The year was 1930. The greatest depression in U.S. history closed around the nation like a dark shadow. Congress was desperate to do something that put the nation to work again. What could do it? Rep. Willis Hawley and Sen. Reed Smoot had a plan – close down imports and make Americans buy products made in America. Their Smoot-Hawley Tariff raised import taxes on over 20,000 items to the highest level they had ever been. Nations around the world responded with their own tariffs, starting with Canada, slashing all trade in and out of the U.S. in half. Nearly everyone agrees this made the Great Depression much worse.
Flash forward to 2013. Japan returns the Liberal Democratic Party to power on the promise to put the nation to work again. Its plan? Not to shut down trade but to increase it – goosing exports by lowering the value of its currency and making its stuff cheaper. A year on it seems to have worked, with new jobs being created and 20 years of stagnation coming to an end, albeit with dark shadows of inflation growing.
The situations and the plans are similar, but the underlying assumption is completely different. The world has passed from nationalism to globalism as the basic driving force. Nations do not raise tariffs anymore thanks to a series of international agreements, enforced by the World Trade Organization. But there are similarities between tariffs and currency trashing in the end.
The Japanese plan is not fundamentally different from standard practice around the world, but it is unique in scale and audacity. China has kept the yuan low for years to boost exports, as have many smaller nations. Maintaining the national currency on the low end of what the rest of the world will accept is very much standard procedure in order to boost exports and thereby jobs, while keeping a net flow of cash into the nation.
Argentina has tried the same policy as Japan but has met with disastrous results. The peso has devalued rapidly, and anyone who can move money overseas, primarily to banks in Miami, has done so. The most recent attempts to control the devaluation have only created a black market where the peso is worth up to 50 percent less than the official rate.
A similar story is playing out in other nations, including Turkey, Russia, South Africa and India. Many developing nations are seeing their currencies plummet as the governments renegotiate the interest on debt already incurred.
Is the new way of dealing with a depression that much better than the old way? The short answer is yes, but the long answer is no. If the nations pursuing the policies that are sparking a currency war can pull out of it before the collapse, everything will be fine. That just doesn’t happen when the economy starts to depend on constant stimulus– and it certainly can’t happen when there is one currency tied to other nations in Europe. Greece, and to a lesser extent Spain and Italy, were caught trying to keep doing things the old way even though it wasn’t possible anymore.
Who can blame them? Well, the currency and bond markets do. What’s unique about the new way of keeping people employed is that it pretends to use market forces even while it gooses them constantly. Eventually, nations practicing devaluation have to go to the bankers of the world and beg forgiveness. The only leverage they have is the old adage that if you owe the bank a million dollars, you have a problem, but if you owe the bank a billion dollars, the bank has a problem.
The web of international finance banks is what makes devaluation feasible, and their bet is on being able to manage the flux of international currencies to their advantage. But it may not be possible. The whole system stays afloat as long as the nations practicing it can accelerate their exports, but those goods have to find a buyer with a more reliable currency, such as the U.S. dollar. When it hits the wall, the banks eventually have to take part of the loss. National borders suddenly become important when a default on “sovereign debt” is outside the reach of any international law.
Were Smoot and Hawley right in the end? Not a chance. The world has changed, and largely for the better. But while governments can spike their way out of a temporary bad situation, they can’t rely on trashing their currency forever.
We won’t know how this international currency war ends until it is done playing out over the next few years. Will the nations practicing devaluation be forever tied to banks by debt, or will they master the banks by threatening default? We will find out.