Coming Soon: Global Trade War?

By Ron Robins, Founder & Analyst - Investing for the Soul

A ‘long depression’ is starting in the US unless massive new stimulus measures are taken to increase consumption and China forced to mark up its currency. This is what renowned Nobel economics laureate Paul Krugman believes. Since any new massive stimulus action is unlikely soon, and if we are to believe what Mr Krugman is saying, then with a depression occurring the ranks of American unemployed could swell by millions more. They, together with the uproar of US unions and politicians, will blame China and others for their woes.

The US Congress would then enact trade tariffs and restrictions beginning round one of the 21st Century Global Trade War!

But have we not learned from the 1930s that a trade war can lead to a depression? Mr Krugman disputes that finding. In a July 10 New York Times post he says that it was not the trade restrictions of the Smoot-Hawley bill that created the depression. The depression had already started and, “protectionism led to falling exports! Indeed. Also falling imports. It’s not at all clear what effect all this had on overall demand. Insofar as it did, it was because tariffs were a form of tax increase — but in that case you should be focusing on the whole range of fiscal actions, not just the tariff hikes.”

As indicated, currently there is little likelihood of Mr. Krugman’s proposal of enacting massive new stimulus measures—he mentions around $1 trillion—as well as for China marking up its currency significantly against the dollar. However, he may still get his way if unemployment or economic stagnation—or worse—takes hold.

If the stimulus is enacted it is highly debatable if it would work any better than previous ones in firing up consumption and investment. Already over the past two years or so, the US government and the Federal Reserve have poured about $4.5 trillion into the American economy. In rough figures, this comprises about $3 trillion in US government deficits and over $1.5 trillion from the Federal Reserve as it bought bonds and other assets to increase cash in the financial system and promote lending. Then there are of course the trillions more in guarantees to various financial and industrial entities such AIG, GM etc.

However, the Federal Reserve also says it stands ready to act should the economy weaken further. Would it spend another $1, 2 or 3 trillion? If the trillions spent so far by it and the US government have not worked, how much more will be needed?

Furthermore, the additional government deficits and Federal Reserve actions might alarm holders of US dollar denominated assets about America’s solvency, encouraging them to sell such assets. In fact, China’s new debt rating agency Dagong says the US government is already insolvent.

So, additional stimulus actions might also crash the US dollar. If that were to happen, it would cause dramatically rising prices for oil and other goods. A significant increase in living costs amidst high or growing unemployment will promote social unrest and add further impetus to growing calls for protectionism.

A dollar crash would create conditions for ‘competitive currency devaluations.’ In 2009, when the euro was trading as high as $1.50, Europeans became alarmed. Henri Guaino, right-hand man of President Nicolas Sarkozy remarked, “the euro at $1.50 is a disaster for the European economy and industry… "

Would Europe stand idly by and see their euro go into the stratosphere as the dollar crashed against it? Would the European Union then enter into a currency war with the US? Would Japan be silent seeing its currency rise substantially against the dollar? Of course Japan is famous for intervening in currency markets to lower the yen’s value against the dollar in previous difficult times. Unfortunately, competitive currency devaluations would add fuel to a trade war.

Already Global Trade Alert counts 650 protectionist measures implemented between the advent of the financial crises in 2008 and the June 2010 G20 Toronto meeting.

According to the International Business Times, the G20 communiqué “included a ritual promise to ‘refrain from raising barriers or imposing new barriers to investment or trade in goods and services.’ But missing from the final declaration… was a sentence reportedly included in an earlier draft of the communiqué: ‘Where any protectionist measures have been enacted in the context of the economic crisis, we agree that these should be lifted.’ Somehow that sentence, pledging a rollback of protectionist trade barriers erected during the Great Recession [2008 to today], disappeared sometime between when the draft declaration was leaked to the media by Greenpeace and when the final declaration was released to the press with solemn summit fanfare.”

Furthermore, the G20 in Toronto took off its agenda setting a further date for completing the vital Doha round of global trade talks that have been stuck in neutral for several years. Perhaps the US already staked out its real position - remember the ‘buy American only’ clause in its $787 billion stimulus package.

The woes of the US stem from failing to see its years of over consumption were a problem. Now, economists like Mr Krugman want even more money from their financiers like China, so they can further increase consumption, while blaming China for their overconsumption.

Unfortunately, an extended double dip down recession-depression is increasingly probable and with it rising unemployment. In a few weeks or months, the pressure for more action to stem the economic decline could impel the US government and the Federal Reserve to spend more, much more—and to what effect? The alarm of all this might cause holders of dollar assets to sell, culminating in a dollar crash—and further incite a 21st century global trade war.

From here.