Mugging the Mullahs

February 20, 2009 Topic: Economics Region: Persian GulfMiddle East

Mugging the Mullahs

America’s sanctions against Iran are working better as of late. To turn up the heat even more, we should start a run on the rial.

Over the last quarter of a century, economic sanctions have become an increasingly important weapon in the U.S. foreign-policy toolkit. Yet, the American government doesn't seem to know how to make "smart" sanctions against Iran. With the Obama administration's attention focused on Tehran, U.S. national-security experts are again recommending questionable economic sanctions. The formulation of smart economic sanctions requires a deep familiarity with the economy and power structure of the target country. Sanctions should scare the regime in power into changing its objectionable policies by placing direct pain on the members of the regime or causing real threats to the regime's survival, while minimizing the hardship of innocent citizens. This simple formula seems to have eluded U.S. security experts when it comes to Iran.

Blunt sanctions designed to disrupt Iran's exports or imports have had little impact. The world needs Iran's oil, especially when the oil market is tight. If the United States does not buy Iranian oil, others will. Tehran can get almost anything it wants with the cash it earns from oil, albeit at a slightly higher price. The United States has also banned investments in Iran and has pressured other countries to follow. This has undoubtedly limited the development of Iran's oil and natural gas industry, somewhat reducing the regime's access to cash. But it has also hurt energy importers by restricting global supplies, increasing prices. The United States has also adopted garden-variety financial sanctions, such as freezing the assets of Iranian financial institutions and of those in power in Tehran. Although these measures have had some effect, recently more focused financial sanctions have pierced the mullahs' cloak for the first time.

In 2007, the United States began to develop more targeted financial sanctions designed to isolate Iranian banks from the international markets. This has increased Iran's cost for letters of credit and thus the price of imports by about 15 percent. On November 6, 2008, the Treasury Department further tightened the screws on Iran by revoking its U-Turn License. When a foreign company or a country bought Iranian oil, it ordered American banks to issue funds in favor of an Iranian bank. The revocation of this license means that U.S. banks cannot make such dollar transfers to Iranian financial institutions, essentially cutting Iran's access to the U.S. financial system. On November 26, 2008, the U.S. Treasury expanded its definition of financial institution to include the National Iranian Oil Company (NIOC) and its subsidiaries, prohibiting transactions with NIOC worldwide.

Turning to the present, a number of renowned U.S. foreign-policy experts are recommending an embargo on Iran's gasoline imports and more stringent, but unspecified, financial sanctions.

A ban on Iranian gasoline imports, while sounding threatening, is just plain silly. To actually cut off the flow of gasoline into Iran, the United States would have to take up a naval and land embargo-a very dangerous option and tantamount to a declaration of war-or get multilateral support, an unlikely possibility. More importantly, if the United States were successful in this quest, it would be doing the regime in Tehran a big favor! Iran's fundamental economic policy mistake has been a system of all-pervasive subsidies, especially of gasoline, which alone has been equivalent to an astonishing 15-20 percent of Iran's GDP in recent years. The government has tried for over two decades to eliminate this wasteful measure but has been afraid to do so for fear of a domestic backlash. If the United States tries to ban Iran's gasoline imports, thus reducing gasoline consumption, it would actually be doing the regime's work. The mullahs would say that this is "Great Satan's" doing and all Iranians have no choice but to tighten their belt. As if by magic, Iran's gasoline consumption would decline with little threat to the regime.

Yes, foreign-policy experts are correct that financial sanctions have been more successful. But "more stringent financial sanctions" as such experts recommend could be anything-or just more of the same. Let me explain what the United States needs to do.

Faced with tumbling oil prices, Iran is rapidly facing a foreign-exchange crisis. The problem has been years in the making because the government has increased credit rapidly and used its foreign-exchange earnings to support the value of the Iranian rial within a narrow range to the dollar. The United States should adopt smart sanctions to rapidly draw down Iran's dwindling financial reserves and further isolate Iran's financial system. America must adopt policies to start a run on the rial, placing further pressures on Iran's rapidly declining financial reserves. We should also encourage the United Arab Emirates and Malaysia to cut off all financial cooperation with Iran.

These sanctions would weaken Tehran, induce the mullahs to be more forthcoming in negotiations and announce to Iran and beyond that American rhetoric carries more bite than bark.


Hossein Askari is the Iran Professor of Business and International Affairs at the George Washington University.