America’s chokehold on Iran’s oil trade is tightening. New sanctions that come into force on June 28th attempt to turn off Iran’s $95 billion-a-year oil trade, and stop the flow of funds into its nuclear programme. The way the rules work shows how controlling the dollar strengthens America’s grip. The way China has responded shows the limits of these efforts. To check the stream of oil cash America needs to punish those that trade with Iran. One option is to block these countries from its own markets. But America accounts for only 12% of global trade, and by cutting off trade with offending countries it would end up hurting its own exporters. Using the dollar is a more powerful and precise weapon: over 35% of international transactions are in dollars, and many of them do not involve American firms.
Iran has a particular dollar weakness. Most of its oil—around 2.5m barrels a day (b/d) in 2011—is sold to foreigners in exchange for dollars. Previous sanctions have already cut private Iranian banks out of the oil trade, so sales are managed by the Central Bank of Iran (CBI). The CBI uses the dollars it receives to maintain the Islamic Republic’s fixed exchange rate.
America’s new sanctions laws, signed in December, target countries that fail to prove a big reduction in their oil trade with the CBI. Any bank that facilitates these trades by dealing with the CBI will be denied access to the American banking system. It would be unable to offer dollar accounts and dollar payments, since these activities rely on links to correspondent American banks. Given the importance of the dollar, customers would go elsewhere. Unplugging lenders from the banking network is easily done. Indeed, an important international-payments system—the Society for Worldwide Interbank Financial Telecommunications, or SWIFT—has already kicked out 40 Iranian banks, after pressure from America. From June 28th non-Iranian banks that deal with the CBI could face the same fate.
Soon after the new law was passed, Japan and ten EU countries reduced trade with Iran. Earlier this month seven others, including India, cut Iranian oil imports. These countries are now exempt from sanctions. As a result Iran’s exports have fallen to around 1.5m b/d, according to International Energy Agency (IEA) data.
Other countries have proved harder to influence. China is Iran’s biggest oil customer, accounting for 20% of its sales. It stands to lose a lot by reducing trade. So rather than cutting imports, China has resorted to exploiting loopholes. The sanctions law in America specifically names the CBI, so some trades have been routed via money exchanges in the Gulf instead. The countries are bartering too, with Iranian oil sometimes swapped for shipments of Chinese gold. China has also set up “swap-shop” segregated accounts which it credits when it receives oil, allowing Iran to buy Chinese goods, according to Mark Dubowitz of the Foundation for Defence of Democracies, a think-tank.
This oil-swapping system is hard to stop. Accurate oil-trade data are collated by monitoring the tracking beacons big tankers must carry in order to prevent collisions. But the Iranian fleet has been flouting safety rules and turning its beacons off since April, according to the IEA, allowing vessels to make clandestine port visits and mid-ocean oil transfers.
Even if it could spot illicit transactions, America might still choose to ignore them. The sanctions are preventing Iran from getting hold of the hard currency it needs to defend its peg, among other things. And confrontation with China could be costly for America. Of the $12 trillion-worth of Treasuries held abroad, China owns over 13%. Excluding China from America’s financial system would wall off a big customer for its own debt.
Financial sanctions: Dollar power, Economist, June 23, 2012, at 75