US Dollar: The Unexpected Victim of Trump’s Iran Deal Exit?
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By Henry Hing Lee Chan

US Dollar: The Unexpected Victim of Trump’s Iran Deal Exit?

Oct. 05, 2018  |     |  0 comments

On September 24, 2018, the European Union and its member signatories to the Joint Comprehensive Plan of Action (JCPOA) — France, Germany and Britain — announced that they are re-committing to the 2015 JCPOA, also known as the Iranian nuclear deal. They will set up an alternative trade settlement mechanism to avoid the reimposition of US sanctions following the American withdrawal from the Iranian nuclear agreement on May 8.

The decision of the EU to set up a so-called Special Purpose Vehicle (SPV) to facilitate trade before the November 4 second phase of American sanction against Iran is significant. US President Donald Trump had urged Europe to isolate Iran and warned of draconian new penalties that would penalize American’s allies for not cutting off commercial ties with the Iranians. The EU’s decision on the SPV is an open challenge to the rationale of the US in abrogating the Iranian nuclear deal and is unprecedented in the cross Atlantic alliance.

The European diplomats involved in the negotiation described the SPV proposal as a means to create a barter system, similar to the one used by the Soviet Union during the Cold War, to exchange Iranian oil for European goods without money changing hands. Iranian exports to the EU can be a credit to the Iranian account in the SPV framework to pay for the products or services exported by an EU entity to Iran. Hence no funds will be sent to Iran.

The SPV would operate in euros rather than US dollars, and US authorities won’t be able to scrutinize transactions, unlike the SWIFT system, which is fully transparent. The mechanism would “immunize” buyers and sellers by avoiding sales in US dollars that could expose them to US sanctions.

China and Russia are the two other signatories to the P5+1+EU nuclear deal with Iran, and they have signalled their support for the EU initiative.

The EU is the third largest trading partner of Iran, after China and United Arab Emirates (UAE). The combined trading volume of China and the EU with Iran accounts for 35 percent of the more than USD 100 billion Iranian trade in 2017. Official trade statistics indicate UAE exports to Iran consist of many re-exported goods originating from the EU and China. The SPV move and a similar move by China means that most of the Iranian trade with the outside world is shielded from US sanctions, and that makes US sanctions not likely to work.

The SPV’s aim to keep trade flowing sans any US participation has raised the specter of a long-term diminishing role of US dollar in global trade, with severe consequences to the global financial system.

2015 Iranian Nuclear Deal

The JCPOA was agreed on July 14, 2015 between Iran, the P5+1 (the five permanent members of the United Nations Security Council — China, France, Russia, United Kingdom, United States plus Germany) and the European Union after more than two years of lengthy and highly technical discussions.

Under the agreement, Iran agreed to eliminate its stockpile of medium-enriched uranium, cut its stockpile of low-enriched uranium by 98 percent, and reduce by about two-thirds the number of its gas centrifuges for 13 years. For the next 15 years, Iran will only enrich uranium up to civilian commercial reactor grade and avoid any proliferation moves. To monitor and verify Iran’s compliance with the agreement, the International Atomic Energy Agency (IAEA) would have regular access to all Iranian nuclear facilities. In return for Iranian agreement to essentially de-nuclearize at the moment and commit not to start the nuclear program in the following decades, P5+1+EU would lift the US, EU and United Nations Security Council nuclear-related economic sanctions.

Taking out the US dollar from the Iranian trade with the world could present a long-term challenge to the pre-eminence of the US dollar in the global financial system.

There was a complex legal framework and political mediation process put in place to handle suspected violations based on a joint commission made up of the international powers and Iran. There was a side agreement that the old UN resolutions would be readopted in full if there was political deadlock over a new UN resolution to reimpose sanctions on Iran in case of Iranian violations of the agreement.

There was also a compromise agreement on UN curbs on access to ballistic technologies by Iran. The curb over ballistic technologies would last for a maximum of eight years, and the arms embargo against Iran would be lifted within five years.

On July 20, 2015, all members of the UN Security Council adopted resolution 2231 endorsing the JCPOA and set January 16, 2016 as the effective date for the said agreement.

The US Withdrawal from the Deal

The US announced on May 8, 2018 that the country was withdrawing from the Iranian nuclear deal and was reimposing sanctions on Iran. The first phase came into effect in August with restrictions on Iranian purchases of US dollars, trade in gold and other precious metals and sales to Iran of auto parts, commercial aircraft and related parts and services. The second set of sanctions will come into effect on November 4 and restrict sales of oil and petrochemical products from Iran.

The American decision means that companies must scrap existing contracts with Iran, and new business deals were immediately barred starting May 8. Third-party countries and private businesses with US operations that are found doing business with the Iranians will be subject to US penalties as well. US sanctions on Iran also bar foreign firms that do business there from accessing the entire US banking and financial system. They cannot use the US dollar in their transactions. The move is designed to paralyze the Iranian economy and force the country to re-negotiate JCPOA.

On May 17, the European Commission announced its intention to implement the blocking statute of 1996 to declare the US sanctions against Iran illegal in Europe and ban European citizens and companies from complying with them. The other signatories have since adopted the EU position to the JCPOA. They have agreed to continue abiding by the agreement with an option for future American participation. There was a lot of backroom negotiation and manoeuvring since the US announcement but no concrete results thus far.

The strong European reaction caught the US by surprise. John Bolton, Trump’s national security adviser, had predicted that “the Europeans will see that it’s in their interests to come along with us” rather than continue with the 2015 deal. The recent statement of the French finance minister, Bruno Le Maire: “We have to work among ourselves in Europe to defend our European economic sovereignty” aptly describes the current European stand on the issue.

The American threat against companies trading with Iran had deterred some multinationals from doing business with Iran. However, many European small and medium enterprises with little US business or US dollar exposure will likely proceed to trade with Iran, together with the similarly situated Chinese and UAE firms. The damage to the Iranian economy might not be as extensive as feared.

US Dollar is the Unexpected Victim

Taking out the US dollar from the Iranian trade with the world could present a long-term challenge to the pre-eminence of the US dollar in the global financial system. Of the five basic parameters to measure a currency’s importance in the international monetary system — international debt issuance, international loan issuance, foreign exchange turnover, global payment currency and foreign exchange reserve — the US dollar holds a pre-eminent position in four of them (see Figure 1). However, in the area of international payment currency, it is just a little ahead of the euro.

Figure 1. A snapshot of the global monetary system

The graph released from the European Central Bank based on the latest available statistics shows that in 2017, the US dollar is used in 39.9 percent of global payment as against 35.7 percent for the euro. For the five basic parameters in measuring a currency’s importance, this particular function is the most closely linked to the real economy and presumably, has the traction to keep its relevance in the long-term.

The decision of other signatories to proceed with the JCPOA and the likelihood of a successful new trading arrangement sans US dollar could hurt the international position of the US dollar and the currency will be collateral damage to the current impasse. Charles Schultze, chairman of the Council of Economic Advisers in the Carter Administration, once summed up the long-term danger of deficits with a metaphor: “It is not so much a question of the wolf at the door, but termites in the woodwork.” His statement on the deficit is analogous to the current situation facing the dollar in the Iran case.

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