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Mar 16 2012

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Pressure Builds on Iran With New Sanctions

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Down to the End Game

During the three plus years of the Obama presidency, one charge by the President’s critics seems to irritate his supporters more than any other – that the President is a closet socialist.

That narrative has been supplemented on the campaign trail where the GOP presidential contenders regularly question the President’s understanding of market economics as part of an indictment of his economic policy and performance.

So how ironic is it that President Obama is apparently using capitalism as the principle tool to undermine Iran, as the West seeks a path to deal with the renegade Iranian nuclear program.

It is not obvious at first, but it does appear that the Obama sanctions policy against Iran is carefully designed to gravely destabilize the Iranian economy, with a hopeful knock on effect for the Iranian government; either making it more pliable to real and effective controls on the nuclear program, or with a new government altogether, enabled by the Iranian people.

Critics of economic sanctions may want to take a second look on recent international moves by the West regarding Iran.

In December, President Obama signed into law a provision banning foreign banks from operating in the US if those institutions do business with the Central Bank of Iran.  That was followed by European action where the EU froze Iranian Central Bank assets, and announced an oil embargo beginning in July.

These new sanctions appear to have had an effect.

Since December, the Iranian currency – the Rial – has been in a free-fall, losing between 50-60% of its value.

This has caused a mini-panic within Iran, where the costs of imported goods have skyrocketed, and the availability of foreign hard currency has all but dried up, complicating any Iranian export-import businesses.

This fluctuation in value has in turn, rippled into the large banks and trading houses in the UAE, where Iran finances the largest chunk of its business,  which have all but ceased dealing in Iranian Rials, both due to currency volatility and the risks from international sanctions.

Mohamed al-Ansari, chairman and managing director of Al Ansari Exchange, one of the UAE’s top two exchange houses where a heavy portion of Iranian trade is done, said the weakness of the Rial, which saw its black market rate roughly halve against the U.S. dollar in the year to January, had made it too risky to handle the currency.

Clearly the US and European moves earlier this year seek to turn internal Iranian economic problems into a tool of international leverage on the Iranian nuclear program.

According to the CIA Factbook:

Iran’s economy is marked by an inefficient state sector, reliance on the oil sector, which provides the majority of government revenues, and statist policies, which create major distortions throughout the system.  Price controls, subsidies, and other rigidities weigh down the economy, undermining the potential for private-sector-led growth.”

Simply put, without oil revenues, the heavily regulated and uncompetitive Iranian economy cannot function.

The new sanctions by the US and EU go beyond targeting oil as a commodity, which over 20 years has failed to influence Iranian behavior, and moved to utilize Western dominance in international finance to deprive Iran of the ability to finance its trade on global markets.

That effort was greatly expanded yesterday when a little-known Belgium-based company that facilitates most international bank transfers took the unprecedented step of blocking 30 Iranian banks from using its service.

The Society for Worldwide Interbank Financial Telecommunication, or SWIFT, said it was complying with  recent European Union sanctions to discontinue service to the Iranian banks beginning Saturday, apparently including a key financial player, the Central Bank of Iran.

 SWIFT is a secure private network used by nearly every bank around the world to send payment messages that lead to the transfer of money across international borders.

With Iran effectively expelled from SWIFT, Western nations make it more difficult for Iran to sell oil even to willing customers, such as China and India.

While there are other methods to finance international purchases – using precious metals or loans from other central banks from friendly (read Russia/China) countries – these avenues are complicated, time consuming and risky.

The potential damage to the Iranian economy and for average Iranians is real.

Nineteen banks and 25 affiliated institutions from Iran exchanged a total of 2 million cross-border payments using SWIFT in 2010. This will come to an end without an immediate replacement vehicle.

“This is like our lifeline to the outside being cut,” Naser Shaker, who owns an oil and gas trading company in Dubai, told Reuters. “All the transactions will be stopped. Through the banks, there are no more options.”

Morteza Masoumzadeh, of the executive committee of the Iranian Business Council in Dubai and managing director of the Jumbo Line Shipping Agency, said it was “devastating news”.

“If Iranian banks cannot exchange payments with banks around the world then this will cause the collapse of many banking relations and many businesses,” he said.

Overall, Iran exports $131 billion per year (2011) and imports $76 billion (2011).  With sanctions effectively shutting down the primary conduit to finance trade, Iran becomes a de facto “walled island,” crippling this trade.

Already unemployment in Iran is running at 15%. Inflation, which was running at 22.5% before the the new sanctions is sure to skyrocket geometrically, destroying the purchasing power of average Iranians, as scarcities of staples becomes real and enduring.

The Iranian government will thus be under tremendous pressure to stabilize the domestic situation through additional subsidies, but this will occur against a backdrop where sanctions will lead to less oil sales, depriving the Iranian Treasury of resources at a time when it needs them the most. Indeed, financial subsidies alone cannot create the imports of food and goods that the Iranians need and will not be able to access.

Simply put, the Iranians are not in a position to cope with externally imposed autarky.

While there are loopholes in any sanctions regime, and friendly governments can ease some specific economic impacts, closing down Iranian access to international finance creates an existential dilemma for Iran’s rulers, with three possible outcomes: 1) compromise the nuclear program, 2) cope with an inevitable internal uprising circa 2009, 3) war.

In 1941, in response to a US oil embargo that would have crippled Japan’s economy in a matter of months, the militarists in Tokyo decided that war was a better solution than compromise with the US.

Pearl Harbor was the result.

By finally marshaling the full scope of economic sanctions to focus on an area of deep vulnerability, the Obama administration and the West have taken some of the last non-military steps to influence Iranian nuclear behavior.

The next move is Iran’s – either its leaders or its people.

 

 

 

 

 

 

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