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The Mythical Concept of Trade War

Politics / Global Economy Apr 03, 2010 - 03:08 PM GMT

By: Ian_Fletcher

Politics

Best Financial Markets Analysis Article As Americans ponder how to get the U.S. out of its current trade mess, we are constantly warned to do nothing – like impose a tariff to neutralize Chinese currency manipulation – that would trigger a “trade war.”  Supposedly, no matter how bad our problems with our trading partners get, they are less bad than the spiraling catastrophe that would ensue if we walked a single inch away from our current policy of unilateral free trade.


But the curious thing about the concept of trade war is that, unlike actual shooting war, it has no historical precedent.  In fact, the reality is that there has never been a significant trade war, “significant” in the sense of having done serious economic damage.  All history records are minor skirmishes at best. 

The standard example free traders give is that America’s Smoot-Hawley tariff of 1930 either caused the Great Depression or made it spread around the world.  But this canard does not survive serious examination, and has actually been denied by almost every economist who has actually researched the question in depth—a group ranging from Paul Krugman on the left to Milton Friedman on the right.

The Depression’s cause was monetary. The Fed allowed the money supply to balloon during the late 1920s, piling up in the stock market as a bubble. It then panicked, miscalculated, and let it collapse by a third by 1933, depriving the economy of the liquidity it needed to breathe. Trade had nothing to do with it.

As for the charge that Smoot caused the Depression to spread worldwide: it was too small a change to have plausibly so large an effect. For a start, it only applied to about one-third of America’s trade: about 1.3 percent of our GDP. Our average tariff on dutiable goods went from 44.6 to 53.2 percent—not a terribly big jump. Tariffs were higher in almost every year from 1821 to 1914. Our tariff went up in 1861, 1864, 1890, and 1922 without producing global depressions, and the recessions of 1873 and 1893 managed to spread worldwide without tariff increases.

Neither does the myth of a death spiral of retaliation by foreign nations hold water. According to the official State Department report on this question in 1931:

With the exception of discriminations in France, the extent of discrimination against American commerce is very slight...By far the largest number of countries do not discriminate against the commerce of the United States in any way.

“Notorious” Smoot-Hawley is a deliberately fabricated myth, plain and simple.

There is a basic unresolved paradox at the bottom of the very concept of trade war. If, as free traders insist, free trade is beneficial whether or not one’s trading partners reciprocate, then why would any rational nation start one, no matter how provoked?  The only way to explain this is to assume that major national governments like the Chinese and the U.S.—governments which, whatever bad things they may have done, have managed to hold nuclear weapons for decades without nuking each other over trivial spats—are not players of realpolitik, but schoolchildren.

When the moneymen in Beijing, Tokyo, Berlin, and the other nations currently running trade surpluses against the U.S. start to ponder the financial realpolitik of exaggerated retaliation against the U.S. for any measures we may employ to bring our trade back into balance, they will discover the advantage is with us, not them.  Because they are the ones with trade surpluses to lose, not us.  So our position of weakness is actually a position of strength.

Supposedly, China can suddenly stop buying our Treasury Debt if we rock the boat.  But this would immediately reduce the value of the trillion or so they already hold—not to mention destroying, by making their hostility overt, the fragile (and desperately-tended) delusion in the U.S. that America and China are still benign economic “partners” in a win-win economic relationship.

At the end of the day, China cannot force us to do anything economically that we don’t choose to.  America is still a nuclear power.  We can—an irresponsible but not impossible scenario—repudiate our debt to them (or stop paying the interest) as the ultimate countermove to anything they might contemplate.  More plausibly, we might simply restore the tax on the interest on foreign-held bonds that was repealed in 1984 thanks to Treasury Secretary Donald Regan.

A certain amount of back-and-forth token retaliation (and loud squealing) is indeed likely if America starts defending its interests in trade as diligently as our trading partners have been defending theirs, but that’s it.  After all, the world trading system has survived their trade barriers long enough without collapsing.

Ian Fletcher is the author of the new book Free Trade Doesn’t Work: What Should Replace It and Why (USBIC, $24.95)  He is an Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think tank founded in 1933.  He was previously an economist in private practice, mostly serving hedge funds and private equity firms. He may be contacted at ian.fletcher@usbic.net.

© 2010 Copyright  Ian Fletcher - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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