Small Financial Wars – Assessing American Strategy and Application of Financial Suasion

Small Financial Wars – Assessing American Strategy and Application of Financial Suasion

Chris Wozniak

Summary

The United States occupies a central role in the global financial system and has leveraged its advantage to combat transnational actors and pressure geopolitical adversaries. The low cost and high utility of financial suasion makes it an appealing tool for presidents seeking alternatives to military force or unsophisticated embargos. However, presidents who make use of this financial strength must understand its roots, appropriate use, and the threats to American predominance it can create.

Introduction

The United States enjoys relative economic and financial preeminence around the globe. American financial clout has long been leveraged to compel state behavior on the world stage with classic use of financial sanctions to freeze assets or halt transactions with bad actors. This strength rests in part on the dollar’s status as the world’s preferred reserve currency and New York’s position as a global financial hub that trillions in assets pass through annually. After the September 11, 2001 terror attacks the sophistication and scope of financial suasion used against transnational terrorists, criminals, and rogue regimes has expanded dramatically and become a preferred tool of the executive branch. This low cost, politically palatable method of pressure has been used to apply diplomatic leverage, destroy illicit financial networks, and influence the internal politics of America’s adversaries. While appealing due to its low cost and high utility, financial suasion carries risk of international blowback if mishandled. Over the long term, misapplication, politicization, and failure to understand the sources of and threats to American financial strength can erode the relative advantage of the United States in the current strategic paradigm. Presidents seeking to use financial suasion must be aware of the risks and act deliberately to avoid degrading its effectiveness and undermining the financial strengths of the United States on the global stage.

Targeting Transnational Terror and Crime

The Treasury Department has been on the forefront of every American financial suasion campaign in the past two decades. Curtailing operational capability of transnational terrorist groups and criminal organizations has been achieved through identification, isolation, and immobilization of their assets. Identification is achieved within US jurisdictions through compliance measures rolled out after 9/11 and overseen by Terrorism and Financial Intelligence (TFI) at Treasury which includes the Office of Foreign Assets Control (OFAC), Financial Crimes Enforcement Network (FinCEN), and Treasury Office for Asset Forfeiture (TEOAF) among others. Financial suasion outside of the United States’ national jurisdiction is exerted on the basis that institutions not in compliance may be denied access to the United States’ financial system. Transaction clearing houses are particularly important because many transactions are dollar denominated due to the United States dollar’s position as the preferred global reserve currency. Oil transactions for instance are almost exclusively denominated in dollars.

Designation by the Treasury as party to illicit activity will often result in subsequent investigation by local authorities. In the event of Treasury designation, private firms and banks dealing with potentially risky clients become exposed to reputational risk that can result in steep fines, departure of clients, or ruinous isolation from the financial system. Riggs Bank suffered such reputational damage after being fined for insufficient controls on high risk accounts and transactions. The bank also failed to report various suspicious activities and the resulting $25 million fine caused massive asset flight and an eventual sale to PNC Bank [1]. The signal to the financial industry that consequences for non-adherence to compliance controls would be enforced has reduced the facile entry of bad actors into the global financial system.

Without access to the global financial system and less funding to operate, it becomes difficult for transnational organizations to plan and execute plots. Additional rounds of fundraising by these organizations and subsequent laundering further risks exposure of networks to authorities. Consequently, laundering strategies must become increasingly complex to overcome compliance and financial surveillance measures. For terror organizations, the objective is often how to navigate this environment and use legally generated money for illicit purposes. Criminal organizations invert this dynamic and seek to launder money generated by illegal means so that is can be used for legitimate purposes. Both are subject to the classic steps of money laundering: placement, layering, and integration. As the sophistication of monitoring and compliance controls have evolved, so too have efforts to circumvent authorities.

Two cases of illicit financial ingenuity are found in the Black Market Peso Exchange (BMPE) and South America’s Triple Frontier Border area (Paraguay, Argentina, and Brazil). The BMPE is a scheme used by Latin and South American narcotics traffickers to launder profits. Taking advantage of a shortage of dollars available to legitimate Latin and South American businesses for international purchases, money traders approach businesses with offers of dollars which are used to buy commodities abroad. The scheme begins as an agent of the trader takes possession of cartel dollars in the United States, makes the commodity purchase, and sends the commodities to the legitimate business. Concurrently, upon receipt of dollars from the cartel in the United States, pesos are immediately disbursed to the cartel from the trader in their home country. By assuming considerable risk, the trader allows unaware legitimate businesses to make dollar purchases abroad with illicit capital from cartels, who in turn receive clean pesos in their home country without any currency actually crossing international borders and triggering traditional money laundering controls [2]. It is notable that the Colombian and Mexican cartels providing the capital are often only able to work with traders and take advantage of unsuspecting legitimate business in need of dollars because of strict currency controls in their countries. These controls are designed to prevent the flow of drug profits back to the cartels from the US market. After 9/11, a more zealous Treasury cadre has aimed to work with governments to tighten loosely regulated financial arenas. Bilateral cooperation is more important than ever to establish and consolidate sound regulatory frameworks and reduce illicit activities.

In South America’s Tri-Border Area, pursuit of profit has led transnational criminal organizations to overlap with transnational terror. A Syrian-Lebanese diaspora in the area make up three percent of the population and Hezbollah operatives have found the loose regulatory environment to be a lucrative one [3].

Longstanding exploitation of lower import tariffs available to Paraguay has led to proliferation of import-export businesses that sell goods to smugglers who in turn cross the Argentinian and Brazilian borders to re-sell goods at a premium. Hezbollah has exploited opportunities in the commercial hub by establishing their own import-export enterprise and using counterfeit goods or under-invoicing strategies to further disguise and maximize profits for transport back to Lebanon [4]. Hezbollah also extorts other Syrian-Lebanese emigrants for a quota by threatening their relatives residing in Lebanon. Plentiful supply of narcotics in the region also makes for another tempting revenue stream that brings transnational terror and criminal enterprise into the same tent. Ayman Joumaa, an indicted narco-trafficker, negotiated large drug transactions between South American criminal enterprises and deposited the proceeds in Lebanese banks where the money could be laundered through in-house accounts. The money was then used to purchase consumer goods that were re-sold in Latin America, where the now completely laundered funds could be transferred to accounts in Lebanon [5]. Recently, direct exchanges of stolen luxury rental cars for drugs indicate that criminal elements are adapting to the enhanced scrutiny. These transactions defy monitoring by governments using traditional currency controls while enabling easy introduction of drug profits into the formal economy [6]. The difficulty of monitoring and combating narcotics trafficking makes inclusion of narcotics into the revenue streams of transnational terror organizations highly attractive. Worryingly, it is estimated that at least half of the world’s designated terror organizations received revenue from the narcotics trade [7].

The Treasury Department’s preferred method for combatting the BMPE and Tri-Border schemes is nurturing international consensus that robust financial controls and monitoring are worth investing in. Carrying this message abroad, the Treasury Department has found receptive audiences seeking respect and inclusion in the international community.

By complying with designations, international partners experience a boost in international stature, greater possibility of foreign investment, and less economic drain attributable to illicit financial activities. As more nations and institutions establish a vested interest in a global financial system with the United States, the relative power of American financial suasion grows. In this ecosystem, multilateral cooperation has proven indispensable to creating effective financial monitoring networks. That spirit of cooperation begins to break down on the international stage where potential for presidential misuse of financial suasion is much greater.

Nation Suasion

Integration of nations with immature, opaque, or poorly regulated financial sectors into the global financial system is achieved by technocratic partnership from which both the United States and partner nations benefit. The United States broadens the reach of its financial warfare against transnational bad actors while host nations earn respect on the international stage and realize the benefits of the international financial system. Nurturing this participation and a stake in a well-regulated and transparent global financial system has brought influential nations (and potential spoiling actors) such as China, Russia, Lebanon, and others on board. Problems begin to emerge however when the Executive Branch employs financial suasion to achieve unilateral political ends. Too often, politicization undermines the multilateralism upon which the potency of financial suasion is based.

International action surrounding the Iranian nuclear program offers a timely example of Executive misuse of financial suasion. The Joint Comprehensive Plan of Action (JCPOA), more commonly known as the Iranian nuclear deal, owed a large portion of its successful ratification to an innovative campaign of financial pressure. Stepping beyond the simplicity of a crude oil embargo, the United States and its partners targeted the financial underpinnings of the Iranian economy with unprecedented granularity. The insurance fraud used by Iranian ships to circumvent sanctions was laid bare to international insurers, businesses associated with the Islamic Revolutionary Guards Corps had their connection publicized, and in an unprecedented move Belgium-based SWIFT unplugged Iranian banks from its interbank messaging system [8]. The Trump administration’s decision to withdraw from the JCPOA in May 2018 is arguably attributable to domestic political incentives and has watered down the multilateralism upon which effective financial pressure relies, especially considering subsequent European statements affirming commitment to the JCPOA. European insurers are now deterred from underwriting Iranian shipping on the basis of running afoul of United States Treasury designations rather than compliance with the laws of their own governments. This decline in goodwill underpinning Iranian sanctions enforcement will potentially increase the difficulty of consensus building in future efforts to rein in rogue state behavior. Also notable is the potential fallout from political pressure placed on the SWIFT messaging service, which once again disconnected some Iranian banks in November of 2018 [9]. Domestic American political calculus impacting the interbank messaging service is unlikely to have gone unnoticed by other nations wary of America’s financial power. The incentive for states like China or Russia to develop their own alternative financial systems will only grow as they seek to broaden their asymmetrical competition for global influence.

Executive misapplication of financial suasion is also attributable to the low cost and domestic political palatability when embarking on campaigns of financial suasion. Directing the Treasury Department to begin a campaign of financial suasion is free of the heavy costs and Congressional approval requirements that accompany a military deployment. However, because these campaigns are predicated upon technocratic integrity and stability of the wider financial system, entanglement with diplomatic objectives divorced from financial compliance carries severe risk. Imposition of financial pressure on North Korea and the illicit narcotics, smuggling, and counterfeiting operations of its Office 39 and their eventual rollback offers another example of Executive missteps. Beginning June, 2005 the Bush administration made a series of escalating moves to freeze the assets of entities responsible for funding missile and nuclear programs culminating in the Treasury designation of Macau-based Delta Banco Asia as a primary money laundering concern under Section 311 of the USA PATRIOT Act [10]. Designation not only prompted Chinese cooperation against a nation state they typically support but also drove North Korean negotiators to initiate talks for the first time ever. Executive misunderstanding of the technocratic case that gives financial suasion its extranational reach was showcased after US negotiators decided to repatriate the frozen Delta Banco Asia assets to entice North Korean representatives back to the negotiations. Due to fear of future 311 designations, negotiators could not initially find a bank willing to handle the transaction. This reversal also signaled to the international community that the Treasury Department’s 311 designation was not exclusively based on a commitment to a sound financial system. Rather, the United States was prepared to leverage its financial heft to compel state behavior. From the perspective of President Bush and State Department negotiators, financial pressure was a spigot to be turned on or off. In actuality, it is a genie that cannot be returned to its bottle without erosion of international goodwill, trust, and long-term efficacy as a tool of national power.

Under Pressure

Pressure from strategic competitors and technological development also threatens the current paradigm. The foremost competition the United States faces currently comes from China, which has made several important strides in cultivation of financial power. In 2016, the Chinese yuan was officially adopted by the International Monetary Fund (IMF) as its third reserve currency after the Dollar and Euro. In the same year, the China-proposed and Beijing-headquartered Asian Infrastructure Investment Bank (AIIB) opened for business. Together, these developments signal the beginning of a Chinese push to expand their financial influence and diminish the advantage the United States has enjoyed globally for the past century. Chinese financial muscle also plays a key role in the Belt and Road Initiative (BRI), where predatory investment into the infrastructure of smaller economies in the region has resulted in default and forfeiture of key infrastructure. Even in instances where default does not occur, the increased volume of trade between China and its neighbors incentivizes greater stockpiling of yuan in national currency reserves and supports the power of the yuan in international trade. Another dangerous financial player on a tactical level is the Russian Federation.  One alarming instance of Russian financial maneuvering is the 2008 overture to China suggesting a dump of shares of Federally backed Fannie Mae and Freddie Mac to increase the severity of the US financial crisis and undermine the dollar [11]. While China declined the offer, there is no guarantee that coalitions of hostile states will not form and cooperate in the future.

Technological advancements such as proliferation of mobile banking services, distributed ledgers, and cryptocurrencies must also be recognized and managed to minimize their impact on the advantageous status quo. Mobile banking services carry significant potential for exploitation by transnational criminal and terror networks. In developing nations, mobile phone subscription rates are high - reaching 98.7 percent in 2017 - and the level of transparency available in comparison to nations with developed financial sectors is poor [12]. In nations without robust banking services where airtime for a mobile phone subscription is valuable, one user might buy airtime for a prepaid mobile service other than their own. Subsequently, the recipient of that airtime may go to their local airtime vendor and cash out the airtime for hard currency. A motivated network of transnational criminals working with unscrupulous airtime vendors could abuse such a system to disguise the origins and destinations of their funding. Mobile SMS payment systems such as MPESA in Kenya and MPAISA in Afghanistan could be abused in much the same way.

Potential technological opportunities for illicit activity or evasion of sanction frameworks exist in the potential impact of anonymous transactions of cryptocurrencies such as Bitcoin or Facebook’s Libra. The anonymity of transactions has clear implications for transnational criminal or terror organizations by enhancing their ability to hide destinations and sources of funding. Widespread international adoption of cryptocurrencies could also upend the dominance of the dollar as the most desirable reserve currency and cause a shift away from dollar denominated of commodity trading. In an August statement, the Governor of the Bank of England Mark Carney provided insight into how such a future might look when he outlined the vision of “a new digital currency backed by a large group of nations [and] reserve assets in a basket of currencies including the US dollar, the euro, and sterling.” [13]

The blockchain technology that cryptocurrencies are based upon may also reduce the importance of strength of any one nation’s financial centers and their ability to wage a campaign of financial pressure. While this may erode the capability of the United States to project its influence abroad, access to this distributed ledger environment would likely be predicated upon participants behaving in a manner compliant with responsible and licit activity. In essence, the United States would not be the nation wielding the stick but would still benefit from the outcomes of such technological advancement.

Recommendations

The low cost and easy use of financial suasion by the Executive Branch makes it a popular but misunderstood tool. Financial suasion should not be used to accomplish diplomatic end states, but to create a transparent licit financial environment that invites participation and spurns transnational criminals, terrorists, and rogue states.To preserve its effectiveness, future administrations should understand that the efficacy of American financial power depends on several considerations that must be examined prior to implementation.

First, relentless overtures to nations with opaque, unsophisticated, or corrupt financial sectors must continue to be fully resourced and predicated on technocratic cooperation. This is a bilateral process in the best interest of both a United States seeking to preserve the current paradigm in which it thrives and the host nation, which can limit the degradation of its licit economy by criminals and terrorists.

Second, when embarking on a “maximum pressure” campaign against a nation state, the Executive branch should seek to verify that there is a sufficient level of international goodwill supporting its implementation. The United States’ long term strategic advantage in part relies on consensus and enthusiastic participation. To behave otherwise risks accelerating the erosion of the American financial advantage by incentivizing the creation of alternative clearing houses, interbank messaging systems, currency reserve diversification, and cryptocurrency transactions.

Third, the United States must recognize that the tools of financial suasion like USA PATRIOT ACT 311 designations should not be tied to diplomatic negotiations with shorter timelines and clear end states other than financial sector reform. To do so exposes private financial actors and nation states to a cycle of whiplash as they struggle to comply and avoid running afoul of a Treasury Department taking its cues from the diplomatic process. Designations therefore should be implemented or rescinded only on the basis of financial reform and compliance.

Fourth, the inception or cessation of financial suasion campaigns should not be made on the basis of political calculation. The corrosive effect this can have on perception of American financial power abroad has been demonstrated in part by the Trump administration’s withdrawal from the JCPOA. Re-imposition of financial designation for perceived political gains is not in line with the steadier technocratic message of compliance for the sake of robust licit financial markets. Signaling to the international community that the treaties of today may be reversed by the elections of tomorrow will in the long-term yield bitter fruits.

While still the world’s most important financial center, the decline of the United States’ relative financial power is a very real risk. Emphasizing integration on technocratic grounds, examining international buy-in, managing the impact of diplomacy, and avoiding the dangers of politicization must be priorities. Today’s Executive Branch can impose some of the most sophisticated and far reaching financial pressure in the world with the stroke of a pen. Presidents seeking to preserve the relative American position in the international order must not allow their own misunderstanding or misapplication to erode a powerful tool of influence.

End Notes

1. Zarate, Juan. Treasury's War: The Unleashing of a New Era of Financial Warfare
   • Public Affairs – 2015, pp. 149-151
2. Money Laundering Through the Black Market Peso Exchange. (2018, June 12). Retrieved from https://www.lexology.com/library/detail.aspx?g=acf393a5-7fea-49ac-a51f-17afab60a75a.
3. A Map of the Reexport Trade on the Triple Frontier. (2012, September 7). Retrieved from https://www.foreignaffairs.com/map-reexport-trade-triple-frontie
4. Zarate, 177
5. Zarate, 358-60
6. Rental Cars from Argentina Exchanged for Drugs on Bolivia Border (2019, September 6). Retrieved from https://www.insightcrime.org/news/brief/rental-cars-argentina-exchange-drugs-bolivia-border/.
7. Zarate 368-70
8. U.S. Department of the Treasury. (2019, September 4). Retrieved from OFAC Advisory to the Maritime Petroleum Shipping Community
9. SWIFT System to Disconnect Some Iranian Banks This Weekend. (2018, November 9). Retrieved from https://www.reuters.com/article/usa-iran-sanctions-swift/swift-system-to-disconnect-some-iranian-banks-this-weekend-idUSFWN1XK0YW.
10. U.S. Department of the Treasury. (2019, October 22). Retrieved from https://www.treasury.gov/press-center/press-releases/Pages/js2720.aspx.
11. Peston, R. Russia 'Planned Wall Street Bear Raid' (2014, March 17). Retrieved from https://www.bbc.com/news/business-26609548.
12. Sharwood, S. (2018, March 2). Developing World Hits 98.7 Percent Mobile Phone Adoption. Retrieved from https://www.theregister.co.uk/2017/08/03/itu_facts_and_figures_2017/.
13. Inman, P. (2019, August 23). Mark Carney: Dollar is Too Dominant and Could Be Replaced by Digital Currency. Retrieved from https://www.theguardian.com/business/2019/aug/23/mark-carney-dollar-dominant-replaced-digital-currency.