America's Trade Is Based on Protectionism

I have been amazed recently with economists and financial types rallying around the flag of free trade – and continue to claim Smoot-Hawley dragged the USA into depression. Anyone who wants adjustments to trade are now labeled an “isolationists” or “protectionists” – and endangering the economy of America.

Now the new Obama administration is thinking of “buy American” provisions for projects which use bailout money.

Trade, duties (tariffs), and import restrictions are very complicated topics. If you just get a feel of what is going on today, you can understand why change is necessary. But history is being distorted by the “facts” on Smoot-Hawley. If the facts surrounding a historical event are misrepresented, you will come to the wrong conclusion of what to do next today.

Is Smoot-Hawley the Boogey Man?

• Smoot-Hawley replaced the 1922 Fordney-McCumber law. It was projected to achieve 16% revenue of the value of all imports (dutiable and non-dutiable).

• The average increase under Smoot-Hawley was less than a 3% increase from Fordney-McCumber. Does it meet your smell test that a 3% change in tariffs threw the USA and the world into an economic hell hole? If tariffs had anything to do with creating a depression, why did it not happen earlier than 1929? Here is a comparison to prior tariff laws:

• It did not cause the depression. It was enacted in 1930 after the depression started. Most of the prior tariff laws had higher duties.

• Based on the value of imports of 1929 - approximately 23% of the total value of imports had their duty increased, and 77% were untouched or decreased.

• Smoot-Hawley did not make the depression worse (it did not make it better either). Over 61% of imported items did not have a tariff, and there were little differences in trade volume ratios between the dutiable and non-dutiable items during the depression. Here is a comparison between prior laws of the non-dutiable item percentages:

• And the following comes from President Hoover’s own lips as he signed the Smoot-Hawley Act:

The increases in tariff are largely directed to the interest of the farmer. Of the increases, it is stated by the Tariff Commission that 93.73% are upon the products of agricultural origin measured in value, as distinguished from 6.25% upon commodities of strictly non-agricultural origin. The average rate upon agricultural raw materials shows an increase from 38.10% to 48.92% in contrast to dutiable articles of strictly other than agricultural origin which show an average increase of from 31.02% to 34.31%.

• There were tit-for-tat tariff increases each time America changed the import tariffs. It is obvious the higher the duty on an import, the higher the price becomes when compared to a domestic product, and the less demand for the foreign product. But in a depression, there is less demand for all products – and usually it impacts the more expensive one more.

Look at what is happening today:

• The volume of trade today is falling significantly more dramatically than the fall in GDP – just like what happened in the Great Depression. Trade is always one of the first victims of world wide recessions. You cannot point to USA import duties and blame them as they average less than 4% of all imports today. Nor should you blame tariffs for making the Great Depression worse.

• If you really want to understand what is going on – download the 2951 pages of the Harmonized Tariff Schedule of the United States (pdf). Duties vary by country and product. The poorer the trading country, the more US import duty is accessed.

And the moral of the story…

There is an old joke of a man asking a woman if she would sleep with someone for $1 million. She says of course. The man asks if she would sleep with him for $25. She indignantly says she is not a hoe, and he replies that he already determined what she is but the only question is the price.

The USA is protectionist – we always were and we always will be. The question is how protectionist should we be. We are too protectionist in some areas, and not enough in other areas. For me, free trade is one of the best vehicles to help the poor of the world have an opportunity to have a better life. For America, it offers a brighter prospect for peace while bringing lower prices for consumers.

But you cannot help others if you destroy or weaken yourself. The power of your ability to help comes from your strength.

Our lack of attention to the effects of foreign trade is causing an erosion of jobs without creation of replacement jobs. We must face up to this problem without getting bogged down in name calling or economic dogma. America will not exist if it cannot provide jobs and opportunity for its citizens. This is a serious problem.

The solution should hopefully not be a change in import tariffs, and this would be the last choice if nothing else works. But I would not take raising import duties off of the table. We do not have a choice about creation of jobs in America. We must make it happen.

We should stop entering into any new trade agreements until the employment percentage of total population starts reverting to 2000 levels. We need long term jobs creation programs. We need to revisit our current free trade agreements in the areas where they are limiting job creation.

The economic reason for free trade allow for economies to develop without artificial distortions. The reason a government exists is to protect its citizens. These concepts are in conflict.

News of the Week

The $17.4 billion petrochemical venture between Kuwait run Petrochemical Industries Co and Dow Chemical (DOW) was cancelled by the Kuwaitis. The project did not make economic sense in light of the low oil prices. This cancellation put into question the $15.3 billion acquisition of specialty chemical manufacturer Rohm & Haas (ROH) by Dow.

I received a news letter from the Nevada Secretary of State advising that the number of corporations declined in Nevada by 1% - the first decline in history. I think this is significant as the effects of the financial crisis did not set in until the third quarter.

Both Chrysler and General Motors (GM) each received $4 billion bailout money to ward off bankruptcy.

Summary of the Week’s Economic Fundamentals

I still see nothing this week to influence my asset preservation investment strategy. As this was New Year’s week following Christmas, the players left the economy on autopilot and celebrated the season with family and friends.

The equities market improved last week on low volume. I see no short or medium range fundamental which should point the market in an upward direction. I have written an article in the last few days demonstrating that corporate earnings will continue to decline and will not begin to improve until after 1Q 2010 at the earliest. This immediately calls into question the current P/E valuations overall, and indicates the market is currently overpriced. Either investors are acting irrationally, the weight of money is too large, or this is a suckers rally.

The trailing indicators continue to show a moderate economic contraction. Below is a list of news which happened this week which either reinforces or contradicts any investment strategy.

Interesting but Not Indicating Anything

• Home loan applications were essentially unchanged from last week. This Mortgage Bankers Association index covers 50% of all loan applications. This was covering the shortened Christmas week so the data was adjusted accordingly. Over 82% of all loan applications were for refinancing existing loans. Basically we are in an uptrend cycle caused solely by consumers refinancing their homes with lower cost mortgages.

Positive Leading Indicators

• None this week

Negative Leading Indicators

• ECRI’s Weekly Leading Index continues to demonstrate deteriorating market conditions six months from now. As I contribute ECRI’s index result at the same time as this weekly summary, I cannot give you a link – but if you click on “more articles” under my picture above you can find this weeks submission.
• The price per barrel of oil remains hovering around $40 per barrel. This is constraining development of additional resources which will be an economic inhibitor when the economy improves.

Positive Coincident Indicators

• None

Negative Coincident indicators

• The national ISM survey of business conditions nationally shows worsening conditions for the last 5 months. The significant point you can make from the survey results are that conditions are getting worse at a faster rate.
• The ISM-Chicago Business Survey was released this week. Unlike other business surveys. This one is fairly objective (versus subjective) and issued quick enough that it can be considered a coincident indicator. Overall, December was worse than November. The significant items to note were that production declines were accelerating, production backlog levels were lower than July 1980, employment levels have been shrinking for the 13^th straight month, and raw material / component prices falls now equals the fall rate of 1949. This survey pretty much confirms my feel of business.
• The Department of Labor released their weekly Unemployment Insurance Claims. Note adjustments in prior weeks. The rate of claims fell this week but it was a holiday week – all data is suspect during holiday periods. If there is a trend in this area we will know by the second week in January.

Positive Trailing Indicators

• None

Negative Trailing Indicators

• The Case-Schiller Home price indexes for October 2008 were released this week showing a continuing falling in USA housing prices. On the day of the report’s release, the market reacted favorably, and some analysts attributed this to a stabilization of housing prices which would be good news for recessionary pressures. Here is the average drop in this index monthly this year – you decide if you think the rate of decline is slowing:

If you would like a summary of all government financial indicators, click here.

Quotes of the Week

From Jim Kingsdale in Financial Meltdown: Good Luck, Bad Luck, Who Knows?:

Social values have been distorted by great wealth that has accentuated a variety of societal addictions. Though not unique to this time in history, money has increasingly influenced politicians who have granted legal opportunities to their supporters to make more money in ways that have turned out to be toxic to the system and have now led to its partial collapse.

Commenter BrucePile on Market Signal: Proceed with Caution concerning whether the market was headed up or down in 2009:

The market seems to be sending out an inscrutable set of conflicting signals over the last month:

1. The quieting of the price action after a severe beating is a good sign

2. The formation of a falling channel consolidation after a sharp drop is a bad sign. These typically break in the direction from whence the initial move came (down).

3. The fact that the market has stopped diving on really bad news is a good sign.

4. The pattern of the 3 rallies within the falling channel formed since lateSeptember hasn't made the change needed to break the channel to theupside. Each rally has been with withering buy volume, and each rallyhas been less sharp leaning more each time to the horizontal - a reallybad sign.

5. The Accumulation/Distribut... strength of this latest rally is notably better than the previous attempts at the 50 dma - a very good sign.

6. The fact that most expert opinions you hear are bullish on 2009 and theRussell Money Manager Survey has fund managers at 72% positive onthe new year is a bad sign. This does not indicate a despairing bottom. Back in December 2007, this survey stood at 76% bullish and only 15% bearish on 2008. This is a very bad sign.

7. Few seem to fully appreciate the destabilizing debt unwind. Funddelevering is just a small part of this. In the 2000-2002 bear market, it provided most of the dynamite (just a mild recession and the rest of Debt World doing just fine, inviting the start of the housing boom, in fact). Butnow, even more fund debt is being reinforced with all the rest of DebtWorld unwinding in unison. A Bernstein Co. survey of funds concluded that fund deleveraging is "only half complete" Barron's 12/15 and theyestimate that about $40 billion was yanked in the October move and that another $200 billion will be unwound as of a November 21 report to clients. The $200 billion would be another 3 or 4 Octobers. This is a very bad sign.

8. The central banks are providing unprecedented infusions. That's good.

So which way is going to be the next big move? I absolutely, positively can say without equivocation that I do not know. You can, however, divide the prosand cons into two camps:

1. Debt money flow and technicals in the one camp, and

2. Opinion/government meddling in the other.

The technicals that aren't bearish are sentiment related (A/D money flow, stable price action). So you have something of a standoff between the debt money flow and geometry signs pointing to lower bottoms, and the opinion and proactive government positive vibes. I wouldn't bet too heavily on either side right now.

From Bespoke on interest rate forecasts for 2009:

I hope 2009 brings greater happiness into all your lives.

Disclosures: none

Comments

[maelstrom:]

Super article

Jan 04 11:49 AM

[Moon Kil Woong:]

It seems that a lot of the depression analysis is focused on the symptoms more than the cause. If I had to make a guess I would tend to say the major cause was a lack of trust in the legitimacy of the money system that was theoretically based on gold that wasn't actually there.

This downturn seems like a lack of trust in the economy and if the government keeps seeming arbitrary and capricious in their response, it may lead to a lack of trust in our monetary system.

Anyway, I'm with you on a wait and see attitude to this upturn. I suspect it may trade up a bit then move back to a trading range of around 8,500-the low 9,000s.

If things go sour this year I think the next shoe to fall may be global political instability. Fortunately, the US is a stable democracy unlike China and much of the 3rd world.

Jan 04 11:53 AM

[Jason Rines...:]

Excellent work as per norm.

Jan 04 01:35 PM

[DaveW:]

Excellent trade policy summary and market update, thanks!

Jan 04 03:16 PM

[DuganS1:]

Smoot-Hawley resulted in retaliatory tariffs, a crash in commodity prices which had very serious ramifications for the agricultural sector (out biggest export sector and a large part of the economy back then), and caused extreme dislocation in the credit markets because the slow down in exports for many European debtor nations made them unable to pay their debts (much of it to the United States). The previous tariffs didn't result in as serious repercussions of the three things listed above and thus aren't good comparisons.

Jan 04 07:20 PM

[Steven Hansen:]

I appreciate all you comments especially DuganS1. this is not a black and white subject.

The great depression was a full blown worldwide economic meltdown. any discussion on trade is preverted by geo-political, credit / finance, and many other issues. these issues cannot be separated and any analysis to prove whether trade played any part in the creating or the deepening of the depression must make so many assumptions that any findings are questionable.

As an example, in 1932 the simple transport of wheat cost four times the value of wheat. this transport problem was valid for all commodities. surely transport costs, not tariffs, were the reason for lower trade.

with an open mind, you can find as many conflicting points on this topic as you would like. what most of us learned in school about the great depression was myth.

but the point i keep returning to is that there was little difference between the trade for items which had or did not have duty. to me, this is prima facia evidence that trade tariffs could not have played any significant role in the depression.

and today, 3Q GDP was still positive, but trade volumes (excluding oil) was off 25%. trade is the first casualty of a worldwide recession.

i am against trade tariffs. but that does not make me want to support a questionable argument to make that point.

steven hansen

Jan 04 11:30 PM

[Al-USA:]

Actually, capitalism will not exist if it cannot provide jobs and opportunity for its citizens while merely serving the owners of capital. America will be fine... The people will not disappear, capitalism, well, that's another story.

The ruling classes have been bailed out instead of liquidating so it looks to me like the first salvo of the coming class struggle has been put into place.

The spark to ignite it all, in my opinion, will be the coming hyperinflation scenario caused by the $trillions of new dollars being printed by the FED and used to bailout out the capitalist elites.

Jan 05 03:59 AM

[John Lounsbury:]

The Hand and DugginS1 - - -

Interesting debate about tarrifs. My feeling is that there are so many conflicted assignments of cause and effect leading up to and during the Great Depression. Many agree with DugginS1 that Smoot-Hawley produced retalitory tarrifs, which accelerated and deepened the depression.

Just as logical a conclusion could be that tarrif laws were changed in response to the depression, rather than causing it. In other words, what is commonly believed to be cause and effect might be reversed. This idea is presented in the article.

The article presents an argument that Smoot-Hawley was a minor tweak to existing tarrif law, with little effect on the Great Depression.

A big take-away from this discussion is that the causes of the Great Depression were very complex and, even almost 80 years after its start, still being debated. Is it any wonder that we don't know everything about the current crisis? We may not know everything 80 years from now.

Jan 05 12:28 PM

[carey_jim:]

Steve,

I think you are right to maintain that Smoot-Hawley was not a major factor causing the depression because trade represented only about 5% of the GDP in 1929 and it went down by about 40% because of Smoot-Hawley. That is not enough to be a major factor even though it WAS a factor.

Cause is a slippery word. From the distance of 75 years it looks like the failure of the banks 'caused' the Great Depression (about 7500 banks) because many, many people lost their life savings and their confidence in banks.

But we know that leading economic thinkers, politicians and advisers to politicians such as Joseph Schumpeter, Secretary of the Treasury Andrew Mellon and the leading British economist of the time, Lionel Robbins advised letting the economy go into a serious depression just to clean out all the waste, corruption, inefficiency, etc. They didn't suspect that the depression would get so deep and last so long, of course. Most of them remained deeply afraid of inflation well into 1932 (which devastated Hungary, Germany and Austria in the early 1920s) and were against public works programs (initiated by Hoover) and increasing the money supply (the gold standard was still a problem too.)

It's arguable that the political turmoil caused by Roosevelt's radical actions after 1932 also prolonged the depression for about two or three years (1933-35), whether you like them or not, because after most of his policies were declared unconstitutional by the Supreme Court (unanimous decision) the economy began to recover. But just because A happens after B is stopped does not mean that B was causing A!

Also, it isn't generally recognized that the depression ended in 1936, at the end of Roosevelt's first term but was followed by another short recession in 1937. But from then on, there was continual growth until the war started for us, in 1942 after which, of course growth really took off (along with government regulations!)

However, after 1937 many people suffered during the recovery because of high unemployment but REAL unemployment was just a little less than it has been during the 1990s and 2000s, or about 15%. Public perception and official number have changed but not much else. Which is to say that the poor are suffering today but probably, because of technology, not as much as during the late thirties.

I agree with most of your points about the real truth about tariffs, behind the rhetoric that seems to come, mostly, from the economics departments of the world who hope they can make something happen by saying it IS happening.

Many good books have been written about this subject as I'm sure you know. The recent book, Bad Samaritans, by Ha-Joon Chang is an interesting read : www.amazon.com/Bad-Sam...


On Jan 04 11:30 PM The hand wrote:

> I appreciate all you comments especially DuganS1. this is not a
> black and white subject.
>
> The great depression was a full blown worldwide economic meltdown.
> any discussion on trade is preverted by geo-political, credit / finance,
> and many other issues. these issues cannot be separated and any
> analysis to prove whether trade played any part in the creating or
> the deepening of the depression must make so many assumptions that
> any findings are questionable.
>
> As an example, in 1932 the simple transport of wheat cost four times
> the value of wheat. this transport problem was valid for all commodities.
> surely transport costs, not tariffs, were the reason for lower trade.
>
>
> with an open mind, you can find as many conflicting points on this
> topic as you would like. what most of us learned in school about
> the great depression was myth.
>
> but the point i keep returning to is that there was little difference
> between the trade for items which had or did not have duty. to me,
> this is prima facia evidence that trade tariffs could not have played
> any significant role in the depression.
>
> and today, 3Q GDP was still positive, but trade volumes (excluding
> oil) was off 25%. trade is the first casualty of a worldwide recession.
>
>
> i am against trade tariffs. but that does not make me want to support
> a questionable argument to make that point.
>
> steven hansen
>

Jan 05 01:09 PM

[Steven Hansen:]

John - thanks as always for your comments.

carey_jim - i felt bad because i thought you had missed commenting on this article. you are in my opinion the seeking alpha expert on the great depression.

steven hansen

Jan 05 06:29 PM

[carey_jim:]

I've only been consulting the experts lately, and judging from your comment, it looks as if I've reported their findings (along with certain inevitable personal biases) accurately.

Thanks for the vote of confidence. I'll keep reading, listening to lectures and reporting what I find!


On Jan 05 06:29 PM The hand wrote:

> John - thanks as always for your comments.
>
> carey_jim - i felt bad because i thought you had missed commenting
> on this article. you are in my opinion the seeking alpha expert
> on the great depression.
>
> steven hansen
>

Jan 05 09:43 PM