Sunday, June 26, 2005

Mythical Protectionism

On the 75th anniversary of the infamous Smoot-Hawley tariff bill that helped trigger the Great Depression, Senators Chuck Shumer (D-NY) and Lindsey Graham (R-SC) proposed a 27.5% tariff on Chinese imports … and the stock market plunged. Will they ever learn?

It is instructive to recount the history of that earlier economic calamity. Thanks to the interventionism (meddling) of Republican President Herbert Hoover and Democratic President Franklin Roosevelt, the American and worldwide economies were critically wounded and kept on life support for over a decade. Furthermore the economic depression exacerbated the frustrations of the German and Japanese peoples that led to the Second World War

The commonly accepted story about the Great Depression of the 1930s is that it was caused by an unavoidable breakdown of capitalism. The popular myth is that the laissez-faire policies of President Hoover permitted the excesses of economic freedom that led to the 1929 stock market crash and the subsequent depression. The corollary is that it took government intervention (tax increases, wage and price controls, business regulation, massive government spending programs) enacted by the great FDR to bring us out of the Great Depression and save capitalism from itself. Such is the history as taught in the schools. Too bad it’s just a myth and precisely the opposite of the truth.

In actual fact, Hoover was anything but laissez-faire. As Secretary of Commerce in the 1920s, he adopted the Russian central planning model and embarked on an ambitious plan to eliminate poverty and transform American society. Hoover believed that “human manipulation could triumph over any alleged law of economics.”

Hoover thought that there was too much “destructive competition” in business that led to “economic waste.” So he installed government planners to oversee industries and limit competition, effectively creating government sanctioned cartels. Of course the reality is that the process of competition is what reveals the best way to do business. (Friedrick Hayek)

Hoover believed that maintaining the purchasing power of labor through high wages, even above what was justified by labor productivity, was the key to prosperity. This made him very popular with organized labor. Of course the inflated wages made workers too expensive to keep and companies had to reduce employment or fail. At the height of the Great Depression the unemployment rate was 25%.

He subsidized farmers, the largest segment of the economy, in order to control surpluses and bolster food prices. Farmers were paid not to grow food, people went hungry and farm laborers were let go.

Perhaps Hoover’s greatest mistake was his advocacy of the “scientific management of the money supply,” having the Federal Reserve create money to lower the cost of credit. From 1921 – 1929 the government increased the money supply by 62%. This caused businesses to borrow for unwarranted capital expenditures and led to the overproduction of goods. The inevitable oversupply of products could not be consumed, prices plummeted and businesses failed. Economist Ludwig von Mises predicted that this policy would cause a crash, in the middle of the 1920s boom.

Having injected money into the private sector, Hoover then took it out in the form of greatly increased taxes to finance massive public works programs (13% of government spending in 1929). As a result, private sector spending decreased just when it was needed to reinvigorate the economy.

Hoover’s biggest sin was to favor high protectionist tariffs that benefited the manufacturers who supported the Republican Party. In 1930, President Hoover signed into law the Smoot-Hawley Tariff over the protest of more than one thousand economists, and the stock market plummeted that same day. The average tariff soared to 59% and the resulting trade wars caused a meltdown of world trade that contributed to the Great Depression.

Hoover’s hyper-interventionism turned a recession that could have been ended simply by allowing the capital markets to work freely, into the Great Depression. Roosevelt was an even greater interventionist and his policies made the Great Depression longer and more severe than it had to be. In retirement Hoover saw the error of his ways. Roosevelt never did and the Democratic Party is still clueless to this day. (Thomas DiLorenzo, How Capitalism Saved America)

Fast forward to 2005: China bashing Senators Schumer and Graham seem to be angry at a rising bilateral trade deficit resulting from Chinese imports to the U.S. But so what? In the last couple of years the U.S. has created about 3.5 million new jobs, the unemployment rate is only 5.1%, and the nation’s GDP is expanding at a 4.5% pace. Meanwhile, China’s economy climbs near a 10% rate, raising the Chinese population from the depths of poverty.

History has taught us that free trade is part of the solution – it’s not the problem. (Lawrence Kudlow)


Blogger Stephanie said...

Thanks for this!

4:08 AM  
Anonymous Pamela Cleveland said...

Argh...this was a major groaner for me! I had no idea Hoover messed with free markets/trade in such a disasterous way! Gee, Bill, thanks for the "re-education"!
You say Hoover saw the error of his ways. Lindsey Graham needs to read this blog and be enlightened!

9:49 AM  
Anonymous Anonymous said...

Loved the Mythical Protectionism blog as it clarified a lot for me (early post depression child 1937). You’re right — never had the crash/Hoover/ F. Roosevelt explained in my public high school.

Loved your son’s blog also..


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