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When U.S. President Barack Obama late Friday (Sept. 11) signed an order that imposed an additional duty of 35% on tires imported from China, it set up the potential for an old-fashioned trade war.
Currently, global trade is down only 20%. During normal times, worldwide commerce would recover on its own. But as most investors understand all too well, these aren't normal times.
Global trade fell by 35% after last September's financial crash. And it plunged 65% between 1929 and 1932 as a result of the Great Depression. With the worldwide economy already in a weakened state, a bare-fisted trade war between the world's two most important trading partners - the United States and China - would be devastating.
Call it "Great Depression II: The Sequel."
Courting Trouble
When it comes to trade wars, there are two factors that are important to understand. First, once a trade war starts, everyone tends to join in. And second, once this happens, there's no percentage in being the only free-trading country left in a totally protectionist world.
That's what President Obama is risking. The 35% tariff he imposed is in addition to an existing 4% import duty. His action should be met with loud protests - not just from China, but from here in the United States and from Europe, too. We must stop the dreadful downward momentum from building.
The Chinese government has replied by accusing the United States of blatant protectionism as part of a World Trade Organization (WTO) complaint. And China is also threatening to retaliate against imports of U.S. poultry and vehicles. This all sounds arcane, but it isn't. This escalating tiff over tire tariffs has the potential to damage the global economy much more than the banking crisis ever did.
President Obama's action comes as a result of an "anti-dumping" investigation by the International Trade Commission (ITC) of the U.S. Department of Commerce. Competitors tip off the ITC about foreign imports that are allegedly being "dumped" - that is, sold below their full costs of production. Why U.S. voters should care about dumping is an interesting question. Dumped products are effectively being subsidized by China.
However, even if dumping mattered, the ITC is an inadequate body to investigate the alleged trade infraction. The commission has no subpoena powers in China. And it is subject to intense lobbying from advocates on only one side of the controversy.
Not surprisingly, the World Trade Organization (the proper judge of such claims) does not regard unilateral anti-dumping claims as an acceptable excuse for randomly imposing extra tariffs on imports. The whole purpose of trade agreements - several of which the United States promoted and signed - is to prevent that kind of thing.
During the 2008 presidential campaign, there was considerable debate about whether then-U.S. Sen. Obama was a protectionist.
Candidate Obama cheered union audiences by announcing that he wanted to renegotiate the North American Free Trade Agreement (NAFTA). But then his economic spokesman, Austan D. Goolsbee, was accused of holding a meeting with the Canadian embassy, and saying Obama wasn't serious. The tough talk about NAFTA was only campaign rhetoric, Goolsbee allegedly confided to his Canadian audience. Then Obama's campaign people said that no such meeting occurred.
Now that he's in the White House, the fog obscuring President Obama's views on trade is beginning to clear. In Group of 20 (G20) meetings, he's paid lip service to free trade. But his actions contradict his statements.
President Obama has done nothing to advance the South Korea and Colombia free trade agreements, stuck in Congress since 2007. He has also done nothing to revive the stalled Doha round of trade talks, though his global prestige is so high he could easily have done so. That would be no small achievement. The World Bank estimates that a deal would add $100 billion a year to global trade.
Worst of all, however, is that President Obama now appears to be doing nothing to enhance trade with China, the country that will be our most important trading partner for generations to come. In the past two weeks alone, he's twice imposed anti-dumping duties on China. On Sept. 9, the administration said it imposed a 23% duty on $2.6 billion worth of steel pipe from China.
President Obama owes a lot to union support, and it's pretty clear that he is prepared to go along with Big Labor's protectionist agenda. But the two cases are very different and one has to question whether the gains will be worth the very real costs.
In terms of the actual dollar value - as well as indirect economic costs - experts say the steel-dumping case may be the biggest case in years to be brought before the nation's trade-dispute system. It demonstrates that there's a deep-and-growing concern that Beijing's industrial subsidies are translating into lost U.S. jobs.
The tire case may be a different story, however. It involves the "low-grade" tire market. The profit margins in that slice of the tire market are virtually non-existent. In fact, U.S. tire manufacturers did not join in the complaint. The reason: They actually lose money in the low-end market. Most had already abandoned it to China-based rivals, reports Irwin M. Stelzer, a columnist and director of economic policy studies at the Hudson Institute.
The One Sequel That Shouldn't Be Made
None of this would matter much if the global economy were sailing serenely along, as it did before the financial crisis struck. For the 20-year stretch that ended in 2007, world trade advanced at a pace that was slightly faster than global economic growth in general. Against such a relatively healthy backdrop, minor disputes on tires or metal pipes would be of interest only to the tire and metal-pipe industries. And perhaps to the poultry or other industries against which China chose to retaliate.
But the global financial crisis changed the game. For a couple of months immediately following last September's near-meltdown of the world's financial system, global trade plunged by an astonishing 35% from its normal levels. That wasn't really a surprise. U.S. consumption was way down. And the near-freeze-up in the banking system made trade financing very difficult to get.
That 35% drop was not as bad as the 65% plunge in world trade that came during the first four years we during the Great Depression between 1929 and 1933. But let's face it, a stretch that's half as bad as the Great Depression - even a relatively short one - is still pretty serious.
Global trade has since recovered somewhat, as trade finance has once again become available. As of July, it appears to be down about 20% on the previous year. However, that's still a lot: Economic activity on a worldwide basis is down about 5%.
Even U.S. retail sales are down only around 8%. The U.S. consumer is being more careful than before, but still is spending at a pretty rapid clip.
By comparing all these numbers, we can come to only one conclusion: Global trade is still ailing as a result of the financial crisis.
Lower global trade affects all of us. Thanks to a concept called "comparative advantage," the whole point of trade is that it allows each item to be manufactured in the place that's most efficient. So if trade is blocked, as it was in the 1930s, the whole world economy becomes less efficient, output declines, and we enter a Great Depression (in which U.S. GDP nose-dived 25%).
There's no reason a Great Depression has to follow a banking crisis. After all, the world has had lots of banking crises, both before and after 1930. And virtually every one has been followed by only a medium-sized recession.
The one banking crisis that set off a really serious downturn was that of 1837, after U.S. President Andrew Jackson abolished the Second Bank of the United States. The Second Bank's notes were the main mechanism for financing trade between different parts of this still-young country. So President Jackson's action effectively wiped out about 25% of the U.S. money supply. Not surprisingly, things got very tough for several years.
As tough as that period was, a 67% freefall in world trade would clearly plunge us into a much more dire period. In fact, were world trade to decline by two thirds, there would be no way of avoiding "Great Depression II - the Sequel."
And this is one sequel everyone is certain to hate.
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News and Related Story Links:
- CBS News/The Weekly Standard:
The Risks In Obama's Tire Tariff. - Bloomberg News:
China 'Strongly Opposes' Obama's Tire Import Tariffs. - U.S. International Trade Commission:
Official Web Site. - Wikipedia:
Group of 20 (G20). - Yahoo News:
China Files WTO Complaint on U.S. Tire Tariffs. - Wikinvest:
U.S.-China Anti-Dumping Laws. - The World Trade Organization (WTO):
Official Web Site. - Wikipedia:
North American Free Trade Agreement. - The Hudson Institute:
Official Web Site. - Wikipedia:
Austan D. Goolsbee. - The Heritage Foundation:
Pass Pending Trade Agreements with Colombia, Panama, and South Korea in 2009. - Money Morning News Analysis:
Doha Discussions Could Take Another Seven Years. - Whitehouse.gov:
Andrew Jackson. - Wikipedia:
Panic of 1837. - USHistory.com:
Second Bank of the United States. - Money Morning News Analysis:
Doha Deal Could Offer $100 Billion a Year to Global Economy if it Gets Done. - The World Bank:
Official Web Site. - The Free Encyclopedia:
Economist David Ricardo and the Concept of Comparative Advantage.
Not to the argument, but why are the advertizers for Mr. Hutchinson's Permanent Wealth Investor given an open window to sell his product in September, when the purchased had to be made in August?
PWI is worth the money, for sure, but that's a long scroll down for something that is outdated?
Now is a perfect time for the United States to start a trade war! Especially with China.
Since we have a trade deficit with most of the world a reduction in our trade would be a net advantage to Americans. An advantage approximating the stimulus package each and ever year without borrowing. The problem with a trade war is the adverse effects of the transition as exporters are harmed faster than domestic production can replace imports. The current recession provides a cushion to that transition. The unemployed provide an instant labor pool for domestic production to replace outsourced production. The rest of the world is already not buying out stuff unless there is no other source. That means that in a tariff driven trade war imports would decline much more than exports. The dire consequences laid out here are unlikely due to the trade deficit. Tariffs would damage the global economy but that would be a good thing for the American people.
Mr. Hutchinson exaggerates the 1929-32 trade decline. True the decline was 66 percent but that is misleading. The decline was from 6 percent of GDP to 2 percent. Much to small to justify the claims made here. Moreover the tariffs of the 1930s were not new. At the time Smoot-Hawley was introduced, tariffs were already at 40 percent and the United States had been the world’s most tariff protected nation for over a hundred years. Prosperous years during which all the bad things free traders claim will happen to a trade protected economy never happened. It is unreasonable to blame the Great Depression of something that had been going on for more that a hundred very prosperous years.
Dumping matters because it cost Americans jobs. Applying David Ricardo’s theory of “Comparative Advantage” is a misreading of the theory. Our free trade agreements are inconsistent with both Ricardo’s theory and Adam Smith’s older theory of “Absolute Advantage.” Under both theories land, labor, and capital are factors of production which the state is obliged to protect. United States free trade agreements protect capital but with some small exceptions labor is thrown to the wolves by both political parties. With both Smith and Ricardo trade was about products. Current trade deals are about cheap labor. Also both were Christians and intended their theories to be practiced within the framework of Christian morality by which they meant a fair return for land, labor, and capital. Not capital alone. Under our present trade agreements wages fall faster than prices. That is reflected in American Average Weekly Earnings which peaked in 1973 and are down since. The claim that consumers benefit while workers are hurt ignores the fact that for all practical purposes workers and consumers are the same people.
A decline in global trade would help Americans but it would hurt a lot of corporations. American tire makers did not join complaint because, having already fired American, it is their plants in China that are making the tires.
The promise of free trade has proven to be as fraudulent as a Bernie Madoff account statement. It is time we end this scam on the American people and develop trade agreements consistent with the theories of Smith and Ricardo.
History by itself has demonstrated that protectionism never works, time after time they have been TAXING the american consumer that buys products overseas even when this trade goes into his best interest. Protectionism or TAXING has also made the upgrade in the economy machine sluggish leading it to obsoletism. The bolshevik stalinistic agenda that the social democrats want to lead has, does and will never work.
my worry is the stupidity of thinking that this will somehow help the car unions here in the u.s. don't the car union workers buy these cars? also, don't they also buy other made in china products? where are they not hurt the same as the rest of us?
it seems that all of us, and the u.s. as a whole, are too dumbed down.
My worry is the stupidity of all the people that have been indoctrinated by the corporate and right wing media all their lives to believe that free trade is a magic bullet that cures everything even though there is absolutely no proof of this. In order to compete with the Chinese, American workers will have to earn $1.50 an hour and live in filth and pollution their whole lives until they die an early death just like the Chinese do. I want better for my country. Free traders only care about other rich people like themselves. Free traders who are not rich are merely foolish, indoctrinated robots who only know how to do what they are told by the rich and powerful whom they worship blindly. I think all patriotic Americans should want all their fellow Americans to be prosperous, not living in filth and squalor which is the inevitable result of free trade.
"Lower global trade affects all of us. Thanks to a concept called “comparative advantage,” the whole point of trade is that it allows each item to be manufactured in the place that’s most efficient."
I think you mean the cheapest labor and poorest environmental conditions.
When I see your "ideas" imported from aboard and you without a job or making $8 per hour with no benefits, maybe you'll get the message.
Tariffs might mean less crap coming in from China? Then by all means let's have more tariffs! I'm fed up with Chinese products that either poison you or stop working after three months. I refuse to buy anything in the supermarket with a Chinese origin. And I now buy my appliances used. Why the hell would I pay full price for a new piece of crap? I learned my lesson after three electric can openers in a row stopped functioning in just a few months.
Meanwhile, all I see are closed businesses being replaced by second-hand stores, flea markets and yard sales. I know the country is for sale to the highest bidder. But if something isn't done about the lost jobs that are NEVER coming back, us "little people" will turn America into a third-world bazaar in order to just survive.
[…] "With the worldwide economy already in a weakened state, a bare-fisted trade war between the world…," wrote Money Morning Contributing Editor Martin Hutchinson, a former investment banker with more than 25 years' experience in the global financial markets. […]