The exchange rate for the U.S. dollar against the Russian ruble, Moscow, March 2020
Maxim Shemetov / Reuters
Sanctions have long been the United States’ favored diplomatic weapon. The Biden administration’s response to Russia’s invasion of Ukraine is a case in point: it immediately imposed a raft of punitive economic measures on Moscow and rallied other governments to do the same. That sanctions are a popular tool of U.S. policymakers makes sense. They fill the void between empty diplomatic declarations and deadly military interventions. Yet the golden days of U.S. sanctions may soon be over.
As Washington has come to rely more and more heavily on sanctions, many rogue states have begun to harden their economies against such measures. Three events over the past decade in particular have convinced them to do so. In 2012, the United States cut Iran off from SWIFT, the global messaging system that enables virtually all international payments, in a bid to isolate the country financially. Other U.S. enemies took note, wondering whether they might be next. Then, in 2014, Western countries imposed sanctions on Russia after it annexed Crimea, prompting Moscow to make economic autonomy a priority. Finally, in 2017, Washington started a trade war with Beijing, which soon spilled over to the technological sector. By restricting the export of U.S. semiconductor know-how to China, the United States put its adversaries on notice that their access to crucial technology could be severed.
These three episodes have fueled the emergence of a new phenomenon: sanctions resistance. The United States’ power to impose sanctions on other countries derives from the primacy of the U.S. dollar and the reach of U.S. oversight of global financial channels. It makes sense, then, that enemies of the United States would seek out financial innovations that diminish these U.S. advantages. Increasingly, such countries have found them with currency swap agreements, alternatives to SWIFT, and digital currencies.
HARD CURRENCY
Warnings about the negative effects of sanctions overuse are nothing new. In 1998, U.S. President Bill Clinton lamented that the United States had become “sanctions happy.” He worried that the country was “in danger of looking like we want to sanction everybody who disagrees with us.” At the time, these fears were overblown: the United States was still an unrivaled economic power, and sanctions were still sometimes an effective tool. For instance, in the late 1990s they compelled Libyan ruler Muammar al-Qaddafi to hand over the suspects of two flight bombings and to accept a dismantlement of his arsenal of nuclear and chemical weapons. But since then, the pace of sanctions use has increased enormously, and U.S. adversaries have responded by taking preemptive measures to circumvent potential penalties.
One way that countries have made themselves more sanctions resistant is through bilateral currency swaps, which allow them to bypass the U.S. dollar. Currency-swap deals connect central banks directly to each other, eliminating the need to use a third currency to trade. China has embraced this tool with gusto, signing currency-swap agreements with more than 60 countries, including Argentina, Pakistan, Russia, South Africa, South Korea, Turkey, and the United Arab Emirates, worth a total of nearly $500 billion. Beijing’s goal is clear: to enable Chinese firms to circumvent U.S. financial channels when they want to.
In 2020, for the first time, China settled more than half of its trade with Russia in a currency other than the U.S. dollar, making the majority of these commercial exchanges immune to U.S. sanctions. That Russia and China would develop payment channels using the renminbi and the ruble should not have come as a surprise. In March 2020, the Shanghai Cooperation Organization, a political club that counts China, India, and Russia as members, had prioritized the development of payments in local currencies in a bid to circumvent the U.S. dollar and U.S. sanctions.
China’s growing desire to abandon the U.S. dollar is understandable, given the abysmal state of relations between Washington and Beijing. But U.S. allies are also concluding currency-swap deals. In 2019, India bought S-400 air defense missiles from Russia. The $5 billion transaction should have triggered U.S. sanctions. But India and Russia resurrected a currency-swap agreement dating back to Soviet times. India bought the Russian missiles using a mix of rubles and Indian rupees, thereby avoiding the U.S. sanctions that could have been used to stop the sale.
Another way that countries have sanction proofed themselves is by developing non-Western payment systems. As long as countries continue to use Western financial channels, particularly SWIFT, they will not be safe from the reach of sanctions. Completely severing a country’s access to SWIFT is the nuclear option in the U.S. sanctions arsenal. It has been used only once, against Iran. China and Russia are busily preparing their own alternatives to the messaging system in case Western countries decide to cut them off as well.
If Russia and China were both cut off from SWIFT, their backup is ready.
China’s alternative, known as the Cross-Border Interbank Payment System, is not yet a match for SWIFT. In 2021, CIPS processed a mere $12 trillion in transactions, the equivalent of what SWIFT processes in less than three days. In addition, CIPS focuses on renminbi-denominated payments, which represent less than ten percent of global financial transactions. Finally, SWIFT is deeply embedded in global financial networks, and financial institutions are unlikely to give up a system that works for a new and politicized one.
But the very existence of CIPS is a victory for Moscow and Beijing: their goal is to have a working alternative to SWIFT, not the biggest payment system. What matters to Russia and China is that around 1,300 banks in more than 100 countries have joined the framework. If Russia and China were to be cut off from SWIFT, their backup is ready. Beijing may one day force firms that want access to the Chinese market to use CIPS. By doing so, China would build its capacity to cut countries off from renminbi-denominated payments and from the Chinese economy, just as the United States can cut countries off from dollar-denominated payments and from the U.S. economy.
A third tool that U.S. adversaries are using to escape sanctions is digital currency. In that field, China leads the way. Around 300 million Chinese already use a digital renminbi in more than 20 cities, including Beijing, Shanghai, and Shenzhen. This digital currency is issued by China’s central bank and stored on the cell phones of Chinese citizens. The 2022 Winter Olympics in Beijing were a testing ground for the new currency: on Olympic sites, payments had to be made with a Visa card or the digital renminbi. The mechanism is growing fast: predictions say one billion people will be using the digital renminbi by 2030.
The digital renminbi is sanctions proof. The United States has no way to restrict the use of a virtual coin that is issued by another country’s central bank. This digital currency also comes with surveillance capabilities: Chinese security services can track digital transactions to spot suspicious patterns (or the operations of foreign intelligence officers on Chinese soil). China is also betting that the digital renminbi will attract users around the world. In 2021, Beijing launched partnerships with the United Arab Emirates and Thailand to settle exports in digital renminbi. Given that China is most countries’ largest trading partner, other such deals will probably follow.
China’s central bank does not conceal its desire for the digital renminbi to challenge the hegemony of the U.S. dollar. But the road ahead looks steep. The digital renminbi remains a minor global phenomenon, even if it is gaining traction. Moreover, China’s recent economic slowdown, coupled with the lack of convertibility of the renminbi, is denting the country’s appeal for investors. It looks less certain than it used to that China will replace the United States as the world’s largest economy in the 2030s. Still, most economists agree that in a few decades, about half of the world’s output will be produced in Asia. In this context, a regional digital currency will certainly be attractive.
END OF THE ROAD?
Individually, currency-swap agreements, alternative payment systems, and digital currencies would not have much of an impact on the efficacy of U.S. sanctions. But together, these innovations are increasingly giving countries the ability to conduct transactions through sanctions-proof channels. This trend appears irreversible. There is no reason to believe that relations between Washington and Beijing or Washington and Moscow will improve anytime soon. The likeliest scenario is that things get worse, prompting Beijing and Moscow to double down on their sanctions-proofing efforts.
The rise of a fragmented financial landscape threatens both U.S. diplomacy and national security. In addition to undermining the effectiveness of sanctions, the rise of sanctions-proof financial channels means that the United States will increasingly have a blind spot when it comes to detecting illicit global activities. Tracking financial transactions that have suspicious features or come from specific countries is vital in the fight against terror. Spotting financial transfers between actors that are known to facilitate nuclear proliferation also helps to track the development of nuclear weapons.
All this means that within a decade, U.S. unilateral sanctions may have little bite. Multilateral measures, supported by Japan, the United States, the countries of the European Union, and other like-minded powers, will probably become the best alternative. These sanctions are more difficult to draft, but are far harder for targeted countries to circumvent. Even China would not be able to afford losing access to the European, U.S., and Japanese markets at the same time. In a best-case scenario, the development of multilateral sanctions will foster the establishment of a global framework to improve the effectiveness of sanctions. Similar institutions already deal with issues that require global collaboration, such as maritime law, the war on drugs, and the resettlement of refugees. Why not establish one for sanctions?
Such an organization would analyze sanctions resistance with an eye toward adapting Western financial channels to meet the challenges ahead. It would also study the effects of sanctions, with a special focus on emerging countries. China knows that the decision of developing countries to stick with or abandon Western financial channels will make or break its bid to undermine U.S. financial hegemony. An organization dedicated to these matters may be the only cure for sanctions resistance.