The Declining Dollar's Impact on US Sanctions Enforcement

Below is an article written by Punit Oza, Founder & Director of Maritime NXT on the opening of the United Nations General Assembly (UNGA)

The Declining Dollar's Impact on US Sanctions Enforcement
by Punit Oza, FICS, AFNI, LLC, M.Sc.

The United States has long wielded economic sanctions as one of its most powerful diplomatic tools, leveraging the dominance of the US dollar in global finance to impose its will on adversaries and pressure allies to comply with American foreign policy objectives.

However, the gradual erosion of dollar hegemony in international transactions is fundamentally altering the effectiveness of US sanctions, creating new challenges for American policymakers and potentially reshaping the global economic order.

The Foundation of Dollar-Based Sanctions Power

For decades, the US dollar's role as the world's primary reserve currency has provided Washington with extraordinary leverage over global financial systems. This dominance stems from several interconnected factors that have created what economists call the "dollar trap" - a self-reinforcing cycle where dollar usage begets more dollar usage.

The foundation of this system traces back to the 1944 Bretton Woods Agreement, which established the dollar as the anchor of the international monetary system, and was further cemented after the 1971 Nixon Shock when the US abandoned the gold standard. The subsequent petrodollar system, forged through agreements with Saudi Arabia and other oil producers in the 1970s, ensured that global energy markets would be priced and settled in dollars, creating permanent demand for US currency.

Today, approximately 60% of global foreign exchange reserves are held in dollars, while roughly 40% of international debt securities are dollar-denominated. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, through which most international wire transfers flow, processes about $5 trillion in daily transactions, with an estimated 40% involving dollars. This infrastructure creates multiple chokepoints where US authorities can exercise control.

When the United States imposes sanctions, it effectively threatens to cut targeted entities off from this dollar-centric financial ecosystem. Banks and businesses worldwide face a stark choice: comply with US sanctions or risk losing access to American markets and financial institutions. This secondary sanctions effect has historically made US economic measures far more potent than those imposed by other nations, as non-compliance could result in exclusion from the world's largest economy and its financial networks.

The Treasury Department's Office of Foreign Assets Control (OFAC) has become one of the most feared regulatory bodies globally, with its sanctions lists capable of instantly isolating individuals, companies, and entire nations from international commerce. The Specially Designated Nationals (SDN) list now contains over 6,000 entries, and violations can result in penalties reaching into the billions. Major European and Asian banks have paid over $20 billion in fines for sanctions violations since 2009, demonstrating the reach and enforcement power of dollar-based restrictions.

Historical Precedents and Evolution

The modern sanctions regime has evolved significantly since the Cold War era. Early sanctions programs, such as those against Cuba beginning in 1960, were primarily trade-based embargoes that relied on US market access rather than financial leverage. The transformation began in earnest following the September 11 attacks, when the US began aggressively using financial intelligence and banking regulations to combat terrorism financing.

The Iran sanctions program, particularly after 2010, became the template for modern financial warfare. By targeting Iran's central bank and threatening secondary sanctions against any institution conducting business with Iranian entities, the US essentially forced global banks to choose between Iranian and American markets. The result was Iran's near-complete isolation from the international financial system, contributing to a collapse in oil exports from 2.5 million barrels per day in 2011 to fewer than 1 million by 2013.

Similarly, the sanctions imposed on Russia following its 2014 annexation of Crimea demonstrated the speed and scope of dollar-based financial restrictions. Major Russian banks found themselves unable to access international capital markets, while energy companies lost access to Western technology and financing. The 2022 escalation following Russia's invasion of Ukraine saw unprecedented measures, including the freezing of Russian central bank reserves and the partial exclusion of Russian banks from SWIFT.

Emerging Challenges to Dollar Hegemony

Several structural shifts in the global economy are now undermining the dollar's monopolistic position in international finance. The most significant challenge comes from China's systematic effort to internationalize the renminbi and create alternative financial infrastructure. Beijing's strategy operates on multiple levels, from bilateral trade agreements that bypass dollar settlements to the development of competing international institutions.

The Belt and Road Initiative has created new trade corridors where transactions increasingly occur in renminbi or through bilateral currency swaps, reducing dependence on dollar clearing systems. China has signed currency swap agreements worth over $500 billion with more than 40 countries, enabling direct trading without dollar conversion. The China International Payment System (CIPS), launched in 2015, now processes over $12 trillion annually and connects more than 1,300 financial institutions across 100 countries.

Russia's response to Western sanctions has accelerated the development of alternative financial infrastructure. Moscow's pivot toward yuan-denominated energy transactions with China and India demonstrates how sanctioned nations can adapt to circumvent dollar-based restrictions. In 2023, China became Russia's largest trading partner, with bilateral trade reaching $240 billion, much of it conducted in yuan. Russia has also developed its own financial messaging system, SPFS, which now connects over 400 users and has signed cooperation agreements with similar systems in other countries.

The European Union's own frustrations with extraterritorial US sanctions have led to initiatives designed to reduce dollar dependence. The Instrument in Support of Trade Exchanges (INSTEX), created to facilitate trade with Iran, represents European efforts to maintain economic relationships despite US sanctions. While INSTEX has had limited success, it signals growing European willingness to challenge US financial dominance when it conflicts with European interests.

Central bank digital currencies (CBDCs) represent another potential challenge to dollar dominance. Over 100 countries are exploring or developing CBDCs, with China's digital yuan leading in both technological sophistication and adoption. The digital yuan enables direct peer-to-peer transactions without traditional banking intermediaries, potentially allowing for sanctions-resistant international payments. Pilot programs have already demonstrated cross-border functionality with Hong Kong and other jurisdictions.

The Cryptocurrency Wild Card

The rise of cryptocurrencies adds another layer of complexity to sanctions enforcement. While Bitcoin and other major cryptocurrencies are not truly anonymous, they do provide alternatives to traditional banking systems that can complicate sanctions enforcement. North Korea has reportedly generated hundreds of millions of dollars through cryptocurrency theft and mining operations, using these funds to support its nuclear program despite comprehensive international sanctions.

However, the regulatory landscape around cryptocurrencies is rapidly evolving. The US has increasingly used existing sanctions authorities to target cryptocurrency addresses and exchanges, while developing new tools for blockchain analysis. The 2022 sanctions against Tornado Cash, a cryptocurrency mixing service, demonstrated US willingness to target decentralized finance protocols. Nevertheless, the emergence of privacy-focused cryptocurrencies and decentralized exchanges continues to present challenges for traditional sanctions enforcement.

Regional Financial Fragmentation

The global financial system is experiencing increasing regionalization as countries seek to reduce dependence on dollar-based systems. The ASEAN+3 monetary cooperation framework has established the Chiang Mai Initiative, a $240 billion currency swap arrangement that allows member countries to support each other during financial crises without relying on US institutions.

In South America, countries have increasingly turned to bilateral trade agreements denominated in local currencies. Argentina and Brazil have discussed creating a common currency for regional trade, while both countries have expanded trade with China using yuan settlements. These developments reflect a broader trend toward regional financial integration that reduces exposure to US sanctions.

The Middle East has seen similar developments, with the UAE and Saudi Arabia both exploring digital currencies and alternative payment systems. The recent Chinese-brokered rapprochement between Saudi Arabia and Iran included discussions about non-dollar trade mechanisms, potentially undermining one of the key pillars of dollar recycling.

Technological Disruptions and Adaptations

Advances in financial technology are creating new possibilities for sanctions circumvention while also providing new tools for enforcement. Artificial intelligence and machine learning are being deployed both to detect sanctions violations through pattern analysis and to develop more sophisticated evasion techniques.

The rise of fintech companies and digital payment platforms has created new intermediaries that operate outside traditional banking oversight. While many of these platforms have implemented compliance programs, the sheer volume and complexity of digital transactions make comprehensive monitoring increasingly difficult.

Distributed ledger technology beyond cryptocurrencies is also creating new possibilities for international settlements. Trade finance platforms using blockchain technology can facilitate transactions without traditional correspondent banking relationships, potentially reducing the leverage that dollar-based sanctions provide.

Strategic Responses and Adaptations

The United States has recognized these challenges and begun adapting its sanctions strategy accordingly. Recent measures have focused more heavily on targeting specific technologies and supply chains rather than relying solely on financial isolation. The semiconductor sanctions against China represent this shift toward more granular, technically-focused restrictions that are harder to circumvent through alternative payment systems.

Export controls have become increasingly sophisticated, targeting not just finished products but also the equipment and materials needed to produce sensitive technologies. The Entity List maintained by the Commerce Department now includes over 600 Chinese companies and institutions, effectively cutting them off from US technology regardless of payment mechanisms.

Enhanced surveillance and enforcement mechanisms are also evolving to address new challenges. Treasury's use of blockchain analysis to track cryptocurrency transactions represents a significant technological upgrade in sanctions enforcement capabilities. The department has established dedicated teams focused on digital assets and has expanded cooperation with international partners to monitor alternative payment systems.

Diplomatic efforts have intensified to maintain sanctions coalitions and prevent defection by key allies. The coordination of sanctions packages among G7 nations and NATO allies demonstrates recognition that unilateral US measures may become less effective as alternative financial systems mature. The creation of multilateral sanctions coordination mechanisms, such as those established for Russia sanctions, shows how enforcement is adapting to a more multipolar financial world.

Economic and Political Ramifications

The declining effectiveness of dollar-based sanctions has significant implications for US foreign policy and global economic stability. Traditional allies have become more willing to challenge US sanctions when they conflict with national economic interests. European companies have increasingly sought US government licenses to maintain business relationships with sanctioned entities, while some have restructured operations to reduce US jurisdiction exposure.

The fragmentation of global financial systems also creates risks for economic stability. Multiple clearing systems and currency blocs could lead to reduced liquidity and increased transaction costs. The potential for financial balkanization raises concerns about the ability to coordinate responses to future financial crises.

For developing countries, the emergence of alternative financial systems provides new options but also new complexities. While reduced dollar dependence might offer greater policy autonomy, it also requires building new institutional relationships and technical capabilities.

Long-term Implications for Global Economic Architecture

The gradual decline of dollar-based sanctions effectiveness reflects broader shifts in global economic power. As multiple reserve currencies emerge and alternative financial systems mature, the international monetary system appears to be evolving toward greater multipolarity. This transition could fundamentally alter how economic coercion operates in international relations.

Regional financial blocs may become more important as countries seek to insulate themselves from external sanctions pressure. The success of regional payment systems and currency arrangements will likely determine whether the global financial system fragments into competing blocs or evolve into a more balanced multipolar system.

The role of international institutions may also evolve. Traditional bodies like the IMF and World Bank, which have been closely aligned with Western interests, may face competition from alternatives like the Asian Infrastructure Investment Bank and New Development Bank. This institutional competition could lead to more diverse approaches to economic governance and development financing.

Conclusion

The declining dominance of the US dollar in international finance represents a fundamental challenge to American sanctions policy and, more broadly, to US global economic leadership. While dollar-based restrictions remain powerful tools, their effectiveness is gradually eroding as alternative payment systems mature, regional financial integration advances, and economic multipolarity increases.

This transition requires fundamental adaptations in how the United States approaches economic statecraft. Greater emphasis on multilateral coordination, more sophisticated targeting mechanisms, and recognition of the limits of financial coercion will be essential. The development of new enforcement technologies and diplomatic strategies will determine whether the US can maintain meaningful sanctions capabilities in a more fragmented financial world.

The implications extend far beyond sanctions policy, potentially reshaping the entire architecture of international economic relations. The emergence of competing financial systems could lead to a more balanced but also more complex global economy, where economic leverage must be carefully calibrated and diplomatically sustained. The challenge for policymakers will be navigating this transition while maintaining stability and preventing the complete fragmentation of global financial systems. The outcome will significantly influence the distribution of economic power and the conduct of international relations in the decades ahead.

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Mr. Punit Oza is the Executive Director at Singapore Chamber of Maritime Arbitration and has over 27 years of experience in Dry Bulk Shipping, holding senior management positions in some leading shipping and trading companies. Punit started his career in 1993 with Precious Shipping in Bangkok and then went on to work with Aries Shipbroking in Singapore, Astra Shipping in Dubai, Noble Chartering in Hong Kong and Torvald Klaveness in Singapore. Since January 2020, he has moved into the board of Klaveness Asia Pte Ltd as a non-executive director. Punit is also the Vice-Chairman of Singapore Branch of Institute of Chartered Shipbrokers.

Punit is a graduate in Financial Management and Accounting from University of Mumbai and a postgraduate in Shipping, Trade and Finance from CASS Business School, London. He also holds an LLB and Post Graduate Diploma in Maritime Law from University of London.