Trade Tariffs Won't Crash The World Economy, Monetary Policy Will

Authored by Carmen Elena Dorobăț via The Mises Institute,

As the Trump administration announces 25% tariffs on over $50bn of Chinese goods, and Europe and China prepare retaliation measures, The Economist concludes that “Rising tariffs are the worst of many threats to the world economy”, because, among other things, “Tariffs temporarily push up inflation, making it harder for central banks to cushion the blow.” 

This statement displays a deeply entrenched confusion—if not utter misunderstanding—of some basic economic concepts. Most important, many people fail to correctly distinguish between the causes and effects of price inflation and those of monetary inflation.

Monetary inflation is the increase in the quantity of money in an economy. This inflation causes the purchasing power of money to fall, which brings about price effects—a general rise in prices of goods and services—which we can refer to as price inflation. However, this general rise in prices following monetary inflation is disproportionate and staggered: prices will rise at different times and to different extents as money reaches a lower purchasing power. 

But monetary inflation also has non-price effects. One of these is the transfer of wealth between the last receivers of the new money toward the first receivers.

Another—and even more important—is the distortion of the pattern of investment and production, as the new money being created through credit expansion reaches stock markets and businesses—thus artificially reducing the interest rate. This latter effect explains the occurrence of production booms misaligned with consumer preferences, and the later, inevitable economic bust or crash. These price and non-price effects of monetary inflation are general and underline every possible economic activity.

Trade tariffs, on the other hand, affect only some markets and bring about increases in some prices in the economy. As this happens, our consumption patterns change: if we consume fewer imports, prices of domestic substitutes will rise. If our consumption of imports rises or does not change, we will have a reduced income to spend on other goods, whose prices will now fall. Whatever the result, it does not engender a ‘general’ rise in prices, or a depreciation of the currency as a result.

Moreover, even if tariffs were applied to every good and service, there would be no systematic, inter-temporal distortion of the structure of production. A stalling of productive activity and a rise in production costs is likely to occur, as capital goods—e.g. steel or aluminum—will now be more expensive. But capital is now underutilized, not squandered. There may be less investment, but no malinvestment.

Understanding this, it is easier to see then that trade tariffs, as bad as they are, cannot produce an economic bust in the same sense as occurs in the business cycle (just as simple domestic taxation, albeit reducing welfare, does not cause an economic crisis). As Rothbard (1963) explained,

“declines in specific industries can never ignite a general depression. Shifts in data will cause increases in activity in one field, declines in another. [...]

The problem of the business cycle is one of general boom and depression; it is not a problem of exploring specific industries and wondering what factors make each one of them relatively prosperous or depressed. […]

In considering general movements in business, then, it is immediately evident that such movements must be transmitted through the general medium of exchange — money. Money forges the connecting link between all economic activities. If one price goes up and another down, we may conclude that demand has shifted from one industry to another; but if all prices move up or down together, some change must have occurred in the monetary sphere.”

It would be remarkably futile, then, to endeavor to cushion the blow of trade tariffs with loose monetary policy.

The worst thing, by far, for a world economy of interconnected financial and capital markets, is monetary inflation and credit expansion. It is never a cure, and always a curse. Trade tariffs are, however, the second worst threat to a global market—often likely to make the bust much worse and the recovery slower, and to diminish our hopes for peace.

Comments

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In reply to by Stuck on Zero

peopledontwanttruth J J Pettigrew Mon, 06/25/2018 - 20:42 Permalink

What happens when nobody buys USA debt or uses the dollar but goes around it. 

The dollar is no longer king, the military is no longer the biggest and baddest especially when “they” put all their forces together.  

We don’t have an industrial economy to even mention.  

When it takes $100,000 for a loaf of bread IF you can find one, that isn’t level playing fields.  

Oh, and by the way we have the most over medicated aka drug users numbing themselves and the most guns in the world.  

In reply to by J J Pettigrew

MusicIsYou Mon, 06/25/2018 - 19:50 Permalink

The only thing that's going to crash is millions of people's ability to buy stuff feeding their lustful addiction to stuff. And because millions of people have to purchase something in order to be happy, millions of people are going to go nuts when high inflation comes. It's going to be entertaining to watch millions of people go nuts from cabin fever because they're used to galavanting around buying happiness.

DingleBarryObummer MusicIsYou Mon, 06/25/2018 - 20:02 Permalink

Exactly.  It's going to be a psychic shift from the material (back) to the spiritual.  If, of course, Trump doesn't cave on July 6th. 

People are going to have to make their own sandals from old lawn mower tires, and other stuff like that.  It will change the entire economy and culture for the better, imo, though it could take decades. 

That's why Trump absolutely can't back down this time.  It already might be too late, but it's worth a shot to get it going on July 6th

In reply to by MusicIsYou

Ron_Mexico peopledontwanttruth Tue, 06/26/2018 - 11:13 Permalink
Lewis: Machines are gonna fail and the system's gonna fail...then, survival. Who has the ability to survive? That's the game - survive.
Ed: Well, the system's done all right by me.
Lewis: Oh yeah. You gotta nice job, you gotta a nice house, a nice wife, a nice kid.
Ed: You make that sound rather shitty, Lewis.
Lewis: Why do you go on these trips with me, Ed?
Ed: I like my life, Lewis.
Lewis: Yeah, but why do you go on these trips with me?
Ed: You know, sometimes I wonder about that.

In reply to by peopledontwanttruth

Mikeyyy MusicIsYou Mon, 06/25/2018 - 20:09 Permalink

Typical simplistic (or should I say simpleton) ZH thinking.  Millions of people buying stuff means millions of people making stuff which means millions of incomes.  

I'll keep it simple for you - millions of people stop buying stuff then that's millions of incomes that are no longer happening.  Whaddya think happens then Einstein ?

Gawd, it's like reading 2nd graders here...

In reply to by MusicIsYou

Consuelo Mikeyyy Mon, 06/25/2018 - 20:26 Permalink

I'll make it even simpler for You: You obviously weren't alive when there was no such thing as easy financing and cheap money.   You have only seen what pulling the future forward has achieved, and it's illusion of real wealth.    Wise parents used to call it: Deferred Gratification.

Save First, Spend Later.

 

In reply to by Mikeyyy

Consuelo MusicIsYou Mon, 06/25/2018 - 20:22 Permalink

+1

Great point - and not made enough around here.   The days when 'credit' is extended only for the purposes of business creation and/or home creation for those with real and high amount of savings, can't come soon enough.   Nor can the asset and wage deflation across the boards that goes along with a reset which rewards prudence with high rates of interest, and shuts out those with little desire to save for the future.

In reply to by MusicIsYou

Balance-Sheet Mon, 06/25/2018 - 20:53 Permalink

US Trade Account goes to a 100B surplus for 8-10 years. This is all that is necessary and it can be approached in a number of ways. US population is under 5% of the global total so the Chinese simply sell their stuff the the OTHER 95% for 8-10 years OR they buy 500B more a year from the US.

TheEndIsNear Mon, 06/25/2018 - 21:31 Permalink

"Monetary inflation is the increase in the quantity of money in an economy."

It's surprising to see this bullshit propagated by the Mises institute. Monetary inflation s the increase in the quantity of money in an economy MULTIPLIED BY the velocity of money. That is why we haven't see enormous increases in the price of goods and services; ie, monetary velocity is extremely low right now because we are in a recession/depression.
PQ = MV

As for tariffs, all other countries place tariffs on US exports, so what is the BFD stink about the US placing tariffs on their exports to the US?

Iskiab rejected Mon, 06/25/2018 - 23:24 Permalink

I think he found that mistake and then spouted his opinion, don’t hold your breath waiting for a link.

He was right about the article though.  You can summarize the entire article as, ‘Please continue to hike rates because our sponsors at the Mises will make more money with higher rates.’

He doesn’t like the economist article because it mentions inflation from tariffs.  Then goes into a bunch of long run theories about the price of one thing increasing will mean other prices will decrease blah blah blah.  As if a company, even in modern times, can change their supply chain overnight and the cost of one input won’t increase their costs, and potentially ripple in the short term as they try to pass along the cost increase.  A sudden tariff is a shock, and totally different than studying the long term effects of tariffs.

Stay tuned though, I’ll wait to buy my next iPhone, because if this guy’s right the price should drop any day now.

 

In reply to by rejected

Charvo Mon, 06/25/2018 - 22:29 Permalink

I think Powell will raise rates, but there will be massive government fiscal spending in order to balance out the money suck from the world economy.  This will be horrible for countries dependent of US dollar FDI, but the USA will survive.

MrNoItAll Mon, 06/25/2018 - 22:36 Permalink

Big time inflation is coming with or without trade wars. The "trade wars" are being put in place to provide world leaders with convenient excuses as to why their respective economies are going down the tubes. But it was going to happen anyway, IS happening anyway.