The Smoot-Hawley Tariff has been given considerable “credit” for the Great Depression in history books going back to the 1940s.
One of the most hotly debated causes of the crash is the Smoot-Hawley tariff. Protectionists like Alfred Eckes and Pat Buchanan argue that it could not have affected the market because the law was not passed until 1930, long after the crash. Although this is true, much of the legislative activity took place in 1929. As economist Alan Reynolds convincingly demonstrated in National Review (November 9, 1979), actions favoring passage of the tariff bill correlate quite well with declines in the stock market during 1929, culminating on October 29.
The reason why the market crashed well in advance of the tariff becoming law is because markets are forward-looking, and quickly capitalize any policy that will impact on future profits.
President-elect Obama has made quite a bit of noise about protectionism, and at one point, an advisor, Austan Goolsbee, was sent to Canada to reassure them that it was just campaign talk. This resulted in a major flap and Goolsbee was shipped off to campaign Siberia.
Well, Obama is elected now and what is the situation?
Well, for one thing, Smoot-Hawley is being resurrected by Obama supporting economists.
How much of a boost to economic activity will a fiscal stimulus provide? For those who believe that we have entered a Keynesian world of shortage of aggregate demand–me included–the answer depends on the Keynesian multiplier.
Democrats are all Keynesians, of course. Republicans became supply siders under Reagan. The difference ? Keynes advocated spending and politicians like spending. That way they get to determine where the money goes.
Now suppose that we had a way to raise the multiplier by more than half, from 1.8 to 2.8. The same fiscal stimulus would now produce an increase in GDP of $2.8 trillion–quite a difference. Nice deal if you can get it.
In fact you can. It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do–but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care?
Spoken like Mr. Smoot and Mr. Hawley.
Protectionism will prevent US citizens, who get government handouts, from spending the money outside the country, for Japanese cars or Chinese toys, for example. A century ago, they called this “Mercantilism.” Mercantilism was an economic theory that advocated maximizing exports and minimizing imports. Carried to its extreme, the mercantilist country would keep accumulating money by beggaring its trade partners. China does this in part.
Megan McArdle doesn’t like it, but that may not be enough. People who think they can plan an economy are not easily convinced they are wrong. Witness the current consequences with Fannie Mae and Freddie Mac. The politicians and Obama have not accepted any blame for that fiasco yet.
The alternative to all this stimulus money being handed out is a tax cut. Why not cut the corporation and capital gains tax rates to zero for a couple of years ? The only problem I see with that is that it allows the people who pay taxes to determine what to do with the money. Politicians don’t like that.
UPDATE: Here is some sober comment on the zero interest t-bill auction this week. If people are buying t-bills at zero interest, the stock market may not be as much of a bargain as some people are saying. I expect it to go lower, a lot lower.
Tags: depression, Keynes, Smoot-Hawley, tariffs, taxes
There’s a reason economics is called the “dismal science.” From the article:
One cannot help wonder how much the Fed today depends on the continued good health of Greenspan, and whether the system is really prepared to cope with his exit from the Fed for whatever reason.
But then, “science” it ain’t.
There are a lot of fathers for the current mess and Greenspan ranks right up there. Still, I think Congress and both parties were major contributers not to mention the Street’s creative financing such as “Auction Rate Securites” (these buggers created the illusion of liquidity and safety by adjusting interest rates to maintain fixed market principal – worked until it didn’t then they collectively did swan dives).
The housing bubble was cheered on by all the vested interests as well as the governmental interest in protecting the economy post 2001 market crash and 9/11. The housing bubble continued the illusion of prosperity and creditors bought into the illusion of collateral value.
I think tightening interest rates in 2005 might have cooled the bubble considerably but politicians don’t like that sort of thing. The derivatives certainly spread the contagion and magnified it. There are accelerator principles in both directions. This is where Bush deserves blame. Depending how bad this becomes, the financial bubble may damage his reputation more than anything else.
Don’t forget much of the ‘bubble’ was a function of credit expansion. Think of the yen carry trade for one example. And all the derivatives piggybacked on that expansion. Then all the players believed their risk was covered by credit default swaps. But for me, it was all was rooted in allowing banks excessive leverage in loan to reserves. Without those cotton candy loans flooding the credit markets, none of these toxic tranches would ever have seen the light of day. Or at least not to any meaningful magnitude. Remember it was the calling in of these loans (Bear Stearns was the first) that started the downfall of Mortgage World.
There is a link to my old 1979 NR article in this recent piece at Forbes:
http://www.forbes.com/2008/09/28/hoover-congress-schumer-oped-cx_ar_0928reynolds.html
I may be biased, but I still think it’s worth reading.
Alan
Dec 8, 4:13 PM EST
Wall Street extends big rally to 2nd session
By JOE BEL BRUNO and TIM PARADIS
AP Business Writer
NEW YORK (AP) — A stock market gaining in confidence has shot higher for a second straight session as investors bet that President-elect Barack Obama’s plans to increase infrastructure spending will lift the economy back to health.
The major market indexes have advanced more than 3 percent, and the Dow Jones industrial average is up 298 at 8,934, giving it a 558-point advance over two sessions.
Investors lured by inexpensive stocks were cheered by Obama’s plans announced over the weekend for the largest U.S. public works spending program since the creation of the interstate highway system a half-century ago.
© 2008 The Associated Press
Mike, have you heard of bear market rallies ? If I were you, I would not invest my pension funds in the market right now.
Alan, I couldn’t find the link to the 1979 NR article but your other points are right on. Raising taxes and tariffs is a formula for disaster. Among other things, Congress could get a decrease in the Michigan corporate tax as part of a bailout but Democrats don’t believe that tax cuts are efficient ways to get money to those who need it. They prefer to write checks to voters.
buy low. sell high. rinse. repeat.
market is low. invest for long term accordingly.
OK, Mike. An elevator going down eventually rises. There are an awful lot of people sitting this out but you are an adult. The last four week t-bill went for zero % interest. That tells me something.