Treasury's War Read online

During the American Civil War, economic warfare in the form of naval blockades, privateering, and counterfeiting became an endemic part of the landscape. Counterfeiting grew to be particularly problematic—with estimates suggesting that approximately a third of all currency circulating in the United States at the time was counterfeit.1 To police the money supply, President Abraham Lincoln ordered the creation of the US Secret Service within the Treasury Department. It was charged with infiltrating counterfeiting rings and shutting down their printing presses—and this remains a core mission of the Secret Service to this day.2

  As the nature of conflict and international relations changed, the use of sanctions and financial pressure continued to evolve. After World War I, the major powers created the League of Nations to regulate international affairs. The Covenant of the League of Nations specifically formalized the use of economic sanctions as a tool for avoiding conflict, signaling the international community’s approval of these methods to change state behavior. Unfortunately, economic sanctions were not only insufficient to prevent war in Europe, but may have actually increased the likelihood of war. The victors of World War I required large amounts of reparations from the losers, bankrupting some and contributing to widespread frustration in Germany that may have led to the rise of extreme nationalist political parties.

  During the years prior to World War II, the United States used sanctions against Japan much as Athens had used sanctions against Megara. Concerned about the expansion of Japanese influence throughout East Asia, the United States placed sanctions on the export of aviation fuel, iron, and steel to Japan in 1940. In July 1941, the United States went further, freezing Japanese assets and imposing a licensing restriction on trade with Japan. Just one week before the Japanese attack on Pearl Harbor, the Japanese ambassador to the United States noted, to an American counterpart, “The Japanese people believe that economic measures are a more effective weapon of war than military measures. . . . They are being placed under severe pressure by the United States to yield to the American position; and [they believe] that it is preferable to fight rather than to yield to pressure.”3

  After World War II, economic sanctions would become a tool not merely for use against enemies, but for persuading allies as well.4 In 1956, Israel, Britain, and France conspired to gain control over Egypt’s Suez Canal, striking against Gamal Abdel Nasser’s revolutionary Egyptian government.5 Seeking to rein in the three US allies, the Eisenhower administration threatened to withhold US financial assistance and oil supplies, warning Britain that a run on the pound was possible. The proposed sanctions forced them to capitulate, and Britain and France, and eventually Israel, withdrew their troops.

  In 1960, the United States imposed a blockade against Cuba. This blockade became almost total in February 1962 in response to nationalization of American properties by Cuban authorities.6 Sanctions on Cuban economic and commercial activity continued in full for three decades, and in the 1990s President Bill Clinton expanded the trade embargo by targeting private assistance to potential future Cuban governments as well as by sanctioning foreign subsidiaries trading with Cuba (although he authorized the provision of humanitarian goods in 2000).

  By the end of the twentieth century, broad sanctions against some countries, such as apartheid-era South Africa, Saddam Hussein’s Iraq, and Muammar el-Qaddafi’s Libya, were applied as a way of expressing international opprobrium and attempting to change a country’s behavior. They served to constrain the ability of those countries to obtain goods and services, leveraging commercial isolation to change their policies. These strategies, though involving a larger number of countries, followed the classic pattern of states applying sanctions against one another. They updated the idea of blockades and trade-route disruption for a modern age—introducing new versions of the sanction to account for international trade and financing that had the effect of isolating a country’s economy.

  Yet, by the mid-1990s, there was a growing sense that broad sanctions had become counterproductive. Aloof and repressive regimes seemed perfectly willing to allow their already vulnerable populations to suffer—and often used the sanctions as propaganda to condemn the international community for assaulting and impoverishing their nation. Such sanctions also threatened to become a way for entrenched regimes and their cronies to more easily enrich themselves. Their control of permissible trade and of loopholes in the sanctions allowed them to benefit at the expense of their populations. This was seen plainly in the Iraqi sanctions program through 2003, where humanitarian exemptions, such as those provided for in the Oil for Food Program, gave the ruling regime an opening to profit. As a result, the international community began to lose faith in the idea that sanctions as traditionally applied could be used effectively.

  One solution appeared to be to move away from broad sanctions to those that targeted individuals. The Clinton administration used economic sanctions to pressure Serbia from 1993 through 1995, specifically targeting Serbia’s leader, Slobodan Milosevic. By seizing the US-based assets of Milosevic and his regime, the United States was able to ratchet up financial pressure on the support network of his government.

  In 1995, after pressuring Serbia, the Clinton administration also greatly expanded the use of targeted sanctions against individuals and companies associated with narcotics in Colombia and elsewhere in Latin America. The Treasury’s Office of Foreign Assets Control (OFAC), responsible for implementing all US sanctions programs, began targeting hundreds of individuals, companies, and associated properties that were subject to asset freezes and shut them out of the US financial system. Banks not just in the United States but throughout Latin America stopped doing business altogether with individuals labeled by the OFAC as “Specially Designated Nationals” (SDNs), including drug kingpins. Those who appeared on what became known as “la lista Clinton” suffered a virtual financial death penalty. Banks clearly recognized that it was better to continue doing business in the United States than to risk doing business with designated parties. The Clinton administration also twice used executive orders to name terrorist organizations, such as Palestinian terrorist groups, Hezbollah, and Al Qaeda, and their leaders, freezing assets and forbidding US citizens and companies from doing business with them.

  The newly minted sanctions of the 1990s offered novel opportunities to focus financial pressure on specific targets. Even so, and in spite of their failings, broad sanctions continued to be the predominant tool. Though the Serbian, Colombian, and anti-drug related policies had proven that targeted sanctions could work, there remained doubts and concerns about the overall effectiveness and sustainability of sanctions as an international tool of statecraft. That would soon change.

  After September 11, 2001, the United States unleashed a counter-terrorist financing campaign that reshaped the very nature of financial warfare. The Treasury Department waged an all-out offensive, using every tool in its toolbox to disrupt, dismantle, and deter the flows of illicit financing around the world. The “smart” sanctions of the late 1990s that had targeted rogue leaders and the entities they controlled were now put on steroids to target the Al Qaeda and Taliban network and anyone providing financial support to any part of that network.

  There were three primary themes defining this campaign that shaped the environment and evolution of financial power after September 11: the expansion of the international anti-money-laundering regime; the development of financial tools and intelligence geared specifically to dealing with issues of broad national security; and the growth of strategies based on a new understanding of the centrality of both the international financial system and the private sector to transnational threats and issues pertaining to national security. This environment reshaped the ways in which key actors—namely, the banks—operated in the post-9/11 world.

  Reliance on the anti-money-laundering regime permitted an all-out campaign to ensure that funds intended for terrorist groups, such as Al Qaeda, were not coursing through the veins of the international financial system. This focus re
shaped the international financial landscape forever, presenting a new paradigm that governments could use to attack terrorists, criminals, and rogue states. It was a paradigm rooted in denying rogue financial actors access to the international financial system by leveraging the private sector’s aversion to doing business with terrorists.

  In this context, governments implemented and expanded global anti-money-laundering regulations and practices based on principles of financial transparency, information sharing, and due diligence. They applied new reporting and information-sharing principles to new sectors of the domestic and international financial community, such as insurance companies, brokers and dealers in precious metals and stones, money-service businesses, and hawaladars (hawala is a trust-based money transfer mechanism).

  This approach worked by focusing squarely on the behavior of financial institutions rather than on the classic sanctions framework of the past. In this new approach, the policy decisions of governments are not nearly as persuasive as the risk-based compliance calculus of financial institutions. For banks, wire services, and insurance companies, there are no benefits to facilitating illicit transactions that could bring high regulatory and reputational costs if uncovered. The risk is simply too high.

  Because of these new strategies, rogue actors who try to use the financial system to launder money, finance terrorism, underwrite proliferation networks, and evade sanctions can be exposed. They can be denied access by the financial community itself. And the sanctions are based on the conduct of the rogues themselves, rather than on the political decisions of governments. It is the illicit or suspicious behavior of the actors themselves as they try to access the international financial system that triggers their isolation. Such an approach was possible because of the unique international environment after September 11. The environment after the terrorist attacks allowed for amplified and accelerated use of financial tools, suasion, and warfare to attack asymmetric and transnational threats.

  The twenty-first-century economy is defined by globalization and the deep interconnectedness of the financial system—as seen in the contagion of financial crises like the Great Recession of 2008. The United States has remained the world’s primary financial hub, with inherent value embedded in access to and the imprimatur from the American financial system. The dollar serves as the global reserve currency and the currency of choice for international trade, and New York has remained a core financial capital and hub for dollar-clearing transactions. With this concentration of financial and commercial power comes the ability to wield access to American markets, American banks, and American dollars as financial weapons.

  The tools the United States applied to tracking and disrupting illicit financial flows—in particular, terrorist financing—were given greater muscle and reach after 9/11. The more aggressive and directed use of these tools amplified their impact and served to condition the environment, making it riskier and riskier for financial actors to do business with suspect customers. The campaign focused on ferreting out illicit financial flows and using that information to our enemies’ disadvantage. The military and intelligence communities focused their attention and their collection efforts on enemy sources of funding and support networks. The Treasury Department used targeted sanctions, regulatory pressure, and financial suasion globally to isolate rogue financial actors. Law enforcement and regulators hammered banks and institutions for failing to identify or capture illicit financial activity or failing to institute effective anti-money-laundering systems. The United States leveraged the entire toolkit, and the aversion of the international banking system and commercial environment to illicit capital, to craft a new way of waging financial warfare.

  This approach puts a premium on targeting rogues based on their illicit conduct. Interestingly, under the right conditions, this model created a virtuous cycle of self-isolation by suspect financial actors. The more isolated the rogue actors became, the more likely they were to engage in even more evasive and suspicious financial activities to avoid scrutiny, and the more they found themselves excluded from financial networks.

  But perhaps the most important insight powering Treasury’s campaign was its focus on the financial sector’s omnipresence in the international economic system. Financial activity—bank accounts, wire transfers, letters of credit—facilitates international commerce and relationships. The banks are the ligaments of the international system. In Treasury, we realized that private-sector actors—most importantly, the banks—could drive the isolation of rogue entities more effectively than governments—based principally on their own interests and desires to avoid unnecessary business and reputational risk.

  Indeed, the international banking community has grown acutely sensitive to the business risks attached to illicit financial activity and has taken significant steps to bar it from their institutions. As the primary gatekeepers to all international commerce and capital, banks, even without express governmental mandates or requirements, have motivated private-sector actors to steer clear of problematic or suspect business relationships. The actions of legitimate international financial community participants are based on their own business interests, and when governments appear to be isolating rogue financial actors, the banks will fall into line. Reputation and perceived institutional integrity became prized commodities in the private sector’s calculus after 9/11. Our campaigns leveraged the power of this kind of reputational risk.

  In such an environment, the Treasury Department, finance ministries and central banks, and financial regulators around the world used their unconventional tools and influence for broader national security purposes. The old orthodoxy of unilateral versus multilateral sanctions became irrelevant—the strategic question was instead about how to amplify or synchronize the effects of financial pressure with other international actors, including states, international institutions, banks, and other commercial actors.

  Transnational nonstate actors and rogue regimes are tied to the global financial order regardless of location or reclusiveness. Dirty money eventually flows across borders. Moreover, in this environment, the banks, as the central arteries of the international financial system, have their own ecosystems, with established regulatory expectations and penalties and a routinized gatekeeping function. With this role come vulnerabilities for America’s enemies.

  This new brand of financial power was spawned by both design and necessity. We recognized the possibilities this new environment presented for reshaping the way the United States used its financial influence to promote its national security. The strategies that resulted focused squarely on protecting the broader international financial system and using financial tools to put pressure on legitimate financial institutions to reject dealings with rogue and illicit financial actors.

  These tools and this approach are no longer new. Economic sanctions and financial influence are now the national security tools of choice when neither diplomacy nor military force proves effective or possible. This tool of statecraft has become extremely important in coercing and constraining the behavior of nonstate networks and recalcitrant, rogue regimes, which often appear beyond the reach of classic government power or influence.

  But these rogue actors are already adapting to this kind of financial pressure. It is only a matter of time until US competitors use the lessons of the past decade to wage financial battles of their own—especially against the United States.

  More worrisome, our ability to use these powers could diminish as the economic landscape changes. Treasury’s power ultimately stems from the ability of the United States to use its financial powers with global effect. This ability, in turn, derives from the centrality and stability of New York as a global financial center, the importance of the dollar as a reserve currency, and the demonstration effects of any steps, regulatory or otherwise, taken by the United States in the broader international system. If the US economy loses its predominance, or the dollar sufficiently weakens, our ability to wage financial warfare could wane. It is vital
that policymakers and ordinary Americans understand what is at stake and how this new brand of financial warfare evolved.

  This is the story of how a small team at the Treasury Department, in concert with other parts of the US government and the private sector, unleashed this new era of financial warfare—how it took shape, why it became so important to US national security, and how it will continue to be shaped by the changing international economic and security landscape. This group of officials and operatives recognized that the world was entering a new financial and political environment and took advantage of the possibilities it presented. We fashioned strategies that used financial suasion and financial tools to attack our enemies’ greatest vulnerabilities, deploying hidden financial campaigns against a range of America’s most dangerous and difficult enemies, including Al Qaeda, North Korea, and Iran. In so doing, we undermined the financial infrastructures of those enemies.

  What we unleashed was a modern Megarian Decree, with all the financial tools and financial firepower America could muster. In so doing, we redefined the very nature of financial warfare as well as the role of the US Treasury Department in national security. And we did it all without ever firing a shot.

  Part I

  FOUNDATION

  1

  A NEW KIND OF WAR

  As our US Air Force C-17 approached Kabul, we were jostled in our jump seats as the pilot corkscrewed down toward the airport to avoid surface-to-air missiles. I looked down the line at our group of Treasury Department officials. We were strapped into the sides of the plane with cargo nets enveloping us. We were clean-shaven, decked out in suits and ties, our briefing books stored away and our briefcases now at the ready. It was November 2002, and our delegation was beginning what would become our “century-hopping” tour of Afghanistan, Pakistan, and India.