Guest Post: Smoot Hawley Redux

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Submitted by Jim Quinn

Smoot Hawley Redux

As the Greater Depression continues along a parallel pathway with the
Great Depression of the 1930s, Congress is about to commit the same
blunder it made in 1930. The rocket scientists in the House of
Representatives in September passed the Currency Reform for Fair Trade Act,
which aims to crack down on Chinese currency manipulation by targeting
imports from China and other countries with currencies that are
perceived to be undervalued.

The vote was 348 to 79, with more than 100 Republicans voting in
favor of the bill. It died in the Senate before the mid-term elections,
but Representative Sander Levin, Representative Tim Ryan and
Representative Tim Murphy are expected to reintroduce the bill when the
House returns in February from a congressional district work break.
Senators Shumer and Casey are also planning legislation to punish the
Chinese for unfair trade practices.

The head rocket scientist, Nancy Pelosi, declared:

“For so many years, we have watched the China-U.S. trade deficit
grow and grow and grow. Today, we are finally doing something about it
by recognizing that China’s manipulation of the currency represents a
subsidy for Chinese exports coming to the United States and
elsewhere. We owe that to American workers.”

This legislation is part of the Democrats’ “Make It in America”
initiative that endeavors to increase domestic manufacturing and
creating new American jobs. In classic congressional fashion, they are
attempting to pass a bill that will make them look good in the eyes of
their constituents, but will exacerbate already dangerous world trade
imbalances.

You can count on Congress to pander to unions, protectionists, and
America Firsters with hollow legislation, when 40 years of bad
decisions, bad policies, and bad choices placed us in this situation.
When you have made legislative choices that will require the U.S.
government to borrow another $6 trillion in the next four years and you
already owe someone $868 billion, it is not a good idea to punch them in
the nose.

The U.S. is running an annual trade deficit exceeding $500 billion
per year. It has not run an annual trade surplus since 1975. The trade
deficit peaked at $769 billion in 2006, subtracting 5.7% from GDP. The
enormous trade deficits are a result of government spending policies,
Federal Reserve monetary policies, and corporate outsourcing that have
gutted the industrial base of the U.S. These policies resulted in
personal consumption expenditures surging from 62% of GDP in 1970, to
71% of GDP in 2009.

The trade deficits are not the fault of the countries selling goods
to American consumers. Trade subtracted 3.5% from growth in April
through June, the most since 1947, as imports surged at the fastest pace
since 1984.

The trade deficit with China reached a record level in August of $28
billion, as imports skyrocketed. The U.S. is on track to exceed the 2008
record trade deficit with China of $268 billion. The facts that you
don’t hear from the protectionist crowd is that exports to China are on
track to reach $84 billion in 2010, 20% higher than the previous peak in
2008. Exports to China have increased by 525% since 2000, while imports
from China have increased by 340%. The storyline about China not
allowing U.S. imports into their country is false. Putting tariffs or
quotas on goods coming from China will not create jobs in America and
will only deepen and lengthen the current depression, just as it did in
the 1930s.

Protectionism During the Great Depression

The complete collapse of worldwide trade during the 1930s, with its
root in trade protectionism, did not cause the Great Depression, but it
certainly didn’t help. In 1929, exports totaled $5.9 billion and
accounted for 5.7% of GDP. By 1933, exports had plunged to $2.0 billion
and accounted for only 3.5% of GDP. Imports plummeted by an equal
amount. Global trade declined by 60% as tariffs were imposed and
retaliation created a downward spiral. The U.S. provoked the trade war
with the passage of the Smoot-Hawley Tariff Act.

Senators Reed Smoot and Willis C. Hawley sponsored the bill, and it
was signed into law on June 17, 1930, by Herbert Hoover. It raised U.S.
tariffs on over 20,000 imported goods to the highest levels since 1828.
The new tariff imposed an effective tax rate of 60% on more than 3,200
products and materials imported into the United States, quadrupling
previous tariff rates. According to the U.S. Statistical Abstract, the overall effective tariff rate was 13.5% in 1929 and 19.8% by 1933.

It seems politicians never change. During the 1928 presidential
campaign, Herbert Hoover promised to help beleaguered farmers by
increasing tariffs on agricultural products. After getting elected,
Hoover asked Congress for an increase of tariff rates for agricultural
goods and a decrease of rates for industrial goods. The
Republican-dominated House and Senate did him one better and increased
tariffs across the board. 

In May 1930, a petition was signed by 1,028 economists asking
President Hoover to veto the legislation. Henry Ford begged him to veto
the legislation. Hoover opposed the bill and called it “vicious,
extortionate, and obnoxious” because he felt it would undercut his
pledge to international cooperation. Then he proved that he was a
standard-issue weak-kneed politician by signing the bill. Hoover’s
initial instinct proved correct. The international community levied
their own tariffs in retaliation after the bill became law. Canada,
Britain, and other European countries immediately imposed their own
tariffs. World trade came to a grinding halt.

Germany, with its war reparations, was particularly vulnerable to
this contraction. Ironically, the U.S. was the lender to the world
during the 1920s. American lending propped up the entire world economy.
Former allies paid war-debt installments to the U.S. chiefly with funds
obtained from German reparations payments, and Germany was able to make
those payments only because of large private loans from the U.S. and
Britain. Similarly, U.S. investments abroad provided the dollars, which
alone made it possible for foreign nations to buy U.S. exports.

By killing world trade with the Smoot-Hawley tariffs, the U.S. shot
itself in the foot and contributed to worsening the Depression in
Germany. This inadvertently led to the rise of Hitler. Talk about
unintended consequences.

Decades of Bad Choices

Blustering politicians like Nancy Pelosi and Chuck Schumer are
attempting to ram through populist legislation in order to appear to be
on the side of the American people. The Treasury secretary of the United
States has declared China a currency manipulator. Chinese Premier Wen
Jiabao responded in kind:

“If we increase the Yuan by 20% to 40%, as some people are
calling for, many of our factories will shut down and society will be in
turmoil. If China saw social and economic turbulence, then it would be a
disaster for the world.”

They are playing a high-stakes game of chicken, and the ante is much
higher than it was in 1930. Exports account for 12.5% of our GDP today,
versus 5.7% prior to the Great Depression.

The United States was a net exporter when the 1970s started. Our
enormous trade deficits, which subtract from GDP, were not imposed on us
by foreign countries. We are in this predicament because we made
appalling choices.

We chose to allow the Federal Reserve to inflate away 95% of the
purchasing power of the USD since 1971. We chose to elect politicians
that have driven the national debt from $371 billion in 1970 to $13.6
trillion today. We chose to support “free trade” legislation that
allowed corporate CEOs to gut our industrial base and ship good-paying
jobs to China, while filling the pockets of these executives with
millions. We chose to spend rather than save and invest in our country.
We chose to become a consumer debt-centered society, relishing in the
cheap goods we could buy from China on credit. We chose low prices at
Walmart over small-business owners and sustainable domestic production
of goods. Decades of bad choices cannot be reversed through taxation,
tariffs, and quotas.

The Chinese have pegged their currency to the USD since 1995. For a
decade, the U.S. was just fine with the peg, as American consumers got
cheap goods, American corporations reaped huge profits from outsourcing,
and banks raked in billions by lending money to everyone. Now that we
have entered the Greater Depression, the finger pointing and accusations
have begun.

Politicians and the people who elected them want someone to blame for
their bad choices. The Chinese are the bogeyman that forced Americans
to buy on credit. They forced American corporations to offshore millions
of U.S. jobs. If the U.S. had a strong dollar policy, ran surpluses,
and lived within its means, the Chinese peg would be meaningless.

U.S. GDP has grown by 335% since 1985. Over this same time frame,
exports to China have grown by 1,800%, and imports from China have grown
by 7,700%. Do politicians actually believe that imposing 30% tariffs on
all Chinese products will magically create new manufacturing jobs in
America? The 42,400 factories that have closed since 2001 and the 5.4
million manufacturing jobs lost are not coming back. A 30% upward
revaluation of the yuan or 30% tariffs on Chinese products would
devastate an economy that is still 70% dependent upon consumer spending.
Just as in 1930, protectionist measures would boomerang and smack
America in the back of the head.  

If the pandering politicians in Washington D.C. are myopic enough to
ignore the lessons of the past and start a trade war with China and/or
the rest of the world, the possible implications would be:

  • An immediate increase in the prices of goods from China, which would
    proportionately hurt the lower and middle classes who shop at Walmart.
  • Retaliatory tariffs and protectionist policies by other countries, resulting in a decline in U.S. exports.
  • A net loss of U.S. jobs as the decline in consumer spending-related jobs will far outweigh any benefits to exporting businesses.
  • A decrease in world trade, resulting in a deepening of the current worldwide depression.
  • Possible unintended consequences similar to what happened in Germany
    after the hyperinflationary collapse of their currency (dictators, war,
    chaos).