Financial sanctions and political risk in the international currency system

Abstract

Scholarship on international currencies has traditionally emphasised how an issuing state’s foreign policy can enhance the attractiveness of its currency for cross-border use. Yet, foreign policy actions need not only boost a currency’s international appeal—they may also undermine it. This study introduces a general theory of how US foreign policy can influence governments’ policy orientations toward the dollar in positive or negative ways. Policies like financial sanctions generate ‘political risk’ that weaken the dollar’s attractiveness for international use. The study tests the claim that the United States’ use of financial sanctions incentivises targeted governments to implement de-dollarization policies. I employ a most-likely case study design, presenting evidence from three countries targeted by US sanctions: Russia, Venezuela and Turkey. In each instance, the evidence shows that financial sanctions created political risk concerns by generating expectations of future direct costs of dollar use. These expectations set off policy efforts by targeted governments to reduce their economies’ exposure to the currency. This study raises important questions about the long-term efficacy of an approach to foreign policy that relies on financial sanctions as a primary means of leverage over foreign adversaries as overuse may undermine the effectiveness of the tool itself.

Keywords:

• dollar
• sanctions
• international currency
• political risk
• financial power
• de-dollarization

Acknowledgements

I would like the thank the RIPE editorial board and three anonymous reviewers for their excellent and helpful comments which greatly improved the quality of this article. I would also like to thank Benjamin J. Cohen and Eric Helleiner for feedback on an early version of the manuscript. Thomas Oatley, Geoff Dancy, and others in the Tulane University Department of Political Science, where this paper was presented, also deserve recognition for their input. I acknowledge Olga Boichak, J. Michael Dedmon, and Sefa Secen for their excellent research assistance. Finally, this work would not have been possible without generous funding from the Andrew Berlin Family National Security Research Fund and the Appleby-Mosher Fund, both at Syracuse University.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 The concept of political risk is widely used in research on multinational corporations and foreign direct investment. In this context, political risk is something firms consider when weighing the costs and benefits of entering into a foreign market. Korbin, (1979, 67) defines political risk as ‘[host] government interference with business operations.’ Similarly, (Butler & Joaquin, 1998, 599) describe it as ‘the risk that a sovereign host government will unexpectedly change the “rules of the game” under which businesses operate.’ Distilled to its most basic elements, political risk refers to the way that political events affect economic value and, in turn, how anticipation of these effects by rational actors influences the kinds of economic decisions they make. From this broad definition, we can more easily export the concept to issue areas outside of investment.

2 Suggestive of a similar dynamic, research has indicated that the states most likely to diversify reserves into Chinese renminbi are those whose foreign policy preferences clash with US preferences (Liao & McDowell, 2016).

3 This total is according to the International Monetary Fund’s (IMF) Currency Composition of Official Foreign Exchange Reserves (COFER) database which is publicly available at https://www.imf.org/en/Data

4 For instance, 80 to 90 percent of world trade relies on a form of trade finance services provided by banks (Auboin, 2009, 1).

5 Chips is distinct from Swift, another key component of the global payments system. Chips banks operate as the “pipes” through which digital dollars flow. Swift operates as the messaging network through which payments requests are delivered from the initiator’s bank, to the correspondent (Chips) bank, to the beneficiary’s bank. See Farrell and Newman, (2019) for details on Swift’s role in global payments.

6 While many SDNs are individuals or firms, such measures are often designed to apply pressure on governments. The specific actors targeted are often entities with close ties to political leaders. In some cases, members of a government or political institutions may also be listed as SDNs.

7 For example, 21 of 30 active sanctions programs were state-centric in nature as of May 2019 according to the Treasury’s own list of its sanctions programs available at: https://www.treasury.gov/resource-center/sanctions/Programs/Pages/Programs.aspx

8 Data were obtained from the World Gold Council available at: https://www.gold.org/goldhub/data/monthly-central-bank-statistics.

9 Foreign exchange reserves data are from the IMF’s International Financial Statistics database available at: https://www.imf.org/en/Data; Data on foreign holdings of U.S. government securities are from the U.S. Treasury’s “Treasury International Capital System” or TIC data and are available at: https://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticsec2.aspx

10 Once again, data are from the World Gold Council.

11 Once again, data from U.S. Treasury and World Bank Databank.

12 In 2016, as the lira was under pressure, Erdoğan noted that promoting trade settlement in local currencies “would bring the price of the dollar down” and help stabilise the lira’s exchange rate (Al Monitor, 2017).

Additional information

Notes on contributors

Daniel McDowell

Daniel McDowell is an Associate Professor of Political Science at the Maxwell School of Citizenship and Public Affairs at Syracuse University. He is the author of Brother, Can You Spare a Billion? The United States, the IMF, and the International Lender of Last Resort (Oxford University Press 2017).