Weaponized Dollars

The Eurodollar system is offshore, but ultimately, all dollar banking transactions no matter the origin will have a link to the U.S. banking system. After all, offshore dollars would not really be dollars if they were not fungible with onshore dollars. The U.S. government has authority over the U.S. banking system, and by extension, over the offshore banking system. This implies that the U.S. government has authority over virtually every dollar transaction done through the banking system in the entire world. Let’s walk through an example to see how this works:

Suppose a bank in Kazakhstan named KBank has a dollar loan business. KBank makes a $1000 loan to its client and credits its client’s account for $1000. The client then withdraws that $1000 to pay a U.S. supplier who banks with a U.S. bank, named UBank. KBank is going to have to settle a payment of $1000 with UBank. There are two ways it can do this: 1) if it has a reserve account at the Fed, then it can send UBank a wire for $1000 in reserves or 2) if it holds its dollars as a bank deposit at a U.S. commercial bank, then it will have to ask that commercial bank to send UBank $1000 in reserves. In the second case, KBank’s U.S. commercial bank will send $1000 in reserves to UBank while reducing KBank’s deposit balance on its books by $1000. In either example, the transaction must go through the U.S. banking system.

This would be the same even if KBank kept its dollar deposits at a non-U.S. commercial bank and the supplier banked with a non U.S. commercial bank. Suppose KBank held its dollars as bank deposits at a commercial bank in London and the supplier banked with a commercial bank in Paris. In that case then KBank would ask its London bank to send the supplier’s bank in Paris $1000. Assume that the London bank holds its dollars at a U.S. commercial bank, who has a Fed account, and that the Paris bank went through the trouble to open a Fed account, so it did not need to hold its dollars at another commercial bank. Then the London bank will ask its U.S. commercial bank to wire $1000 into the French bank’s account, who would then credit the supplier’s account. The U.S. commercial bank would send the Paris bank $1000 in reserves. Even though both banks are foreign, the dollar transaction ultimately has to go through the U.S. banking system.

The U.S. government, through its control of the U.S. banking system, has the power to shut anyone out of the dollar banking system. If the U.S. government decides that someone should be sanctioned, then that person will not be able send or receive dollars through commercial banks anywhere in the world. Banks take these sanctions very seriously because if they are caught violating them, then they may also be shut out of the U.S. banking system. That would be a death sentence to any bank. In June of 2014, BNP Paribas admitted to helping Sudan, Iran, and Cuba evade U.S. sanctions and move money through the U.S. banking system. They were forced to pay a breathtaking fine of $9 billion.

In recent years, the U.S. government has shown greater willingness to use its control over dollar payments to further its policies. This is arguably the most powerful nonlethal weapon it possesses as exclusion from the global dollar system would send most into the Stone Age. Iran, who has been sanctioned by the U.S. and the Eurozone, now must sell oil for payment in gold.

Excerpted from Central Banking 101.