Chaos Theory: Sanctions in Practice

Chaos theory is a branch of mathematics that says that random events actually follow patterns that are heavily dependent on the initial conditions. Simply put, how things behave chaotically depends on the initial shove to the otherwise-stable environment – but, ultimately, they are logical, not random. Sadly, this describes the current state of U.S. relations with Iran. Not only could we have predicted the recent current events, but we can reasonably extrapolate to what is likely to transpire over the near term.

Relative stability

The Joint Comprehensive Plan of Action (JCPOA), which was implemented in January 2016, initiated a multiyear period during which relatively few provocative moves by any of the signatories occurred. While Iran continued to provide support for terrorist groups and insurgencies around the Middle East, and continued development of ballistic missile technology, the International Atomic Energy Agency (IAEA) continued to certify that the terms of the agreement that prevented the continued development of nuclear weapon technologies were being met by Tehran. While one might quibble with the breadth of the JCPOA, there were no apparent breaches of the agreed-to elements.

In addition, as Paul Pillar wrote on the Responsible Statecraft blog, during this period of comparative calm, Iran was not trying to impede the global trade of petroleum and related products by attacking pipelines and oil tankers. Nor were Iranian forces or proxies targeting Western forces in the regional skirmishes it was engaged in.

2018: The first domino

The May 2018 withdrawal of the United States from the JCPOA, followed by the two-phase reinstatement of both primary and secondary sanctions that had been removed in 2016, set the trajectory of the two main antagonists on a collision course. While the actual level of commerce between the U.S. and Iran that had been created under the JCPOA was modest (since primary sanctions were still in place for a significant number of parties, and firms were skittish about the prospects of the restrictions being reimposed under the agreement’s “snap-back” feature), the removal of secondary sanctions had created an opening for European firms to trade with Tehran. When those secondary sanctions were reimposed and the parties that had been removed from primary sanctions restored to the Specially Designated Nationals (SDN) List, E.U. firms with significant U.S. business interests also cut ties with Iran, fearful of losing access to the larger American market.

Nature abhors a vacuum

In response to the U.S. withdrawal, the European Union agreed to provide the sanctions relief that had previously brought Tehran to the negotiating table. The Instrument in Support of Trade Exchanges (INSTEX), a barter-like system for trading with Iran denominated in euros, was intended to facilitate trade not subject to secondary sanctions while avoiding use of the U.S. financial system, where such transactions would have been stopped and the funds frozen. It was also only intended for commerce between small and medium enterprises. Tehran, of course, envisioned a more wide-ranging channel for bypassing the sanctions imposed by the U.S. Office of Foreign Assets Control (OFAC).

Additionally, the E.U. expanded its Blocking Statute, which originally exempted its firms from having to pay any fines levied by OFAC for violations of the U.S. Cuban sanctions program, to include violations of Iran sanctions.

Neither of these actions, however, provided the needed equilibrium required to incentivize Iran to limit its nuclear program as agreed to under the JCPOA. INSTEX had not, as of November 2019, cleared any transactions. While the enhanced Blocking Statute provided regulatory relief from regulatory fines for E.U. firms, it could neither force European firms to conduct trade with Iran nor prevent U.S. regulators from imposing severe penalties that were not fines. For example, OFAC always has the power to sanction a firm that aids and abets a designated party in evading its sanctions, even if that conduct is legal under the firm’s host country’s laws. For those reasons, many firms chose trade with the U.S. over that with Iran.

Things fall apart

Iran responded to the loss of its expected sanctions relief through asymmetrical means. In a measured fashion, it stopped adhering to a number of limits on its nuclear program dictated by the JCPOA. Through its proxies, it apparently was responsible for attacks on oil tankers and oil pipelines. In retaliation for the detention of one of its tankers bound for Syria, Iran detained a British vessel. Iranian forces shot down a U.S. drone, and its Iraqi proxies later took part in a series of attacks, one of which resulted in the death of a U.S. contractor.

Outside of the U.S., the reaction to these steps were varied. The E.U. tried to persuade Tehran to keep within the limits of the agreement, threatening to invoke its dispute mechanism (which could lead to the reimposition of E.U. sanctions). Meanwhile, a Russia official in Crimea offered use of its Black Sea ports to Iranian oil tankers so they could not be seized by the United States.

The Trump Administration, however, continued to ratchet up the economic pressure on Iran by sanctioning other elements of its economy and government. The Iranian metals industry was targeted, as was Supreme Leader Ayatollah Ali Khamenei and members of his office, including Foreign Minister Javad Zarif (which was eventually used to deny him a visa for meetings at the United Nations). Additionally, in response to the actions of the Iraqi proxy forces, the U.S. attacked their strongholds. And that led to attempts by Iraqis to storm the U.S. embassy in Baghdad over a 2-day period in December 2019.

Chaos ensues

In response to the death of the U.S. contractor, President Trump ordered a drone strike that killed, among others, Qasem Soleimani, the leader of the Islamic Revolutionary Guard Corps (IRGC) Quds Force and a senior member of the Iranian regime, while he was present in Baghdad. The Iranian government, predictably, vowed revenge for the assassination.

Perhaps less obviously, the Iraqi legislature approved a non-binding resolution calling for the U.S. military forces in Iraq be removed. Additionally, the joint military efforts against Islamic State forces were put on hold due to the deteriorating security situation in Iraq.

When faced with these reactions, President Trump threatened to target 52 Iranian sites, including cultural sites. Additionally, he vowed that U.S. forces would not leave Iraq, and that any such effort would be met with sanctions on that country.

Notably, there has been a lack of international support for these recent U.S. actions, even from reliable allies such as Israel. This is in stark contrast of support for other American positions about Iranian proxies and its ballistic missile program.

Where to from here?

On the evening of January 7^th, Iran attacked non-populated areas of two Iraqi airbases. However, there was no loss of life, likely due to prior notice given to Iraq, and the use of ballistic missiles (which are easier to detect sooner) rather than cruise missiles or drones. President Trump promised more sanctions in response to the attacks, did not threaten additional military action.

But, then what?

There are likely two factors that, if properly managed, would promote a return to a more stable status quo. The first is Iran’s stated intention to withdraw from the remaining JCPOA restrictions. While E.U. nations were concerned about Tehran exceeding limits agreed to under the pact, even the most recent meeting between the parties did not result in immediate calls for invoking the dispute mechanism. Were Iran to publicly announce that they will not follow through on the threat, it is likely that the European Union would not ultimately re-impose its sanctions, but would continue to provide some measure of economic safe haven for international trade.

The second issue that requires resolving is the status of U.S. troops in Iraq. If the American forces were forced to leave by Baghdad (likely due to Iraqi political considerations), it would have real consequences on the global war on terror but would also reduce the likelihood of skirmishes between Iranian proxies and U.S. facilities and personnel. On the other hand, should U.S. forces remain, Iran could continue to de-escalate the situation by directing its proxies to aim their fire elsewhere, since the shelling of American forces and facilities was the proximate cause of the recent string of near-calamitous events.

Even if both of these issues are “successfully” removed as potential flashpoints, it does not mean that U.S.-Iranian relations will ultimately resolve themselves peacefully. However, it would return matters to a more manageable, less chaotic state of affairs – until the next precipitating aggression, of course.

Eric A. Sohn, CAMS, global market strategist and product director, Dow Jones Risk & Compliance, New York, NY, USA, eric.sohn@dowjones.com