Smoot-Hawley tariffs 21st century style

Posted: Apr 12, 2005 12:00 AM

There is a disturbing trend under way in Washington these days where politicians threaten Draconian action as a "stick" to coerce a result they desire. They do this even while they acknowledge that swinging the stick won't solve the problem it purports to address and most likely will exacerbate it and lead to undesirable consequences. They typically justify their use of provocative and extreme threats as the only means available to rectify a situation they characterize as a pending "crisis" or a "systemic meltdown."

The most recent instance that comes to mind immediately is levying huge protectionist tariffs on selected trading partners (China) to stifle their exports into the United States and to coerce them into artificially altering the value of their currency. It is an extremely dangerous stratagem to impose a protectionist tariff on China just because some people believe we are importing too many Chinese goods and would like to coerce the Chinese government into cutting their currency free of its link to the dollar. For example,  Sen. Charles Schumer, D-N.Y., has introduced a bill to hit all Chinese imports with a 27.5 percent protectionist tariff, which is co-sponsored by the Democratic Senate Leader Harry Reid, (D-Nev.) and the junior senator from New York, Hillary Clinton (D-NY).

Red flags are raised immediately by the way supporters of smacking China in the face with a huge protective tariff mangle the English language to distort reality. Schumer is fond of calling his bill a "tough-love effort" to force the Chinese to "stop playing games with their currency." Similarly, other senators supporting the legislation insist it is crafted to pressure the Chinese into "ending their currency manipulation."

How can one rightly call anchoring a nation's currency to the dollar, as China does, "playing games" or "manipulating" their currency? Was it "currency manipulation" under the Bretton Woods international monetary system when the value of the dollar was fixed at a specific weight of gold and the value of foreign currencies then fixed to the dollar? It may be the best policy or the worst possible policy (I happen to think it was one of the best) but it certainly isn't "manipulative." There is substantial professional opinion among economists that a nation can effectively stabilize the value of its currency (especially if it isn't widely traded) and de-politicize its monetary policy by linking it to a strong foreign currency like the dollar or the euro.

Imposing a 27.5 percent tariff on Chinese imports not only would be disastrous in its own right, it would not stop there. China almost certainly would retaliate, and the seeds of a trade war would be sown. The Schumer-Hillary tariff on China could easily turn into the Smoot-Hawley tariff of the 21st century. Just as Smoot-Hawley quickly got out of control - expanding originally from an effort to protect farmers - so too would Schumer-Hillary get out of control as other petitioners quickly lined up to demand protection against other countries "flooding" our economy with "cheap" goods and "manipulating" their currencies to give their exports an "unfair" advantage.

There is a permanent lobby in Washington for replacing free trade with managed trade led primarily by Fred Bergsten, a former assistant secretary of Treasury for international affairs under President Jimmy Carter and now the director of the Institute for International Economics. Bergsten recently made a pitch before the Counsel on Foreign Relations for a pre-emptive 50 percent tariff on China to prevent an international economic calamity. Even former Nixon Commerce Secretary Pete Peterson, who supports the idea, acknowledges that a hefty protectionist tariff on China is playing with fire. Peterson said, "I don't suggest using sticks lightly. They're a very dangerous thing to get started because they can result in retaliation and so forth."

The simple truth is, there is no demonstrable instance in economic history where nations were made worse off by free and open trade. There are only doomsday scenarios spun out of the imagination of half-baked economists that are concocted to spur governments to act pre-emptively. There are, however, innumerable instances where a false fear of free trade (usually goaded by economic interests who benefit in the short run from protectionist policies) has led a government to "pre-empt a crisis" with protectionist policies that very quickly cascaded into a genuine economic calamity. Smoot-Hawley is the most dramatic instance in the last hundred years. Let's not tempt fate with a Schumer-Hillary tariff that could become the Smoot-Hawley tariff of the 21st century.