Photograph via Flickr by the Secretary of Defense.

A sharp drop in the value of the Iranian currency as a result of new American sanctions may sound like good news to hawks in the U.S. But actually this development may signal ways in which Americans will also be harmed, and Obama may have put a second term in jeopardy, cutting off his nose to spite his face.

An amendment to the National Defense Authorization Act signed by President Obama this past weekend will seek to slap third party sanctions on countries and enterprises that deal with Iran’s central bank. It will go into effect this summer. In effect, the law says that if you buy Iranian petroleum, you cannot do business with American financial institutions. Since the United States is still over a fifth of the world economy, and most institutions with capital need to deal with it, the hope of Congress is that Iran will be left without customers.

The measure, pushed by the American Israel Public Affairs Committee on behalf of the government of Israeli Prime Minister Binyamin Netanyahu, might well be a trap for Obama. In an election year, he could not refuse to endorse new sanctions against Iran (the Republican candidates in Iowa are practically running on promising that if elected they will launch a war on Iran; and they are lambasting the president as weak on this issue).

But the new sanctions may well hurt Obama’s own election chances. Iran’s military exercises in the Persian Gulf, aimed at reminding the world that it can play the spoiler and stop one-sixth of the world’s petroleum from reaching the market, helped put Brent crude up to $108 a barrel, a spike helped along as well by news of a jump in Chinese manufacturing.

Those two factors, the likelihood of rising Asian demand for petroleum in 2012, and investor nervousness about how tensions with Iran will play out, will probably keep petroleum prices at historically high levels in 2012, and some analysts believe that there could be a return to the overheated pricing of 2008 before the crash.

It would be much better for the American economy if prices sank back down to the levels of only a few years ago, of $50 a barrel or less.

If the Congressional sanctions actually worked, and took Iran’s roughly 2.5 million barrels a day in exports off the world market, that would take out 80 percent of Iran’s export income and deeply hurt the regime. But it would also send world petroleum prices through the stratosphere, deeply harming Western economies already teetering on the edge.

[T]he non-NATO world will likely find workarounds to thwart these new U.S. sanctions sufficiently to allow the regime to survive, even if they do add to the cost of peteroleum and so harm U.S. recovery.

Actually, I have to wonder whether the fall in the value of the Iranian currency might not even be good for the country. Nations with pricey primary commodities such as petroleum suffer an artificially hardened currency. In turn, that makes it expensive for outsiders to buy what they make, leading to stagnating industry. Softening the currency should help Iranian exports, a key element of the economy. Iran has had a crash program to expand its non-oil exports, with some success.

Obama cannot hope for decisive help from the only quarter able to offer it in the short term, Saudi Arabia. The Saudis were willing, in the late 1970s, to flood the petroleum markets with their excess capacity for political gain. But Riyadh now no longer wants inexpensive petroleum, because the king is using extra petroleum receipts to bribe the Saudi population into repudiating any “Arab Spring” inside the kingdom. The Saudi government has expanded subsidies so much, in a quest to mollify a formerly angry public, that it probably cannot afford them if prices fall too much. Hence, the Saudis cannot pull Obama’s bacon out of the fire, though they could try to blunt the force of the crisis by pumping an extra million barrels a day or so.

Moreover, the sanctions on those who deal with Iran’s central bank threaten profound harm to the economies of American allies. South Korea is deeply worried about their impact and will seek an exemption. South Korea imports roughly $11 billion a year of petroleum and other products from Iran and sells Iran $6 bn. worth of South Korean manufactures—automobiles, etc. If Seoul cannot buy Iranian petroleum (some 10 percent of its oil imports), that would hurt its economy. If it cannot receive payment from Iran for Hyundais and other exports, that would hurt its economy. In short, some $16 billion a year in trade is at stake for South Korea. That is about 5 percent of its external trade, a significant hit. And, energy is not like just any other import—it is foundational. In a world where petroleum supplies are already tight, it will not be easy or maybe even possible for all of Iran’s former customers (should they cut Iran off as the U.S. Congress urges) to make up the shortfall from other sources.

In fact, the non-NATO world will likely find workarounds to thwart these new U.S. sanctions sufficiently to allow the regime to survive, even if they do add to the cost of peteroleum and so harm U.S. recovery. Venezuela opened a binational bank with Iran in 2009, which provides a back door for Iranian financial transfers in Latin America.

Russia says it will refuse to cooperate with new sanctions.

And India, for instance, has found ways to pay Iran for its petroleum without dealing directly with an Iranian bank. It uses Halkbank in Turkey. There is talk of simply setting up new private banks in each other’s countries, which would not be under U.S. sanction. There are admittedly drawbacks to the current ad hoc arrangements. Without the security of bank transactions, Indian exporters to Iran are reduced to dealing on a basis of trust with importers. And, Iran this fall was reluctant to accept payment in rupees held in Indian accounts because of a steep decline of the rupee against the dollar. (Iran may rethink this skittishness, given the similar decline in its own currency provoked by the new American sanctions). Still, India needs the petroleum it imports from Iran, and needs to sell its made goods to Iran, and it is likely that ways will be found to keep that trade going, whether the U.S. Congress likes it or not.

For its part, China has been paying for Iranian petroleum with Euros, and if that becomes difficult they are considering just paying in Chinese yuan. China’s Sinopec petroleum company seems completely unafraid of U.S. sanctions and is actually helping develop Iranian fields, something that was already sanctionable under U.S. law. Iran now does $30 billion a year in trade with China, something that the U.S. probably can do nothing about. China and Iran, it is true, have been having some tough negotiations on prices going forward, and China has been able to resort to Saudi Arabia, Libya and Iraq to make up the petroleum shortfall from Iran while the two countries are playing hard ball. But a) this tiff will probably be over by March; b) China is likely to continue to import a lot of petroleum from Iran and c) the world petroleum market is not so saturated that China can probably permanently reduce its reliance on Iranian sources. If it did, that would make it harder for other countries to do so.

In short, even Congress’s more severe sanctions and targeting of Iran’s Central Bank are likely to be ultimately ineffective in changing Iranian policy or undermining the regime. The international community will find work-arounds and close U.S. allies like South Korea, facing major economic consequences, will lobby hard for exemptions. Obama, who was forced into this law and had opposed it, has every reason to grant the exemptions. In other instances, the NDAA will cause American will to be tested. It will take a lot of impudence to attempt to impose sanctions on Chinese banks for dealing with Iran, when Chinese finance is so important to propping up the U.S. economy.

An Iran with its back against the wall will be a formidable adversary for the U.S. and its allies in the Middle East. The 20,000 U.S. personnel at the massive American embassy in Baghdad are vulnerable to reprisals by Iraqi militias allied with Iran. The American war effort in Afghanistan depends for success on Iranian good will. And, Iran can put up petroleum prices incessantly with just a little saber-rattling.

In signing the NDAA (which also allows the U.S. military to arrest Americans anywhere in the world and to hold them indefinitely without trial), Obama has likely done harm to himself. Iranians will suffer some inconveniences and ordinary people may face real hardship in Iran. But the ayatollahs will still have their billions, and the regime will go on enriching uranium and supporting Syria and Hezbollah. The U.S., on the other hand, will suffer massive opportunity costs (i.e. it won’t do all kinds of things in the economy that it might have otherwise) from a policy of keeping petroleum prices artificially high by bothering Iran.


This post originally appeared at Informed Consent.

By arrangement with Informed Consent.

Juan Cole

Juan Cole is the Richard P. Mitchell Professor of History and the director of the Center for South Asian Studies at the University of Michigan. His latest book, Engaging the Muslim World, is just out in a revised paperback edition from Palgrave Macmillan. He runs the Informed Comment website.

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