Monday, December 12, 2016

A history lesson - the Smoot Hawley Act of 1930

People tend to forget things as time goes by. Most of us have forgotten the lessons of the Great Depression. It is understandable because lets face it - that was a long time ago.

Today I would like to revisit one of the most crucial actions of the Hoover administration that turned the recession that followed the great crash of 1929 into a Great Depression - the passage of the Smoot Hawley Act of 1930. Wikipedia has a great article on this - it is worth reading - but we have to see the Smoot-Hawley against a background of other events in that time.

The stock market crashed in October 1929. The Hoover administration rooted in ideas of laissez faire capitalism, found itself ill-equipped to handle the fallout of the crash. As it struggled to cope with the situation it fell into a series of ham-fisted measures that actually made matters worse.

As things stood in January of 1930, most factories were reporting a steady decline in productivity. This was a natural consequence of the crash. As the stock prices fell, companies were not able to raise working capital and the banks that lent them money were struggling to get repayments from stock brokers who lost everything on margin calls. One sure fire way to bring up productivity was to increase demand - this gave rise to a kind of wishful thinking as in

"Gee - wouldn't it be nice if Americans could only buy stuff that was Made In America? Why there'd be loads of demand for goods then..."

This overly simplistic view prevailed inside the Hoover Administration which was completely unprepared for the difficulties it faced.

It was this idiotic idea that took physical form in Smoot-Hawley Act of 1930. Smoot-Hawley called for an increase in tariffs on foreign made goods entering the US. The exact increase in tariffs was somewhat confusing and unclear - but the results of the tariff hikes were obvious for all to see.

US manufacturers that depended on imported goods could no longer afford to make products. They failed and had to lay off all their employees. With falling internal demand and weak prices, the Agricultural commodities side was a shaking footing at the time. The US agricultural sector relied on exports to generate a massive amount of income. This sector was badly hit by the counter-tariffs that our trading partners imposed on us following the passage of the Smoot Hawley Act. The glut of agricultural produce was dumped on to the local markets and as the farm produce prices fell, farms went out of business. As farms went out of business, rural banks followed. With significant fluctuations on the supply side of soft commodities - a famine ensued. The failure of rural banks removed a crucial support column from under the banking sector as a whole and several banks that moved debt between rural and urban areas failed soon after the rural ones collapsed.

We don't call these conditions in 1930-1934 a "famine" that is because we like to think that our country is immune to that - "That doesn't happen here..." we tell ourselves. This is a psychological thing - we lie to ourselves because we can't face the truth - It Can Happen Here!

As the various provisions of Smoot Hawley kicked in unemployment rose from 9% (1930) to 25% (1933). The act was repealed in 1934 but it took more than a decade to restore productivity to levels before the act was passed. International trade channels don't restore at a moment's notice.

The trade wars started by Smoot Hawley impacted the world. Germany was unable to earn enough money to make its reparations and rebuild itself from the ashes of WW-1. The German economy entered a black hole - and from that hole emerged Adolf Hitler. The Russian economy ended up in a similar place and from its hole emerged Joseph Stalin.

During his campaign President Elect Donald Trump has spoken of reinstating tariffs. The "35% tax" on "imported air conditioners from Carrier" that he has spoke about is actually a typical number from Smoot Hawley Act provisions.

If President Donald Trump steps outside the realm of rhetoric and actually goes ahead with imposing tariffs he will create conditions identical to 1930. We are already in the middle of a great recession - but this kind of stupidity will turn it into the greatest depression ever.

As my colleague Dr. LM says - "Hey its all new stuff - unless you actually know your history". 

Unregulated HFT in the commodities sector has clear parallels in the cartel driven stock market of the late 1920s. Smoot-Hawley has parallels in the PEOTUS Trump's promises on tariffs.

Will it really be any surprise if the Great Depression repeats?

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