In June 1930 Congress passed the Smoot-Hawley Tariff. Although intended to help the faltering economy, it had the effect of worsening and extending the Great Depression for another 10 years. You can look at the linked article for the details, but in general it had a couple of effects, both of which hurt the American economy. First, it made imports more expensive, an effective price increase for American’s. Second, retaliatory tariffs in other countries, triggered by Smoot-Hawley, dried up markets for American exports. In summary, it retarded the normal exchange of goods in the global economy.
The lesson of Smoot-Hawley does not relate only to tariffs. The results offer the broader lesson that interference, of any kind, with international trade hurts the American economy. The Fed Chairman, Ben Bernanke, has focused so much on trying to mitigate deflation and unemployment through Fed monetary activities (a questionable strategy) that he has failed to consider the broader lesson of the Smoot-Hawley Tariff.
The entire chain of causality would take more time to follow that I have for this memo, but, in summary, the U. S. monetary policy interferes with trade across national borders. The interference will like Smoot-Hawley will have detrimental effects in America. Describing a few of the links in this chain of potential disaster should highlight the problem.
The falling value of the dollar in exchange for foreign currencies acts as an impediment to imports, which, like tariffs, raises relative prices in America (an effective reduction of real wages). In reaction, other countries (e.g. China) expand their money supply driving higher the prices in China of products that we might export to China. Since these effects do not happen in all segments of the respective economies equally, it tends to stifle trade for the goods that would have the strongest exchange markets. Although not quite as specific as tariffs, exporting inflation has much the same effect.
In addition to impeding trade across borders, when foreign countries inflate to defend their currencies it causes malinvestments in those countries. When those malinvestments, or bubbles, collapse, the American economy also suffers. So, even though fed actions in this country have failed to get banks to inflate our money supply, other countries, through their purchases of our government’s debt, pass the ill effects of Fed actions on to their economies.
I don’t predict an eminent return to recession. Fed policy, however, has set the stage. When you walk along the edge of a cliff, the odds of falling increase greatly.