In light of President Trump’s recent trade tariff threats, financial news articles are citing the Smoot-Hawley Tariff Act of 1930 with increasing frequency. While U.S. industrial workers cheer on new tariff proposals, free traders sternly warn that Trump is on the verge of starting a global trade war that could throw the world into a global depression, just like Smoot-Hawley caused the global depression.Are these worries well-founded? Is Ferris’s teacher correct? Should you be selling your stocks to avoid a repeat of the 90% stock market downturn which occurred between 1929 and 1933? Or are fears about repeating the mistake of Smoot-Hawley just a tempest in a teapot?
I don’t think Smoot-Hawley caused the Great Depression, for several reasons.
The Tariff Rate Was High Before Smoot-Hawley
Signed into law by President Hoover, Smoot-Hawley raised tariffs on 890 products, increasing the average industrial tariff from 37% to 48% in the United States.
Since the industrial revolution began, the world has experienced great periods of prosperity even in the midst of significant trade barriers. As demonstrated in the chart below, the U.S. tariff rate averaged 10%+ between the 1830s and the 1940s, a period in which the United States grew enormously, even as it evolved from an agrarian country into the world’s industrial powerhouse.
As you can see in the chart below, the average import duty, already high in 1929, did not increase by very much after Smoot-Hawley was passed. Moreover, previous increases in the average import duty during the course of the 19th and early 20th centuries did not cause a Great Depression.
Companies Involved in Global Trade Didn’t Cause the 1929 Stock Market Crash
A year before Smoot-Hawley was signed into law, the stock market crashed on September 4th, 1929, with the worst performing sector being utility companies. Utility companies were heavily indebted, but their revenues and profits were largely unaffected by global trade. In other words, the possibility of a future trade war did not cause the stock market crash.
Prior to the 1929 crash, the Federal Reserve had tightened the availability of credit in order to temper the strong stock market, and monetary policy remained restrictive even after the crash. Post-crash, central banks were unwilling or unable to pursue countercyclical lending to stimulate demand. Subsequently, during the early 1930s, a series of banking crises took place in the United States and across Europe which likely turned what should have been a garden-variety recession into the Great Depression.
World Trade Declined Due to Inadequate Global Demand, not Trade Tariffs
As the Depression progressed, world trade suffered due to inadequate global demand, but a reduced level of trade was most likely the result rather than the cause of that inadequate demand. While the Smoot-Hawley Act most worsened an already-bad situation, circumstances suggest that its economic impact was somewhat muted.
Prior to the passage of Smoot-Hawley, European countries were already erecting trade barriers in response to their weakened economies. Importantly, Smoot-Hawley applied tariffs to roughly one-third of U.S. imports, representing just 1.3% of U.S. GDP. Furthermore, the tariff rate was already quite high prior to the Smoot-Hawley Act, with Smoot-Hawley increasing the average duty from 13.48% in 1929 to 17.75% by 1931.
Perhaps more importantly, exports plus imports represented less than 10% of U.S. GDP in 1929; international trade was simply not as prevalent then as it is in the present era. As such, the $470mm decline in net exports which occurred between 1929 and 1931 represented only 0.5% of U.S. GDP in 1929. Relative to the stunning 26.6% decline in U.S. GDP that occurred between 1929 and 1931, a 0.5% GDP detraction from net exports seems relatively minor when taken into context.
Based on the economic evidence, I would agree that the passage of Smoot-Hawley was not an incrementally positive development for the ailing U.S. economy in 1930, but it was certainly not the primary cause of the Great Depression either. In this view, I concur with economist and New York Times columnist Paul Krugman, who said in 2010, “I don’t think the Smoot-Hawley tariff was a good thing…but did Smoot-Hawley and other trade restrictions cause the Depression? No.”
To be sure, there are plenty of reasons to worry about the U.S. stock market and the global economy, having nothing to do with trade:
- The U.S. stock market has been on a nine-year tear, which is a relatively long bull market.
- The overall valuation of U.S. stocks is high.
- The Federal Reserve is hiking interest rates, slowing down the economy and creating financial stress for highly indebted corporate and household borrowers.
- According to the Congressional Budget Office, the U.S. fiscal situation, already poor and deteriorating, is poised to worsen considerably as a result of the Trump tax reforms.
- Geopolitical risks remain at elevated levels.
Overall, I think the consequences of a trade war today would be quite different than what happened during the Great Depression. Back then, a contraction in trade occurred coincident with deflation, monetary policy that was too tight, and a banking crisis.
While this is a subject for another post, the facts suggest that trade tariffs will be inflationary rather than deflationary. The prices of most U.S. stocks and bonds currently do not discount for this risk.