Insight: Is the US risking overuse of sanctions?

As the US government increasingly turns to energy-sector sanctions — or the threat of them — as a foreign policy tool, some have started to question whether the strategy carries long-term risks.

Iran and Russia, the chief targets of US sanctions at the moment, would like the world to believe that the US is addicted to sanctions.

Iranian Foreign Minister Javad Zarif tweeted this month(opens in a new tab) that the US needs to "rehabilitate its addiction to sanctions." A few days later, Russian Foreign Minister Sergey Lavrov said that US over-reliance on sanctions would eventually undermine the dollar as the global settlement currency.

The statements are obviously self-serving, as both countries are staring down major new US sanctions. But as the US reaches over and over again for this foreign policy tool — and President Donald Trump flexes "maximum economic pressure" against countries he wants to behave differently — should policy makers pause to consider the long-term implications of overusing sanctions?

"Sanctions are a tool of the strong," said Daniel Fried, a former national security adviser to Presidents Bill Clinton and George H.W. Bush who served as ambassador to Poland and assistant secretary of state for Europe. "In the long run — I'm talking decades — if we misuse sanctions, we provide an incentive for countries to come up with ways to circumvent the dollar."

"It's not a near-term problem, but it's not a trivial one," Fried said in a recent interview with S&P Global Platts. He is currently a distinguished senior fellow at the Atlantic Council in Washington.

To be clear, there is no immediate risk to the dollar as the global settlement currency or its dominance in oil trading.

"You're not going to have the euro or the ruble or the yuan replacing the dollar or even competing seriously with the dollar," Fried said. "The Russian economy is weak, and the Chinese economy is not sufficiently open or credible. The euro is much more credible, but still I don't think it is a credible substitute for the dollar."

It is nevertheless worth examining the long-term implications of relying so heavily on sanctions to pressure other governments to change their actions, Fried said.

Sanctions loom large

New US sanctions loom over the Iranian and Russian energy sectors this fall. Iran is already seeing its crude oil exports fall ahead of the November 5 resumption of US secondary sanctions against its oil customers as a result of Trump pulling the US out of the Iran nuclear deal in May. S&P Global Platts Analytics estimates Iranian crude and condensate exports will fall to 1.47 million b/d in November, a cut of 1.44 million b/d from April levels and a cut of 874,000 b/d from July.

The Trump administration is expected to take a hard line on enforcing the Iran sanctions, but a spike in oil prices could lead the White House to ease enforcement or sell oil from the Strategic Petroleum Reserve. The government already plans to sell 11 million barrels from the SPR in October and November as part of a previously mandated drawdown.

S&P Global Platts Analytics expects full compliance from Japan and South Korea and near-full compliance from Europe, where companies with US exposure will not risk violating sanctions. China and India will likely demonstrate partial compliance, given various strategic interests including the US/China trade talks and India's recent move to lock in term contracts for US crude exports.

In Russia, a ban on western participation in Arctic, offshore and shale development imposed in 2014 is starting to limit investment in new projects needed for expanding production capacity, according to the Treasury Department, an assessment even Russia's own natural resources ministry acknowledged in part. The State Department recently triggered additional Russia sanctions under a 1991 law after determining Moscow used banned weapons in the poisoning of a former double agent and his daughter in the UK in March. The law says Russia must take certain steps prove that it is not using banned weapons or risk a second round of much harsher US sanctions that could cut off almost all trade with the US and block financing for Russian sovereign debt.

Congress is now considering a string of other sanctions bills ahead of the US midterm elections in November to punish Russian interference. The bills target international investment in Russian oil and gas projects and the Nord Stream 2 gas pipeline to Germany, among other energy sector impacts.

Elsewhere, the US continues to expand its North Korean sanctions, earlier this month adding the names of two Russian shipping firms and six vessels for involvement in banned ship-to-ship transfers of oil.

However, the administration has backed off additional oil-sector sanctions that it considered imposing on Venezuela as the country's economic free fall accelerated.

Tailoring for maximum effect

The use of sanctions has evolved significantly from the economic blockades of past decades. The US Treasury Department now aims to tailor sanctions to hit specific companies and sectors to have maximum effect without punishing a country's entire populace.

"Now they are extremely targeted, both in terms of the companies, but also in terms of the trade that's involved," said Richard Kauzlarich, a career diplomat and former US ambassador to Azerbaijan from 1994–1997.

Kauzlarich remembers the Rhodesia embargo in the 1960s when he was a young foreign service officer. "These were blanket sanctions that hit everybody who lived there," he said. "Now the instruments – whether Lavrov likes them or not – are much more targeted."

Kauzlarich does not think the US is overusing sanctions but said the administration should be considering the alternatives and examining if current sanctions are having their intended effects. In many cases, he said, sanctions have become the most effective tool of "extracting a price for misbehavior."

Secretary of State Mike Pompeo has said the renewed Iran sanctions are aimed at changing Tehran's support for terrorism, its nuclear program and arbitrary detention of American citizens.

Former Treasury Secretary Jack Lew made the case in 2016 the US should turn to sanctions only when other countries' actions threaten the country’s national security, foreign policy or economy.

"And even then, we should impose sanctions only when we have reasonable confidence that they will achieve their intended policy goal, and only when the balance of costs and benefits is in our favor," Lew said in a speech to the Carnegie Endowment for International Peace.

Overusing sanctions could ultimately reduce the US' ability to use sanctions effectively, Lew argued.

"While sanctions are a valuable alternative to more severe measures, including the lawful use of force, it is a mistake to think that they are low-cost," Lew said. "And if they make the business environment too complicated — or unpredictable, or if they excessively interfere with the flow of funds worldwide, financial transactions may begin to move outside of the United States entirely — which could threaten the central role of the US financial system globally, not to mention the effectiveness of our sanctions in the future."

Secondary sanctions prompt particular concerns, Lew argued. These target foreign companies and individuals rather than US companies and individuals.

The Iran sanctions target buyers of Iranian oil. These refineries, shippers and other companies in China, India, Japan and elsewhere around the world must decide whether to end their deals with Tehran or risk getting cut off from US financial system.

Lew said global norms are hard to reshape, and existing alternatives are not well-positioned to fill the role of US markets and the dollar.

"But our central role must not be taken for granted," he said. "If foreign jurisdictions and companies feel that we will deploy sanctions without sufficient justification or for inappropriate reasons – secondary sanctions in particular – we should not be surprised if they look for ways to avoid doing business in the United States or in US dollars. And the more we condition use of the dollar and our financial system on adherence to US foreign policy, the more the risk of migration to other currencies and other financial systems in the medium-term grows."