In a nutshell, secondary sanctions are meant to enhance the effect of primary, or designated, sanctions, which target certain parties to bring about behavioral change. They are, in essence, an extension of those primary sanctions, as they are used to penalize companies that are outside of the sanctioning country’s jurisdiction for doing business with targets of primary sanctions by restricting their commercial access. Using this more coercive type of sanction effectively, however, requires significant leverage.
A Brief Introduction
Secondary sanctions are a uniquely US phenomenon at the moment and are designed to apply additional pressure on third parties that would usually be outside US jurisdiction in order to incentivize them to stop doing business with the targets of primary sanctions. When secondary sanctions are imposed, commercial privileges are restricted: Export licenses, loans, Export-Import Bank assistance and other foreign exchange transactions can all be denied as a result of the imposition of this type of sanction.
The most severe penalty for noncompliance would be a complete loss of access to the US financial system — a devastating prospect, given the potency and prevalence of the dollar on the global market. The US dollar comprises more than 60% of the world’s central banks’ reserves. Oil and other globally traded commodities are virtually all bought and sold with dollars. Further, 65% of all dollars circulate outside US borders and, in countries with high volatility and inflation, are often preferred over local currencies for local transactions.
But Are They Effective?
In short, the effectiveness of secondary sanctions is predicated on the amount of leverage a country has. Sometimes, even just the threat of imposing secondary sanctions has been enough to influence third parties, as illustrated by the response to the US’ unilateral withdrawal in 2018 from the Joint Comprehensive Plan of Action (JCPOA) with Iran.
The Trump administration’s re-imposition of strict sanctions against Iran and the prospect that the US would impose secondary sanctions to enforce compliance on a global scale caused many European entities to preemptively cease business operations with Iran. While the EU still trades with Iran under the JCPOA, they are limited to transactions involving Euros. Nevertheless, trading volumes are on the decline.
The cost to Iran has been significant too. Overall economic growth has declined, with Iran experiencing a 4.8% GDP contraction in 2018 followed by an anticipated contraction of between 8.7% and 9.5% in 2019. While official numbers for 2019 haven’t yet been released, if those predictions are accurate, it would mark Iran’s poorest economic showing since 1984. The value of the Iranian rial against the dollar has also taken a sharp drop: the official exchange rate was 42,000 rials to the dollar, yet the black market exchange rate reported in early 2020 was 139,500 to the dollar — in part due to US sanctions and in part due to the US strike that killed Iranian general Qassem Soleimani.
With unemployment hovering at 12%, long-term unemployment significantly higher at nearly 38%, and the cost of living rising due to high inflation, it’s clear that Iranians are feeling the strain and is a reminder that there’s a real human cost to sanctions. This is likely the intended consequence: these conditions fuel political and social discontent. The hope is that this will compel Iranian citizens to push for a regime change. Whether that spurs the Iranian government to act in accordance, however, remains to be seen.
While secondary sanctions have been wielded primarily by the US government up until now, there’s no guarantee that will continue to be the case. The prospect that the dollar will lose its dominance looms large, even though it is still a ways off in reality. Yet there is evidence that efforts are underway to create new economic models and financial avenues that avoid using the dollar. If successful, secondary sanctions will inevitably become less effective.
Russia, for example, has long been trying to circumvent the dollar-dominated financial system. It has reduced the amount of its international reserves held in dollars, opting instead for Euros and renminbi. It has also pursued currency swap agreements with China and launched its own interbank messaging system for payments, SPFS, to rival SWIFT in 2017. As of late 2019, India, China and Turkey intend to participate as well.
Europe has also expressed interest in an alternative to SWIFT. Indeed, when the US announced it was reimposing sanctions on Iran, the EU began its work to create one in earnest and launched INSTEX in 2019. The success of such a system, however, is still dependent, in part, on the US government’s reaction: it may sanction those who choose to use it.
There are still many hurdles to overcome before the US’ ability to leverage its status within the global financial system is significantly reduced. But as these new systems gain traction, it’s possible we’ll start to see other countries obtain enough leverage to challenge the US on this front. How that will play out and what impact that will have on the global financial system, however, remains to be seen.