China and Economic D-Day vs. Iran

Last week, on August 24, U.S. Secretary of the Treasury Scott Bessent announced “Economic D-Day”, also known as “Operation Economic Outcast”. The objective was to warn and put on notice any government, company, or party in the world facilitating trade, investment, money transfers, swap lines, maritime business, cryptocurrency movement, free trade zones, entrepôts, or other financial activity with the Islamic Republic of Iran that it could be subjected to sanctions by the U.S. Treasury. The announcement was accompanied by commentary from the White House and Treasury and conveyed this intention.

It is well known that China, Iraq, Turkey, India and the UAE could each be affected in varying degrees.^[1] While China is the leading economic supporter of the Islamist regime, it is not exempt from the sanctions. However, to think that the U.S. would aggressively sanction Chinese banks, trading companies, government entities, multinational firms, technology enterprises, shipping firms, and perhaps even individuals of the Politburo as enablers requires a “willing suspension of disbelief”.^[2]

Indeed, broad sanctions against China would threaten the neo-mercantile economic model of the nation. It has generated massive trade surpluses over decades and has been successful in lifting hundreds of millions out of poverty and making the coastal elites rich. China would therefore face an existential risk. But it could react in ways that would damage the U.S. and frighten its allies.

First, as a signal to the world, China could dump some holdings of U.S. Treasuries, over $630 billion^[3] as of June – just enough to cause gyrations in fixed-income and equity markets but not enough to severely damage its own balance sheet and economy, since the value of its remaining holdings would decrease and the yuan would rise in relation to the dollar, negatively affecting China’s export model. China would suffer capital losses from a quick sale, but that would need to be weighed against the costs of a kinetic conflict. Further, as of June, China had $3.4 trillion^[4] of total foreign currency reserves – that is a very large stick to potentially wield against the U.S.

China can also harm the U.S. with its control of the supply and processing of rare earth metals, and it has already restricted shipments of certain elements. These are essential for use in the manufacturing, electronics and aerospace and defence industries, and they are necessary for a U.S. manufacturing revival and tech dominance. Further, China could nationalise selected high-visibility U.S. companies in that country in the technology, manufacturing, and finance sectors, and it could harass American CEOs based there. The ensuing seizures in financial markets would also affect China, and there would be the distinct possibility of a global crash, reminiscent of September 2008 with the then failure of Lehman Brothers and the collapse and rescue of AIG, Fannie Mae and Freddie Mac, Merrill Lynch, and Washington Mutual – and subsequent capital infusions into the banking system by the Treasury.

Secretary Bessent^[5] himself stated that he does not wish to “blow up the global financial system”. Given that China buys 90%^[6] of Iran’s oil and is its principal economic lifeline, according to the U.S.-China Economic and Security Review Commission of Congress, new robust sanctions against China are both impractical and potentially dangerous. The UAE has already signalled cessation of business relations with Iran, and it is doubtful that potential sanctions against Iraq, India and Turkey will be hard-hitting enough to be a game-changer.

As for India in particular, it appears to have adjusted to U.S. sanctions against Iran since the peak years of 2018-2019, with trade volume reduced by 90%.^[7] India’s exposure, as the third-largest oil consumer in the world, is the price of oil itself. The Reserve Bank of India^[8] has stated that the disruption in the Persian Gulf presents pressure on inflation and economic growth and that it is taking action to defend the rupee, which is already at historical lows versus the U.S. dollar.

The top priority should be a secular and moderate Iran – which, at this point, only regime change can achieve. Battlefield metrics, while very impressive, have not yet attained strategic objectives. The enriched fissile material remains in Iran; Iran controls directly or by threats much of the Strait of Hormuz, choking the world’s oil supply and damaging insurance markets; and an even harder-line regime remains in power. Military action and diplomatic and economic pressure have thus far not brought Iran to seriously negotiate an end to the conflict.

Regime change will require time and patience: recognising dissidents and encouraging opposition within the Islamic Revolutionary Guard Corps, the Artesh (regular army), and the Iranian government; equipping the populace with arms and fomenting rebellion; and mobilising credible new leadership that can dismember the military and clerical complex. A major contingency would be assistance from the Iraqi Kurdish Peshmerga, estimated at 200,000, who are well-armed and America-trained,^[9] but that could entail territorial concessions that would fragment Iran. So far, the Kurds have been reluctant to do so, and Turkey would most certainly object.

The confrontation with Iran may well extend into the next U.S. administration. In the meantime, sweeping and severe sanctions against an array of Chinese institutions and entities, although potentially decisive, would constitute risk to the global financial system, and this appears to be well recognised by Secretary Bessent. There appear to be no attractive options for the U.S. at this time – with a kinetic war now having become mainly an economic one: “Economic D-Day” is the next phase.

Frank Schell is a former senior vice president of the First National Bank of Chicago and later was a management consultant. He was a lecturer at the Harris School of Public Policy, University of Chicago, and is a contributor of opinion pieces to various journals.

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