US Sanctions Send Iran Into Asia's Arms

TARGET IRAN

(Part 1)

By China Hand
Apr 11, 2008
Courtesy Of ATimes

From a Western-centric point of view, the United States and its allies are pushing Iran into a corner in its efforts to rein in what Washington considers Iran's move towards becoming a nuclear power. A broader perspective would indicate that we might simply be driving Iran into the arms of Asia.

On March 24, Iran's official media reported that Iran will apply for full membership in the Shanghai Cooperation Organization (SCO), headed by China and Russia and containing a fistful of continental Asian states.

Connoisseurs of irony will find fodder in Iran's reported appreciation of the SCO's goals of "anti-terror, anti-extremism, and anti-splittism" as well as its discovery of the deep cultural affinity between Iran and Asia.

But Consider This:

- The two largest customers for Iranian oil are China and Japan.

- China has surpassed Germany as Iran’s biggest trading partner.

- The main market for Iran's gasoline purchases has switched to Singapore.

- The main investors in Iran's energy industry - led by China - are all Asian.

In a development that may involve substance as well as symbolism, China will host the next round of G5+1 (UN Security Council members plus Germany) talks in Shanghai on April 16 concerning Iran's nuclear program. China's Assistant Foreign Minister for the region, Zhai Jun, visited Tehran on April 9, presumably to give the Iranian government a heads up on China’s position going into the G5+1 conference.

Iran's Foreign Minister Manuchehr Mottaki took the opportunity of Zhai's visit to lobby for "an Asian union" including Iran and China, presumably a step even beyond membership in the SCO.

If Iran's state media is reporting Zhai's remarks correctly, China is not spurning Iran's advances: Zhai said that China is prepared to cooperate with Iran in the area of key industries such as oil and gas. "Iran’s growth of power in the region and the international arena is to Beijing's interest," he stated.

Iran’s rediscovery of its Asian side - and its turn away from Europe, which has long served as a focus of Iranian aspirations, economics, and diplomacy - is the most important and perhaps least expected consequence of the network of national financial sanctions that the Bush administration has labored to pile atop the toothless UN sanctions against Iran.

American efforts to isolate Iran through the international financial system provide an object lesson in the iron law of unintended consequences. Instead of briskly destroying the Iranian Death Star with the help of the US coalition of the willing, the Americans appear to be engaged in global whack-a-mole, with a continuously expanding supply of holes and moles, and Uncle Sam demanding more and bigger hammers so he can win the game.

The United States has devoted immense efforts over the past two years to achieve international adoption of what is essentially a US national sanction regime that goes beyond the global consensus reflected in the UN Security Council resolutions. The results have been, at best, mixed.

In its last year in office, the George W Bush administration has apparently embarked on a risky path to escalate its way out of the difficulties, contradictions, ambiguities - and perceived ineffectiveness that dog its Iran sanctions policy. As the US is well aware, the sanctions chain is only as strong as its weakest link. Aside from the United States, Israel, the UK, and France, it has weak links all the way across. One of the weakest links is, of course, China.

China is a major trade and energy partner of Iran, and has labored consistently to limit and dilute UN Security Council sanctions against Iran for its uranium-enrichment related activities. As a result, to US frustration, Security Council sanctions remain highly targeted, directly addressing individuals and organizations involved in enrichment activity, and specifically preclude military action.

There were attempts in the Western press to present the latest Security Council vote (14-0 with Indonesia abstaining) as a sign of united world resolve to pressure the Iranians for refusing to give the IAEA the answers it wants about its allegedly abandoned weapons program, or suspend uranium enrichment. However, the Chinese quickly went on the record to counter the Western interpretation with its own.

Courtesy of Xinhua, here’s what Chinese-language coverage had to say (translations by China Matters):

The resolution emphasized diplomatic efforts, resumed dialogue and negotiations with Iran ... balance between sanctions and encouragement of negotiations.

There are strict limits on targets of sanctions ... sanctions are "reversible", temporarily or even permanently if Iran takes positive steps to implement the Security Council resolution.

Different countries have different interpretations of the resolution ... roots [of deadlock] are in the severe lack of mutual trust between the United States and Iran. If this problem is not resolved, then there will be no breakthrough on the Iran nuclear question.

In other words, there is no support for meaningful international sanctions that would pressure the Iran regime.

Call For Vigiliance

In the wake of this less than decisive outcome at the United Nations, the US Treasury Department, exploiting a generalized call in the resolution for "vigilance" regarding financial dealings with Iran, announced a broadening of national measures against Iran on March 20.

From the Financial Times: "The [US] Treasury department has issued a warning of the risks of doing business with 51 state-owned and seven privately held Iranian banks - in effect the whole of Iran’s banking sector. The list includes institutions specializing in export financing and foreign investment, as well as Iranian state-owned banks located as far away as Venezuela, Hong Kong and the UK."

The prospect of the United States implicating the entire Iranian banking sector as an accessory in terrorist financing and proliferation, thereby cutting it off from the Western financial system, is a source of real anxiety for Iran.

However, the looming US sanction also looks like an attempt to deal with the unintended consequences of its financial campaign against Iran: Iran’s abandonment of the dollar and total disconnection from the US financial system in Iran’s economy, coupled with the wholesale shift of Iranian trade and finance away from the United States, first to Europe and now to Asia.

The Asian trend is symbolized by the announcement of Iran’s oil minister this January that, following successful negotiations with customers in China and Japan, the entirety of Iran’s energy sales - over $50 billion per annum - are now conducted in euros and Japanese yen, and none in US dollars.

Sometimes it looks as if the United States, and not Iran, is getting boxed into a corner. America’s difficulties can best be illustrated by looking at the intertwined cases of Germany and China. Depending on how you look at it, Germany is either the keystone - or the weakest link - of the US campaign to isolate Iran, insofar as maintaining a European united front against Tehran is concerned.

Here’s how Der Spiegel reported the situation in July 2007: "But the US government is no longer content with United Nations economic sanctions on Tehran - Washington wants more ... American officials are irked that German companies are still doing business worth billions with Tehran. In particular, Washington has little understanding for the export guarantees Berlin still offers firms, effectively helping the mullah regime to buy new ships and power plant technologies.

"[The Treasury Department’s Deputy Secretary for Terrorism and Financial Intelligence Stuart Levey] demanded Germany cut its so-called Hermes export credit insurance coverage when it came to deals with Iran ... Levey told the officials that Washington wanted Germany to scale back all of its other economic ties with Iran as quickly as possible.

"But Levey ran into resistance from the Germans, who said his demands were understandable coming from a country that has no trade with Iran. Germany, however, exports more than 4 billion euros (US$5.45 billion) in goods to the country each year, creating thousands of jobs ... Besides, explained the Germans, the Hermes cover has been excluded from UN sanctions against Iran. In short, Levey could forget his request - Germany would stick to the UN resolutions, but would do no more.

"The United States did not take no for an answer. The US was also not shy about going around the [Angela] Merkel government to go directly to Germany’s financial institutions and lean on them to follow US policy regardless of what their government’s official position was - something the Merkel government most certainly resented."

Again from Der Spiegel: "And Levey hasn’t just been knocking on the doors of government ministries while in Europe - he’s also been visiting the continent’s captains of industry. While in Germany he went to the country’s financial center, Frankfurt, to try to persuade the bankers there not to do business with Iran. German financial institutions feel the United States government has been engaging in 'downright blackmail', according to one banker. Anti-terror officials from the US Treasury are constantly showing up to demand they cut their traditionally good relations with Iran. The underlying threat from the men from Washington is that they wouldn’t want to support terrorism, would they?

"But there are no plans to stop financing German exports to Iran. 'Of course our member institutions respect all sanctions set out in the UN resolutions,' says a spokesman for the Association of German Banks. However, that didn’t stop Deutsche Bank, along with German industrial heavyweights BASF and Siemens, from being put on a list by the US Securities and Exchange Commission (SEC) for having contacts with Iran."

Business Continues

German attitudes toward the sanction regime are clear from another Spiegel article:

[T]he economics department of the German Foreign Ministry has collected revealing data which [German Foreign Minister] Steinmeier will use to back up his argument against EU sanctions. Several French companies in the automobile, energy and financial sectors - including Peugeot, Renault, Total, BNP Paribas and Societe Generale - have hardly reduced the level of business they do with Iran, according to the Foreign Ministry data. German exports to Iran, in contrast, have dramatically declined.

Even more explosive is the data that reveals US hypocrisy over sanctions. The German Foreign Ministry accuses American firms of bypassing the boycott against Iran, which has been in place since 1979, by creating front companies in Dubai to carry out their business. German politicians have long internally accused the United States of knowingly tolerating the practice. Microsoft software is present in Iran, as is Caterpillar heavy equipment. And it's difficult to overlook the presence of brands like Pepsi and Coca-Cola in Tehran.

Despite this attitude, German defiance did not survive the summer. In November 2007, Siemens announced it would sign no new contracts with Iran (while executing its existing agreements).

German banks took concrete actions to limit trade with Iran in Fall 2007 to cut back, as this report from a Chinese exporter message board indicates:

I have checked with Commerzbank AG and Dresdner Bank AG and it seems to be true that by order of their board of directors from the beginning of October 2007 only welfare operations would be supported by them and not even usual commercial businesses like deliveries of garments would be done.

The German government continued to wind down its Hermes export credit program. According to the February 28 International

Herald Tribune, the consequences of German participation, no matter how grudging, in US-led pressure on Iran on Germany’s bottom line was unmistakable: "German exports to Iran have dropped drastically in the past two years amid increasing concern over Tehran's nuclear ambitions, according to a new report from the German Economy Ministry."

The report shows a drop in German exports to 3.2 billion euros in 2007 from 4.3 billion euros in 2005. Meanwhile, government guarantees that exporters will be paid for their goods sold to Iran have more than halved, to 503.4 million euros in 2007 from 1.16 billion euros in 2006. No doubt an occasion for triumphant high-fives at the US Treasury Department. The mood in Germany, however, was assuredly less joyful.

The Summer 2007 Der Spiegel article pointed out: "Were Germany to end its Hermes export guarantees, German locomotives might no longer be delivered to Iran, but Chinese and Russian companies would gladly step into the breach. The Americans would end up gaining nothing, while the German economy would stand to lose a lot."

Over in Asia, China was undoubtedly pleased to see Germany surrender the Iranian market under US duress. Chinese exports to Iran have skyrocketed at exactly the same time that Germany’s sagged. China has displaced Germany as Iran’s biggest trading partner, with trade of about $20 billion, not including the significant sanction-evading trade through Dubai (many, many billions more).

In a development that Germany undoubtedly noted, on March 26, two weeks after Tehran announced it was making a 90 million euros progress payment toward a 2006 contract it signed with Siemens for 150 locomotives, Tehran Urban & Suburban Railway Co signed a new 360 million euros contract with China Northern Locomotive & Rolling Stock Industry Group for 455 metro cars and 160 double-deck coaches. Another 455 coaches are under tender.

Trends like these create new problems and responsibilities for the United States. Now the onus is on the Bush administration to show Berlin that it is able to live up to its self-elected role of global sanctions cop, and prevent others from profiting by Germany’s participation in the network of national, US-led sanctions against Iran.

Invitation To China

The sanctions regime certainly won’t flourish if the Europeans see it as nothing more than an invitation for China to eat their lunch. Treasury Deputy Secretary Robert Kimmitt acknowledged the issue in October 2007: "We hear from the business community that it's a concern of theirs - to act responsibly, only to see someone else act irresponsibly," Kimmitt said in Brussels after talks with four EU commissioners. "The Russians and Chinese have been signatories to each of the UN Security Council resolutions and I would think, whether it be in the financial sector or other sectors, someone else stepping in would be very inappropriate and very counter to what the Security Council has called on the world community to do."

The trouble has always been, of course, that China and Russia have always insisted on following the UN sanctions to the letter and no further - heeding annexes listing a few dozen companies and individuals and hundreds of items of equipment and materials - but declining to endorse the open-ended statement of principles and broad call to action that the US is trying to read into the resolutions.

The headline of a June 2007 report in the Wall Street Journal - which noted a 70% surge in Chinese exports to Iran over the previous year - says it all: "China-Iran Trade Surge Vexes US"

What To Do?

More specifically - and awkwardly - how could the United States extend its reach beyond its own borders and perform the apparently sovereignty-affronting task of interfering in Iran's third-country trade with China without the legal cover of UN Security Council sanctions?

Beyond pressure on allied governments to restrict their export credit facilities to Iran, apparently, the solution chosen by the Treasury Department was to attack Iran’s ability to use the most common financial instrument in international trade - the Letter of Credit or LC - in its import and export dealings with China and other business partners.

The Letter of Credit system relies on a network of cross-border banking relationships that offer payment guarantees and financing to importers and exporters. To a significant extent, the LC is the underpinning of the Asian export miracle since the 1950s and, until recently, it was the backbone of billions of dollars of non-oil trade between China and Iran. The United States has labored mightily to disrupt this system as far as Iran and Asia are concerned and create the risk that both Iranian and export-country banks would be unable to meet their payment obligations because of US harassment.

Typically, a bank will have ties with fewer than 100 international banks - and the names are published in a directory that no doubt saved the officers at Treasury’s Office of Terrorism and Financial Intelligence a good amount of heavy lifting. Since dollar-denominated Letters of Credit largely clear through New York, the Treasury Department was able to convince Iran’s correspondent banks worldwide that handling an Iranian LC made them liable to penalties for violation of US national sanctions.

The US government has in the past imposed sizable penalties for violation of US sanctions - ABN-Amro was hit with an $80 million fine in 2005 - so the risk was genuine and significant. The US also made it clear that U-turn transactions - by which intermediary banks in third countries could strip out references to Iran in dollar-denominated LCs - would be grounds for enforcement actions.

The compliance departments of international banks - responsible for controlling the risk when the bank puts its own assets and reputation on the line in an LC transaction - inserted boilerplate clauses in their LC undertakings not to pay or process Iran-related credits.

On the supply side, Stuart Levey and the US Office of Terrorism and Financial Intelligence (OTFI) jawboned the Chinese government and, in a reprise of the German end-around, also bypassed the Chinese government to pressure Chinese banks directly with the threat of legal proceedings against their US operations if they were caught handling Iranian LCs.

The result was a significant dent in LC-based business between China and Iran as many Chinese banks reportedly decided the risk of US penalties outweighed the benefits of handling Iranian LCs.

Iran sent five delegations to China to try to achieve a workout - and even proposed establishment of a China-Iran bank that would presumably clear all transactions internally without going through New York - but the Chinese demurred. China’s attitude toward the US sanctions campaign against Iran could be characterized as one of grudging outward compliance combined with energetic evasion.

The lesson of Iran sanctions appears to be Trade Will Find a Way - to China - and, if not directly to China, then through Dubai.

The Financial Times reported: "Chinese banks have become very nervous and are reluctant to deal with Iran directly," said a second businessman. "They prefer to work with Iranians who import goods to Iran through Dubai to pretend they export goods to UAE rather than Iran."

Chinese exporter message boards for the last three years make interesting reading. One finds detailed and impassioned accounts of Chinese exporters - and their equally anxious Iranian customers - laboring to work around sanctions, embargoes, and blocked LCs, and deal with the problem of Iranian banks that want to pay them but are unable to move US dollars.

Advice on the message boards was virtually unanimous. Go Dubai. Go euro. And go T/T.

Go Dubai, as in route Iran business through the Middle East entrepot located across the Straits of Hormuz in the United Arab Emirates.

In response to the US sanctions against Iran, there has been a rush of thousands of Iranian businesses and hundreds of billions of dollars of Iranian capital to incorporate in Dubai, which plays the role of free-wheeling Hong Kong to Iran’s socialist PRC, and transact Iran’s business under UAE cover through the banks there.

Next: Dubai's Role In Iran Trade (Part 2)

China Hand is the author of the Asian affairs website China Matters.

(Republished with permission from Japan Focus )