China’s Smoot Hawley?

Comparisons to the Great Depression and to other nasty past downturns (Panic of 1873, anyone?) are coming fast and furious these days.

But one thing that continues to surprise me is the frequency with which the US in 2007-2008 is being compared to the US of 1929-1930. I’ve mentioned in passing that China is in the position that the US occupied in the late 1920s: a massive manufacturer that was generating large trade surpluses, to the point where the imbalance was destablizing (under a gold standard, the US was sucking the metal out of its trade partners; the modern analogy is China’s massive foreign exchange reserves). And as the US was the epicenter of the Great Depression, we cannot be certain of the trajectory of this economic crisis until we have a sense of how bad things are getting in China and how good its policy responses are.

Reader Michael has been e-mailing me from time to time with not-pretty sightings on China’s responses to the downturn. This post from Michael Pettis tells us that China appears to be trying to keep its exports up, which is eerily parallel to what the US did in the Great Depression.

He finds other supporters of a view we presented earlier (and that attracted lots of jeers), that the Chinese are planning not to let the RMB rise, in fact to have it fall slightly against the dollar. Again, if you are a student of the Great Depression. trashing one’s currency was key to getting back on track to growth. The US economy did not start to recover in a meaningful way until it went off the gold standard, which lead to a 40% fall in the currency’s value. So China is planning to block the course to what is needed most: an end to destablizing global imbalances (not that we didn’t happily go along when they appeared to beneficial in the short term, mind you, but we need to find an end game).

From Michael Pettis. There are three must read paragraphs I have put in boldface. I am kicking myself for not having connected these particular dots, but it is also distressing that no one other than Pettis has:

Most people believe that the official urban employment rate significantly understates real urban unemployment, and although I have hear that real unemployment is as high as 10-11%, I have seen nothing very credible on the issue. I assume unemployment is higher but I don’t really know what it is.

If unemployment is rising, however, it does mean that there will be serious pressure to do whatever it takes to support employment growth. One thing that I am worried about (and this was the subject of the “longish writing commitment” I mentioned above) is that it puts pressure on the government to engineer measures to expand export growth. For example I suspect that the fight over whether or not to continue appreciating, and even depreciate, the RMB is intense. Two days ago Bloomberg had a piece that said the following:

The yuan fell as policy makers focus on supporting exporters amid signs the world’s fourth-largest economy is slowing because of global financial turmoil…”We expect the dollar to move higher versus the yuan as the focus shifts decisively to growth,” said Thomas Harr, a senior foreign exchange strategist with Standard Chartered Plc in Singapore. “But not a massive move though, probably up to close to 7 in the first half” of next year, he said. The currency traded at 6.8270 per dollar in Shanghai as of 9:45 a.m., compared with 6.8269 yesterday, according to the China Foreign Exchange Trade System.

Perhaps more importantly, Xinhua said in an article on Monday that:

China’s Ministry of Finance announced on Monday a list of 3,770 items involved in the third export tax rebate increase this year. The items include labor-intensive, mechanical and electrical products. New export tax rebate rates on these items were also announced. The change take effect Dec. 1….

Export subsidies, depreciating RMB – all of this might seem to make sense if you look at China as divorced from the global balance of payments system…

But if you think of China’s role within the global balance of payments, it seems to me that this is little more that a form of Smoot-Hawley-with-Chinese-characteristics. Global demand is slowing, just as it did in the 1930s, and China as the leading source of global overcapacity is trying to address its global demand problem by shifting the burden abroad.

In that light I should mention a recent exchange… Reference was made to a recent Washington Post OpEd piece by the British historian Niall Ferguson….:

Ferguson is probably right to compare the 2008 G20 with the failed 1933 London conference, but the problems with this account, I think, is that he has the US playing the same role in the 1930s as today. But the positions are very different.

In the 1930 it was the US who had huge overcapacity which it exported abroad (via huge trade surpluses) and it was Europeans who were over-consuming, financed by capital exports from the US. When the credit crunch came it was unreasonable, as Keynes argued bitterly, to expect the rest of the world to continue demanding US goods, especially since the financing of their consumption had been interrupted. Since US production significantly exceeded US consumption (with the balance consisting of course of the trade surplus), the need for demand creation most logically rested in the US.

Yves here. Note the Chinese have a problem that probably did not obtain in the US during the Depression: a huge disparity in living standards between the exporter and importers. Remember, there was still a great deal of international labor mobility in the early 20th century, and that helped dampen wage differentials between countries. Presumably, many of the goods the US exported in the 1920s would have been the sort that US consumers would buy. By contrast. a lot of the goods made for export to the US would not appeal to the mass market in China. I do not know how specialized manufacturing is and how hard it would be to reorient production for the domestic market. But American like to overconsume in quantity as well as type (when I lived in Australia, I was struck by how much smaller their closets are than ours. It was refreshing, in a way).

Back to Pettis:

As we all know, in spite of FDR’s Keynesian reputation (he wasn’t) the US not only failed to expand fiscally as much as it needed to but it actually tried to use trade restrictions to protect its overcapacity problem and “export” its lack of demand to the rest of the world. That didn’t work, and when world trade collapsed the US had to bear the full adjustment cost of the gap between production and consumption, and it did so in the most difficult possible way, by contracting production.

Today it is China who is exporting overcapacity and it is the US who is consuming too much, fed by Chinese financing. With the collapse of bank intermediation US households and businesses are cutting consumption and raising savings. This is a necessary adjustment. Calling on the US government to engage in massive fiscal expansion to replace lost private demand is crazy. It means that we should continue the current game that has led us into so much trouble, but instead of having US over-consumption and rising debt at the private level we must have it at the public level.

If Keynes were around today he would probably make the same point he did over 60 years ago. Demand must be created by the current account surplus countries, which have, to date, relied on net exports to protect themselves from the consequence of their overcapacity. They must force demand up quickly in order to close the gap, and since expecting private consumption to rise quickly enough is unrealistic, it has to be public consumption – a large fiscal deficit.

Just as the US stupidly tried to increase its ability to dump capacity abroad by creating import restrictions (which has the effect of further expanding domestic production), China seems to be hoping for the same thing by increasing export rebates and slowing the currency appreciation (there is even increasing talk of depreciation).

This can’t work for long. The world has excess production and there is a need for the US to reduce its demand and increase its savings. The only proper place for new demand to originate is, once again as in the 1930s, from current account surplus countries. They should be engaged in demand creation, not supply creation. If they continue trying to export their way out of a slowdown, there will almost certainly be a trade war, as in the 1930s, and the full force of the adjustment will be borne by the current account surplus countries, again as in the 1930s. Remember that back then the current account deficit countries, like Germany after 1932, found it relatively easy to limit the impact of the crisis by forcing balanced trade — which has the effect of increasing demand (domestic) and reducing supply (foreign).

It is amazing to me that people like Ferguson, who have been arguing correctly for years that US consumed too much and saved too little, are now terrified of the necessary adjustment, and are arguing that it should be stopped and even reversed. The process cannot be stopped – US savings are too low and will rise one way or the other. The global imbalance between production and consumption must grow because US and European consumption must decline, and if we cannot find a new source of demand, there will have to be a contraction in production. In an open world, the contraction will be paid for by everybody more or less equally, with those aggressively pursuing export growth getting off relatively lightly and the rest doing worse. In a closed world most of the cost will be borne by the countries with overcapacity.

If Asian countries continue to try to boost exports it is not hard to see why this could easily lead to trade barriers.
China needs to resolve this problem by expanding fiscally, not by stimulating exports. The US in the same position sixty years ago tried to do the same thing China is doing (half-hearted fiscal stimulus and more interfering with trade in order to alter the terms in its favor), with disastrous consequences mainly for itself. Instead of looking for and dreading Smoot-Hawley in US or European policy-making, we really need to worry about an Asian Smoot-Hawley.

Remember that there is no difference in this case between restricting imports and subsidizing exports and, by the way, currency depreciation does both.

Yves again. Ahem, there is a wee bit that Pettis fails to mention in the supposedly “easy” adjustment of the trade deficit countries like Germany, France, and England defaulted on their debts. The handwriting is on the wall.

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  1. Jason

    Hi Yves,

    I don’t think the US will default on its debt. Part of it is because we aren’t on the gold standard anymore. The other part of it is because China has a pretty big vested interest in us not defaulting either. A devaluation seems more plausible. Also, Germany, the UK, and France were all coming out of a major crisis and WW prior to their defaults. As bad as the US position might be, it wasn’t as bad as it was back in the 30’s.

  2. Anonymous

    There is so much awful great depression history floating about. I noticed today that Merrill’s Rosenberg discovered one of the only decent histories written by Rothbard.

    The emerging Keynesian counter-meme that there wasn’t enough stimulus is so absurd. Even the use of the word stimulus is absurd. Just like “liquidity injection” is it merely a euphemism. When money is printed to “stimulate”, all that is doing is transferring capital from one group to another. But this simple economic fact is lost on Keynesians on only care about prices, which is why they’re so obsessive about reinflation.

    This article by Bob Murphy is a must read.

  3. Yves Smith

    Anon of 3:37 AM,

    The problem with the Austrians is that they treat economic needs as dominating broader social needs, a stance repeated by libertarians who often hew to Austrian principles.

    Societies can only tolerate so much stress before they come apart. Yes, the recovery might be faster if you, as Andrew Mellon suggested, “Liquidate, liquidate, liquidate,” but what do you have left when you have a few years of mass unemployment and hunger? Malnutrition in the young leads to lower mental capacity and shorter life expectancy. Hunger in the older leads to violence. Why do you think the Chinese are so concerned about unemployment? The officialdom is afraid for its hold on power, on the disorganized outbreaks they see now rising in number and leading either to chaos or organized opposition to their rule. And this is in an autocratic society where people do not own guns!

    A reader sent me a 30 or so page manual from someone living in Argentina describing how he functioned. It made the stuff from survivialist crazies in the US look tame. A long discourse on which type of gun to have for what purpose (I dimly recall Glocks were the preferred pistol), where to live and why, even discussion on the merits of various types of ammo and what types of gold (cheap rings are good, again I forget the reason). Physical security is clearly a big big preoccupation. I would give up a LOT of income not to feel I had to carry a gun at all times for my protection. My life is worth a lot to me, as is some peace of mind. And as upsetting as a crappy economy is, physical danger is worse. I lived in New York before the city was cleaned up, and although the risks were pretty tame (it was more risk to property, break ins, having wallets stolen), it was still enough to keep one on edge a little bit all the time.

  4. Yves Smith

    I am sorry, I was on TV with Schiff, I am NOT impressed. He is rigid, ideologically driven, and does not listen to facts. When presented with information that contradicts what he says, he just gets louder and refuses to engage with what was presented. He’s the sort they love on Fox News.

  5. Blissex

    «Remember that there is no difference in this case between restricting imports and subsidizing exports and, by the way, currency depreciation does both.»

    Well, technically China is just reducing export taxes. But it has engaged in massive currency depreciation for years. Their overcapacity is not in the production of good, but of people, and they have been desperate to import jobs from the USA and Europe.

    Also a very important point that Yves usually makes but was forgotten here: a lot of China’s excess capacity driving exports is actually Japanese.

    A lot of China’s exports are actually Japanese exports, as they consist mostly of higher value added Japanese parts with some lower added value Chinese assembly work.

    It is Japan as well or even more than China that has been driving global overcapacity and financing overconsumption by USA, UK and other countries with the 0% carry trade.

  6. Yves Smith


    You are correct, points I missed.

    And sorry to make the stuff re Schiff sound personal, It was not his interaction with me that was bothersome (I got to speak after him). It was the way he dealt with the Australian finance minister and a very well regarded local economist. They made very sound, sensible arguments in response to what Schiff had said, and Schiff refused to engage them, merely kept repeating what he had said earlier. I take that behavior to mean that someone is either intellectually lazy, dishonest, or out of his depth.

  7. Anonymous

    Yves wrote:
    Again, if you are a student of the Great Depression. trashing one’s currency was key to getting back on track to growth. The US economy did not start to recover in a meaningful way until it went off the gold standard, which lead to a 40% fall in the currency’s value.


    Economies recover after shocks, with or without government interventions. “Time heals all wounds.” Without sufficient proof, attributing the recovery of an economy to a specific policy is just wishful thinking.

  8. CrocodileChuck


    re: your 4:34 AM post

    Yes, Lindsey Tanner (Finance Mininster) was most impressive in his response to Mr. Schiff-but I thought Schiff was ‘pre recorded’, so detached/off topic/were his remarks..


  9. Anonymous

    Yves wrote:
    Why do you think the Chinese are so concerned about unemployment?

    The Chinese have more experience with starvation under full employment than any other nation. Should one conclude that full employment causes starvation?

    I don’t mean to attack you, Yves, but you are making lots of logical fallacies.

  10. Anonymous

    A 10 % fall in US GDP will take the country back to economic conditions prevailing in 1Q 2006, 15%, to those in Q2 2005. Cast your mind deep into the depths of history and tell us what will happen. If it is absolute levels of economic activity that are important then was 2005-6 so bad? What then are the social and or economic needs will shape society in such an event?

    In China, such events would mean a 1 to 1.5 year reversion.

  11. alan von altendorf


    Thank you very sincerely again for the breadth of your study and giving us the best, most pertinent analysis, including your own.


  12. River

    ‘ Jason said…
    Hi Yves,

    I don’t think the US will default on its debt. Part of it is because we aren’t on the gold standard anymore. The other part of it is because China has a pretty big vested interest in us not defaulting either. A devaluation seems more plausible.’

    Here we go again with the ‘devaluation’ meme. Please tell me exactly how, technically, the US will ‘devalue’ the dollar?

    The dollar, and many other currencies, are floaters; pegged to nothing, not backed by anything except ‘full faith and credit’ of governments. The route to ‘devaluation’ is really through the process of ‘depreciation’. IOW, increasing the money supply faster than goods and services are increasing. This point may seem insignificant but it is not. The assumption that a course of action is available when it is not can lead to a series of mistakes.

    From Wiki: ‘Devaluation is a reduction in the value of a currency with respect to other monetary units. In common modern usage, it specifically implies an official lowering of the value of a country’s currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency. In contrast, (currency) depreciation is most often used for the unofficial decrease in the exchange rate in a FLOATING EXCHANGE RATE SYSTEM.’ (caps mine)

    ‘Generally, a steady process of inflation is not considered a devaluation, although if a currency has a high level of inflation, its value will naturally fall against gold or foreign currencies. Especially where a country deliberately prints money (a usual cause of hyperinflation) to cover a persistent budget deficit without borrowing, this may be considered a devaluation.’

    It is easy to throw around the word ‘devaluation’ but accomplishing devaluation is not so easy and brings with it serious consequencies. If the US Government wishes to continue brisk sales of treasury issues to foreign entities then any attempt at depreciating the dollar must be approached very cautiously. Caution has not been the hallmark of the current administration.

  13. Anonymous

    I owe you fifty dollars, I got a problem. I owe you 500 Million dollars, You got a problem.
    Reading Braudel,you get the impression that this may be a seissmic event where world leadership transfers. Problem is, is that China has a history of flying apart at the seams under stress. Lets see how they handle their first recession.

  14. ndk

    I strongly agree that the U.S. is going to default on its debts, but not necessarily Treasury. Look back: all our interventions have been very carefully firewalled and the Treasury has avoided explicit guarantees. The truly major interventions have been done by the Fed and implicit bailout, even when FNM and FRE desperately cried out for an explicit choice.

    We’ve prepared for it. If things get bad enough, you just let the Fed become the Third National Bank of the United States, and move on.

  15. Anonymous

    The Chinese government was not trying to export its way out of the problem, it recognizes it needs to stimulate internal consumption in its massive stimulus program announced earlier. Whether they can pull it off is another issue. They were actually in the process of trying to move up the food chain from low value-added, labour intensive industries but will now may have to slow things down to maintain some semblence of stability.

  16. François

    I’m sorry to be on Schiff side here. And on Austrian economist’s side by the way.

    Of course he is rough. Austrian economists all are by design. Should they be as soft as an investment banker? Certainly not IMHO…

    How can you not be rigid anyway when you are one of the VERY few to dare say the obvious including:
    – daring to mention the housing the bubble on major TV networks early,
    – exposing that deficits matter at any level and confronting the fact that wester industry has been destroyed… And that it matters as well.

    Not all of us here have had the chance to find their way into the headoffices of international corporation reigning the globalization or, much better, banks and friends.

    Some of us here have to care about our savings for basic survival. Schiff was instrumental in getting a lot of people to get out of the housing bubble in time and sell their over-priced equity portofolio in time as well.

    An invaluable piece of advice.

  17. joe


    John Authers had some nice charts a couple of days ago linking crashes in the carry trade and the oil price to Chinese monetary policy.


  18. River

    How many times have we heard ‘the Chinese are not familiar with the intracies of banking’?

    For eithteen of the last twenty centuries China was the worlds largest economy.

    and…Does this sound familiar?

    ‘The Mongol Yuan dynasty (元, 1271-1368) also attempted to use paper currency. Unlike the Song dynasty they created a unified, national system that was not backed by silver or gold. The currency issued by the Yuan was the world’s first fiat currency, known as Chao. The Yuan government attempted to prohibit all transactions in or possession of silver or gold, which had to be turned over to the government. Inflation in 1260 caused the government to replace the existing paper currency with a new paper currency in 1287, but inflation caused by undisciplined printing remained a problem for the Yuan court until the end of the Dynasty.’

  19. David Pearson


    There’s an interesting implication of China’s refusal to let the Yuan appreciate.

    As a dollar-linked currency, China has no control over its monetary policy. So if the Fed prints money (which they are), the supply of Yuan also potentially increases. This implies that there is constant demand for Yuan assets, of course.

    So the implication of likely Fed policy is that the value of Chinese assets will depreciate in gold terms. Both the Yuan and the dollar would experience rising prices of inelastic goods — essentially commodities and big-ticket assets.

    People have to draw a difference between nominal and real demand. The Fed controls nominal demand in both the U.S. and all other dollar-linked countries. The Fed has little long term impact on real demand. You can have a recession and inflation at the same time. In Latin America the two coexist quite easily.

    Of course all of the above depends on velocity — animal spirits. Latin American countries prove that you can achieve positive velocity through monetization of fiscal deficits. That does NOT immediately result in hyperinflation, as the deflationists would have you believe. That only happens later. A terrible outcome, but not an unlikely one.

  20. Stephen

    There is an essential point here that Yves is making. Demand is down and the supply has been coming from China.

    Assuming some core economic principles still hold true then there needs to be adjustments to get us to equillibrium.

    Options are

    1) Fire Sale to clear the goods (deflation)

    2) Massive increase on the demand side, the cause of which is unknown for the momemnt…either a magical productivity device is created that causes new hiring and income to flow to the West or there is government stimulus to put money in peoples hands

    3) Reduction in production till inventory clears

    4) All 3

    The tools with which these adjustments vary but if the stories are true then the Mongolian desert will soon start filling up with unsold refrigerators and other goods.

    China is opaque and information is slow in coming out, I too have heard the reports of unrest, bank runs etc. I have also heard the reports of continued production by state run companies…which makes you wonder when the losses will be realized by the state companies and then the banks.

    The Yuan has been undervalued against the Dollar for YEARS. The Chinese government has been punishing consumers for years, holding their standard of living back (not so bad when the level is rising but still causes back pressure)

    The countries with the trade surpluses are the ones who see the greatest adjustment at the consumer and job level, they were living the mirror false paradise of the US consumer.

    There was a recent article about massive Chinese overcapacity and the price of gold, dont want to go there, but the other point was that the Chinese have not been pricing cost of capital, price of maintenence and price of innovation. This may or may not be true but is worth discussing.

    So the 3 years worth of refrigerators is a worthwhile scenario. What happens if there is a change in regulation or mythical technological innovation that obsoletes the refrigerators….can the Chinese factor afford to retool? Why did their managers build such a huge inventory pile (assuming it is true), reminds me of the 70’s in the US when you had slowdowns based on mis-estimated demand and slow retooling schedules. This was one of the reasons used to argue against deflation as it made estimations of demand and supply so difficult. JIT and technology helped cut those down.

    There is lots going on here, and one scenario to think about is that the Chinese are going to need all of those savings for domestic purposes, retooling, infrastructure, covering losses on previously mis directed loans to companies run by the army and political cronies….add that to the mix to get yourslef really depressed.

  21. Marshall Auerback

    There are a number of things which bother me about the so-called Austrian school of analysis. One is the propensity to denigrate the achievements of FDR’s fiscal activism in spite of significant evidence to the contrary. The key to evaluating Roosevelt’s performance in combating the Depression is the statistical treatment of many millions of unemployed engaged in his massive workfare programs. The government hired about 60 per cent of the unemployed in public works and conservation projects that planted a billion trees, saved the whooping crane, modernized rural America, and built such diverse projects as the Cathedral of Learning in Pittsburgh, the Montana state capitol, much of the Chicago lakefront, New York’s Lincoln Tunnel and Triborough Bridge complex, the Tennessee Valley Authority and the aircraft carriers Enterprise and Yorktown.
    It also built or renovated 2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds, 7,800 bridges, 700,000 miles of roads, and a thousand airfields. And it employed 50,000 teachers, rebuilt the country’s entire rural school system, and hired 3,000 writers, musicians, sculptors and painters, including Willem de Kooning and Jackson Pollock.
    Even pro-Roosevelt historians such as William Leuchtenburg and Doris Kearns Goodwin have meekly accepted that the millions of people in the New Deal workfare programs were unemployed, while comparable millions of Germans and Japanese, and eventually French and British, who were dragooned into the armed forces and defense production industries in the mid-and late 1930s, were considered to be employed.
    This made the Roosevelt administration’s economic performance appear uncompetitive, but it is fairer to argue that the people employed in government public works and conservation programs were just as authentically (and much more usefully) employed as draftees in what became garrison states, while Roosevelt was rebuilding America at a historic bargain cost.
    If these workfare Americans are considered to be unemployed, the Roosevelt administration reduced unemployment from 25 per cent in 1933 to 9 per cent in 1936, up to 13 per cent in 1938 (due largely to a reversal of the fiscal activism which had characterized FDR’s first term in office), back to less than 10 per cent at the end of 1940, to less than 1 per cent a year later when the U.S. was plunged into the Second World War. So it is WRONG to say that Keynesian style activism never works!
    The reasons for the discrepancies in the unemployment data that have historically arisen out of the New Deal are that the current sampling method of estimation for unemployment by the BLS was not developed until 1940, thus unemployment rates prior to this time have to be estimated and this leads to some judgment calls. But to ignore workfare seems as foolish as those who advocate simply letting “the market clear” and thereby allowing debt liquidation to intensify with no corresponding government response. It’s a nice recommendation for those who hate government and have never sufferend the horrors of long term unemployment, but it’s about as helpful in the end as Clayton Williams’s comments on rape.While running unsuccessfully against Ann Richards for governor in 1990, the Texan was overheard comparing rape to the weather: “As long as it’s inevitable, you might as well lie back and enjoy it.” That’s sort of how the Austrians approach economics and debt liquidation.

  22. Anonymous

    Pettis is correct to suggest that we need to consider China 08 in the light of USA 29. I think it’s a really insightful analysis point.

    However, he’s weaker on the details of comparing USA 08 with Europe 29. Anyone who suggests that US policy merely has to follow German policy of 29 onwards may be setting up something very ugly indeed.

  23. Yves Smith


    There were a LOT of people who saw the bubble coming who were NOT libertarians. Calculated Risk, George Soros, Marc Faber, Jeremy Grantham. I started blogging late in 2006 because it was obvious then this was going to end in tears.

    CR can recite lots of others in the housing space who were screaming about the froth. Attributing to Schiff having gotten his call right because of his libertarian views is faulty, even if he tried incorrectly to link the bubble to government intervention. However, he may have been able to get air time because he was a libertarian.

    I was also told at the time of the show (about six weeks ago) that Schiff’s fund was down 30-40% this year, so his investment calls otherwise have been less than stellar.

    Re default, there are a lot of ways to default. England made only partial payments on its debts so as to force renegotiation. Jesse has pointed out that as of NEXT YEAR, the US will, like overextended credit card borrowers, of not be able to service our debt out of real cash flows. And we are clearly not raising taxes in this environment. Das. who is generally not an extremist, has also predicted a US debt default. The other way is covert, by depreciarting the currency massively, but per above, but if we cannot service the debts on our own, that may not be sufficient.

    It has already been reported on AFP that the US asked for $300 billion from four Gulf states to hlep pay for the bailout. And we did NOT ask for loans. It was described as “foreign aid” aka a handout.

    Anon of 4:40 PM,

    If you do not accept correlation, which I agree is a not a strong form of proof, you cannot make ANY statements regarding large-scale economic activity, since (except for the sort of contained experiments they do in behavioral finance) you cannot construct any exercises with controls, as in, take two identical economies and try a certain approach on one and leave the other be.

    In the Great Depression and other financial crises, countries almost without exception needed to let their currency depreciate significantly. The most common pattern is excessive levels of debt relative to GDP, with that often accompanied by large, sustained current account deficits. That leads to solvency crises and demand shocks. Reducing the need for foreign capital is imperative, hence the need for a cheaper currency to bring trade flows into balance.

    In the US in the Depression/possibly China case. the economy had become seriously imbalanced, supporting an unsustainable level of exports. The US crisis in the Depression was a liquidity, not a solvency crisis. That is why economists here were so quick to call for looser money, because that remedy allegedly would have worked then. There has been a failure in many proposals to acknowledge and address the fact that we are facing the much more difficult problem of combating a solvency crisis.

    But as Pettis alludes, the US did not try to expand its domestic consumption soon enough (Keynes argues that stimulus needs to be aggressive early, if you wait even six months, it takes a great deal more to achieve the same effect) and instead we had a combo plate of some late stimulus, contraction of production, and defense of exports (both Smoot Hawley and the later going off the gold standard).

    Now I am not anywhere as confident as Pettis that more stimulus in the Depression would have eliminated the need to reduce production. But I am willing to believe that had we been able to find better remedies, the pain and dislocation could have been considerably less.

  24. ndk

    The other way is covert, by depreciarting the currency massively, but per above, but if we cannot service the debts on our own, that may not be sufficient.

    I agree. There’s also still the need to import foreign raw materials, particularly oil. Demand has certainly collapsed, but this is still an extraordinarily large flow. We can’t run our economy without it.

    It has already been reported on AFP that the US asked for $300 billion from four Gulf states to hlep pay for the bailout. And we did NOT ask for loans. It was described as “foreign aid” aka a handout.

    Here’s a link to the report Yves is talking about. By way of comparison, USAID spends about $22 billion per year on foreign operations. Teehee.

  25. Stephen

    So the pro’s of a strong dollar policy were????

    As for the debt, I seem to remeber some stating that long bonds havent been issued, essentially 25 and 30 year bonds. Whether there are any buyers is another matter but this large re-fi would need to be done once this is completed to make the debt payments even reasonable.

    Question is will they be sold largely domestically, like war bonds, or will they go abroad?

    Or am I totally off base here.

    Guns and Butter, gets you in trouble every time.

  26. Anonymous

    Yves, thank you for replying to my post about Austrian depression history. Firstly I would like to say that Schiff isn’t dogmatic. Although the formats in which he is often seen make him seem that way. He had a nice interview on NPR which I thought showed he is pretty normal. Yes his economics is rigid, but that’s because he believes it is true. As do I.

    I totally agree with you about consequences BEYOND economics. You make an excellent point there. But one must understand that economics, per se, is value free, just as physics is. I would be less agitated if the Feds just told the truth: We’re taking money from everyone in the country and giving it to the banking industry. Rather they use Keynesian euphemisms such as “liquidity injections” which dissemble the true meaning of what is going. There is no such thing as a perpetual motion machine, except in the minds of the Federal Government.

    And in real terms here is exactly what is going on: for years we had people digging holes and refilling them (well, not quite, but you get my point). Now everyone realizes this industry is a huge waste of capital resources. Instead of letting the shovels be reallocated by to productive uses, the government is saying we need to prop up the hole diggers. It’s even worse, they’re saying we need to take shovels from other people doing productive work, and give them to more hole diggers!

    But the truth of what is ACTUALLY happening is buried under a mountain of sophistry and false rhetoric.

    Anyway, even as an Austrian I love your blog. You’re obviously honest and curious, which makes you 100 times more interesting to listen to than anyone in the mainstream media.

  27. Jesse

    Exactly correct. China is ‘the US’ in this scenario.

    Somewhat similarly but on a smaller scale, Japan was in a similar posture of emphasizing exports over domestic consumption throughout its great deflation.

    As I recall, the US was one of the last of the developed nations to emerge from the Great Depression, because of its last of emphasis on debt fueled stimulus of working wages through public works, despite the attempts of FDR and the New Deal, because of interference from the minority Republicans in congress and the supreme court, in addition of course to a mistaken monetary policy.

    Plus ca change, indeed

  28. Anonymous

    Having an economist from the Austrian school or any libertarian pointing out the Wiki “correlation does not imply causation” reference is rich. I mean really, really, really rich.

    Don’t get me wrong, a book like The Road to Serfdom is an eloquent text that explicates the dangers of socialism. I don’t mean to impugn all of the great works that have come out of the Austrian school.

    But at the same time, the Austrian idealogues really have to just step back and calm down. Let me tell you something: You don’t know everything.

    Trust me. You don’t. The more you think you know, the more I know you have no idea what you are talking about.

    And to top it off, almost all Austrian theory (and also all anarcho-capitalist theory) is not even correlation based, it’s almost totally counterfactual, based almost entirely on logic and hypotheses. Get a grip. Go out and take a walk. Honestly.

  29. Anonymous2

    A well known (I thought) book by Rothbard was mentioned with approval.

    I am not sure how many readers have read this book. It is really worth reading because Rothbard makes mostly good points but, I am afraid, the author failed to notice the elephant in the room. Rothbard, though a great analytical mind, could have been blinded by his own ideology. You have to read the section on inequality to see what I mean. It is as if it were written by someone other than Rothbard. He lamely says something to the effect (it has been years since I last read it) that even if money is concentrated in a few hands, this is not a problem for the economy because even the rich must spend at some point. Wow. I had expected something better from someone with Rothbard’s intellect. It is issues like that that have doomed the libertarian movement to irrelevance.
    Now that we may be faced with problems similar of those of 1930s, we will have some chances to see whether Rothbard was right.

  30. Anonymous

    1. China will have to drive down their currency relative to dollar. (everybody else in Asia do it. China’s direct competitor Korea, taiwan, Indonesia, vietnam, philipine, etc. They all have plunging currency.

    2. China’s imports are all so cheap, they couldn’t care less if dollar goes up. Australia, brazil, oil and metal feed price are all going down.

    3. US debt are in dollar. Making sure Dollar is high is good for exporting economies.

    If I were chinese policy makers, I would lower yuan to 7.1 or so. Do cliff dive.

  31. Anonymous2

    More on Austrian Economics.

    Assume I am a billionaire who last year had net value of 6 billion and spent at a rate of 120 million a year. This year, I am valued at only 3 billion as my investments have performed badly. Would I spend more to help the economy? Why should I? On the contrary, I will be spending at the rate of 60 million of year, to maintain a 2% expenses to capital. I will have to fire my second gardener (I forget his name) and one of the maids, Francoise, close a couple of my mansions, postpone ordering a new Rolls Royce, and forego a few other minor luxuries.

    As a result of my actions, spending is reduced by considerably more than 60 million a year (because of the multiplier — the gardener and the maid must reduced their expenses somewhat since they are now unemployed).

    My good-for-nothing brother, on the other hand, makes 120,000 per year working as biophysicist at a Merck. He usually spends all his income, and he continues doing the same even though he is now more concerned that he may lose his job. (I am ashamed to even think we have the same mother.)

    Let us now consider universities like Harvard that has a large endowment. They spend out of this endowment at some annual rate, say 4% of market value. When the endowment drops by 30%, this income that streams into the general budget drops by 30%. But how can they do that? At the end, it comes down to spending less on salaries by firing and not hiring. Again, account for a multiplier…

    As spending is reduced, we discover that we have a surplus of everything. Too many factories, too many Starbucks, too many hot-dog stands, too many nail salons, too many universities, too many newspapers… Hence the rush to LIQUIDATION. If a store closes, none other may be willing to rent it. This affects the income of the wealthy who cut down their expenses further, etc. How exactly does the Austrian School suggest we address this little problem?

  32. Mencius Moldbug

    This is a great discussion of the merits and demerits of Austrian economics.

    The Austrian School does indeed retain a prehistoric belief in the value of “logic and hypotheses,” as opposed to models and hindcasting. Indeed, quantitative modeling has proven itself so thoroughly of late – I can’t imagine why anyone would want to go back to logic and hypotheses. How medieval.

    To anyone who has not made up their mind on the subject, I would say: read the core Austrians (Mises and Rothbard), but don’t believe them.

    Ie: the kind of orthodox Austrian who believes that everything Mises and Rothbard were some kind of Popes, and everything they said is true by definition is, indeed, a dangerous fellow.

    The proper goal in reading the Austrians is to understand and become proficient in the Austrian method of thinking about economics. If you use this method to think for yourself, you may notice that you do not always reach the same conclusions as the old Austrian masters. This is a sign that you are doing it right.

    So, for example, I am an Austrian in that I think the Austrian model of the banking cycle is basically accurate. However, I do not follow this to the usual Austrian conclusion that liquidation is the only way back to stable prices. I think a structured, one-off dilution of the currency can work. To orthodox Austrians, this is an “inflationist” position.

    But who cares? It’s not like there is some massive bank of jobs teaching Austrian economics, all distributed by the Elders of Vienna. Since it is permanently out of favor with the powers that be, Austrian economics is intrinsically diverse and has no way to maintain a party line. No wonder it’s becoming so popular in the Internet era.

  33. Snake

    I said it months ago that China should increase domestic consumption to soften the landing from reduced consumption in the US, so I think they are very well aware of what they need to do.

    The problem?

    It is impossible to increase domestic consumption to the point where it would actually make a difference. It would take too long, and trying to speed up the process could lead to the country’s collapse.

    Increasing domestic consumption significantly and at a quick pace in a country where there are strong disparities in income and living standards is playing Russia roulette. No one has even done it to the extent China would have to. It would imply a lot of movement of population internally, among other issues, and their infrastructure and services could not support such a quick change.

    It will not happen, and it would seem that the China government knows the above implications.

    There is no law of the universe that guarantees solutions to all problems.

  34. Anonymous2

    I agree with Mencius that we should not look at Mises or Rothbard at some kind of prophets or popes. They contributed a lot to economic thinking but Economics is a social science (rather than a hard science like physics) and so cannot be separated from the study of human societies. Human societies and cultures change over time and economics must take that into account.

    Austrian economics provides a blueprint for what is logical under some idealized conditions but not what is feasible in the societies we live in and under the conditions we experience. For example, it would be just stupid to apply Austrian Economics to the societies of Western Europe immediately after WW II. Instead, Konrad Antenauer followed in Germany a mixed-economy system that worked in those difficult times but did not follow any particular orthodoxy. Do what works.

  35. Anonymous

    There are a number of things which bother me about the so-called Austrian school of analysis. One is the propensity to denigrate the achievements of FDR’s fiscal activism in spite of significant evidence to the contrary.

    Again correlation does not imply causation. What about *Hoover’s* quite large fiscal activism starting in 1931? Hoover’s spending is correlated with the *increase* in unemployment (which peaked in 1933). Also note that unemployment was falling well before FDR embarked on the massive spending spree. You can look at the numbers here:

    I’m not in any camp, except the “there’s not enough data to provide reasonable evidence either way” camp.

    I do feel that most of the conventional “wisdom” about the Great Depression is probably mistaken though. The conventional “wisdom” (which Yves seems to believe, at least mostly) certainly was not derived from empirical data. One data point does not a data set make.

  36. Chris

    @ Anonymous 3:16 PM:

    That’s the basic point of the Austrian School: they are humble enough to recognize that we as humans know too little about the markets’ complexity to produce any meaningful forecasts, let alone to “fix” the economy… so they just discourage tampering with it, that’it! And IMHO this is the most precious notion that one can have. The current situation demonstrates this concept very well. In hindsight we are all geniuses and saw this coming a very long time ago, but back then…

    Oh my goodness, Taleb’s Black Swan truly left a mark on me!

  37. Yves Smith

    Anon of 11:34 AM,

    I have traveled in six continents, lived in three, including 13 different places in the US. I am sorry that you lead such a paranoid life and base your world view on narrow, distorted experience. I have lived in places that have strict gun controls (London, Sydney) and felt at no risk for my physical safety, and I cannot think of anyone who lived there who did either. (And BTW, I lived in London when the IRA was active, but Brits are far more rational than Americans. Your odds of dying in a bombing are considerably lower than of dying in a car accident, and no one was terribly overwrought about the IRA. Probably the legacy of the Blitz. The IRA was dreadful for those directly impacted, but was not a society-wrenching event).

    For instance, when I was in Sydney a man was in a violent argument with his girlfriend that I could hear and see from my apartment. I called the cops, but also went down to intercede before she got hurt worse, armed with only with a metal cane. I think I kept worse from happening to the girl before the cops arrives (and my interceding also got some people on a neighboring street to come over and try to reason with the guy).

    In the US, I would only have called the cops. I would have been afraid that the guy had a gun.

    BTW, he was convicted and went to jail for his treatment of the woman. I provided evidence. So your charge that I do not live in the real world is misguided, and shows clear bias.

  38. Joe

    China may yet stimulate domestic consumption more sharply…

    China may yet find enough non-U.S. buyers for their goods, and see enough of its own capacity close…

    The U.S. Democrats may yet raise taxes and control spending better than we imagine…

    The U.S. may yet generate faster export growth in the years ahead…

    But to think all these things you have to cling to a religious belief that America is a provident nation.

    So, prepare for the worst. The potential solutions I see are (1) blogs like Yves’ that help intermediaries steer our political figureheads,
    (2) find the right hedge fund managers who understand what’s happening, or prepare your own trades, such as shorting long-dated Treasuries when the time is right,
    (3) gain employment in high intellectual property / U.S. export-driven companies that will benefit from the dollar wipeout that lies ahead.

  39. dfb

    Yves, what do you suggest will happen when the U.S. either defaults or devalues the currency? Will the U.S. look like Argentina?

  40. rahuldeodhar

    Hi Yves,

    This post was long due!! Just a few points –

    hunger of deprived and hunger of developed is different
    So pre-Mao chinese hunger and post-Den Chinese hunger are two different animals. If a developed

    country goes hungry, violence is also a fallout. Sale of guns has risen in US for a good reason. We

    have to realise that people on ground know best.

    China wants to run this engine for a wee-bit longer
    China has nearly 1.5-2 trillion dollars in USD assets. Now China wants just a little bit of time to

    sae some of it. China believes that this is their sweat money. The way around as they see it is to

    let CNY depreciate against the dollar. But this relation is difficult to hold if USD depreciates and

    commodities rise.

    With 2 trillion at stake – War is not yet a possibility
    The cost of Iraq war was about a trillion (vague recollection). And it was a trillion dollar

    “stimulus”. As one part of the world’s “skin in the US game” increases the probability of war will

    increase. WAr has many benefits for regimes. It aggregates the population, it creates employment,

    creates a stimulus, creates an enemy outside of the regime. In this matter India is lethargic and

    will never have enough “mind in this game”. But war is on the horizon – and I am scared.

    China and India must become consumers
    I have been making this point for like ages now (even in comments to your posts). A recovery without

    demand from China and India will not happen. US is not going to be a consumer – it has to be a

    producer. The best way to get these 3 billion people into consumption fold is by letting exchange

    rates correct. SE Asia and other surplus countries will need to do the same.

    Import restriction response is a threat
    I hope there is enough sense to not impose import restrictions. Yet, I fear India and China will

    impose them eventually. There will be a race to corner the “able” consumers for domestic industries.

    China has a difficult decision to make then. The domestic consumer will be a loser and their money

    will be looted by domestic corporation. Though it will be done sophisticatedly as a economic process.
    The best way to get domestic consumption going is to first get the latent demand for best brands going. For that you need to keep imports open.

    USD and Gold – Printing currency does not matter
    There is a lot of talk that Us can print its way out of the crisis. It is surely doing that. However,

    real value is able to discount this printing phenomenon. The only way this might work is – if US has

    some means where it can aggregate this printed money and destroy it as write-down or something.

    Printing will set the new money in motion and it has to be collected and destroyed else there will be


    Currently”US denominate” (in terms of thoughts) people are asking this question hence possibility of US dollar depreciating does not seem feasible – it never does to local as it does not matter so long as other things remain equal. But “other things” like commodities do not remain equal – hence the effect is actually measured as rise in commodity prices. (Or conversely – commodity tries to retain value – whereas USD depreciates).

    Further one must understand that equity is open to risks whereas debt has the habit of correcting / adjusting for currency changes. (Particularly cross currency debt).

    In sum – welcome to center of the storm!!

  41. Spidey

    Someone else mentioned this section of the post in an earlier comment, and I thought they were going to point out the obvious, but they did not. Here is the section:

    “Again, if you are a student of the Great Depression. trashing one’s currency was key to getting back on track to growth. The US economy did not start to recover in a meaningful way until it went off the gold standard, which lead to a 40% fall in the currency’s value.”

    Perhaps I’m just reading too much into this. The Great Depression was from 1929 to about 1931. The US economy certainly started to recover in a meaningful way long before it went off the gold standard in 1971. Am I just parsing words, or does the author truly believe that there was no recovery/expansion in the US for forty years?


    – Pete

  42. Yves Smith


    With all due respect, you need to read up on the Depression.

    The US made it illegal to use gold in private transactions in 1933 and confiscated monetary gold. The dollar was revalued in gold terms in 1934, which was effectively a 40% devaluation.

    From e-notes:

    The Gold Reserve Act of January 30, 1934, now enters the picture. The president had specifically requested this legislation to end the coinage of gold. All gold coin was to be withdrawn from circulation and formed into bars. Redemption of any U.S. currency in gold was forbidden. Thus the gold standard was legally terminated. Also, a provision supplementing the Thomas Amendment stated that the weight of the gold dollar could not be fixed at more than 60 percent of its present weight. This meant that the price of gold could be set at no less than $34.45 per ounce.

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