One of the ugly features of the Great Depression that in many (but not all) cases worsened the severity of the contraction was that countries adopted “me first” policies with little regard to their broader ramifications. The poster child of this pattern is Smoot Hawley. Although there is some dispute among economists as to whether it was as deleterious as sometimes claimed, the US increased tariffs to protect domestic employment. This proved to be short-sighted, since the US was the biggest exporter, and had a great deal to lose when other countries retaliated.
Similarly, England left the gold reserve comparatively early, in 1931. Currency devaluation proved a great help in escaping the worst of the Depression. However, competitive devaluations also limited the benefits for any one player.
We are now seeing what looks to be “devil take the hindmost” behavior. China has quietly gone back to a hard peg against the dollar (as opposed to letting the RMB do what it would otherwise do, appreciate). This is very detrimental, since it means that China is going to try to continue to rely on exports to see its way through this downturn, rather than use more aggressive fiscal stimulus. It also means that China is trying to prop up the system of global imbalances (Chinese savings glut, US overconsumption and borrowing from China et. al.) that helped create this mess. We need to collectively find our way out of this smoky airplane, but everyone seems to want to go back to their seats and strap themselves in.
In a very good Financial Times piece, Wolfgang Munchau in passing mentions “unsynchronised monetary policies” and suggests that the Fed’s aggressive move to quantitative easing (oh, we don’t dare call it that, the Fed insists its flavor is different) will force the ECB to follow suit to a fair degree. Munchau does not consider this to be a plus:
I am sceptical about the benefits of the Fed’s new policy of quantitative easing. We do not have a liquidity crisis, but a solvency crisis, which expresses itself in large spreads and dysfunctional money markets. I cannot see how adding more and more liquidity to the system solves this problem.
Instead of propping up each bank, and swamping the market with cash, we need to restructure and shrink the banking system, as a first step to a sustainable solution to this crisis. Quantitative easing without deep structural financial reform could cause lot of trouble in the long run.
I think, however, there is a case for temporary interest rate cuts in Europe, but only on condition that this policy would be forcefully reversed once credit markets start to recover, and once the economy emerges from the slump.
But we should not delude ourselves into thinking that monetary policy can save the world. It can play a useful role, especially since we do not have the stomach for an optimal fiscal policy response. But it will not prevent the worst slump of our generation.
Ambrose Evans-Pritchard chronicles a rise in good old garden variety protectionism, so far limited to secondary and emerging economies. But don’t kid yourself that the sentiment might not spread.
It is important to keep in mind that cartoon extremes often cloud the debate. How smart is it to advocate open trade when some countries stack the deck by having artificially cheap currencies? That is tantamount to an export subsidy, but we haven’t done much except jawbone China very late in the game (and the yen has been awfully cheap until recently too, and Japan has remained an export powerhouse, but we never gave them a hard time due to the sorry state of their domestic economy). Similarly, we consider it completely reasonable to restrict exports of advanced military technology, and acquisition of strategic assets.
Again, I am not saying trade is a bad thing, merely that we have often been faced with counterparties with mercantilist objectives, and our responses appear not to have served us well in the long term.
From Evans-Pritchard:
We are advancing to the political stage of this global train wreck. Regimes are being tested. Those relying on perma-boom to mask a lack of democratic or ancestral legitimacy may try to gain time by the usual methods: trade barriers, saber-rattling, and barbed wire…
Russia has begun to shut down trade…It has imposed import tariffs of 30pc on cars, 15pc on farm kit, and 95pc on poultry (above quota levels). “It is possible during the financial crisis to support domestic producers by raising customs duties,” said Premier Vladimir Putin.
Russia is not alone. India and Vietnam have imposed steel tariffs. Indonesia is resorting to special “licences” to choke off imports…
There have been street protests in Moscow, St Petersburg, Kaliningrad, Vladivostok and Barnaul. Police crushed “Dissent Marchers” holding copies of Russia’s constitution above their heads in Moscow’s Triumfalnaya Square.
“Russia has not seen anything like these nationwide protests before,” said Boris Kagarlitsky from Moscow’s Globalization Institute….
The omens are not good in China either…
Exports fell 2.2pc in November. Toy, textile, footwear, and furniture plants are being closed across Guangdong, now the riot hub of South China. Some 40m Chinese workers are expected to lose their jobs. Party officials have warned of “mass-scale social turmoil”.
The Politburo is giving mixed signals. We don’t yet know how much of the country’s plan to boost domestic demand through a $586bn stimulus package is real, and how much is a wish-list sent to party bosses in the hinterland without funding.
Shortly after President Hu Jintao said China is “losing competitive edge in the world market”, we saw a move towards export subsidies for the steel industry and a dip in the yuan peg…Such raw mercantilism can only draw a sharp retort from Washington and Brussels in this climate.
“During a global slowdown, you can’t have countries trying to take advantage of others by manipulating their currencies,” said Frank Vargo from the US National Association of Manufacturers.
It is a view shared entirely by President-elect Barack Obama. “China must change its currency practices. Because it pegs its currency at an artificially low rate, China is running massive current account surpluses. This is not good for American firms and workers, not good for the world,” he said in October. The new intake of radical Democrats on Capitol Hill will hold him to it.
There has been much talk lately of America’s Smoot-Hawley Tariff Act…. The relevant message of Smoot-Hawley is that America was then the big exporter, playing the China role. By resorting to tariffs, it set off retaliation, and was the biggest victim of its own folly.
Britain and the Dominions retreated into Imperial Preference. Other countries joined. This became the “growth bloc” of the 1930s, free from the deflation constraints of the Gold Standard. High tariffs stopped the stimulus leaking out.
It was a successful strategy – given the awful alternatives – and was the key reason why Britain’s economy contracted by just 5pc during the Depression, against 15pc for France, and 30pc for the US…
This crisis has already brought us a monetary revolution as interest rates approach zero across the G10. It may overturn the “New World Order” as well, unless we move with great care in grim months ahead. This is where events turn dangerous.
The last great era of globalisation peaked just before 1914. You know the rest of the story.
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yves — if everyone does a competitive devaluation, there isn’t a gain in competitiveness, but there is still a potential gain in the face of an adverse shock: call the benefit of a coordinated monetary expansion.
bsetser
Yves Smith said: “How smart is it to advocate open trade when some countries stack the deck by having artificially cheap currencies? That is tantamount to an export subsidy, but we haven’t done much except jawbone China very late in the game…”
And vice-versa, of course. The US government has pursued an artificial ‘strong dollar’ policy for a long time and this has served American global corporations extremely well. Including those operating in China and exporting to the US.
“Half of the world’s 500 billionaires and a third of the 27 million millionaires call the USA their home. Five of the top ten banks are US, six of the top ten pharmaceutical/biotech companies, four of the top ten telecommunications companies, seven of the top information technology companies, four of the top gas and oil companies, nine out of the top ten software companies, four of the top ten insurance companies and nine of the top ten general retail companies. The concentration of economic power is even more evident if we look at the top ten companies in the world: 90 percent are US owned; of the top 25, 72 percent are US owned; and of the top 50, 70 percent are US owned. Within the inner circle of the biggest companies, the US has an overwhelming presence and dominance. Africa and Latin America are absent from the list. And the so-called Asian Tigers have three companies among the top 500, less than 1 percent. World markets are divided up among the 238 leading US and 153 European companies and banks. 80% of the leading oil and gas companies are US and EU owned. These sales earn high profits and are used to payoff or buy up allies and the armed forces in strategic regions. The US spends more than $400 billion on defense – about half the world total..“
Facts on the US Economic Empire
by etra Jaimers. Eat the State. Volume 7, #3 October 9, 2002
http://eatthestate.org/07-03/FactsonEconomic.htm
Well, in for the kill.
1. Russia weapons export exploded due to cheap rubble.
2. China seems to be able to handle the slow down due to collapsing commodity and energy price.
Both have gigantic reserve and see their economy start climbing up. They also know western capitalism is for sucker and they are not about to become the biggest sucker.
Brazil and Indonesia also seeing economy that are stabilizing. We’ll see about India.
Basically, it’s countries with big population that has the population reserve to get back up and start running again.
Anglo european banks won’t be healthy until late next year.
So, I for one say…this is the so called de-coupling they have been talking about. It’s the break of policy supporting traditional G-7 wish.
Without the US consumer consuming, the world enters slow or no growth.
Without the US consumer requesting and receiving more dollars from the banks, the rest of the world goes into a panic as there are no excess dollars to flow into other economies.
As the US government tries injecting credit and money into the system, the outright spending of the money is just not there, mostly going towards old debt.
Nobody is interested in short or long term new debt at this time.
Worse overall, the excess dollars are losing value.
U.S. Files Trade Violation Case Against China
“The United States could be cleared to impose economic sanctions against China if negotiations between the two nations failed to resolve the dispute and if a W.T.O. hearing panel ruled in favor of the United States.”
I take it as a given that sovereigns will optimize locally. This is one of the reasons that debt/deflation is so dangerous. If there ever was any doubt, civil unrest should undo that. The modest civil unrest we are seeing in Greece (why greece??) is a prelude. Prosperity is the mothers milk of stable governments. Begger thy neighbor is a small price to pay to retain or gain incumbency.
I will argue that although the financial panic portion of our crisis has been milder than 1930, that the recoil could be harsher. Smoot-Hawley does not need to be repeated, because our situation is much more fragile.
The interconnectedness of just-in-time inventories and cross country layers of low-margin/high-leverage subcontractors makes the free flow of both capital and goods critical.
The center cannot hold, and that is going to be the next big earthquake.
It turns out that too big to fail, and highly interconnected and systemic risk are not just financial industry concepts.
Yes, beggar thy neighbor has started.
The problem is that the world’s trading model is based on failed national economic models. China is export dependent and we are borrowing to support our imports. Both models have been broken due to the current financial crisis busting the bubble of 30 years of debt accumulation by the U.S. There is no going back, there have to be serious changes in both countries’ economic models. That is going to be very painful …
See I have to press bsetser’s view. I read a similar sentiment on Prof. Rodrik’s blog. Sure in theory coordinated devaluation (Rodrik referred to it as coordinated fiscal stimulus) could help increase global growth rates and therefore be a mathematical way to cushion the blow.
I say mathematical because I have two problems with this. First of all, stimulus for stimulus sake doesn’t help at all, it has to be accompanied by rebalancing trade. Prof. Rodrik suggested tariffs by debtor countries would help in this. But I don’t see how import/export economies are interchangeable. I doubt Chinese consumers want to buy all the stuff that they make for us even if they could, and our domestic industry is a mess. It would take years to repurpose factories and with massive stimulus you are really playing with fire hoping things stay together for the process to complete.
The second problem I have is that even if global growth rates go up and in the proper fashion, what about natural resource constraints? Oil was skyrocketing based on the “inevitable” rise of China and India, and now we’re saying that we can turbocharge them and increase the industrial world faster than those prior projections? Oil and basic metal shortfalls would become huge very quickly and I could easily see resource collapse destroying any monetary progress that had been made.
If there are two scenarios I dread it is the one Yves brings up in the post above this and the other one is the world expending all its resources to make “stuff” that no one needs because we’re trying to avoid all our bad debt.
Again, I am not saying trade is a bad thing, merely that we have often been faced with counterparties with mercantilist objectives, and our responses appear not to have served us well in the long term.
Exactly. I’ve been saying that for years. I think trade is great, and the US should look the other way small, poor countries engage in some degree of protectionism/mercantilism. But Japan is too rich and China too large for there not to be a policy response of some sort. Now is not the time to start responding, but it should be telegraphed that a response will be coming at some point – if Bernanke’s printing press doesn’t solve the problem first.
I will note that the 2nd, 4th, and 5th largest trade deficits are with OPEC, Mexico, and Canada. That’s another issue I harp on – America does an excellent job of shooting itself in the foot with its energy non-policy.
Fortunately, foreign investors in the US don’t do so well with their efforts over here. The net investment position is only (!) 20% of GDP to the negative, despite the cumulative trade deficit having reached 50% of GDP.
“Again, I am not saying trade is a bad thing, merely that we have often been faced with counterparties with mercantilist objectives, and our responses appear not to have served us well in the long term.”
So, Detroit builds bad cars because the Chinese peg the RMB? The Japanese forced option ARMs onto Californians? I don’t think so.
Detroit does not build bad vehicles. They did though and that damaged their brands and they might not recover.
Buick,Mercury and Cadillac were 2, 3 and 4 in the latest JD Power long term reliability report and the Ford Fusion topped the initial quality report in 2009 for mid-sized cars.
To get a very unreliable car buy VW, MB or any BMW not in their 3 series. Those badges are at or near the bottom in any quality or reliability study.
The US ZIRP policy is not exactly a non event in the currency ERM and with the Obama putative social and or ‘environmental’ tariffs the US seems as willing as anyone else to play the ‘beggar thy neighbor’ game.
That said, the larger issue maybe the decline of the 19th century concept of ‘comparitive advantage’ and the satiation of consumer demand in the advanced countries.
I’ve got a drawerful of old cell phones. I’ve got a TV in everyroom and I own two cars and a truck. I’m not a rich man either. Beyond the economic issues of exchange rates, debt financing and commodity
prices, China, inter alia, may find
they have to expand their domestic
market as they have satiated their export ones no matter what the price of the next boatload of trinkets is priced at.
So, almost everyone agrees that restricting trade by devaluing currencies or by using tarrifs or other trade-limiting tools is detrimental and will exacerbate the current crisis. At the same time there seems to be a vision that adopting a mercantilistic position as a nation can be beneficial as long as you’re among the first to do it and you cannot be retaliated against easily.
So, what is the appropriate reaction to deal with mercantilistic foreign nations?
A casual glance at the situation would suggest that the US would benefit from protectionism with its imports exceeding its exports. Any action though would probably provoke a retaliatory action, like trade tariffs on US goods or selling of treasuries. It is for this reason that protectionism is unlikely to be the first choice of decision makers at the moment in my view. My guess would be that Japan who are suffering from currency appreciation will be the leaders in any counter action. Lets face it you might as well build a wall along the Canadian and Mexican borders at the same time to lock the US away from the rest of the world.
The incoming team of US decision makers is likely to be placed in a difficult position though as the risk of public sentiment turning against those perceived to have stolen US jobs increases. Obama seems already quite keen on tackling competitive advantage due to exploitation of the work force. Where levelling of wage differences in the US may probably benefit the economy applying that philosophy externally may cause more harm than good if applied wrongly. While the FED can still print lots of money with impunity and short term there is no reason to assume they cannot being a global reserve currency then the need for protectionism is somewhat limited.
The FED changed the game completely though with its latest change in the interest rates. This means the money market funds can no longer make a profit and like Credit Suisse funds may be forced to close. Considering 500 billion dollars of money market funds was spent on treasuries last month, you have to wonder what will happen to liquidity in the short term. Managers think the FED’s idea is to shift investment back to more risky investments like stocks and shares. The problem is those riskier investments don’t necessarily have to be US investments. This could add to liquidity problems on top of solvency problems and it is not much of a stretch of the imagination to see the TARP needing to be 700 billion per month.
I perceive a pattern developing where established ideas and strategies are being used by investors and money managers rather than taking a fresh look at things. These strategies are only changing as it becomes blatantly obvious that they will fail. The Yen will continue to rise until it becomes obvious that export is totally decimated in Japan. US treasuries will be bought until it becomes obvious they can not be paid back. The dollar will remain the reserve currency until it becomes obvious that there is a dollar currency crisis. The Treasury will continue with quantitative easing until it becomes obvious it is damaging the economy. At each step that the fog begins to clear investors and decision makers are caught out. Protectionism is just another step which will cause investors and decision makers to be caught out with unanticipated results.
When La Fontaine’s grasshopper and ant have a joint
checking account, denominated in Chimerican Yuollars, things could get interesting. Like a tornado
or a Tennessee divorce, either way somebody’s going to lose a mobile home.
Yes, China is now the net exporter, as the US was in during the Great Depression. But there’s a big difference. Then, the US had simultaneously the strongest trade position and the highest wages. Now, China which has the big trade surplus is toward the low-wage end of the spectrum.
Let’s suppose (following both Keynes and Marx) that the fundamental cause of both crises is insufficient aggregate demand due to income inequality. In the current situation, the income inequality has to be looked at world-wide. Free trade risks aggravating the problem, especially if China lacks the institutional capacity to equalize incomes due to authoritarianism and pervasive corruption.
The question on the money markets is who has the “strong hand”? Bernanke is on record theororizing about negative interest rate for savers (tax) which is essentially what he is cramming down on MM holdrs. Went to the majro bank in NY and the 3-1 year CD rates are in the .25-.65% range.
Buffet has approached the problem several years ago with the idea of import certificates. Fair trade not free trade.
The problem with trade all along has been the globalists used it as cover for pushing their agenda. Free trade and integration means more coordination and more centralization. It is uncanny that there was/is amnd will contineut o be so much resisitance to Kyoto, the ICC and even the UN dating back well before Bush. And that sentiment is not confined to the US. The elites want free trade not out of dogmatic economic ideology. They want it becasue is is aligned with centralizing power.
Merely look at the policy response across the spectrum. The action/call is for more centralization, more regulation and greater oversight. Some needed ut like most everything else there will be overeach. but the overreach must be viewed in the slow moving ball aimed at consolidating the global superstructure. To wit, Bloomberg is running a story today saying the economic crisis is leading down the road to centralization that could be dangerous (and reminiscent of 3rd Reich)The archbishop must have read the article. (http://www.google.com/hostednews/afp/article/ALeqM5j6Rs-H23gCQ5Iu8h6AszRQX03FpA)
BRoss said…
Yes, China is now the net exporter, as the US was in during the Great Depression. But there’s a big difference. Then, the US had simultaneously the strongest trade position and the highest wages. Now, China which has the big trade surplus is toward the low-wage end of the spectrum.
———
During the early 20th century. US is very much low wage labor place (de facto slavery/segregation) Most of US export are agriculture.
British was the world empire.
In fact china at that time was about to enter the nadir of their 16th century power.
What continues to boggle my mind is how people forget that China was the world super power for 400 yrs. It control 1/4-1/3 or global wealth and population. It was winding down only recently during the imperialism age. (only less than a century ago.
Sustaining power for 4-500yrs takes different skill than being a super power for 40-50yrs.
Academia likes to tout the virtues of free trade but actually the US, by using the tax code to pay large US corporations to ship manufacturing jobs overseas, has managed trade. All those lost US manufacturing jobs are now exacerbating the severe US recession. Survival through trade protection is human nature, lets use the tax code to bring those manufacturing jobs back home.
Proposal:
Set a deadline.
All overseas holdings of US dollars are to be exchanged for Treasury IOUs.
Bring the paper money home. If it didn’t come in by deadline, it’s worthless. If it did, they got a Treasury IOU for it.
Burn half of the paper money.
Do the same thing inside the US.
what right does the US have to tell China how to relate to ITS OWN CURRENCY? It belongs to THEM, not us. They can do as they wish.
Wtf is wrong with this country? If we don’t like it, we can figure out another response.
The Ford Fusion is manufactured in Mexico, away from US union wage. It will be tough to compete with wages set outside the US. Probably why Ford doesn’t need a bailout, for now.
2009 may see many of the international ramifications of the collapse in world trade subsumed within important geostrategic shifts. For some years the USA has been faced with having to choose between two thrusts: control Europe (the much underestimated potential future rival) or control the Persian Gulf (and thus dictate energy terms to e.g. China and India). The USA does not have the imperial resources to do both at once. Cheney and Bush chose the second option. It seems likely, judging by what Brzezinski and others have been writing, that Obama may choose the first. A major flag-waving opportunity in this would be a campaign to counter Chinese mercantilist policy (China’s surplus is shared half-half between USA and Europe) with a call for a carbon tarif on Chinese exports. Obama would gather Europe up behind American leadership on both a “good” protectionism and action on climate change, and effectively put an end to independent European policy making on all the key issues.
(I do not mean that I myself think it would be “good” protectionism, just that this is how it would be presented.)
mft,
The US does not have the collective will power that would come with such a policy. Any way you frame it it is a collective downgrade in standard of living. youa re right that brezinski8 is focused on the Russian menace as he has always been. He is also the architect of his own middle eastern failures so hands off there wouldn’t be a surprise.
As for the US controlling Europe, this is exactly what the US is trying to do by imposing its detestable monetary policy on the rest of world. Trichet is resisting the urge but the chorus of appease me now folks declared mercy before the game started. The respnsible central bank in Europe will at some point put an end to the US folly. Berlin comes to mind.
The idea that the US is in a position to dictate terms to anyone is retrograde. Debtors don;t negotiate the terms. They abide by the settlement. I fear that time is approaching and no amount of smart bombs or nukes will stop it.
The Telegraph’s point about Imperial Preference is well made but I wonder how much relative British out-performance during the Depression is related to oil (I ignore coal, simply because all of the big economies had domestic coalfields).
The world’s major oilfields were located in the Gulf and under British control. I don’t know the figures but I imagine the major part of European consumption came from Gulf fields (rather than the more minor Romanian and Caspian production, and US production that was presumably subject to tariffs). A non-discretionary import by your competitors is a helpful thing to have when devaluing.
NB: The balance of payments implications of the Anglo-Persian oil company were still important enough to justify the UK-promoted coup against Mossadegh in the early 50’s.
America today has an empire (the BWII dollar zone) and she has a reserve currency but she does not have oil exports. If America is determined to devalue, rather than deleverage, and the Chinese refuse to agree to revalue within BWII – for which they have ample cushion, given their recent growth has been in trade against the strong Euro – the USA will come closer to “the last devaluation” – i.e. forcing the dollar down through the floor imposed by reserve status.
The price of this will be the end of the US-Gulf compact, because the petro-dollars are mostly spent in Eurasia so why generate and hold oil revenue in dollars? Where the Gulf goes, China will follow, since her Euro trade is as important as her dollar trade, and BWII will have been replaced by a Eurasian Euro-bloc.
Some fine solid points and “protectiism” did NOT work out too well during our last….?
BUT, a minor(?) point, Smoot and Hawley were NOT trying to protect “employment”, but, as very conservative Republicans,(Senate and House) our exporting corporations!
That huge failure was the very LAST time the GOP “embraced” “protectionism”, but we ought to be honest about Econ History, to form our philosophies!
One point that should not be overlooked regarding Britain’s “outperformance” during the 1930’s is that large parts of Britain did not enjoy the roaring 20’s as a precursor.
For the heavy industrial areas in the North of England (especially the North-East), it can be argued the Great Depression started in 1919 rather than 1929.
(Perhaps parts of the US Rustbelt are in a similar position today. They’re not going to fall as far in percentage terms simply because they weren’t involved in the earlier rise.)
@ozajh
Agreed. There’s not much space in comments for a rounded treatment of issues!
WW1 distorted capital, labour and consumption, towards smokestack industries.
Britain incurred hige war debts to the US, repayment of which depressed the economy in the 1920’s, and she found her continental European markets difficult to re-enter because America was preferred by Germay et al. (can’t imagine why, it was just a small war!).
However, the labour and consumption disasters were particularly long-lasting: WW1 wiped out a generation of managerial and skilled labour (the kind that made up to the post-WWII prosperity boom) while heavy industry workers were not drafted. The war, which did not significantly damage the US, Germany, central European and British industrial heartlands (although France got nicked and Belgium took a bullet), so at its end, the global economy found itself with a surplus of heavy industry and a lack of domestic consumption and foreign demand for a generation.
It would have taken more than a generation to restore, except WWII was the opposite kind of war, that flattened cities and industrial plant but left the people standing (relatively – and I ignore the civil wars and famine in Russia and China for the period WW1-WW2). So capacity was brought in line with consumption growth. Most of the capacity happened to be in the USA. Consumption growth in Europe was again fuelled by US finance (the Marshall Plan).
Only Britain was forced to fund recovery post-WWII from internal cashflow, and while her Empire was dismantled, but those were always explicit goals of America in WWII – brought about in part because of Imperial Preference and the use of tariffs, which were only tit-for-tat for Smoot Hawley.
“Fair trade” has some nasty consequences, especially for Empires rather than small trading nations….