Thread by @yarbatman

1. Today, President Biden issued an executive order authorizing sanctions to block foreign banks that facilitate transactions related to Russian "technology, defense... construction, aerospace, or manufacturing."

Will these new secondary sanctions hobble Putin's war economy?

2. Coinciding with the new executive order, @wallyadeyemo has an op-ed in the @FinancialTimes explaining what Treasury aims to achieve.

Banks that are found to be supporting Russia's "war machine" will "risk losing access to the US financial system."
ft.com/content/f1fe5e…

3. This is a big deal because the US is finally set to use its most powerful sanctions authorities to try to hurt Russia's war effort. There remains a widespread impressions that the Russia sanctions are the strongest ever imposed. That's not quite right!

4. In fact, the lack of secondary sanctions had made the Russian sanctions program much weaker than that placed on Iran, for example.

The new measures borrow from the Iran playbook. This executive order is very similar to the Iran sanctions Obama included in the 2012 NDAA.

5. Enacted in December 2011, the 2012 NDAA included authorizations for secondary sanctions to be imposed on foreign financial institutions found transacting with the Central Bank of Iran or designated Iranian financial institutions, whether or not the trade was related to oil.

6. Basically if foreign banks transacted with Iran's financial system, they would be blocked from the US financial system.

The US had been adding sanctions on Iran for years, but it was only after foreign banks were put on notice that the Iranian economy swung into a recession.

7. What happened in Iran over the course of 2012 tells us something about what is likely to happen in Russia next year.

Right now, Russia's war economy is dependent on two channels for the import of machinery and technology to keep the war economy going.

8. European goods are still making it to Russia indirectly through places like Turkey and Kazakhstan.

Plus, more Chinese goods are bought directly and indirectly to offset the decline in industrial trade with Europe.

Charts from @RobinBrooksIIF who has been tracking the trends!

9. A similar thing was happening in Iran between 2008 and 2012.

As the sanctions tightened and European suppliers pulled back, Iran began to buy more capital goods from China and sourced European goods indirectly from places like Turkey and the UAE.

10. For the US, this was a dilemma. Iran was really a large manufacturing economy with a lot of trade partners. Putting real economic pressure on Iran required stopping trade through these channels.

Threatening foreign banks with secondary sanctions is how they decided to do it.

11. Here is a charge showing EU and Chinese machinery exports to Iran. In the years leading up to the 2012 sanctions, Chinese exports were rising to compensate for falling European supply.

But the secondary sanctions on foreign banks halted that compensatory trend immediately.

12. The sanctions had a rapid impact because foreign banks quickly refused to process Iran-related transactions, making it harder to Iranian firms to pay for critical machinery.

Banks in China, Turkey, the UAE saw the executive order and said "this isn't worth it anymore."

13. Moroever, Iran's economy also went into a recession during 2012 and the first half of 2013, which also reduced demand for machinery imports.

Currency devaluation, higher inflation, fiscal pressures, and lower business and consumer confidence combined to hit demand.

14. So through two channels, the sanctions had an impact on Iran's manufacturing output contributing to the first major recession in the Iranian economy since the end of the Iran-Iraq war.

Around a year later, the JPOA interim nuclear deal led to some sanctions relief.

15. But Iran's experience in 2012 really proved the power of US secondary sanctions targeting foreign banks. Chinese machinery exports fell 26% between 2011 and 2012.

That's why the new executive order on Russia is a big deal. It can really hurt Putin's industrial supply chains.

16. As @edwardfishman points out in this great reflection on the new executive order, export controls aren't really the best tools to deny a target access to critical technology or machinery.

Targeting banks that facilitate payments hits harder.

https://x.com/edwardfishman/status/1738192568637145254?s=20

17. But I disagree with the view that the success of the new executive order depends on enforcement.

What's striking about the Iran case from 2012 is that the US did not have to actually enforce the sanctions for them to have an impact, which is why the impact was immediate.

18. Banks don't really "fuck around and find out" when it comes to secondary sanctions risks and they don't need to see other banks get hit for them to understand the magnitude of the risk.

19. When we talk about the risk aversion of banks in the face of US sanctions, people often point to the billions in fines that the US imposed on banks like HSBC and BNP Paribas for violations of Iran, Libya, and North Korea sanctions.

20. But what gets missed is that these were fines levied after the banks knowingly violated *primary* sanctions.

The banks in question had a direct "nexus" to the US financial system when they were violated the sanctions. In the eyes of US prosecutors, they were American banks.

21. When foreign banks violate secondary sanctions, they aren't fined. They are "blocked" from the US financial system by becoming a designated entity.

The US didn't have to go and add many banks, to the sanctions list in order to create a chilling effect.

22. So if the new secondary sanctions are going to have an effect, I expect we will see it reflected in the trade data pretty quickly. Most banks supporting Russian trade in machinery and technology will probably pause their activities in January, even the small players.

23. What will happen is that trade will be centralised through a few financial institutions, probably state-owned banks or policy banks. Eventually the trade will rebound, but the more limited number of financial channels will become a hard constraint on trade.

24. We also have to see what effect the new measures have on FX availability for Russian importers. A lot of Russian money might have gotten trapped today and a lack of access to dirhams, lira, renminbi etc. also becomes a source of supply chain weakness.

25. Finally, I think its worth reflecting on why these sanctions are coming now. When it came to secondary sanctions, the Biden administration really kept the powder dry, even as Russia made big gains in Ukraine and shrugged off the initial sanctions packages.

26. These are the kind of sanctions you apply when you realise things are heading towards a stalemate.

They aren't sanctions you want to impose, because they are actually very hard to lift and the target knows this. But you are trying to maximize pain to maximize leverage.

27. If the new sanctions cut most of Russia's financial channels with China, India, Turkey, Kazakhstan, the UAE etc. those channels won't come back, even if a negotiated end to the conflict leads to sanctions relief.

It's a definitive move to cut Russia out from global banking.

28. In a sense, if Russia has managed to lock Ukraine in a painful stalemate in the war, the US is now trying to force a stalemate in the economic war by locking Russia into economic stagnation. Each side can claim victory, and therefore they can negotiate an end to the two wars.

29. I also think the Biden team is borrowing a bit from the Trump administration's "sanctions wall" approach.

Trump's advisers were worried Biden would pursue diplomacy with Iran, so they intensified the sanctions at the end of 2019, adding more sanctions on the central bank.

30. Biden's team is likely worried Trump will be soft on Russia, so they have made this move now, a move Trump can't really undo, in order to ensure that US "maximum pressure" on Russia is locked-in even if Trump comes into office.

31. The sanctions come at a "critical juncture." As @wallyadeyemo writes, "By raising the stakes for banks supporting sensitive trade with Russia... our coalition is pouring sand into the gears of Russia’s military logistics."

Let's see if those gears start grinding to a halt.

32. Here is the text of the executive order:
whitehouse.gov/briefing-room/…