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.
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.