G20 Finance ministers meeting in Baden Baden last weekend agreed, on America’s insistence, to drop the long-standing commitment to free trade from the final communiqué. It is hard to know to what extent America’s position is driven by her autarkic view on world trade, or to what extent it is an acknowledgement of the fruitlessness of paying lip-service to an ideal which is never delivered. Doubtless, it’s a bit of both.
It is certainly true that finance ministers in the advanced nations have always shown a protectionist attitude towards international trade, protectionism that has intensified through attacks on American international corporations, which to a large extent can choose where to pay their taxes. The thrust of research by international NGOs, particularly the Paris-based OECD, has been to decry tax competition; however, even though it has bullied tax-havens to supply tax-related information to revenue-hungry states, it has failed to stop multinationals, armed with teams of tax lawyers, from complying with their statist demands.
Therefore, the reasons for anti-globalisation in high-spending governments so far have been based on job protection and maximising taxes. But with President Trump, it’s different. He wants to tilt the odds firmly in favour of American business, and he appears to believe that the World Trade Organisation is little more than an obstructive repository for anti-business bureaucrats. This view is misinformed, because over the years WTO officials have successfully managed to get their members to reduce tariffs to historically low levels.
The threat to this progress is not new. America has in the past often ignored WTO rules, banning or imposing tariffs on imports on overtly protectionist grounds. As always, vested interests and protectionism prove difficult for politicians to resist. However, Trump is different in one respect: he appears to be an old-fashioned mercantilist, seeing America as one gigantic commercial enterprise needing direction. It should, he doubtless reasons, secure and use its monopolistic power. You don’t do that by working to non-American regulations. For this reason, America is becoming more autarkic.
Trump’s approach is to promote business conditions for American multinationals. Consumers, which are all of us as individuals, are never considered, beyond being told government policy is making our jobs more secure. But any such security is short-term, because government intervention at a company’s behest is an anti-competitive, anti-free market action and economically negative. As consumers, Americans are increasingly directed into buying state-mandated goods and services, to the disadvantage of genuinely competitive production.
You cannot slip a thin sheet of paper between the fallacies behind modern protectionism and those of the disastrous Smoot-Hawley Tariff Act of 1930. It is only a question of degree. Where Smoot-Hawley did so much harm, as increasing protectionism does today, is through tariffs applied not only to imported consumer products, but to imported raw materials, semi-manufactured goods and capital equipment as well. It wasn’t long before American industry began to seize up in the 1930s. Bank credit was contracting, banks were failing, but money was sound, and anyone could demand gold for dollar deposits. When domestic prices were artificially supported through import tariffs and other price maintenance policies, unemployment was increasing to levels never seen before. Products remained unsold. Put another way, the purchasing power of gold rose, a fact formally recognised in the dollar’s devaluation of 40% to $35 per ounce in January 1934, and by the earlier banning of gold ownership for American citizens.
Furthermore, Smoot-Hawley provoked protectionist responses from America’s trading partners, which killed many export markets for American enterprises. It is no exaggeration to say this was the single most damaging piece of American legislation in the inter-war era. Even before Smoot-Hawley, tariffs were high, averaging about 40% on dutiable goods. The slump in trade following the introduction of extra tariffs is estimated to have reduced tariff revenue to the government overall, and was a major factor in cutting world trade from $5.3bn in 1929 to less than $2bn in 1933.
Have we learned the lesson of import tariffs? Unfortunately, in democracies driven by lobbying interests, the answer is an emphatic no. Even the front-runner in France’s presidential election, Marine Le Pen, is echoing Trump’s nationalistic, anti-trade rhetoric. Competition gets classified as unfair, or even as dumping, accusations both easy to make and conveniently emotive. For example, if Chinese steel is cheap and unprofitable, the market needs to be cleared. Someone is going to benefit from bargain prices, so why deny this to your own citizens and businesses? You may in the short-term protect your own nation’s steel mills by imposing high tariffs on it, but you disadvantage your businesses downstream, in the motor industry and all manner of heavy and light engineering manufacturing, because foreign competitors will still have access to the cheaper steel.
Let’s put it another way. If the store down the road is offering something you want to buy cheaper than the local store, you are perfectly entitled to buy from the cheaper store. It is no different with cross-border trade, except for one thing: the concept of nationalism. Ignore the borders, and buying something cheaper, wherever it’s made, is what consumers and purchasing managers want, and it is the way markets work.
How unsound money is affected by falling trade volumes
An important difference between the thirties and today is in the money. With sound money, people must choose, they must live within their means. Consequently, the persistent trade imbalances of today were unknown.
Contracting bank credit led to the depression, and prices for everything fell, from raw materials to finished goods. To support agricultural and other prices, to protect domestic profits and production, tariffs on imported goods were raised. President Hoover began this process as soon as the Wall Street Crash happened in 1929, and the Smoot-Hawley Tariff Act was an added extension of this policy. Far from protecting domestic producers, as discussed above these price-maintenance policies made things considerably worse.
However, if we make the same mistake today, the price effect is bound to be different from the gold-backed regime of the thirties, because the quantity of money is now infinitely flexible. The slightest whiff of falling prices, or even prices that fail to rise by a mandated 2% annually, and central banks stand ready to pump ever-increasing quantities of money into the economy with one purpose in mind, to stop prices falling.
With unsound money, producers are no longer challenged by contracting bank credit and markets driven by consumers retaining their sound money. In aggregate, armed with easy credit consumers can continue to buy this and that. They can pay the price demanded because easy money discourages saving and permits consumers to spend more than they earn. The question of consumer preferences for money relative to goods is based on different grounds today from when money was real.
Are Trump’s trade policies economically destructive?
President Trump’s declared trade policies will be economically destructive, not just for America’s trade partners, but also for America. They ride roughshod over the enormous progress the WTO has achieved in getting default tariffs down to generally low levels, particularly compared with those of the interwar years. He is repeating the mistakes of Smoot-Hawley for much the same reasons as Herbert Hoover, who signed it into legislation. By dismissing WTO rules in favour of his own higher tariff trade policies, he risks provoking harmful responses from other jurisdictions and discouraging global trade. And if global trade volumes contract, so does the quantity of the currencies used to settle it, which could be disastrous for the dollar.
You can argue that the WTO is a creature of the past, no longer appropriate today. That being the case, trade should be a free-for-all, the discipline being one of self-interest. Any country which cuts itself off from the benefits of free trade pays an economic price. Surely, the logic goes, without the WTO, it is in the interest of countries to advance their economies through free trade.
The logic is sound, but only from a purely economic point of view. It ignores political reality. Politicians in modern democracies, however personally enlightened, are driven by nationalism, lobbying, popular misconceptions, and the need for tax income. They focus on the short-term, ignoring the longer-term consequences of their actions. Policies that decry the cumulative progress that the WTO has patiently achieved are not born out of a desire for free markets, but an intent to sacrifice market freedom for popular gain. President Trump may think he is managing America for competitive advantage, but he is on course to repeat the same mistakes as Herbert Hoover nearly ninety years before him.
Admittedly, no one is talking yet of imposing the high and widespread protectionist tariffs set in the 1930s, but growing economic nationalism in America has the same potential to collapse global trade. And because America is at the centre of this renewed protectionism, and her currency is the one used for settling it, the ultimate loser will be America herself. We have moved from sound to unsound dollars as the currency of trade, and their value today is not ultimately decided by the government, but by the markets which will find its quantity too great for its purpose. It then becomes a certainty that a decline in the volume of cross-border trade will end up with the mass redundancy of the currency in which it is settled, undermining its value.
Doing China’s work for her
China has had a long-standing policy of promoting the yuan as a trade settlement currency, displacing the US dollar. It is a slow process, but in 2016, she made notable progress. China has been selling dollars and US Treasury debt to pay for the energy and raw materials she will need. She has been encouraging her trade partners to take yuan, and she has managed to get the yuan included in the SDR basket. The Trump administration is now likely to speed up the process of a declining internationally-owned dollar by reducing global trade volumes.
China’s gold policy is strongly anti-dollar. The enabling regulations, establishing China’s gold and silver strategy, date back to June 1983. By 2002, presumably she had acquired enough gold, hidden in various state accounts, to permit her own citizens to acquire gold for themselves, establishing the Shanghai Gold Exchange, and even advertising the benefits of gold ownership. She is now the largest miner of gold in the world, by a long chalk. She does not declare her bullion holdings, other than relatively nominal amounts held as public reserves.
I have postulated in the past that she could have accumulated as much as 20,000 tonnes, based on a prudent percentage of inward capital flows over the forty-four years since 1983 at contemporary prices. Her investment in mining, imports of doré, plus willing sellers in the west (some of which is likely to be undeclared sales and leasing of official reserves) and second-hand intelligence from various Chinese sources confirm this quantity as entirely possible. Bear in mind that since 1983, mine supply has almost doubled above-ground stocks by about 80,000 tonnes. I have no idea if my estimate of China’s bullion stockpile is correct and make no claim as to its accuracy, but am comfortable with it as an approximation of the scale of China’s gold ownership.
Why has China been such a keen buyer of gold? There are two broad answers to this question. Firstly, all Marxist economists have been commanded that western capitalism will destroy itself, and their currencies with it. And while one can argue over the theory, it certainly appears to be borne out by developments, particularly in America and the Eurozone. China’s policy of state and public ownership of gold as a reservoir of sound money makes sense in this context.
Secondly, China has always been conscious of a potential backlash from America and her allies against Chinese economic success, particularly when it has been based on exports of cheaply manufactured goods. The single greatest threat to her economic development has always been a break-down of global trade arrangements, and she has been careful to counter this by ensuring the wealth effect of her economic policies has supported not only her neighbours in South-East Asia, but other lesser-developed nations beyond Asia, from Africa to Latin America. This policy, upon which so many nations now depend, has been difficult for western establishments to counter. Gold is the ultimate protection for China against a trade war.
With the election of President Trump, the chess-board has changed. However, through forward planning, China’s focus has already moved elsewhere, and while American tariffs against her exports will hurt private sector businesses manufacturing in the region, at the state level China has plans in place that will absorb the resulting unemployment. Her trade with the rest of Asia, which is her new focus, is already overtaking her exports to America.
China’s overall concerns must now centre on the value of the dollar component of her reserves, and the knock-on effect on the other currencies she holds therein, particularly the euro. China’s leaders can surely see that there is a causal link between the level of global trade and the quantity of dollars possessed internationally. Reduce global trade through tariffs, the excess dollars will be sold and decline in value.
There comes a time when the pace of selling dollars to buy energy and raw materials is not rapid enough for China to escape losses on their dollars. The strategic calculation then becomes, what is the level of the exchange rate between dollars and gold that will fully compensate China for her dollar losses from here? Based on 20,000 tonnes and China’s foreign reserves of $3 trillion equivalent, a 10% loss on the value of these reserves requires a gold price of over $1700 to cover it.
We do not know if China is ready, or even prepared to protect herself by causing the gold price to rise, but the temptation must be growing. For now, she is more likely to continue to sell down dollars for raw material stockpiles, lend foreign currencies to trading partners to be repaid in yuan or gold, and await Trumpian developments. Her leadership has been nothing if not patient.
This article highlights significant dangers arising from President Trump’s approach to trade. Besides his electoral commitment to make America great again and some debate about how imports might be restricted, the first hard news has been for the G20 finance ministers to drop the commitment to free trade. While this may appear an innocuous acceptance that commitments to free trade by western politicians are little more than a sham, it is a clear signal the new Trump administration fully intends to repeat the mistakes of protectionism, which have been so damaging to world trade in the past.
Unless the Trump administration has a rethink, American trade policies are set to undo much of the good work the World Trade Organisation has achieved since it replaced GATT in 1995. The last time American protectionism all but collapsed world trade volumes, was in the 1930s depression. This time, the contraction in trade will almost certainly be countered by stepping up unsound money policies. This being the case, the outcome is likely to be inflationary for dollar prices, particularly since dollars will be redundant from trade finance.
The monetary dynamics are building up to replicate the conditions that led to the abandonment of the $20.67 dollar peg to gold in 1934. At that time, the bulk of the world’s gold reserves were in the possession of the United States. This time, they are in the hands of China, in undeclared form. The transfer of wealth from America to China through the mechanism of the gold price will be accelerated by America’s mistaken attitudes to global trade, set to repeat the mistakes of Hebert Hoover and of the Smoot-Hawley Tariff Act which he signed into law.
Head of Research• GoldMoney