Trade Wars Lead to Depressions

  1. The U.S. Fed creates money out of thin air. This is inflation and it leads to price inflation, which is most noticeable in gasoline prices and food prices.
  2. The U.S. Fed expands and contracts (tapers) its bond buying (money creation) program in an attempt to manipulate (stimulate) the economy as it sees fit. This is based primarily on its perception of the U.S. economy, not necessarily what is happening in the rest of the world.
  3. The world is on a U.S. dollar reserve standard. This means that the whole world uses U.S. dollars to conduct business. Thus, the whole world is affected by the U.S. Fed's dollar expansion/contraction maneuvers.
  4. When the U.S. Fed expands the world's money supply (quantitative easing) in an attempt to stimulate the economy, people/businesses do indeed expand their operations. When the U.S. Fed contracts the world's money supply (tighter money), people/businesses contract their operations.
  5. When business contracts, people are laid off from work and life becomes more difficult for the unemployed. Tempers flare and fights start.
  6. Not only does strife occur on a personal basis, but it also occurs on a national basis. Witness wars and civil strife around the world from China, to Iraq, to Syria, to Israel, to South Africa, to Central America, etc.
  7. Trade wars and currency wars follow and/or lead wars and civil strife.

So what's next?

I can't help but see a similarity between today's Fed/U.S. government behavior and that of the Fed/U.S. government during the 1920s and 1930s. Consider the following excerpt from The Great Depression: Will We Repeat It?:

The United States had emerged from World War I as the financial and industrial leader, the creditor to European belligerents who had consumed much of their capital substance and incurred unprecedented burdens of debt [as the United States is today]. In a world staggering under such debt, it was absolutely essential that the debtor countries be permitted to export their goods to the creditor countries in payment of their debts, and that creditor countries permit such payment. Unfortunately, under the influence of protectionist thought, the United States was not about to adjust…. The Emergency Tariff Act, passed in the 1921 special session, imposed high import duties on a large variety of agricultural products. The Fordney-McCumber Tariff Act, passed in 1922, raised rates on many manufactured goods to 100% or more….The tariff legislation provided the setting for the economic disaster to come; the Federal Reserve credit expansion created the financial distortions that made it unavoidable….The Hawley-Smoot Tariff Act of June 1930 raised American tariffs to unprecedented levels, which practically closed U.S. borders to foreign goods….Curtailment of imports inevitably hampers exports. Even if foreign countries do not immediately retaliate for trade restrictions injuring them, their foreign purchases are circumscribed by their ability to sell abroad….American exports fell from $5.3 billion in 1929 to $1.7 billion in 1933…Agricultural commodity prices, which had been well above 100 (1926=100) before the crisis, dropped to a low of 47 in the summer of 1932….When farmers fell into bankruptcy by scores and by hundreds, many rural banks closed their doors….The panic that had engulfed American agriculture now also gripped the banking system indirectly and its millions of customers.

With all the means at its disposal, the Hoover Administration sought to prevent the readjustment and thereby made matters worse. It aggravated and perpetuated the maladjustments by resorting to every known money trick. It created unemployment by keeping wages up or even raising them. In reaction to popular demand, it sought to stabilize price, that is, keep goods prices above their free market rates, which creates surpluses and depresses goods prices further. Finally, facing steep economic decline, it raised its outlays, exacted more taxes from individuals and businesses, and thereby boosted consumption and reduced savings, all of which delayed the recovery and deepened the depression.

Does any of this sound familiar? It will be interesting to see how the Obama administration reacts to the trade war that it started with Russia and where we go from here. Will the trade war expand to other countries? Will we have another Great Depression?

Robert Jackson Smith

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