The New Age of Economic Warfare: Are We Ready? ft. Edward Fishman

[00:00:07] Edward

The temptation for things like military conquest begins to rise. If you look back at sort of Hitler’s calculus in the 1930s, you know, a lot of this desire for Lebensraum and kind of conquering parts of what was then the Russian, the Soviet Union was getting key resources and commodities for the German people that they couldn’t get through other means. So, I do think that there are two very, very different futures that we could be headed toward in this block-based economy. And I certainly hope we’re in the former rather than the latter.

[00:00:41] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager diligence or investment career to the next level.

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Here’s your host, veteran hedge fund manager Niels Kaastrup-Larsen.

[00:01:37] Niels

For me, the best part of my podcasting journey has been the opportunity to speak to a huge range of extraordinary people from all around the world.

In this series, I have invited one of them, namely Kevin Coldiron, to host a series of in-depth conversations to help uncover and explain new ideas to make you a better investor. In the series, Kevin will be speaking to authors of new books and research papers to better understand the global economy and the dynamics that shape it so that we can all successfully navigate the challenges within it. And with that, please welcome Kevin Coldiron.

[00:02:15] Kevin

All right, thanks, Niels. And welcome everyone.

So, over the last 25 years the US has come to rely on economic warfare to confront global crises. The key to that strategy is control over chokepoints, areas of such vast importance that economies struggle to operate when access to them is cut off. But what are these chokepoints?

Well, there’s the US dollar, there’s advanced semiconductor technology, and there’s even things like services that underpin the global trade in oil. And today, we’re going to explore the details of how this process operates and how the reactions to it are going to change the world economy.

And we’re going to base our discussion around a brand new book called Chokepoints: American Power in the Age of Economic Warfare. The author and today’s guest is Edward Fishman.

Edward currently teaches at Columbia University School of International Public Affairs. He’s worked in several positions that put him at the center of the US Effort to essentially weaponize the world economy. He served on the team at the US State Department that designed and negotiated Western sanctions against Russia after it annexed Crimea. And he’s advised the Secretary of State. He’s advised the Chairman of the Joint Chiefs of Staff and also the top sanctions officials at the U.S. Treasury Department. So, he’s the perfect person to help kind of elucidate what’s going on here, help us build our understanding.

Edward Fishman, thanks so much for joining us and welcome to the show.

[00:03:49] Edward

Thanks, Kevin. Really great to be here with you today.

[00:03:54] Kevin

So, to me, one of the really enjoyable aspects of reading the book was the feeling that you were kind of a fly on the wall for a lot of these very important discussions. And I know you say at the end of the book that you were a direct participant in some of these events, and that you were only able to really write this book because of the personal relationships and network with the participants that you’ve built up over the years.

So, I’m curious, maybe if we could just start with maybe a quick overview of your own career, how you got involved in working with the US Government and how that led you into, as you say, being involved in some of these very important discussions about the applications of American economic power.

[00:04:39] Edward

Sure thing. So, my story really begins as a college student in the years after 9/11. I was studying history and international relations. And you know, we learned in all of our classes that the United States was the most powerful country on earth. You know, we were living in a unipolar moment. But when I looked at the world, it just seemed like the United States was struggling to translate that power into getting what we wanted in the world.

I think the biggest sort of examples of that were the wars in Afghanistan and Iraq, which, you know, quite quickly became these quagmires that were costing the US untold blood and treasure with very little to show for it.

And you know, this period, sort of in the mid ‘80s, was sort of when Iran’s nuclear program had become really the top national security problem that the United States was confronting. And you know, the United States had invaded Iraq to try to stop Iraq from getting a nuclear weapon. And you know, it was quickly found out that Iraq didn’t even have a nuclear weapons program, whereas Iran had a real nuclear weapons program.

And so, this really presented a pretty serious problem for anyone who wanted to work in foreign policy. How do you stop Iran from getting a nuclear weapon? And it was really at this time that, you know, US government officials started experimenting with novel forms of sanctions and export controls, what I would classify as economic warfare, as really the primary vehicle to try to stop Iran from getting a nuclear weapon.

So, I became really interested in it and was lucky enough that a week after graduating from college I moved down to Washington, D.C. to work for the Undersecretary of the Treasury for Terrorism and Financial Intelligence. So, the official who oversees the sanctions apparatus at the Treasury Department. And that wound up being sort of my entree into this world.

I eventually, as you said, wound up serving at the State Department, where I was on the Iran sanctions team there, got to work on implementing the first Iran nuclear deal, the Joint Plan of Action, in November 2013. And then when Russia annexed Crimea, a few months later, In March of 2014, I shortly thereafter became the first Russia Sanctions Lead in the State Department’s Sanctions Office. I was part of the team that designed and negotiated the sanctions on Russia.

And, you know, what these experiences taught me was that these tools, like sanctions and export controls and tariffs, they have really tremendous potential to try to advance American interests. But we’re really just scratching the surface in terms of their capability, and the US Government is still not very well positioned to do them strategically.

So, since leaving government, I really devoted myself to studying these tools, trying to understand what makes them work when they don’t work, how to reorganize the US Government to fight and win economic wars more effectively, and really to train the next generation of practitioners of economic warfare at Columbia, which is what I’ve been doing now for the last four years.

[00:07:36] Niels

So, kind of like the West Point of economic warfare.

[00:07:42] Edward

That’s our aspiration. Kevin. I think we’re still probably in our infancy, but that would be a dream.

[00:07:47] Kevin

Do you imagine a potential for you going back and working for the government again in that capacity?

[00:07:55] Edward

It’s possible. I stay very close with folks in the US Government on both sides of the aisle. I’ve often been called in to advise on various matters of sanctions and economic statecraft. And it’s possible I’d go back into government, but I also live in New York City. I’ve got two children. And so, you have to balance opportunities in public service also with family life as well.

[00:08:23] Kevin

Right. Okay, well, thanks for that. That’s a really good context. So let me take a step back.

I mean, the first part of the book is a history, a little bit, of chokepoints. And you say there that, you know, economic warfare is not new. And, in fact, the failures of economic warfare kind of are better known than its successes.

So, could you maybe just give us an example of past economic warfare that failed and maybe, more generally, why we know the failures better than the successes and then we can kind of use that to move into the modern age.

[00:09:07] Edward

Sure, yeah, maybe one thing just to say, off the bat, is I’m often asked, Kevin, whether sanctions work. And I always find that to be kind of a strange question because no one ever asks, you know, does military force work? I mean, sanctions and tools of economic warfare, they’re just tools of statecraft the same way that military force is. And sometimes they work, sometimes they don’t.

I think that, inherently, economic tools are weaker than the use of military force. But they also present a lot of benefits. You’re not necessarily risking human life, and blood, and treasure. They’re usually a lot easier to deploy. They’re sort of a midpoint between diplomacy and the use of military force.

But yes, you’re right that the failures of economic warfare are better known than the successes. And in fact, you know, the very first kind of canonical use of sanctions happened in the 5th century BC. This was when Athens, you know, Periclean Athens, during the golden age when Athens was sort of at the height of its power, imposed this wide ranging trade embargo on a neighboring city state called Megara. And the goal here really was deterrence.

It was to show the rest of the Greek city states, and in particular Sparta, that Athens, because of its dominant sea power, was so powerful that it could basically cripple Megara’s economy, and it was not worth ever trying to attack Athens. And the irony of the situation is that the sanctions really worked.

And Megara, you know, I think Aristophanes, the playwright, reports in one of his plays that the Megarians were basically slowly starving because of this embargo. But the irony is that it actually encouraged Sparta to go to war with Athens because I think the Spartans saw the Athenians as reckless and that basically their power had to be brought to heel. And this has happened other times in history.

I think, more recently, the US oil embargo on Japan in the lead up to Pearl Harbor. You know, some people blame that oil embargo, basically, for incentivizing the Japanese to attack the United States. And I think probably the lesson here isn’t that economic warfare can’t work. It’s that it’s a really powerful tool, and you shouldn’t use it without being serious about it. You got to mean it. And you have to realize that it can be quite aggressive and is part of an escalatory ladder that sometimes leads to military force.

I think the biggest change though, Kevin, between all of these historical examples of economic warfare all the way back to Athens in the 5th century BC to the US oil embargo on Japan in the 1940s, is that they always required the use of military force to implement. So, Athens was able to blockade Megara because of its navy, and the same was true of the US Navy in the 1940s.

What has changed, really, only in the last 20, 25 years is that because of this hyperglobalization we saw in the 1990s and the creation of the chokepoints you mentioned before, coupled with the really extensive reach of the American regulatory state, we now have a situation where an official in OFAC, which is the Treasury Department agency that oversees sanctions, can effectively sign a document in an office in Washington, D.C. and employ sanctions and embargoes that are even more powerful than the ones that were implemented throughout history using naval blockades and UN sort of mandates.

And so, I think that’s the thing that’s really new about today’s economic warfare, is that it can be done through the stroke of a pen and doesn’t actually require sending out the US Navy to implement it.

[00:13:02] Kevin

You talk about that in the book in the sense of how really how recent a development that truly is. There’s a character, one of the main characters in the book is Stuart, is it Stuart Levey?

[00:13:17] Edward

Stuart Levey, yeah, exactly.

[00:13:18] Kevin

Stuart Levey. Stuart Levey, yeah. And there’s a great quote from him where he says, well, when I started my job, in 2004, I don’t think the National Security Advisor would have even taken my call. By the time I left, I could get the President to sign an executive order within four hours of deciding it was worth doing.

I think he was there for less than a decade, and he accumulated kind of enormous influence. I was wondering maybe if we could use his experience as a way to talk about the evolution of the power of sanctions. Can you tell us about him and what were his insights that he had that other people hadn’t in terms of the use of economic power?

[00:14:04] Edward

Yeah, Stuart Levey is kind of, I would say he’s the through-line of the book. He’s right there at the beginning and there all the way to the end. I call him the Zelig of the age of economic Warfare.

[00:14:16] Kevin

I’d like that reference, by the way.

[00:14:18] Edward

Yeah, he appears in all these different guises. So, I hope readers of the book don’t think that that’s an exaggeration.

So, look, Stuart Levey was a young lawyer at the Justice Department on 9/11. He was in his 30s, went to Harvard Law School and was very, very smart and sort of had developed this understanding, I think, of how the private sector viewed risk. He was really sort of more of a inter-regulation as opposed to a foreign policy/national security type of a person. And, you know, after 9/11, he started working on terrorist financing cases at the Department of Justice.

And when this new sort of Treasury Department organization, the Office of Terrorism and Financial Intelligence, was created in sort of the aftermath of 9 /1, Levey was asked to become the first head of it. And so, he was given this job sort of at the tail end of Bush’s first term. So, this is in 2004.

I think he accepted it largely because he wasn’t even sure Bush was going to be reelected. So, he said he might as well take a flyer on a startup and see how it goes. And so, he assumes this job. Of course, Bush gets reelected. And really shortly after Bush was reelected, I think In December of 2004, he’s asked about Iran because by then everyone is really focused on Iran’s nuclear program. And Bush gives this comment saying, sanctions, we’ve tried sanctions against Iran, but they haven’t worked and we’ve sanctioned ourselves out of influence with Iran.

And there’s Stuart Levey, a young lawyer, just taking over this new group at the Treasury Department who kind of takes this as a challenge from the President and says, well, let’s see if we can make sanctions work against Iran.

And what he really comes up with is sort of using some of this knowledge he had developed as a lawyer, both in private practice and the Department of Justice, which is that banks around the world make risk-based decisions in terms of who their clients are, who they do business with. I think up until really Levey ‘s time, whenever the US was trying to get other countries on board with sanctions, it was always through diplomacy. It was going to the UN Security Council. And government, the Bush administration, was always frustrated that it could never get the UN Security Council to agree to really aggressive sanctions on Iran.

What Levey realized is, you know, he could short circuit that process and go directly and talk to banks around the world. Not just banks in the US, because the US had an embargo on Iran, but going to talk to banks in London, and Frankfurt, and Tokyo, and Hong Kong, and Dubai.

And so, what Levey does is he basically creates this roadshow. He travels around, meets with hundreds of different banking CEOs and compliance executives, chief legal officers, all around the world. And what he does is he comes bearing these sort of like dossiers of declassified intelligence that shows exactly how Iran is using the international financial system to evade sanctions and also primarily to fund its nuclear weapons program, as well as its support for terrorist proxies like Hamas and Hezbollah.

And these banks, in the aftermath of 9/11, the last thing they want is a front page article in the Wall Street Journal saying that, HSBC is involved in funding Iran’s nuclear program, or BNP Paribas is involved in supporting Al Qaeda. And so, from just a sheer perspective of reputational hazard, a lot of these banks decide it’s not worth doing any business with Iran after meeting with Levey. But then as this is happening, there’s also sort of an increased effort to actually enforce these sanctions.

And so, some of the banks, of course, I think many of them do sort of get out of Iran, but some of them continue to do business with Iran. And what we wind up seeing is, you know, the scale of penalties for sanctions violations just goes up by an order of magnitude.

And so, banks, I think, up until really the late ‘80s, I think, viewed sanctions violations kind of as a cost of doing business. You know, maybe they’d get slapped on the wrist, but it was worth it. But then you start seeing fines in the hundreds of millions of dollars. And then, by 2012, in the billions of dollars. You see a $2 billion fine on HSBC, and then kind of this epic $9 billion fine on BNP Paribas in 2014.

And so, by that point, banks really, they can’t just sort of write off sanctions violations as a cost of doing business. They have to take it seriously. And basically what Levey does, I think if you just look at it from a macro level, is he conscripts the international banking system to be these frontline infantry officers in American economic wars. And so, what he does, you know, it works. Iran is really the focus of his efforts.

But as we see throughout the course of this book, and over the last 15 years or so, this sort of these infantry can work, whether it’s Iran or Russia or China, you know, it really doesn’t matter. They’re now conditioned based basically, the international financial system, to implement American sanctions.

[00:19:26] Kevin

This is maybe going a little bit off piece, but as I was reading that section of the book and just listening to you make that description, I started thinking like, well, what type of person wants to end up as head of a bank now? Because you’re almost, at some level, they’re semi-state actors.

It’s almost like I’m wondering if your students are more likely to be running banks than, you know, people coming out of, I don’t know, the Haas Business School, where I teach. People rise up through banks because of their skill in finance. But, you know, when you get to the very top now, your skill as… or I don’t know if skill’s the right word, but you’re having to deal with these kind of much bigger geopolitical issues that have nothing to do really with core banking.

[00:20:17] Edward

I think that’s right. I think that, you know, what we’ve seen, and I think, another macro story of the book is, it’s sort of an ironic story, a lot of these chokepoints are created through financial deregulation and neoliberalism. A lot of them are created in the wake of the deregulatory push of the 1980s under Reagan and Clinton, in the ‘90s and WTO, et cetera.

But then what happens is that, after these chokepoints are created, it’s the story of kind of the resurgence of state power – the state kind of reclaiming the central role over the global economy and saying that, you know, yes, we want banks to make money, but really, national security comes first and they have to be complying with these laws.

And look, you know, I called Stuart Levey the zelig of the age of economic warfare. After he leaves his job at Treasury, he does become the chief legal officer of HSBC, the largest bank in Britain, and is really kind of the number two there, where he winds up building this massive sanctions compliance apparatus that becomes a gold standard that other banks emulate, I think with over a thousand people there.

So, I think you’re right that geopolitics compliance with sanctions has become incredibly central to the banking system. And I think the story that we’re probably going to see now, over the next five to 10 years, is that that’s going to become true in other sectors too, as in the technology sector. We’ve already seen the semiconductor industry taking these issues really seriously. But yeah, I think the banking sector is probably, you know, the tip of the iceberg.

[00:21:58] Kevin

I think that’s absolutely right. And that points to a world where it’s a different form of capitalism. I don’t know if we have a great name for it. Some people call it national capitalism. We’ll find out.

There are two points I really want to focus on with Iran. First, I wonder if you could explain to the listeners one of the key tools that I think Levey used, which was these escrow accounts. So basically, I think the insight was, hey, we can allow Iran to continue to sell oil and earn money from it, but we’re going to prevent them from actually using the money.

[00:22:36] Edward

That’s exactly right, yeah, look, I think this is probably the most single successful sanction we’ve seen in modern times. And what winds up happening, this is actually a few years after Levey leaves. I think he leaves the Treasury Department in 2011.

By the time he leaves, there’s this interesting dynamic that develops in Washington where Congress, there’s a bipartisan super majority in Congress for really aggressive sanctions on Iran. So, you have people like Mark Kirk, who’s the senator from Illinois, Bob Menendez, a Democratic senator from New Jersey, who are pushing basically any, as aggressive sanctions as they possibly can against Iran.

And so, folks in the Obama administration, the people who many of whom Levey had trained and cultivated at the Treasury Department, start realizing, look, we need to figure out a way to turn up the heat on Iran even faster. And the one area that Levey never really gets to touch during his tenure is Iran’s oil sales. And that’s because there’s always this fear that Iran is a massive oil producer. They export two and a half million barrels of oil on global markets each day, at the time.

If you try to take this oil off the market, first of all, you probably couldn’t. But even if you could, you’d cause a spike in oil prices that would damage the world economy, which is then really at the beginning of recovering from the global financial crisis of 2008.

What winds up happening is Congress is saying you have to do something about oil. And so some of Levey ‘s successors at Treasury, including Adam Szubin, who was his protege and became the head of OFAC, as well as David Cohen, who succeeded him as the head of TFI, come up with this strategy which is, we can go around to banks in places like Tokyo, and in various Chinese cities, in Seoul and South Korea and say, look, if you are helping process a payment for Iranian oil, so if a refinery in China is buying a cargo of Iranian oil, you can pay for that oil, but only if it’s into a Central bank of Iran account in your home country.

And so, what it does is it sort of forces Iran to set up these bank accounts in places like China, and India, and Japan, and basically say, okay, well, we can accumulate our oil proceeds in these countries, but we can’t repatriate them to Iran. We can only use them for bilateral trade in non-sanctioned goods. So theoretically, they could use all of those oil proceeds if they really wanted to import, I don’t know, millions of toasters from China, but they couldn’t actually use them to buy whatever they wanted around the world.

What winds up happening is, because Iran honestly cannot find ways to spend all of its oil proceeds in these countries, within 18 months you have roughly $100 billion of Iran’s oil proceeds that have accumulated in these overseas escrow accounts. It’s really remarkable, I think, because if you think about it, you know, it’s a unilateral sanction.

This is not something where the UN has backed it. The EU has not backed the same sanctions. This is something that is just being done, you know, at the behest of the US Congress and the Treasury Department. And it’s working to effectively change the way that Iran is getting paid for its oil.

And I think the reason that the sanction is so successful is a few of them. One is that it doesn’t actually require Iran to stop selling oil. They continue selling oil. So, you don’t have the market disruption that I mentioned earlier.

But I think more to the point, once you get into nuclear negotiations with Iran, the US Government has the ability to basically sign a document and repatriate money to Iran and say, okay, Iran, you freeze your nuclear program? Okay, take $5 billion of your frozen oil funds, and you can have access to them. And that’s how the original Iran nuclear deal happens in November of 2013. The US agrees to unfreeze, I think roughly, around $5 billion of those oil proceeds. And Iran agrees to freeze its nuclear weapons program.

And so, it’s pretty remarkable. It’s like you’re almost taking another country’s export revenue hostage and then getting them to stop their nuclear program in order to get some of it back.

[00:27:02] Kevin

Yeah, and I want to follow up on that, because you do a good job of saying, at some point, it was like, okay, hey, we’ve reached the point of maximum pain with these escrow accounts. There’s not much more squeezing we can do. So, now let’s use these sanctions as a tool in a negotiating position.

And so, we want them to end their nuclear weapons program, and we can kind of dangle this ending the financial sanctions, freeing up the escrow accounts as part of that. And that becomes a key aspect of the Iran nuclear deal. But then Trump comes in and basically says, well, the deal is off the table. And so, there’s a kind of…

My thinking was, well, hold on. If the real value of these tools is that they can be used in the negotiation to say, okay, we’ll switch off the sanctions if you agree to do what we want, but if those deals can then be quickly undone, doesn’t that actually undermine their value in the first place? Because why should I trust that you can deliver on what you’ve agreed?

[00:28:21] Edward

Yeah, that’s a really important point, Kevin. And I think that Trump’s decision, in 2018, to unilaterally pull out of the nuclear deal, and by the way, this is while the International Atomic Energy Agency has verified that Iran is complying with the deal. Where the other parties of the deal, so that’s Germany, the United Kingdom, France, China, Russia, have all said that Iran is complying with the deal. They’re not pulling out. It does very significant damage, I think, to a paradigm of US sanctions.

The paradigm is that sanctions are a tool of behavior change. That basically we impose sanctions on a country, and those sanctions are kind of unnatural, and they’re only in place until we get what we want. And then once we get what we want, we remove them. And that really had been kind of the model for sanctions up until 2018.

I think that after Trump kind of unilaterally pulls out of the JCPOA, it makes it really hard for the US to credibly put forward sanctions as a tool of behavior change. And you do see the Iranian government, shortly thereafter… Well, first of all, the President Rouhani, who had been elected basically to deliver the JCPOA, is discredited, and they wind up electing a hardliner to replace him a couple years later.

But I think more importantly, from the perspective of US national security, Iran quickly reconstitutes its nuclear program and builds back its program to an even greater extent than it had been before the nuclear deal. So, I think in retrospect, Trump’s pull out of the JCPOA was a real, I think, serious foreign policy blunder. I think even hardliners in places like Israel, who I think had supported it at the time, have now come out and said that it was a big mistake.

I think what’s happened in the years since, Kevin, which, you know, touches on your point about national capitalism or what kind of new global economy are we moving toward, is that sanctions have become less a tool of behavior change and more, honestly, a tool of remaking the global economy itself. And I think what you’re seeing today is sanctions on countries like Iran, Russia, China, there’s not really a behavioralist calculus behind them. It’s not clear what China could do to get export controls removed, or what Russia or Iran could do to fully be reintegrated back into the world economy.

And so, we’re really seeing is a lot of these tools like sanctions and tariffs and export controls, they’re really building the foundations of a new economic order. One that is much less globalized, much more focused on geopolitics and national security. And I don’t think we fully appreciated that. But I do think that 2018 and Trump’s pullout of the Iran nuclear deal was a major turning point in that story.

[00:31:26] Kevin

That’s interesting. I mean, that seems to be like an extraordinarily important point, because what you’re saying is we can examine the export controls of the sanctions, and they’re kind of like the gray contours of what the world economy is going to look like over the next 5 to 10 years. It’s like you’re building a house and you’re starting to put up the studs, and you can kind of see what the house is going to look like.

[00:31:57] Edward

Yes, I think that’s exactly right. And if you think about it, I mean it’s kind of a strange way to… You’ve got really do some mental gymnastics to get to this vision.

But if you think about the ‘90s, building the globalized world economy, it was built really through these trade agreements like NAFTA, the WTO, giving China permanent normal trade relations with the US. It was really through bringing down barriers.

Now the new global economy, which I don’t think we have a name for yet, that’s being built is really being built through tools like sanctions and export controls and tariffs. It’s being built through barriers. You know, it’s sort of a different process than the process we saw in the ‘90s.

And while the materials that we’re using to build the house that you mentioned are different, I think we can’t deny that’s what’s happening right now.

[00:32:55] Kevin

I’d like to talk a little bit. We did sort of both alluded to the export controls on China and there’s a couple, in the same way that the escrow account was an important kind of game changing tool on the financial side, there’s a couple of other tools that the US has used more kind of on the physical trade side that are illustrated in your section on China.

So, you know, you tell the story of Huawei and ZTE which we actually had Chris Miller on this show. And so, we’ve talked through the importance of TSMC and Huawei and you talk about the CFO of ZTE. So, both Huawei and ZTE are telecoms equipment makers, broadly speaking. And the CFO of ZTE was caught with a plot to buy US Tech and then kind of resell it to Iran.

And they were fined, but then they were later found violating the settlement and they were hit with a “denial order” which almost bankrupted them within a matter of weeks. So, I was wondering if you could explain to the listeners what a denial order is and why that is such a powerful tool.

[00:34:14] Edward

Sure. So, up until now in our conversation, Kevin, we’ve been talking about primarily financial sanctions which the Treasury Department and the State Department really are the ones who are administering it. You know, the chokepoint that’s being used there is the dollar, right?

It’s the fact that the US dollar is used as kind of this way station in all major international transactions, or at least a very significant percentage of them. It’s very hard to operate in the global economy without the dollar.

A denial order is done by the Commerce Department, and it’s not focused on finance, it’s focused on trade. And basically, what a denial order does, like the one on ZTE from 2018, is it tells US exporters that they can’t sell anything to ZTE.

And some of the things that US exporters might sell to ZTE are trivial. It could be a company that’s selling tables to ZTE for their office space, which may not be so painful for a company like ZTE.

But then there are other products like semiconductors, which ZTE totally relies on, or at the time, something like the Android operating system, which, if that is cut off from a phone maker or telecom equipment maker like ZTE, it can be really, really serious. And I think at the time, ZTE was really dependent on American microelectronics from companies like Qualcomm. And as a result, you know, they did almost go out of business in a matter of weeks. And they would have, I think, had it not been for Xi Jinping placing a phone call to Donald Trump and basically saying, you know, you really need to give ZTE a reprieve, and really kind of doing everything he can to get Trump to cave.

And my understanding, from talking to several people who were part of that conversation, is that Trump agreed to it because he thought Xi Jinping might owe him one down the road. And so eventually, you know, pretty quickly after this call, Trump instructs Wilbur Ross, the Commerce Secretary, basically, to come to a deal that allows ZTE to survive.

And so, for a lot of folks, China hawks in the first Trump administration, they viewed this as incredibly frustrating because it felt like that Xi Jinping maybe had cajoled Trump in a way that wasn’t justified.

But I think, on the flip side of that, these China hawks and the Trump administration realized that, wow, some of these major Chinese industrial companies that are reliant on American semiconductors, we can really hurt them if we cut them off from US products. And this was really important because I think sanctions, financial sanctions against China, have always been seen as a very significant action, something that so far, we haven’t seen – major financial sanctions against China. But I think these export controls were sort of seen as, okay, well, here’s another really aggressive tool we can use.

And so the ZTE case, while it winds up being short lived, I think it provides A clue to people like Matt Pottinger, who was overseeing China policy at the Trump NSC, that this is a tool they can use to kind of spearhead the more competitive strategy that they wanted vis a vis China.

[00:37:51] Kevin

And then there’s another tool called the Entity List, which I think is kind of one level down. Can you just explain that? Because that’s also been used.

[00:38:02] Edward

Yeah, that’s right. The Entity List is one level down. It’s also administered by the Commerce Department, by the Bureau of Industry and Security there. And what the Entity List says is that you can export… An example here, is that Huawei eventually is put on the Entity List in 2019. And what that says is you can export things to Huawei, but you have to seek a license first. So, It puts a regulatory barrier and gives… So, at the very least, it slows down trade with the target. But usually, the Entity List also comes with a presumption of denial.

So, unless there’s sort of clear exemptions written in, it’s pretty close to being as aggressive as a denial order. It’s just less black and white. You know, it gives more flexibility to the Commerce Department to allow some licenses to be granted if they think that they’re warranted.

[00:38:56] Kevin

One of the things that was kind of shocking in this section was kind of the relationship between the US And Europe. And so, there’s TSMC, which is the semiconductor manufacturing company, but of course, TSMC can’t really operate without machines from ASML, which is the Dutch manufacturing firm that makes lithography machines that basically carve the chips. And it’s the only company in the world that can make these ultra-advanced lithography machines. So, they themselves have become a chokepoint.

And at one stage there was, I think this is in 2020, ASML was going to sell one of their machines to a Chinese chip maker. And there was actually discussions in the US that they should send the Navy to block the shipments.

[00:39:50] Edward

Yes, yeah, this is, I think, the ASML lithography machine, I think it’s one of the best examples you can find of a chokepoint that exists in the sort of physical world, because you really cannot produce advanced chips without access to these EUV machines that are only made by this one Dutch company. And so, what the Trump administration, I think, realizes, as I mentioned just a few moments ago, they put the Huawei on the entity list in 2019.

And while that does do quite a bit of damage to Huawei, the company recovers. And they say, oh, well, we actually can continue sourcing chips from places like TSMC, because if you think what TSMC is doing, TSMC is a foundry. So, Huawei, their high silicon unit, is designing chips that are then are being manufactured by TSMC and being sent to China.

And so, in an ideal world, the US Government would just get Taiwan, and the Netherlands, and all these other countries to agree to the same export controls that they have. But that’s really, really hard to do. For the same reasons it was hard for the US to get the UN Security Council to back really aggressive sanctions against Iran in the early 2000s. And so, the Trump administration kind of starts looking for ways that they could do this unilaterally.

Kind of similar to, again, Stuart Levey trying to think about how could he isolate Iran without getting every country in the world to agree to it. And what they come up with in May of 2020 is this tool called the Foreign Direct Product Rule or the FTPR. And what that says is that, you know, it’s not just sort of US Companies that can’t sell things directly to Huawei. It’s if you’re a foreign company and you’re selling chips, for instance, to Huawei, you cannot buy products from the United States and then sell chips to Huawei. So, it basically gives companies like TSMC a choice. You can either make products for Huawei or you can buy products from the United States.

And by and large, the major chip makers, be it TSMC, or SK hynix, or Samsung, after the Foreign Direct Product Rule comes out in the summer of 2020, they comply. And so, this winds up becoming the Trump administration’s version of secondary sanctions. They’re using the unilateral power of the American regulatory state and our control over technology chokepoints to really cripple Huawei’s access to frontier technologies. With ASML, we could apply the FTPR to ASML.

What has happened, I think, is the company came to a gentleman’s agreement with the Trump administration in 2020, so they didn’t have to send the US Navy, thankfully, after the shipment. And then I think what happened in the Biden administration is they actually got agreement with the Dutch government, in 2023, to impose export controls and not approve the licenses for those EUV machines to be shipped to China.

So, what kind of started as very aggressive unilateral policy was turned into a more sort of alliance based diplomatic policy under the Biden administration.

[00:43:03] Kevin

I mean, it really underscores the fact that the US needs to have technological products that these other countries and companies need for these sanctions to be effective.

[00:43:15] Edward

Yes, that is very clear. I think maybe one of the dangers that we face, if we are moving to a world in which it’s more of a state capitalist model (the reason that the US possesses these chokepoints), it’s not just because of the US government, it’s because of private industry. It’s because of technological innovation. It’s because of financial innovation, that created things like the SWIFT Network which was created by a consortium of banks in the 1970s, or the correspondent banking system was created by American banks.

And so, I think that in order for the US to maintain control over the most valuable chokepoints, we need US companies to stay at the frontier of innovation. And I think that applies not only to physical technology, like semiconductors, but also financial technology.

And that’s something I explore toward the end of the book. We are seeing new mechanisms come up to settle cross border payments without using the dollar, using things like central bank digital currencies. And I think, you know, I’m concerned that the US is a laggard in some of these areas and we’re not on the frontier the way that we were in the past.

And so, you know, that’s one of the challenges, I think, about where we are today. As we’ve put national security more at the foreground of our economic policy, we also run the risk of kind of losing control of some of these chokepoints over time if we’re not innovating fast enough and getting our adversaries, frankly, hooked on our products.

[00:44:53] Kevin

Yeah, we had Richard Holden on the show a couple months ago who’s you know, talked about the digital currencies and how the US was definitely falling behind and China was on the lead there. But it points to this sort of irony in the sense that it was the kind of hyper competition of the globalized economy that led the US to have these world leading technology companies.

Chip manufacturers moved from the integrated model to kind of offshoring or outsourcing production to places like TSMC, and then focusing on chip design. And people said that well, we were losing our manufacturing capability, which is true to some extent. But then the flip side is that we’ve got Nvidia, and Nvidia becomes one of the most important companies in the world.

So, it’s like when you remove that hyper competition of globalization, are we still going to be able to develop these technologies that give us the power in the first place? I suppose it’s a question we’ll find out the answer to.

[00:46:09] Edward

Yeah, look, I think the United States has always thrived when we’ve competed with the rest of the world. You know, and I think that’s been a big secret to American success. People ask, why do we not have an industrial policy? Or why are our tariffs so much lower than even European tariffs? You know, forget about the Chinese.

And in some sense, I think we have had blind spots on our policy. We’ve allowed our defense industrial base, for instance, to atrophy, I think, and that has been a serious problem. But I think outside of a very sort of select group of technologies that are fundamental to national security and war fighting, America has always done better when we have opened up our economy, when we’ve competed with the rest of the world, and frankly, when we’ve allowed our companies to set international standards.

I think that’s really critical because the reason we can use these tools as a coercive mechanism against foreign countries is because foreign businesses rely on American finance. They rely on American technology.

And if we provide an incentive for these foreign countries not to rely on us, or worse, if we fall behind and our products aren’t the best in breed anymore, that’s a real problem. And I think, to kind of go back to the Huawei example, part of the reason that Huawei was such a psychological shock to the American national security establishment is that the reason it was winning market share across the world wasn’t because China was holding a gun to foreign government’s heads and saying, buy Huawei or else. It was because Huawei’s technology had become best-in-class. They had the best-in-class 5G kit that was being sold for 30% less than the competition.

And so, we see this now in things like clean energy technology, where China very clearly has the lead, and their lead has become such a significant problem for the United States that the Biden administration saw fit to impose 100% tariffs on the import of Chinese electric vehicles into the United States. And so, I think we need to be really careful about remembering that innovation, our technological capacity, our financial capacity really is what underpins American power both in economic warfare and more broadly.

[00:48:28] Kevin

I know we’re kind of running out of time here. And, you know, a lot of the book is focused on the US relationship with Russia, both in reaction to the annexation of Crimea and then the invasion of Ukraine. And one of the, I guess, innovations, if you want to call it that, that happened after the invasion of Ukraine was, I think you call it the service plus cap model.

And that’s not something that I fully appreciated, but it seemed to have been extraordinarily effective and kind of a backdoor way to get people involved who normally wouldn’t want to come out and support sanctions on Russia. So, I’m wondering, because it’s so important, if you could just explain what that is and why it’s been so effective.

[00:49:26] Edward

Yeah. So, after Russia’s full-scale invasion of Ukraine in February of 2022, the US and the rest of the G7 were intent on imposing really aggressive sanctions on Russia. And I think one of the challenges they had was honestly similar to the challenge that policymakers faced toward Iran in the early 2010s which is, you know, that Russia was a massive oil producer, five million barrels of crude oil and another two and a half million barrels of petroleum products each day. And so there was, really, a limit probably to how much pressure you could put on Russia without going after its oil sales.

And I think quite quickly the US and the G7 hit that limit. They imposed sanctions on Sberbank and VTB, which are the two largest banks in Russia.

They impose the foreign Direct Product Rule on Russia. So, the same technology and semiconductor export controls that we talked about with Huawei are imposed on Russia as a whole. And so, over the course of 2022, you know, Russia’s economy is definitely struggling under these sanctions and export controls. But the war is going on. And so, it’s quite clear that something needs to be done about Russian oil.

And so, what the US and its allies come up with is this idea of a price cap, which is that you can continue buying Russian oil. So, if you’re a Chinese or Indian refinery, you can import Russian oil. But if you use services from companies based in the G7, so, for instance, if you use Greek shipping, or British insurance, or American trade finance, then you can only buy that Russian oil for a price below $60 a barrel. So, it effectively imposes a cap on the price of Russian oil.

And the reason that the US and its allies think that this might work is because of these chokepoints that exist in energy supply chains, in particular, the shipping sector, which, you know, is really dominated by Greece and several other European countries. The maritime insurance sector, I think 95% of all oil cargoes are covered by the International P&I Club, which is based in London, and then of course, US Dollar and trade finance.

But even when this price cap is imposed, I think there’s still some anxiety that if it’s done too aggressively that you could see some Russian oil come off the market and you could cause a spike in oil prices, which is something the Biden administration is petrified about because of inflation running at 40-year highs and gasoline prices pretty high.

And so, what we see is really for the first six to 12 months of this policy being in effect, it works really tremendously well, and it cuts Russian oil revenues very substantially. But sort of in the vein of the conversation we had just before about where is this headed in the long term, it also creates a structural incentive for Russia to build its own end-to-end oil supply chain, to buy old tankers that it can use basically as a substitute for the Greek shipping companies it used to use, or do sovereign guarantees instead of using British insurance. And so, what happens is, over time Russia does find ways around this price gap by effectively indigenizing its energy supply chain.

And I think where we are now is we’re at sort of an impasse because the price cap is still in effect. Russia has, I think, successfully built workarounds to it and the Biden administration never tightened it, I think, to the extent that it could be effective in the long term. And so, I think one of the first big decisions the Trump administration is going to have to make on Russia is what to do about this policy.

You know, they could, could strengthen it pretty significantly by using some of the tools we talked about with respect to Iran, like the escrow accounts, I think could work very well against Russia. But you know, a lot of that will come down to the prioritization and whether they’re going to take a risk in terms of energy prices.

[00:53:31] Kevin

Yeah. And you know, it’s, it’s led to a kind of a bifurcation in the oil market, which was, for a long time, kind of the ultimate globally traded commodity with a single price. And now we have multiple prices. And I just was wondering if you think that is what we’re going to see with, with other markets around the world.

[00:53:52] Edward

I think that’s right. I think that you sort of hit the nail on the head where a barrel of oil was roughly the same price, whether it was coming from the Gulf of Mexico, or Saudi Arabia, or Russia, up until 2022. And now you’re starting to see really two oil markets.

You see a market for regular oil and a market for sanctioned oil. And a part of the reason that countries like India and China have bought so much Russian oil is that they’re getting it at a significant discount to Brent, which is the international benchmark.

And I do think that, to go back to our conversation about kind of building this new global economy that comes after globalization, I do think a hallmark of it is going to be that some of these markets that used to look like a global commodified market become really geopoliticized, where there are markets for Russian commodities that sell for discounts, and can only go to countries that don’t support sanctions, and then markets for commodities from countries that sell probably for a higher price but have a lower risk of incurring sanctions.

So, I do think that in many ways the oil market, by kind of coming under this grip of the national security state, points the way forward for what we’re going to see in a lot of other markets in the years to come.

[00:55:17] Kevin

So do you… Is your… I mean, this is kind of an unfair question, I guess, but I’ll ask it anyway. Is your vision or view of the… I don’t know if endgame is the right term, for where we end up that kind of mirrors the Cold War, where we go into like an Orwellian world where there’s kind of three big powers that don’t really interact very much economically? Is that where we’re headed? I mean, you know, that’s one argument, but then the data says that global trade has actually held up remarkably well. So, I don’t know, where do you think we are in 10 years?

[00:55:58] Edward

Yeah, it’s a, it’s a really good question. I think that almost certainly we are going to see some level of kind of blocks that form in the global economy. I think that there are different versions of that future and, and we’re not exactly sure where it’s going to be.

I think in the optimistic version of that future, you know, you really see blocks that are formed really only around very strategic technologies and commodities. So, maybe there’s a semiconductor supply chain or supply chain for advanced semiconductors and military technology that exists only with the US and its allies. So, this is kind of the friend shoring model. And then maybe another supply chain that China and Russia and some of, you know, what I would call the authoritarian axis has.

And maybe in that world you wind up, actually, with a more stable global economy because you don’t have necessarily the ability to coerce other countries through economic warfare and you feel a little bit more secure. I think part of the reason you’ve seen such, I think, hawkishness on China in the US, both in the Democratic and Republican side of the aisle in recent years, is that there’s a real sense of vulnerability that we’re reliant on China for really strategic products that we can’t get in a crisis. And I think we felt that viscerally during the worst part of COVID when we couldn’t even get masks because China kind of had produced, was producing all the world’s masks.

I think the bleaker version of that future, and it’s the one that I’m particularly worried about with the Trump administration, if they do sort of go into this direction of not only sanctions and tariffs against China, but also against Europe and Mexico and Canada and other close US allies and partners, is that you have just a much more disorderly kind of breakdown of the global economy that probably doesn’t happen overnight just because the US and China still have what, $600 billion almost in bilateral trade a year.

You can’t go from that to zero overnight, but you start to see more shortages, more inflation. That just kind of becomes more of a regular part of our daily life. And then of course, at the end of that, where are we left? We’re left in a situation in which countries may not be able to get the critical resources they need through trade. They may not be able to get the things they need through for sort of peaceful commerce.

And what has happened, when that has happened historically is the temptation for things like military conquest begins to rise. You look back at sort of Hitler’s calculus in the 1930s, his desire for Lebensraum and kind of conquering parts of what was then the Soviet Union was getting key resources and commodities for the German people that they couldn’t get through other means. So, I do think that there are two very, very different futures that we could be headed toward in this block-based economy. And I certainly hope we’re in, in the former rather than the latter.

[00:59:05] Kevin

Well, thanks for that. I appreciate you taking the challenge of answering that question. I know it’s impossible to answer, but I think these are things we should all be thinking about. And the book is a great kind of entree into just a deeper understanding, as we said, of the contours of the new world economy that are being built.

You say, toward the end of the book, that trust once lost is not easily regained, and the scramble for economic security is underway, and we’re not going back to where we were in the past.

So, Edward, thanks so much for writing the book and for taking the time to talk about your ideas with us on the show. We really appreciate it.

[00:59:49] Edward

Thanks so much for having me on, Kevin. I really enjoyed our conversation.

[00:59:53] Kevin

Okay. The book is called Chokepoints: American Power in the Age of Economic Warfare. And please go out and get a copy of Edward’s book and make sure you follow his work because I think, as you can tell from our conversation today, a lot of these ideas are not being discussed enough on mainstream media. For all of us here at Top Traders Unplugged, thanks for listening and we’ll see you soon.

[01:00:19] Ending

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