John Taylor: Rushing Toward Smoot-Hawley v.2.0

Tyler Durden's picture

Rushing Toward Smoot-Hawley v.2.0?
May 20, 2010
By John R. Taylor, Jr.
Chief Investment Officer, FX Concepts

Everyone studying the economic history of the 20th century learns about the Smoot-Hawley tariff and its role in “causing” the Great Depression. Senator Reed Smoot and Representative Willis Hawley and the President, Herbert Hoover, who signed that bill over the protests of 1028 economists and the leaders of American business, will carry the infamy of their decisions for many years to come. Of course, no modern politician would ever dream of passing a similar tariff-raising bill. We are well protected from making this mistake again, but then history never repeats itself. To use another shopworn aphorism, generals – and politicians – are always fighting the last war. Trade is an important factor in today’s world, but a far more important one is financial mobility, capital flows and the freedom to invest in one place and hedge in another. The spectacular global growth that we have all enjoyed since World War II actually began in 1950, with the start of the European Payments Union, an offspring of the Marshall Plan, and the precursor of full currency convertibility in 1958. Moving money from one place to another without restrictions has been a boon to every country that allowed it. The eurodollar market, born out of the dollar deposits that the French bank, Banque Commerciale pour l’Europe du Nord, would not deposit in the US because its Russian Soviet owners feared their dollars would be confiscated there, grew rapidly through the late 1960’s. That Communist bank, widely known as Eurobank, gave birth to this ultimate capitalist tool, the free-wheeling Eurodollar market allowing stateless money to go anywhere, invest in anything, and build economies everywhere.
Even in the 1970’s at Citibank, we measured the growth of the global financial system by the size of the Eurodollar pool. It was obvious, the faster it grew, the faster the economies grew. The eurodollar pool brought global monetarism to life and tied the major economies together. Over time, with floating currencies and free capital movement, the global financial system has become a somewhat selfregulating one, prodded and distorted by countries within it. Our understanding of how this system works is definitely incomplete, but we can forecast what will happen if someone games the system like China does by holding its currency steady while exhibiting high returns on capital. It’s simple: lots of capital goes there and Chinese reserves explode higher. The experience of 2007 and 2008 brought home the critical nature of this pool. The major global banks, the main conduits of this money, had expanded dramatically as they had to with the growing size of the market, making some very bad investments along the way, and then they all got into financial trouble at the same time. They stopped doing their job and the world almost stopped. Global trade collapsed and financial paralysis would have followed if the governments had not stepped in to basically guarantee all the bank flows.

Today, these banks are being widely castigated for their stupidity and cupidity. In both the US and in Europe, legal restrictions on leverage, on off-balance sheet vehicles, and on proprietary trading are widely supported in government circles and by the public. Universal banking is probably on its way out in the US. In Europe the rage against those who foresaw the weakness in Greece and protected themselves or profited has fanned the political desire to curb the movement of capital. Protecting weak credits by banning short selling or restricting offshore investors’ access to the markets will drive capital away. If banks can’t protect themselves against risk, they won’t invest at all. Eliminating SIVs and offbalance sheet vehicles may seem smart, but they are the investors in government debt and private bonds. Who will own this debt? Less leverage and smaller banks, plus restricted hedge funds, mean that the global money supply will drop and global GDP will too. Welcome to Smoot-Hawley v.2.0.

h/t Teddy KGB

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Lux Fiat's picture

Michael Pettis makes an interesting case for potential trade protection measures in 1-2 yrs in his latest missive, but from a different vantage point.

depression's picture

Welcome to Deflation 2.0

Quinvarius's picture

You can't have true economic growth through financial innovation.  The banking system merely masterbates itself as it watches the snuff film that is our 24 hour news feed. 

Mako's picture

Less leverage.... hahaha... you will have to start leveraging up at an exponential rate to keep the scheme going.   Sorry, try and deleverage and let me know how the mushroom cloud looks. 

Tic tock's picture

Citibank should have known better. Moving money around is useful but not an end unto itself- that much should be bone-simple to any banker. Arbitrage is all well and good- but HAS to be a marginal activity when you are the largest financial banking institution. Forgive me if I've mis-read the above article as being overweight hedge-fund advantages. is difficulat to argue with the German banking model, or for extending international financing through peculiar boutique institutions, whose ownership could be syndicated.

I think it is irresponsible to argue strongly against a substantial reform of hot-money flows, at a time when tax receipts as well as interest rates are pushing adverse effects onto the GLOBAL economy. If governments are to achieve stability, if they are able to manage confidence in amongst the Bond investors/speculators- at least from this particular perspective- it will be due to a stable and functioning fiscal framework, which hot-money flows take advantage of but, are detrimental to. 

If Libor is to remain low then it follows that higher reserve balances are locked in. I don't see how we get around that hurdle. In fact, putting SovBond take-up BEFORE a revision of new working practices seems counter-intuitive, but what do I know.


sushi's picture


In Europe the rage against those who foresaw the weakness in Greece and protected themselves


But in some cases those who saw the risk and profited are the very same firms that created the risk in the first place. Look at the CDO market in the US. Banks will fund your mortgage as long as you can fog a mirror; then they turn around and generate huge profits out of the very mess they have created.

This is easy money. It is also unscrupulous money. You want to bank like this then society has every right to take you out behind the barn and shoot you. Calling bankers whores is an insult to whores.

Psquared's picture

All this tells me is what I already knew. There is too much debt; corporate, private and public.

LetUsHavePeace's picture

The Tariff Act of 1930 (Smoot-Hawley) had very little effect on U.S. trade for the simple reason that it was a minor change from the tariff rates prevailing at the time. The Tariff Commission - the equivalent of the CBO for that time - studied the tariff rates proposed and compared them to those already in place under the Tariff Act of 1922 (Fordney-McCumber). There differences were not significant. The overall ad valorem rate increased from 38.48% to 41.14%. As is too often the case, what "everyone" has learned from "studying the economic history of the 20th century" says far more about the conventional thinking of late 20th and early 21st century academia than it does about actual U.S. tariff policy after the Great War or the verifiable "causes" of the Great Depression. Zero Hedge readers may want to read the work of Anthony O'Brien of Lehigh University. As Professor O'Brien points out, the data from the Commerce Department's National Income and Product Accounts of the United States, Vol. I, 1929-1958, shows the small part that the decline in real and nominal exports had in the overall collapse in U.S. economic activity between 1929 and 1933.  

Year GDP Real GDP Exports RealExp NetExp RealNetExp

1929 $103.1 $103.1 $0.4 $0.3 $5.9 $5.9

1930 $90.4 $93.3 $0.3 $0.0 $4.4 $4.9

1931 $75.8 $86.1 $0.0 -$0.4 $2.9 $4.1

1932 $58.0 $74.7 $0.0 -$0.3 $2.0 $3.3

1933 $55.6 $73.2 $0.1 -$0.4 $2.0 $3.3

LetUsHavePeace's picture

My apologies.  The captions for the data are incorrect.  Here is the correct matrix:


Year GDP Real GDP NetExp RealNetExp Exports RealExp 

1929 $103.1 $103.1 $0.4 $0.3 $5.9 $5.9

1930 $90.4 $93.3 $0.3 $0.0 $4.4 $4.9

1931 $75.8 $86.1 $0.0 -$0.4 $2.9 $4.1

1932 $58.0 $74.7 $0.0 -$0.3 $2.0 $3.3

1933 $55.6 $73.2 $0.1 -$0.4 $2.0 $3.3


CapTool's picture

the problem with sivs and other ways of taking your risk off balance sheets is they allow a financial institution to expand its real leverage and balance sheet while keeping an artificially low one for reporting purposes, thus requiring lower capital and recieving a more favorable rate for capital. indeed the whole problem with the cds market is the fact that it allows bad debts to be written. As we've seen bankers will write anything if they can get a fee and sell it. especially if they can get it rated  AAA.  And with fund managers chasing a bigger bonus instead of longer term yield for their customers you have a spiral of stupidity and cupidity, where they know they are buying crap but if they can win for the next year, they get the return and some unknown consumer gets the risk. We had credit expansion and a booming economy before the 1999-2005 deregulation.  Lets just get rid of those "reforms" and go back to a non financial dominated economy. it will hurt in the short term, especially for our over expanded banks that spent too much to capture deposits.  however i still would like a return to the old days wheres when i bought a rental property I had to prove everything with a 200 page application and a real assessment of use. Last week i got offered a refi over the phone with no paperwork, so we are still in the woods.

strannick's picture

'Today, banks are being widely castigated for their stupidity and cupidity'

Nice. I gotta get a better thesaurus...

strannick's picture

Today, banks are being widely castigated for their stupidity and cupidity'

now dey been banned from shortin nuditity..

an dat be suckin up all de liquidity..

Grand Supercycle's picture


For several days I have been warning of EURUSD buying support as detected by my indicators, and this has been confirmed by the recent break out.

The proprietary indicators I use can identify trend changes before they occur.