In all the comparisons between the Great Recession of the past three years and the Great Depression of the 1930s, one comforting thought for policymakers has been that there has been no return to tit-for-tat protectionism, which saw one country after another impose high tariffs in an attempt to shorten the line for unemployment benefits.
Yet the commitment of governments this time round to keep markets open was based on the belief that recovery would be swift and sustained. If, as many now suspect, the global economy is stuck in a low-growth, high-unemployment rut, the pressures for protectionism will grow.
The former British chancellor of the exchequer Ken Clarke aptly summed up the downbeat mood when he said in last Sunday’s Observer newspaper that it was hard to be “sunnily optimistic” about the West’s economic prospects.
Adam Posen, a member of the Bank of England’s monetary policy committee, made a similar point last week in a speech advocating more quantitative easing.
Despite a colossal stimulus, the recovery has been short-lived and, by historic standards, feeble. The traditional tools — cutting interest rates and spending more public money — were not enough, so have had to be supplemented by the creation of electronic money. In both the US and the UK, policymakers are actively canvassing the idea that more quantitative easing will be required, even though they well understand its drawbacks and limitations.
There is the sense of finance ministries and central banks running out of options. They can’t cut interest rates any further; there is strong resistance from both markets and voters to further fiscal stimulus, and so far quantitative easing has had a more discernible effect on asset prices than it has on the real economy. The reason for that is that the money created by allowing commercial banks to sell bonds has tended to be used for speculative purposes rather than lent to businesses and individuals.
So what’s left? The answer is that countries can try to give themselves an edge by manipulating their currencies, or they can go the whole hog and put up trade barriers. It is a sign of the etiolated nature of the recovery that both options are currently “in play.”
Brazilian Finance Minister Guido Mantega warned that an “international currency war” has broken out following the recent moves by Japan, South Korea and Taiwan to intervene directly in the foreign exchange markets. China has long been criticized by other nations, the US in particular, for building up massive trade surpluses by holding down the level of its currency, the yuan.
It is not difficult to see why individual nations are pursuing this strategy. The lesson from the 1930s is that those countries that devalue their currencies early steal a march on their rivals. So Britain, the first nation to come off the gold standard in September 1931, recovered more quickly than France, which stuck it out to the bitter end.
A second lesson, of course, is that for the global economy as a whole, competitive devaluations represent a zero-sum game, since for every currency that depreciates there has to be a currency that appreciates.
As things stand, the currencies that are under most upward pressure are the Japanese yen and the euro. Why? Because the Chinese have all but pegged the yuan to a US dollar that has been weakened by the prospect of more quantitative easing over the coming months.
But currency intervention is one thing, full-on protectionism another. The existence of the WTO, with its strict rules for what is permissible and sanctions for countries that transgress, has made it more difficult to indiscriminately slap tariffs on imports. What’s more, there is still a strong attachment to the concept of free trade; it is the one piece of the so-called “Washington Consensus” that has survived the crisis.
Policymakers still recoil in horror at mention of the Smoot-Hawley tariff, introduced in the US in 1930 and blamed for turning the Wall Street Crash into the Great Depression. Paul Krugman has shown that the collapse in US production could not have been caused by protectionism, but the myth that the slump was caused by a trade war is an enduring one.
The most that could be said is that beggar-my-neighbor policies eventually added to the problems caused by ill-conceived monetary and fiscal policies: The failure to cut interest rates quickly enough, the failure to keep credit flowing, the failure in the US to keep banks in business and the insistence on running balanced budgets.
In Britain, protectionism in the form of “imperial preference” — for goods from within what we would now know as the commonwealth — was one of the three factors that helped the economy recover after 1931: Devaluation and cheap money were the other two.
The question now is whether the commitment to free trade is as deep as it seems. The round of trade liberalization talks that were started in Doha almost nine years ago remain in deep freeze. Repeated attempts to conclude the talks have run into the same problem: Trade ministers talk like free traders, but they act like mercantilists, seeking to extract the maximum amount of concessions for their exporters while giving away as little as possible in terms of access to their own domestic markets.
The approach taken by countries at the WTO talks also governs their thinking when it comes to steering their countries out of trouble. There are plenty of nations extolling the virtues of export-led growth, but very few that are keen on boosting their domestic demand so that those exports can find willing buyers.
The global imbalances between those countries running trade surpluses and those running trade deficits are almost as pronounced as they were before the crisis, and are getting wider. This is a recipe for tension, especially between Beijing and Washington.
This tension manifested itself last week when the US House of Representatives passed a bill that would allow US companies to apply for duties to be put on imports from countries where the government actively weakened the currency — in other words, China.
The US Senate will debate its version of the same bill after next month’s mid-term elections, but it was interesting that the House bill was passed by a big majority and with considerable bipartisan support.
China responded swiftly and testily to the developments on Capitol Hill: It argued that the move would contravene WTO rules and quite deliberately tweaked its currency lower.
It’s not hard to see why Beijing got the hump. It introduced the biggest fiscal stimulus (in relation to GDP) of any country and helped lift the global economy out of its trough. It can only fulfill its domestic policy goal of alleviating poverty if it can shift large numbers of people out of the fields and into the factories, and that requires a cheap currency. It has been financing the US twin deficits.
Unsurprisingly, then, its message to the US was clear: It’s not smart to get on the wrong side of your bank manager, so don’t mess with us.
What happens next depends to a great extent on whether the global economy can make it through the current soft patch. There are plenty of analysts who believe that policy is working — and that what we are seeing now is but a small blip.
But imagine that the next three months see the traditional policy tools becoming increasingly ineffective, that the slowdown intensifies and broadens and that the Democrats in the US get a pasting in the mid-term elections. In those circumstances, a trade war would be entirely feasible.
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