On Economic Statecraft, With Professors Waxman, Menand, and Judge

Economic statecraft—the use of targeted economic and financial tools to achieve foreign policy objectives—has become an increasingly prevalent strategy to ensure the United States’ national security. “Twenty years ago, the tools of foreign policy mostly had to do with diplomacy and soft power, or military and hard power,” says National Security Law Program Chair Matthew C. Waxman, Liviu Librescu Professor of Law. “Now, it’s in the use of financial and economic instruments to advance American foreign policy and national security.” 

Among the most important levers to try to influence the behavior of other states, as well as nonstate groups, are trade restrictions and tariffs, export controls, and economic sanctions, Waxman says. “We see economic statecraft being used widely in our competition with China, in U.S. policy toward Iran—especially in trying to stop Iran’s nuclear weapons development—and in U.S. policy toward Russia, especially since the 2022 reinvasion of Ukraine.”  

Waxman, banking law expert Kathryn Judge, Harvey J. Goldschmid Professor of Law, and Federal Reserve/Treasury expert Lev Menand, associate professor of law, discuss the challenges and opportunities of using economic statecraft to ensure national security as well as its impact on the global financial system.

Is economic statecraft a new tool in the U.S. national security effort? 

Matthew C. Waxman: There are some ways in which economic statecraft is very new, but in many ways, it is very old. One of the animating purposes of the Constitutional Convention of 1787 was to strengthen the capacity of the United States, then a confederation of states, to compete better internationally in the economic realm. Thomas Jefferson thought a lot about foreign commerce and U.S. national security. Alexander Hamilton thought a national bank was key to national security. So some of these issues are very, very old. 

In the past two decades, however, there has been a lot of creative thinking within the U.S. government, especially in the Treasury Department, about how the United States can leverage its unique position in the global trade and financial systems. These changes correspond to a moment in which there is deep skepticism on both the political right and the left about American military overcommitments abroad. Reluctance to rely too heavily on military tools in foreign policy increases the relevance and temptation to use economic statecraft tools: The less reliant we are on military statecraft, the more reliant we are on economic statecraft. That has helped to elevate the importance of economic statecraft in American foreign policy, national security policy, and domestic economic policy.

What roles do global banking and the financial regulatory system play in economic statecraft? 

Lev Menand: The banking system is a core partner of the U.S. government in economic statecraft. U.S. economic statecraft has increasingly leveraged the fact that many countries rely on the U.S. dollar to conduct international trade. Even countries like China and Russia use the U.S. banking system. One of the U.S. government’s primary tools is to create a list of illicit transactions or parties with which transactions are deemed illicit. The government then requires banks worldwide to monitor the trillions of dollars of transactions that are processed through their systems every day to make sure that those prohibited transactions do not take place.

Kathryn Judge: Economic statecraft uses corporate actors and private industry to further state goals not limited to foreign policy. The banks were roped into this system starting with the Bank Secrecy Act in 1970. We use banks as first-order overseers of potentially illicit financial flows. As a result, through anti-money laundering laws [AML], banks have been forced to build up robust compliance systems, where they have to know a lot about their customers and monitor certain types of suspicious activities. That operates a little bit differently than sanctions, where you’re oftentimes just trying to block financial flows, but the infrastructure overlaps dramatically.

Are anti-money laundering laws aimed at preventing crime or protecting national security? 

Waxman: A point about economic statecraft is that it’s not so easy to draw clear lines between what is foreign policy, what is national security policy, what is domestic economic policy.

Judge: That is one of the core problems with the efficacy of the anti-money laundering scheme. It is trying to serve multiple different aims simultaneously, and it is using a single framework for doing so. The Bank Secrecy Act was aimed at the use of Swiss bank accounts to enable tax evasion and other white-collar crime. A core part of the war on drugs in the 1980s was a significant expansion of anti-money laundering laws. Post 9/11, countering efforts to finance terrorism became a central component of AML. The overall AML regime became far more expansive—and you ended up having a single regime that is meant to serve a variety of aims, even though the types of financial flows that you look for are quite different depending on which of those aims you are trying to prioritize. This is one reason that the system is both costly and ineffective. 

What are the risks to central banking of relying on tools of economic statecraft?  

Menand: Recently, sanctions have touched central banks in a somewhat new way with the imposition of sanctions on a host of Russian actors, including the Russian central bank. This development has raised questions about whether other central banks might try to inoculate themselves in advance from potential U.S. sanctions by diversifying away from U.S. dollar assets. One way that might happen is a country could change the financial reserves it holds from U.S. Treasury securities to other securities or to gold. Or it could change where and how it holds its reserves and what sort of counterparties its government has so that it might be less susceptible to U.S. sanctions.

The concern for central bankers is that the current system has a lot of benefits in facilitating low-cost transactions and global trade and investment and finance. Fragmentation has costs. Policymakers try to consider these costs when they deploy these economic statecraft tools and to mitigate them as best as possible. 

Judge: There are significant risks associated with aggressively using banks and other financial institutions as tools of economic statecraft. One concern that has gotten a lot of attention is a possible decline in “dollar dominance.” Dollar dominance can mean two different things. One is the dollar as a means of transacting. The other is Treasury instruments as a form which central banks and other investors hold as “safe” assets. The two are correlated, in that it is convenient to hold assets denominated in a very useful currency, but they can diverge. Part of the reason we had dollar dominance is, what else did you trust? On Russian sanctions, for example, the U.S. was aggressive, but the euro, which is a potential alternative to the dollar, was even more aggressive. Russian sanctions may have made the dollar unattractive; it made the euro even less attractive. 

But it will be different if countries start to explore payment alternatives. This is where we’ve seen China become a much bigger player: We’ve seen a massive growth in the use of renminbi for purposes of trade, mainly because it’s a very effective way to avoid sanctions. A development such as oil being traded in renminbi, even when China is not a party, would be a way of creating an alternative payment system that is not reliant on U.S. banks, U.S. correspondent banks, and the dollar-denominated system that the U.S. government indirectly has a significant amount of control over. We could have a whittling away of the efficacy of sanctions because we’ve accelerated the rate at which alternative payment systems have grown. China has accentuated its advantages by making a fairly effective digital payment alternative. 

For now, the dollar remains dominant. But understanding the shifts underway does suggest that there are reasons to be concerned that the tipping point away from dollar dominance may yet come earlier than many people expect. And it may well be the case that nothing comes along to replace it. We just end up with a more fragmented global financial system.  

Does economic statecraft conflict with a commitment to free markets? 

Waxman: Economic statecraft tools are all about intervening in markets, and for decades, a dominant dogma in American economic policy was to promote free markets. Now this tide has shifted, partly because the free markets haven’t generated the kinds of economic benefits that were promised to wide swaths of the American public. Further, free markets didn’t deliver on promises in U.S. foreign policy. It was thought that integrating China into the global economic system would moderate that country’s politics and would bring it towards democracy. And that just hasn’t been borne out.

Is economic statecraft successful in enhancing national security? 

Waxman: That’s the million-dollar question. It is undoubtedly true that the United States can use these tools to deliver some punishing effects on our adversaries' economies and some beneficial effects on our allies’ economies. What is uncertain is just how effective economic sanctions are in changing adversaries’ behavior—and even changing adversary regimes. For example, the United States had a trade embargo on Cuba for decades. And the Castro regime lived on as presidential administrations turned over again and again. The use of trade restrictions almost certainly helped to reduce or to undermine Cuba’s revolutionary activities throughout the hemisphere. But those policies did not achieve their maximal objectives of changing the system of government within Cuba.

What kinds of legal reforms would be helpful to strengthen the economic statecraft tools that we’ve been talking about? 

Judge: For the anti-money laundering regime, the countering-terrorism-financing regime, and sanctions to be able to be effective, officials have to know who actually owns an asset. Not just the name of a corporation but the actual owners who receive the money that flows into that corporation. This is one of the areas where the United States has fallen dramatically short relative to our peers abroad. We’ve allowed there to be incredible secrecy at the level of a corporation or a trust through the creation of shell corporations. And it’s been a huge problem in the overall system. 

The Corporate Transparency Act, [which became law in 2021,] requires the Treasury Department to build a database of beneficial owners of the shell corporations that currently exist in the United States. The act has now faced court challenges, and it’s likely to make its way to the Supreme Court. But this is fundamental: The United States is the outlier, globally, in allowing opacity at the level of a corporation or a trust. It’s deeply troubling that Congress’ power to require disclosure of beneficial owners is being questioned. It’s a core challenge that we’re facing in making the overall system work better. 

This interview has been edited and condensed.