn't otherwise occur. But in the end, the European SPV can never nullify the effects of U.S. sanctions, it can only slightly dampen them. It remains to be seen if this will be enough to keep the Iranians in the JCPOA.

JP Koning
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  • Bill Gradwohl

    You’ve explained well the valiant attempt by the Europeans to help neutralize US aggression. You also reach the obvious conclusion that it probably won’t amount to much because the US still has the upper hand.

    It’s time for the whole world to get together and sanction the US. Countries should start dumping dollars and start trading with their partners in their respective national currencies. Should such a thing occur, someone might get the bright idea that it is the existence of national currencies that cause the problems between nations and gives the 800 pound gorilla the opportunity to do its dirty work.

    There should be no such thing as a national currency. The world should run on “money”. That money should be created outside gov’t and backed with tangible assets, traditionally gold and silver, but anything agreed upon will work. Paper “money” as opposed to paper “national currency” would be backed 100% by tangible assets meaning all the central banks are defunct, gov’t can’t create money out of thin air and there is no possibility of arbitrage because there is only one “money”.

    The price for a new car might be 30:5:0 – 30 ounces of gold, 5 ounces of silver and 0 ounces of copper, for example. Paper “money” receipts for this or the electronic equivalent facilitates easy payment.

    • Sguv

      check the 1988 issue of The Economist. It seems that was already the plan.
      Could be crypto, could be gold as its been for ages. Lets see

    • John

      All that needs to be done is to go back to the gold standard to back fiat currency and get rid of the highly manipulative paper gold derivatives market. Gold is severely underpriced. China and Russia understand this.

      • Bill Gradwohl

        As long as there are “national currencies” there will be problems. The gold standard only partially backed currencies which meant that gov’t could still print to infinity and drive the value of their currency to zero via hyperinflation. The problem is in the concept of national currencies.

        If, for example, only gold and silver were considered “money”, miners could extract the wealth via their hard work and the metal could be used as collateral to back up newly printed or digitized money, not currency. Every miner/minting combination could issue metal money without gov’t involved. That metal money is collateral for paper receipts or digital equivalents. Blockchain could tie serialized metal to the paper receipts.

        Once gov’t can’t simply print bogus wealth, wars would become rare events, politicians couldn’t promise the moon to get elected and there is no such thing as a reserve currency since anyone’s gold is as good as everyone else’s gold. All the BS central banking invents disappears.

    • JP Koning

      Bill, if the world adopted a gold based system, I don’t think that changes the equation. The U.S. would simply say, don’t trade with Iran. If you do, you can’t use U.S. supply chains or access U.S. customers. Nor can you use U.S.-based payments networks that provide electronic equivalents of gold, nor can you get gold loans from U.S. lenders. And just as in our fiat dollar system, everyone would stop doing business with Iran. What allows the U.S. to exert leverage over the rest of the world isn’t just the U.S. dollar, it’s the fact that it is the largest economy in the world on all sorts of metrics.

      • Bill Gradwohl

        You are, of course, correct that the US has a near infinite number of ways to coerce, threaten, intimidate, etc the rest of the world. What I’m suggesting is the removal of one avenue currently favored by the US administration.

        I think Trump is doing the world a favor in a left handed sort of way. He is slowly but surely alienating even the “usual suspects” in Europe that have blindly followed US diktats for decades. They are growing a pair and at least making noise about not going along with every insanity proposed by DC.

        I’d ask you to consider what would happen to the US economy if the rest of the world decided to stop doing business with the US in a coordinated effort. The US imports all sorts of things not available from US sources. In short order, the economy would come to a halt. If the Chinese just stopped selling anything and everything to Walmart, their shelves would be empty in about a week and that would upset Joe and Jane Sixpack enough, along with trashing the stock market to send a wake up call to the deep state that actually pretends to run things.

        The US is getting away with its bullying because no one has been willing to tell them to buzz off. It reminds me of how McCarthy got away with his machinations decades ago up until a lone individual called him out and he suddenly lost his power. The BS came to an abrupt end.

  • MrMilanoLau

    The effectiveness of the SPV remains to be seen. However, the most important implication of the whole incident is Europe has decided to break free from US bondage and she makes no effort to hide this. The old order established after WWII is raveling; all major players are striving to build new ones to replace it. Both Europe and China want their own paper money to be reserve currencies. Russia may make use of her advantage in crude oil to exert influences over other countries, especially Europe. Saudi is busy building her sphere of influence in the Middle East. What trump cards, besides Trump, do the US have? There are two. First, her military might. Second, the physical gold she has. As to the latter, it is a matter of dubious if she really has all the gold she claims to have. However, don’t forget, she could confiscate other countries’ gold in her vaults. A gold backed greenback is not totally out of question.

    • Bill Gradwohl

      I think some day soon, the US military will be shown up for the paper tiger it is. I suspect the bulk of the high tech weaponry won’t work as advertised and the stock pile of it is so small that what does work will disappear in a flash during a hot war. The scam of the Military Industrial Complex will then be revealed for all to see.

      Yes, the US military can wreck a lot of things, but it can’t seem to win a war AND hold territory. The MIC is bankrupting the nation and sooner or later the economy will put the brakes on the murder and mayhem the US military is famous for.

      As far as confiscating other people’s gold, that’s possible. The US administration has no moral center, so outright theft will be seen as a positive and the media will spin it so that Boobus Americanus will cheer.

      • MrMilanoLau

        “Paper Tiger”? I only heard the Communists in China use this term.

    • JP Koning

      “Europe has decided to break free from US bondage”

      Europe didn’t go along with Cuba sanctions in the 1990s. And it was very angry about the Iran and Libya Sanctions Act of 1996. So I need more convincing that this event is the start of anything new.

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