Economic sanctions serve as a robust foreign policy tool for the US government. However, could this ultimately backfire on the US?
Article by Mike White March 3rd, 2022
Over the last several years, many countries have made a concerted effort to limit dependence on the US dollar. The economic warfare waged against Russia reveals precisely why.
The US hit Russia with a round of economic sanctions after Russian President Vladimir Putin recognized two breakaway republics in Ukraine and announced he would send troops into those regions. President Biden announced additional sanctions after Russia invaded Ukraine.
US sanctions against Russia could harm the US economy in the short run and cause even more inflation. Nevertheless, there are also possible long-term consequences for using the dollar as a tool for war. It could accelerate de-dollarization globally and even threaten the dollar’s role as the world’s reserve currency.
The US is a global superpower and maintains an aggressive foreign policy. Nevertheless, the US does not only project power across the globe through its massive military. It also weaponizes the US dollar, using its economic dominance and privilege as the global reserve currency issuer in a carrot-stick foreign policy tool.
The US government showers billions of dollars in foreign aid to “friends.” On the other hand, “enemies” can find themselves locked out of SWIFT, the global financial system that the US effectively controls using the dollar.
This is the nuclear option when it comes to economic warfare
Initially, the US said it would not lock Russia out of SWIFT. However, a few days later, the US, the EU, the United Kingdom, and Canada issued a joint statement saying “selected” Russian banks would be disconnected from the global payment system: “This will ensure that these banks are disconnected from the international financial system and harm their ability to operate globally.”
Think of this as a tactical nuclear strike
SWIFT stands for the Society for Worldwide Interbank Financial Telecommunication. The system enables financial institutions to send and receive financial transactions in a secure, standardized environment. Since the dollar serves as the world reserve currency, SWIFT facilitates the international dollar system. SWIFT and dollar dominance gives the US a great deal of leverage over other countries.
The US has used the system as a stick before. In 2014 and 2015, the Obama administration blocked several Russian banks from SWIFT as relations between the two countries deteriorated. Under Trump, the US threatened to lock China out of the dollar system if it failed to follow UN sanctions on North Korea. Treasury Secretary Steven Mnuchin threatened this economic nuclear option during a conference broadcast on CNBC. If China does not follow these sanctions, we will put additional sanctions on them and prevent them from accessing the US and international dollar system, which is entirely meaningful.
Locking a country entirely out of SWIFT would effectively cut it off economically from the world. Nevertheless, there would also be consequences that ripple through other economies. For instance, a member of the Russian parliament warned that locking his country entirely out of SWIFT would halt the flow of goods into Europe.
If Russia is disconnected from SWIFT, then we will not receive [foreign] currency, but buyers, European countries in the first place, will not receive our goods—oil, gas, metals, and other essential components.
Given America’s history of using sanctions as a foreign policy tool, Russia was not unprepared for the move. Several countries that know they could easily find themselves in the crosshairs have taken steps to limit their dependence on the dollar and have even established alternative payment systems. This includes Russia, China, and Iran. Russia developed its payment system for internal use several years ago. According to the Central Bank of Russia, 416 Russian companies and government organizations had joined the System for Transfer of Financial Messages (SPFS) as of September 2018.
A growing number of central banks have also been buying gold to diversify their holdings away from the greenback. Before ending its purchase program at the onset of the COVID pandemic, Russia was gold’s most prominent central bank buyer. The Central Bank of Russia bought $4.3 billion worth of yellow metal between June 2019 and June 2020. Furthermore, the Russians were buying gold long before that. The Central Bank of Russia bought gold every month from March 2015. According to Bloomberg, “Russia spent more than $40 billion building a war chest of gold over the past five years, making it the world’s biggest buyer.” Meanwhile, the Russian central bank was aggressively divesting itself of US Treasuries. Russia sold off nearly half of its US debt in April 2018 alone, dumping $47.4 billion of its $96.1 billion in US Treasuries.
It is not just America’s “enemies” who are worried about the US abusing its economic power. Her friends are also wary, as they should be. After Donald Trump pulled the US out of the Iran nuclear deal, the EU announced the creation of a particular payment channel to circumvent US economic sanctions and facilitate trade with Iran. EU foreign policy chief Federica Mogherini announced after a meeting with foreign ministers from Britain, France, Germany, Russia, China, and Iran. She said the new payment channel would allow companies to preserve oil and other business deals with Iran.
This underscores a risk to the US. Economic sanction policies could also have long-run consequences, eventually undermining the dollar as the world reserve currency. We warned that other countries watched how the US handled its power as the global reserve currency issuer during the Russian-Ukraine war.
China is thinking, well, Russia is doing something America does not want. They are getting sanctioned. What if we do something that America does not want? We get sanctioned. They pull the dollar out from under us. Let us get out from under the dollar on our own. Let us not leave this weapon in the hands of the US that can be turned against us at any time.
This could create a significant problem for the United States. The dollar remains the reserve currency because China warehouse dollars are a reserve asset. This props up the value of the dollar.
This scares a lot of the world into recognizing that they have entrusted the US with a power that could be misused against them. Furthermore, I think this situation will hasten the demise of the dollar’s status as the reserve currency. If enough countries abandon the dollar, the value of the US currency would collapse and create economic chaos here at home. The de-dollarization of the world economy would likely perpetuate a currency crisis in the United States. Practically speaking, it would likely lead to hyperinflation.
Meanwhile, the US government should be wary of throwing its economic weight around too glibly. It is not the only country with an economic nuclear option. China ranks as the largest foreign holder of US debt. If the Chinese were to dump a significant amount of US Treasuries, it would collapse the bond market and make it impossible for the US to finance its massive debt.
America’s undeclared wars have cost trillions of dollars. Furthermore, economic sanctions are an act of war. Most people view economic sanctions as an acceptable alternative to military force. Nevertheless, economic warfare also comes at a cost. It is typically not the sanctioned government that suffers. Instead, the innocent people living in that country must cope with shortages and increasing prices.
As James Madison said, “Of all the enemies to public liberty war is, perhaps, the most to be dreaded because it comprises and develops the germ of every other.”