How the Iran Sanctions Could Also Hurt North Korea

Sanctions are a complex technology with correspondingly complex macro- and microeconomic as well as political effects. Iran is currently facing quite draconian oil-related sanctions, most notably the  EU decision in January 2012, to wind down purchases of Iranian crude oil by July 1, 2012. But the country has also been hit by a wave of complex financial sanctions that may be of interest to North Korean watchers; we focus on those here, although their effects will be compounded by the squeeze on oil.

Some background: United Nations Security Council Resolution (UNSCR) 1929 of June 2010 includes targeted asset freezes but also calls upon all states to prevent the provision of financial services to Iran if they "could" contribute to Iran's nuclear aspirations. The resolution specifically mentions the need for "vigilance" with respect to the banking system and possible connections between the energy industry and the funding of the nuclear program.

As with the North Korea sanctions resolutions, these measures are designed to establish a floor defining what countries are obligated to do, not a ceiling. The European Union, Canada, Japan, South Korea, and Australia as well as the United States have subsequently promulgated rules significantly limiting Iran's access to their financial systems.

President Obama signed the Comprehensive Iran Sanctions, Accountability, and Divestment Act (CISADA) in July 2010, which was followed by a detailed set of guidelines by Treasury in August 2010 (the Iranian Financial Sanctions Regulations [IFSR]; the Treasury sanctions page can be found here). The IFSR prohibits entities owned or controlled by US financial institutions from benefiting Iran's Islamic Revolutionary Guard Corps.

But like the Iran and Libya Sanctions Act of 1996—which sanctioned foreign companies investing in the Iranian oil sector—the new sanctions also have a crucial extra-territorial component. Foreign financial institutions that engage in proscribed transactions also risk having correspondent banking relations in the United States curtailed. Given the continuing centrality of the United States to world financial markets, most multinational banks are unlikely to take this risk. In the wake of the November 2011 International Atomic Energy Agency (IAEA) report—on which we commented in detail—the Administration issued an Executive Order under the International Emergency Economic Powers Act (IEEPA) which further expanded secondary or extra-territorial sanctions on firms providing goods and services to the oil, gas, and petrochemical sector. Again, for any major suppliers of relevant technologies, the threat of such secondary sanctions poses a substantial risk.

Then on February 5 of this year came Executive Order 13599 "Blocking Property of the Government of Iran and Iranian Financial Institutions." It is worth reading. Iranian banks—including the Iranian Central Bank—naturally tried to circumvent all of the sanctions outlined above by hiding proscribed transactions. The new executive order not only blocks transactions but actually freezes the assets of these institutions in the United States.

But perhaps the body blow to the Iranian financial system is coming from the Europeans. Following an EU Council decision, it was clarified that the EU sanctions extend to the operations of the Society for Worldwide Interbank Financial Telecommunication or SWIFT because it is incorporated in Belgium. SWIFT posted a short, almost stunned, announcement on its website in mid-March. This member-owned entity provides the technical platform for the exchange of financial information among more than 10,000 banks and thus provides a crucial complement to the international clearing system. In effect, as of March 17, 30 major Iranian banks now face substantial—even debilitating—hurdles in conducting everyday business with their foreign counterparts.

The New York Times' Rick Gladstone wrote an intelligent piece capturing some of the effects these sanctions are having; we extend the list here.

1. As in Venezuela, North Korea, and other closed economies, Iran maintains an official exchange rate (12,260 rials to the dollar); access to foreign exchange at this rate is obviously rationed. The black market rate has been pushed to about 19,000 rials to the dollar. Similar dynamics are visible in North Korea.
2. But clamping down on this market is really not feasible; North Korea is currently making the effort to ban the use of foreign currency, but the likelihood they will succeed is nil. The Iranian government has given up the ghost and tried to ease restrictions on traders, in part to have more information on the market rate.
3. Easing trade in dollars is a mixed blessing, however, because it may facilitate capital flight as Iranians bet on further depreciation.
4. In addition to excess demand for dollars, gold and other precious metals are also in high demand as a hedge against depreciation;
5. Since the sanctions make ordinary trade difficult, the country is being pushed back into barter arrangements, including for key commodities. Pakistan has recently agreed to provide wheat to Iran on this basis.
6. Of course, the sanctions have a number of potential humanitarian pitfalls. Juan Cole's Informed Comment makes the case against them on these grounds. One concern is that depreciation of the rial translates rapidly into higher prices for food. We have noted similar dynamics in North Korea

By contrast with the situation relating to North Korea, a number of American firms are getting caught in the crossfire because permitted trade is effectively blocked by the inability to receive payment; MSNBC provides an exemplary story. But the more interesting political development is that third countries were scrambling furiously to get exemptions from the American banking sanctions, a sure sign that the sanctions matter. Japan and 10 European countries were granted waivers last week; Turkey is scrambling but the interesting issue will be the effects of the secondary sanctions on China, India, and Russia.

North Korea does not export oil. In some sense, it lacks the "protection" of a strategic commodity on which importers are reluctant to impose sanctions. Yet the Iranian case demonstrates that once that Rubicon is crossed, reliance on a mono-export can be devastating. Ironically North Korea appears less vulnerable in this sense. China also provides a shield; Iran's trade is more diversified.

If North Korea is possibly less vulnerable than Iran in trade terms, the reverse could be true with regard to finance. Iran's network of international financial linkages are more diversified than North Korea's, as demonstrated by the data from the SWIFT annual report reproduced above. North Korea has fewer participant banks, fewer counterparties, and vastly fewer transactions (though to be sure, as much of the North's activity may be through non-SWIFT channels). Indeed, North Korea's activity through the SWIFT network is actually shrinking.

The paucity of external financial links creates vulnerability as the case against the Macao-based Banco Delta Asia (BDA case) demonstrated a few years ago, and the North Koreans have been trying to rectify ever since. A recent comment on the blog by Roger Cavazos suggests that the SWIFT plug be pulled on North Korea as well.

Sanctions may not have political effects—at least on their own—but to say they have no economic effects is misguided. Many of the economic dynamics visible in Iran are playing out in North Korea as well.