Financial sanctions have become the primary instrument of US foreign policy. Their effectiveness is declining as the architecture that makes them powerful is gradually replicated and circumvented.
How Financial Sanctions Work
The effectiveness of US financial sanctions rests on a specific structural feature of the global financial system: the central role of the US dollar in international trade and finance, and the corresponding central role of US financial institutions in the clearing of dollar-denominated transactions. Because most global trade is invoiced in dollars and most dollar transactions clear through US correspondent banking relationships, the US Treasury's ability to exclude entities from the dollar-clearing system gives it effective control over those entities' ability to participate in global commerce — regardless of whether the excluded entity has any direct connection to the United States.
This structural leverage is the foundation of secondary sanctions — the US practice of threatening non-US entities with exclusion from the dollar system if they maintain commercial relationships with primary sanctions targets. Secondary sanctions extend the reach of US sanctions beyond the entities directly targeted to all entities globally that wish to maintain access to the dollar-clearing system, which is effectively all entities engaged in significant international trade or finance.
The Erosion Dynamic
The overuse of US financial sanctions is gradually eroding the structural conditions that make them effective. Every application of secondary sanctions gives affected entities a material incentive to develop alternatives to the dollar-clearing infrastructure that makes them vulnerable to those sanctions. China's development of alternative payment infrastructure, the growing use of yuan-denominated trade in China's bilateral relationships, and the acceleration of central bank digital currency development in multiple jurisdictions are all responses to the sanctions vulnerability that dollar dependence creates — responses that are gradually reducing the structural leverage on which US sanctions effectiveness depends.
Financial sanctions are the most powerful coercive tool available to the United States because of the structural position of the dollar in the global financial system. That position is being gradually eroded by the overuse of the tool itself — motivating the development of alternatives that will eventually reduce the structural dependence that makes the sanctions effective.
Discussion