Politics & Policy

Knucklehead Economics

The Schumer-Graham tariff can't possibly work.

I’ve been in the investment business for over 36 years and I am still astounded by some of the logic used by a variety of politicians to formulate economic policy. The latest barrage of dangerous prescriptions come from both Republicans and Democrats: They say they want to level the playing field for free trade (fair trade), but in the process they would undermine the free market, guarantee the return of high inflation, and sandbag a rising standard of living for all participating Americans. The primary mechanism to accomplish this fair-trade policy is the imposition of tariffs on countries that don’t play ball with U.S. politicians. As Alan Greenspan pointed out in his recent congressional testimony, tariffs don’t make sense. History shows us why.

In 1930, politicians Smoot and Hawley (both Republicans) pushed through a major tariff to protect American farmers, their legislation becoming law when President Hoover (also a Republican) signed on the bottom line. This protectionist legislation has been identified as an important contributor to the Depression in the 1930s. Yet even with the overwhelming evidence that Smoot-Hawley had dire economic consequences, Sen. Chuck Schumer, Democrat from New York, and Sen. Lindsey Graham, Republican from South Carolina, are offering up a fat tariff on Chinese imports.

These heir-apparents of Smoot-Hawley, as Larry Kudlow has identified them, plan to impose a 27 percent tariff on all imported goods from China if the Chinese do not allow their currency to float. The relationship between the Chinese currency, the yuan, and the dollar has been fixed since the early 1990s, and the Chinese intervene in the marketplace to maintain that fixed rate. The decision this week by the Chinese to add flexibility to their currency’s value relative to the dollar by tying the yuan to a basket of foreign currencies may not satisfy the tariff crowd. This “mini-float” may not produce the intended effects that Schumer and Graham want, and the threat of major tariffs may still be strong.

The U.S. now participates in a huge trade program with China, with U.S. consumers benefiting from low prices on a broad range of consumer goods that come from that country. In exchange, the Chinese are accumulating dollars for future purchases of U.S. goods and services. A 27 percent tariff imposed on goods from a major trading partner could have significant repercussions, perhaps even worse than the impact of Smoot-Hawley.

If the mini-float does not produce yuan strength and a tariff is imposed, it’s impossible to see how Schumer-Graham could possibly produce the intended consequences. Their proposal implies that the U.S. will punish China by raising the price of Chinese imports and thereby reduce China’s sales here. Where is the logic behind that? Have Schumer and Graham forgotten that imports are a benefit and that exports are a cost? Such a tariff will punish U.S. consumers as prices will rise. Similarly, a retaliatory tariff would no doubt punish U.S. exporters at the expense of Chinese consumers. In the 1930s, the U.S. farmer felt the brunt of Smoot-Hawley as Europe retaliated against U.S. farm products and the U.S. failed to take proper measures to sustain domestic demand.

Of greater importance is the fact that the Chinese have been accepting huge amounts of IOUs from U.S. consumers in the form of dollars that are invested in U.S. government bonds. (No folks, we don’t ship dollars to China when there is a trade deficit.) In other words, we get to consume and enjoy the fruits of Chinese labor while the Chinese don’t demand that we provide them with actual goods and services in return. Yes, some day they may wish to go shopping in the U.S. with their hoard of U.S. dollars, but in our market economy the Chinese can only buy from willing sellers at market prices — no confiscation allowed!

What about U.S. jobs? When one country performs a function better (or cheaper) than we can, we are given an opportunity to reemploy some of our workers where we need them most. Today, those jobs can be found in healthcare, education, or the repair and upgrading of our infrastructure, via contracts to private companies and not by expanding the direct government workforce.

Would some economist or politician who supports the Schumer-Graham plan for economic suicide please take us through the logic that leads to a positive outcome? In the process, will they also identify those times in history when massive tariff barriers have translated into improved standards of living for the countries involved?

I don’t think we will find many takers on that challenge.

Most Republicans have familiarized themselves with the lethal implications of tariff barriers. Democrats once understood the impact of tariffs just like they once understood the value of tax-rate cuts under President John F. Kennedy. Maybe they won’t have to learn the hard way as Republicans did during and after the Depression.

– Thomas E. Nugent is executive vice president and chief investment officer of PlanMember Advisors, Inc. and principal of Victoria Capital Management, Inc.

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