From Smoot-Hawley to the Yuan Controversy

How the Senate's anti-Chinese tariff legislation is inviting a trade war—and a global economic breakdown.

On May 5, 1930, President Herbert Hoover received a petition from 1,028 U.S. economists with a stark and urgent warning: Don’t sign the Smoot-Hawley tariff bill that was wending its way through Congress. “Countries cannot permanently buy from us unless they are permitted to sell to us,’’ the economists explained, “and the more we restrict the importation of goods from them by means of even higher tariffs, the more we reduce the possibility of our exporting to them.’’ Moreover, warned the economists, the tariff would slam the finances of Americans who had invested in foreign ventures—to the tune of an estimated $12.5 billion to $14.5 billion, as of January 1, 1929. Restrictive duties, said the economists, would thwart the foreign debtors’ ability to pay interest to American investors.

Hoover ignored the advice and signed the tariff bill on June 17, 1930. In doing so, he sealed the fate of the global economy—and his own political fate as well. As countries around the world reacted to the new U.S. trade barriers with increased tariffs of their own, a trade war ensued, and soon global commerce was in a state of stagnation. Most students of the era believe Hoover’s tariff contributed significantly to the depth and duration of the Great Depression. And the Great Depression contributed to a voter reaction that expunged Hoover from the White House at the next presidential election—in favor of Franklin Roosevelt, who ran on an anti-tariff message.

It’s a lesson worth pondering in these times of world economic danger—with Europe on the brink of a financial collapse, with America struggling to regain its economic footing, and with China facing a wave of inflation that could threaten its domestic stability. A trade war of the kind unleashed by the Smoot-Hawley tariff could devastate the entire world trading system.

And yet the Senate yesterday passed legislation that likely would lead to the imposition of tariffs on imports from China in the amount that China undervalues its currency. The aim is to get tough with China to teach it a lesson, so it will bolster its currency and usher in a greater flow of U.S. goods into China. More likely, China will react with new trade barriers of its own, thus grinding down commerce between the two countries and dealing a blow to the international economy. Although House Speaker John Boehner has said he has no intention of bringing up the bill in his chamber, the issue merits attention because of its potentially ominous ramifications.

So far in the debate, the Chinese perspective has been passed over to a significant extent. That perspective, and the internal political and economic forces driving it, are worth a look, not because they are likely to generate sympathy for Chinese leaders but because they can inform U.S. thinking on the broader ramifications of the issue.

China’s big problem today is the specter of inflation, which its leaders see as a potentially huge destabilizing force. The country’s inflation rate is pegged officially at 6.5 percent, but nobody in the know thinks that’s an accurate figure. More likely, it’s closer to 10 percent, perhaps even higher. And much of this inflation is food prices, which adds urgency to official fears. China’s leaders know that last spring’s anti-government protests in Tunisia and Egypt stemmed in significant measure from rising food prices. And they harbor a deathly fear of societal instability in their own country.

Responding to this unsettling specter, China has been fostering significant wage increases in its controlled economy in order to fend off any rise in citizen agitation. But this policy threatens to flip the country’s economy into a vicious circle in which intertwined wage and price increases set off an uncontrollable inflationary spiral.

But, one may ask, if inflation is the greatest danger, isn’t the best answer to bolster the national currency, as the United States wants? Couldn’t Chinese leaders address inflation and the nettlesome American pressures at the same time by increasing the value of the yuan? Isn’t a strong currency is the best defense against inflation?

Theoretically, yes. And China has been trying, very carefully and with a delicate touch, to do that. Tennessee’s Republican Senator Bob Corker wrote in The Wall Street Journal the other day that China’s currency has increased about 30 percent against the dollar in recent years and will likely continue to rise in the near term.

But the problem is the country’s export sector, the driving force behind China’s torrid economic growth rate. No other entity in China’s domestic system even comes close to the export sector in its ability to throw its political weight around. “It’s the Big Kahuna of Chinese politics,’’ says David M. Smick, the international economic consultant and author of a bestselling book on the global economy.

That sector would be devastated by any precipitate Chinese moves to bolster the yuan against the dollar. Low-cost producers all over Asia would quickly step in and eat their lunch by undercutting their prices in the U.S. market. The result would be a huge blow not only to China’s export sector but to the entire Chinese economy, which is fueled by that export sector.