Trump's Currency War Smacks of the 1930s
Too many have forgotten the searing pain of the last "uncoordinated break-up" of the world's currency regime.
A trade war between China and the U.S. has become something bigger: a currency war. Beijing's weakening of the yuan prompted the Treasury Department to brand it a "currency manipulator." Central banks around the world, including Thailand, India and New Zealand, promptly followed China's lead nonetheless.
This isn't the first time that protectionism became entangled in exchange rates. In fact, what we're seeing has an eerie resemblance to a back-and-forth volley of currency devaluations and retaliatory tariffs that ripped apart the global economy in the 1930s. There's no reason something similar won't happen again.
After the carnage of World War I, when the gold standard temporarily collapsed, the world gradually resurrected the stable system of fixed exchange rates that the system created. While they largely succeeded by the late 1920s, the crash of 1929 marked the beginning of the end of the classical gold standard.
But this didn't happen all at once. Instead, as the global economy began a coordinated slowdown in 1930, many nations began imposing quotas and tariffs to protect domestic interests. The most famous of these was the Smoot-Hawley Tariff, passed by the Congress in 1930. It slapped protective tariffs on a wide array of imported goods.
Conventional wisdom has it that this outpouring of protectionism immediately launched a global trade war and led to the Great Depression. That's not quite right. As the economic historians Barry Eichengreen and Douglas Irwin have observed, the biggest wave of retaliatory tariffs didn't come until at least a year later.
Something else happened first: the end of the gold standard. The troubles began with the failure of the Austrian bank, the Credit-Anstalt, and the liquidity crisis that followed in Europe. The German government, which depended on foreign financing, had to impose capital controls. As panic spread, the British pound came under growing pressure, and the Bank of England watched gold flow out of its vaults – and out of the country.
The British could have addressed the situation by raising interest rates. Instead, on September 19, 1931, it abruptly abandoned the gold standard, sending a shockwave through the global economy. This move devalued the pound, making Britain's exports far cheaper than in the past. At a moment when every country around the world was fighting for declining market shares, this was no small thing.
As many as twenty countries swiftly followed Britain's lead while much of Europe formed a "gold bloc" that unleashed retaliatory tariffs to even the score.
Other countries did the same. Canada and South Africa, gold-standard stalwarts, slapped anti-dumping duties on Britain. In 1932, the German government secured the right to impose "equalizing" tariffs on countries that abandoned gold. The Netherlands did something similar. A number of countries, including Germany, also instituted exchange controls to help maintain the peg to gold.
But each move – devaluations, tariffs, and other attempts to level the playing field – led to more retaliation. In the single year that elapsed between the third quarter of 1931 and 1932, world trade declined 16 percent. One historian described the series of events as an "uncoordinated break-up" of the global currency regime.
In 1933, the League of Nations reported on the "harassing complexity" of quotas, prohibitions, tariff, and other restrictions. "By the middle of 1932," the organization reported, "it was obvious that the international trading mechanism was in real danger of being smashed as completely as the international monetary system."
And things would only get worse. In 1933, representatives from the world's major economies met at the London Economic Conference with the goal of stabilizing the global economy. But President Roosevelt was in an unabashedly isolationist and nationalist mood. He denounced the idea of stabilizing currencies as a "specious fallacy," and poured scorn on the gold standard. "Old fetishes of so-called international bankers are being replaced by efforts to plan national currencies," he said.
Roosevelt promptly dropped the gold standard, swiftly plunging the dollar against Europe's gold-backed currencies. But this only sparked further devaluations, more tariffs, and eventually, the end of the gold standard throughout the world.
What does this tangled tale tell us about where we're headed now? In the early 1930s, currency devaluations and protective tariffs combined to create an unstoppable cycle of retaliation. Unlike a simple bilateral trade war, where two countries slap tariffs on one another, currency devaluations force neutral countries to take protective measures of their own: tariffs, devaluations, or other tactics. But these inevitably invite further retaliation, adding more fuel to the fire.
In 2019, Britain is once again at the center of the crisis. It looks poised to crash out of the European Union, a move that will almost certainly lead to a steep devaluation in the value of the pound relative to the Euro.
Don't think, though, that the European Union isn't going to factor that into its calculations when it comes time to impose tariffs on Britain under WTO rules. Expect Britain to get hit with retaliatory tariffs commensurate with whatever advantages a cheap pound may provide.
Then there's China and the U.S. Here the twinned perils of retaliatory tariffs and currency devaluations are already in full bloom. As more countries that aren't part of the original dispute become collateral damage in this conflict, expect central banks to protect themselves. As some currencies slide more than others, some countries may use tariffs to level the playing field.
How will this end? By 1934, President Roosevelt, realizing that his beggar-thy-neighbor policies had only worsened the Great Depression, gradually, if reluctantly, became an advocate of currency stabilization, free trade, and international institutions that could bring order to the global system of finance and trade. Those early efforts – the Reciprocal Trade Agreements Act, the Tripartite Agreement of 1936 – set the stage for the more robust institutions of the postwar era.
Donald Trump is no FDR. Trump isn't going to get religion and suddenly work for international cooperation on trade and currency before things go off the rails. He's going to stay the course.
And that, sadly, means that we're in for a rocky ride.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
To contact the author of this story:
Stephen Mihm at smihm1@bloomberg.net
To contact the editor responsible for this story:
Mike Nizza at mnizza3@bloomberg.net
