Asian economies are even more exposed than it seems to the economic impact of the U.S. withdrawal from the multilateral nuclear agreement with Iran.
As well as the obvious effect on the region's oil imports (China, India, Japan and South Korea buy around three quarters of Iran's exports), there is the concealed pain that will come from ubiquitous use of the U.S. dollar in Asian economies. Unlike Europe, it has no common currency of its own. Unlike Africa and much of Latin America, Asia's advanced and important economies cannot hide or hope to be ignored by Washington.
The bulk of Asian trade is conducted in dollars. Local currencies are directly or indirectly linked to the dollar. A significant proportion of central bank reserves, sovereign wealth, corporate investments and personal savings are invested in dollars. Asian foreign borrowings are primarily dollar based. Major regional trading hubs -- Tokyo, Hong Kong and Singapore -- are important trading centers for dollars and dollar-denominated securities.
At the 1944 Bretton Woods conference, the U.S. leveraged its undisputed power and British and French desperation for American money to create a global trading system underpinned by its currency. Even when the fixed link of the dollar to gold at $35 an ounce was removed in the early 1970s, the dollar's dominant role continued because of a reluctance of other major powers to disturb established trading arrangements or allow their currencies to become reserve currencies.
Today, over half of all global trade is conducted in dollars, two thirds of central-bank reserves are in dollars and more than half of all global cross-border debt is dollar-denominated. This requires access to dollars, and the U.S. payment and banking system.
However, American legislation, such as the International Emergency Economic Powers Act, the Trading with the Enemy Act and the Patriot Act, allows the U.S. to target financial flows to regulate foreign activity, not least as part of the nebulous fight against terrorism. Combined with access to formerly confidential SWIFT data, a global bank messaging system, the U.S. can exert control over global commerce and finance.
This power manifests itself through sanctions which target persons, entities, and organizations, a regime or an entire country. Secondary sanctions restrict foreign corporations, financial institutions and individuals from doing business with sanctioned entities. Any dollar payment, flowing through a U.S. bank or the U.S. payment system, creates the necessary nexus to enable the U.S. to enforce its diktat. This gives the U.S. extra-territorial reach over non-Americans trading with or financing a sanctioned party. Mere threat of prosecution is effective in regulating activities of non-Americans.
The risk is real. BNP Paribas paid $9 billion in fines and was suspended from dollar clearing for one year for violating sanctions against Iran, Cuba and Sudan. HSBC, Standard Chartered, Commerzbank and others have also paid large fines. In each case, these non-American entities were not in violation of any European or other law. The proscribed acts took place outside the U.S.
More recently, Rusal, one of the world's largest aluminium producers, was sanctioned. The company sells only 14% of its product in the U.S., does not use American banks and is listed in Moscow and Hong Kong. Despite this, secondary sanctions forced many investors to sell its securities and made it difficult for the company to refinance in dollars causing its shares and bonds to fall by almost half in value. Global businesses and exchanges were forced to stop dealing with Rusal.
Similarly, until a temporary reprieve as part of current U.S.-China trade negotiations, ZTE, a Chinese electronics company with limited relationship to the U.S., came close to failure when unable to buy essential components from suppliers because of sanctions for trading with North Korea and Iran. Rusal and ZTE had not breached Russian or Chinese laws, respectively.
New sanctions on Iran's oil and energy sector, shipping, port operators, central bank, banks and insurers threaten non-Americans trading, investing and financing the Islamic state, exposing them to secondary sanctions after the expiry of a short grace period. Any entity that purchases Iranian oil in the spot market which is paid for in dollars risks fines or worse.
Given limited trading relationships with Iran outside of oil, Asians may not consider this problematic. However, sanctions could be placed on other countries such as China, where relationships with America on trade and military matters have deteriorated. Asian trading involves multiple parties with unknown potential links to a sanctioned entity in lengthy global supply chains. A component supplied to another party which is assembled into oil industry machinery, transport equipment, telecommunications gear, or control software and then sold to a sanctioned entity paid for in dollars settled in the U.S. banking system creates risk of potential prosecution. .
The world has limited options in dealing with secondary sanctions. One alternative is compliance, limiting trading and financial relationships with a sanctioned party. It is unlikely that Washington would agree to exemptions, at least without extracting significant concessions from supplicants. For example, European companies may be allowed to continue limited trading with Iran but only if EU importers agree to buy expensive U.S. natural gas in preference to present purchases from Russia.
Attempts to block the effect of U.S. sanctions are likely to be ineffective. It is already evident that businesses with interests and assets in the U.S. are reluctant to risk potential violations of Iranian sanctions because of the high penalties.
A more radical alternative would involve limiting trading with the U.S., using the Euro or other currencies for payment and obtaining financing from non-U.S. banks and markets. This would require non-U.S. supplies of essential components and intellectual property, difficult in the aerospace or technology sectors. It would also need the establishment of new reserve currencies, settlement and payment systems, which is also difficult. The Euro's long-term future is far from certain. The Yuan has limited convertibility. China's capital account is restricted. Its state-controlled banking system is fragile. European and Chinese capital markets lack the depth and liquidity of their U.S. counterparts.
Asia faces additional complications. Many individual nations are too small to influence outcomes. Just as EU states are cautious about aligning with a revanchist Russia, many Asian nations are wary of increasing the role of China and Japan because of the former's maritime territorial claims and the latter's Second World War history. Like Europe, Asia, excluding China and India, depends on U.S. military power for security and will be reluctant to take steps which affect this relationship.
Whatever the trajectory, American "unisolationism," a mix of unilateralism and isolationism, is reshaping the global trading and financial order, affecting the value of the dollar and U.S. interest rates. The region will have to choose between increasing economic subservience to a U.S. which determines how it does business, thereby subordinating its sovereignty, or embracing uncertain new trading arrangements, which would threaten existing economic models and the safety of dollar-based investments and savings.
Former French President Valery Giscard d'Estaing believed that the dollar's dominant role gave the U.S. an "exorbitant privilege." The rest of the world, not least Asia, is now learning how extraordinarily far this privilege extends.
Satyajit Das is a former banker. His latest book is "A Banquet of Consequences" (published in North America as "The Age of Stagnation"). He is also the author of "Extreme Money and Traders, Guns & Money."