The U.S. and Japan assailed Argentina’s Mercantilist Trade Policies at the World Trade Organization

Posted by PITHOCRATES - August 26th, 2012

Week in Review

International trade can be a funny thing.  For mercantilist ways of the past are hard to give up.  Especially the misguided belief that a trade deficit is a bad thing.  Some nations are better at some things than other nations.  And have a comparative advantage.  And it would be foolish to try and produce something another nation can produce better.  It would be better for nations to do the things they are best at.  And import the things that others are better at.  Just as David Ricardo proved with his law of comparative advantage.  Still everyone still wants to export more than they import.  Still believing that their mercantilist policies are superior to the capitalistic policies that are characteristic of advanced economies.  While mercantilist policies can rarely advance beyond emerging economies.  Case in point Argentina (see Argentina says to file WTO complaint against U.S by Tom Miles and Hugh Bronstein posted 8/21/2012 on Reuters).

The United States and Japan assailed Argentina’s import rules as protectionist at the World Trade Organization on Tuesday, putting more pressure on the country to revamp policies that many trading partners say violate global norms.

The two complaints mirrored litigation brought by the European Union in May and triggered a swift reaction from Argentina’s center-left government, which vowed to challenge U.S. rules on lemon and beef imports.

Argentina is seen by many fellow Group of 20 nations as a chronic rule-breaker since it staged the world’s biggest sovereign debt default in 2002. It remains locked out of global credit markets and relies on export revenue for hard currency.

They have inflated their currency so much that it is nearly worthless.  They can get little of foreign currency in exchange for it.  So they depend on the foreign currency buying their exports for their money needs.  For they can’t destroy foreign currency with their inflationary policies.  Only the wealth and savings of those in Argentina who don’t have access to these foreign currencies.

In the old days the mercantilist empires brought gold and silver into their countries.  They had their colonies ship raw material back to the mother country.  The mother country manufactured them into a higher valued good.  Then exported it for gold and silver.   Today we don’t use gold and silver anymore.  So Argentina just substituted foreign currency into the formula.  While keeping the rest of it in place.

Argentina began requiring prior state approval for nearly all purchases abroad in February. Imports have since fallen compared with last year’s levels, boosting the prized trade surplus but causing some shortages of goods and parts and sharply reducing capital goods imports.

EU and U.S. officials say Argentina has effectively restricted all imports since the new system came into place…

On Monday, Argentina hit the EU with a separate WTO complaint, alleging discriminatory treatment by Spain against Argentine shipments of biodiesel.

“This measure, like others taken by the European Union and other developed countries for decades, effectively aims to keep our industries from rising along the value chain, limiting the role of developing countries to the provision of raw materials,” the Foreign Ministry said in a statement…

Latin America’s No. 3 economy relies heavily on a robust trade surplus, which is used to help fatten central bank foreign reserves tapped to pay government debt. The government has also moved to curb imports to protect local jobs, while imposing capital and currency controls to keep dollars in the country.

“Import growth has halted, which we should have done long before,” Foreign Trade Secretary Beatriz Paglieri was quoted as saying on the presidential website last weekend…

Argentina has also been criticized for a policy of “trade balancing,” which forces an importer to guarantee an equal value of exports. That has spawned offbeat deals whereby a car producer, for example, must ship a large amount of rice out of the country in return for a consignment of vehicle components.

Mercantilist to the core.  Which will forever trap them into being an emerging economy.  For they’ve been doing this for decades.  And they’re still an emerging economy.  Juan Peron rose to power with the same mercantilist arguments.  He was a Justicialist.  Today’s president is a Justicialist.  President Cristina Fernandez.  And little has changed since World War II.  Argentina is still an emerging economy.  Thanks to their mercantilist policies.  If they’d only give capitalism a chance their economy would explode with economic activity.  At least, based on history.  For the most advanced economies today are NOT based on the current Argentine model.  They’re based on the free trade of capitalism.  And David Ricardo’s comparative advantage.

In countries with free trade people enjoy higher standards of living.  Their governments give them this good life by doing as little for them as possible.  Letting the free market shower them with wealth and happiness.  Which brings us back to the funny part about international trade.  The countries that try to do the most for their people by restricting free trade give their people a lower standard of living.  Except, of course, for the few in power.  Or for those connected to power.

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Comparative Advantage and Free Trade

Posted by PITHOCRATES - May 21st, 2012

Economics 101

Mercantilism benefited only Protected Industries which Profited Handsomely from Higher Consumer Prices  

The Age of Discovery ushered in the era of mercantilism.  An era of trade.  But protected trade.  Tariffs, quotas, protectionism, restrictions, subsidies, etc.  You name it they used it.  To favor their trade position and their domestic industries.  And to restrict that of everyone else.  For mercantilism was a zero-sum game.  You only did well if others did not.  A thought that still has traction today.  Especially in older, inefficient industries.  That cannot compete with international competition that provides better quality at lower prices.  Such as textiles.  Steel.  Automobiles.  The Americans protected these industries in the face of better foreign competition.  Which only hastened their decline.

A protected industry has no incentive to improve.  When protective tariffs raise prices of lower-priced and higher-quality imports consumers buy the inferior domestic goods.  Because the tariffs make the better goods more costly.  So when a business has a captive audience their only focus is in maintaining that protectionism giving them that advantage.  Not improving their quality.  Or improving their productivity to lower their prices.  Why?  Because they don’t have to.  So prices continue to rise to pay for inefficient labor and management.  And quality continues to decline due to the lack of real competition forcing them to continually provide a better product.  By improving designs.  Production methods.  And making capital investments in new machinery and equipment.

This is the cost of protectionism.  Poorer quality and higher prices.  Because of the misguided belief in the zero-sum game of mercantilism.  There was a reason why mercantilism was abandoned for free trade.  Because free trade was better.  For consumers.  Giving them lower prices and higher quality.  Whereas mercantilism benefited only those protected industries which profited handsomely from those higher consumer prices.  And the government officials who granted those favorable protectionist policies.

The Consumer gets Lower Prices AND Higher Quality thanks to the Division of Labor, Specialization and Comparative Advantage

As civilization advanced so did the division of labor.  People began to specialize.  Instead of growing our own food, making our own tools, spinning our own pottery, etc., we did only one thing.  And did it well.  Then we traded the things we made for the things we didn’t make.  This division of labor created a middle class.  And this middle class would take their goods to market to trade with other middle class artisans.  At first bartering with each other.  Trading good for good.  Then they introduced a temporary storage of value into the economy.  Money.  Making those trades easier by reducing search times.  Trading your goods for money.  And your money for goods.  Making life a lot simpler at the market.

Let’s take a closer look at the division of labor.  Let’s consider two artisans.  A toolmaker.   And a potter.  Both are skilled craftspeople.  And can make an assortment of goods.  But each excels at one particular skill.  The toolmaker can make 10 plows a day.  But if he makes 2 pottery bowls he can only make 4 plows in that same day.  The potter can make 12 pottery bowls in a day.  But if he makes 3 plows he can only make 5 pottery bowls in that same day.  Each can make more of their specialty.  But when they try to make other things in addition to their specialty they can’t make as much of their specialty as before.  So there is a cost to the toolmaker to make pottery.  To make 2 bowls cost the toolmaker 6 plows.  And there is a cost to the potter to make tools.  To make 3 plows cost the potter 7 bowls.  So the economy as a whole is better off when the toolmaker and the potter focus all of their energies in their own specialty.  When they do we get 10 plows and 12 bowls in one day.  When they don’t we only get 7 plows and 7 bowls.

We call this economic principle comparative advantage.  Where we look at economic output.  Which is what matters.  The more we bring to market the better it is for consumers.  Because greater quantities mean lower prices.  And when these skilled craftspeople focus on their specialty they improve the overall quality of the goods they bring to market.  So the consumer gets lower prices AND higher quality.  Thanks to the division of labor.  Specialization.  And comparative advantage.

We will always Have Jobs regardless the Size of our Imports for Having a Job is the Only Way to Buy those Imported Goods

If you multiply this over and over again to represent all the individual economic exchanges throughout the world you see why free trade is better than the protectionist policies of mercantilism.  Because it provides consumers with greater economic output at lower prices and higher quality.  This is why nations practicing free trade have the highest standards of living.  Because their people can walk into large department stores and fill their carts with inexpensive, high quality goods on a moderate paycheck.  Which could never happen if the mercantilists had their way.

The old inefficient industries want tariffs to increase the costs of those goods we fill our shopping carts with.  Including the food we eat.  And the cars we drive.  They use lofty arguments about protecting American jobs.  But those protectionist policies destroy jobs by increasing costs for businesses throughout the supply chain.  Raising consumer prices everywhere.  Reducing the amount of things we can buy.  Meaning businesses can’t grow and create new jobs.  Or they have to cut back production and eliminate existing jobs.

There’s also a lot of talk about the balance of payments.  Which actually meant something during the days of the gold standard.  For any trade deficits had to be paid for with gold.  But we don’t have the gold standard anymore.  Governments everywhere abandoned it in favor of irresponsible government spending.  So we don’t have to pay for trade deficits with gold.  Most money today is just electronic entries in a computer.  International capital flows have never been greater.  There are currency markets where people actively trade the world’s currencies.  So trade deficits don’t mean the same thing they once did in the mercantile world.  Then there’s the argument that if all our manufacturing jobs go overseas there will be no jobs for Americans.  If we import everything and export nothing there will be jobs everywhere but here.  Sounds like a problem.  But can that happen?  Not unless we get those imports for free.  So we will always have jobs regardless the size of our imports.  For having a job is the only way to buy the imported goods in those department stores.

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Mercantilism

Posted by PITHOCRATES - May 14th, 2012

Economics 101

Wealth is the Stuff we use our Talent and Ability to Make

Mercantilism gave us the United States.  For it was because of these policies that the British established colonies in North America.  And it was those same policies that led to American Independence.  Because those polices pissed off the Americans. 

The mercantile system came into being as nation states arose from feudal estates.  Kings arose and consolidated these estates into larger kingdoms.  Then one king arose to consolidate the kingdoms into a nation.  Creating Spain, France, the Netherlands, England, etc.  Enlightened thinking and better technology created food surpluses.  With food surpluses a middle class of artisans arose.  And manufactured goods.  People met in markets to trade their food and goods.   These markets grew into cities.  All of this economic activity created wealth.  Food.  And manufactured goods.  That we bought with money.  Often silver and gold. 

There was wealth.  And there was money.  Two different things.  Wealth is the stuff we use our talent and ability to make.  Food and manufactured goods, for example.  And the more food and manufactured goods a nation has the wealthier that nation is.  This is a critical point.  And the mercantile policies ultimately failed because those policies mistook money for wealth.  But money is not wealth.  It’s a temporary storage of wealth.  To make our trading of food and manufactured goods easier.  By reducing the search costs to find people to trade with.  Which is why the barter system failed in a complex economy.  It just took too long to find people to trade with.  Money solved that problem.  Because you could trade what you had for money.  Then trade your money for what you wanted.

England used the Positive Flow of Bullion to Finance the Building of the Royal Navy

Mercantilism focused on the money.  And used wealth to accumulate it.  Instead of the other way around.  The way most advanced nations do today.  These European nations accumulated money with international trade.  Beginning in the 15th century they started looking at the balance of trade between nations.  And did everything they could to maintain a positive balance of trade.  Meaning they tried to export more than they imported.  Why?  Well, nations often did trade with each other.  So they owed each other money.  And when you settled your account if other nations owed you more than you owed them there was a net flow of money to you.  Bullion.  Silver and gold.  Which is what they wanted.

To maintain a positive balance of trade the government actively intervened into the economy.  It set up monopolies.  It provided subsidies for manufacturers who exported their goods for bullion.  It placed tariffs on imports.  Or simply blocked the importation of any goods that they produced domestically.  They set up colonies to harvest raw materials to ship back to the mother country.  Which would use those raw materials in their factories to produced higher valued finished goods.  That they would export.  Especially to their colonies.  Which were convenient captive markets for their finished goods.  On the mother country’s ships.  Through the mother country’s ports.  Where they, of course taxed it.  Guaranteeing that at every step of the way they added to the positive bullion flow back to the mother country.

And it worked.  To a certain extent.  England used that positive flow of bullion to finance the building of the Royal Navy.  Which proved invaluable in the wars that followed in the mercantile world.  For mercantilism is a zero-sum game.  For every winner there had to be a loser.  Which is why this era was an era of world war.  To wrest control of those colonies.  And those sea lanes.  Great Britain came out the victor.  Thanks to their Royal Navy.  But it wasn’t all good.  For Spain found gold in the New World.  And they took it.  Shipped it back to the Old World.  Just like a good mercantilist would.  Which caused problems in the Old World.  Because money is not wealth.  It’s a temporary storage of wealth.  And when they inflated their money supply it took more of it to hold the same amount of value it once did.  Because there was so much of it in circulation.  And what happens during inflation?  Prices rise.  Because the money is worth less it takes more of it to buy the same things as it did before.  So by hording bullion to create wealth they actually destroyed wealth.  With wealth-destroying inflation.

With the Boston Tea Party the Americans Renounced Mercantilism and Demanded Free Trade

Spain was one of the greatest mercantile nations of the era.  But they quickly became a shadow of their former self.  Even though they had more bullion than their European neighbors.  For it turned out that those mercantile policies hindered economic growth.  Which is the true source of wealth.  Economic growth.  Where people use their talent and ability to create things.  That’s where the true value lay.  Not the money that held that value temporarily.  All those mercantilist policies did was raise domestic prices.  And allocated scarce resources poorly. 

It turned out free trade was the secret to wealth.  For free trade can increase wealth.  For both nations.  Thanks to something we call comparative advantage.  Instead of both nations manufacturing all of their goods they should only manufacture those goods that they can manufacture best.  And trade for the goods they can’t manufacture best.  This more efficiently allocates those scarce resources.  And produces a greater total amount of wealth.  By allowing people to buy lower cost imports they have more money left over to buy other stuff.  Increasing the overall amount of economic activity.  Which is why when Great Britain adopted free trade in the 19th century the British Empire went on to rule the world for a century or so.  And led the Industrial Revolution.  By creating wealth.  Goods and services people created with their talent and ability.  That changed the world.  And ushered in the modern era.  Something no amount of bullion could do.

But before Britain adopted free trade they were struggling with one of their belligerent colonies.  Their British American colonies.  Who were unhappy over taxation without representation in Parliament.  And the mother country forcing them to buy only British tea shipped on British ships at higher prices than they could get from the Dutch.  The British thought they found a solution to their problem.  By permitting their British East India Company monopoly to ship their tea directly to America without passing through an English port.  The tea was cheaper because of this.  But it also would set a precedent for taxation without representation.  Something the Americans weren’t about to accept.  So they threw that tea into Boston Harbor.  What we affectionately call the Boston Tea Party.  Renouncing mercantilism.  And demanding the right to engage in free trade.  Which they got after winning their independence.  And the mother country would follow suit in a few decades.  Because they, too, would learn that free trade was better than mercantilism.

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Japan shutters 52 of 54 Nuclear Reactors because of Fukushima, Energy Imports cause Trade Deficit

Posted by PITHOCRATES - March 11th, 2012

Week in Review

The two oil crises in the Seventies hurt Japan’s economy.  Because the Japanese have little domestic energy sources.  Which means they have to import most of their energy.  Coal.  Natural gas.  And, of course, oil.  After suffering the economic fallout of two oil crises in one decade they made a decision to prevent that from happening a third time.  By diversifying their energy industry.  And going nuclear.  Increasing the amount of electricity produced by nuclear power to almost 25%.  Which helped to insulate them from another economic shock.  But that all changed with the 2011 Fukushima nuclear disaster (see Japan reports record current account deficit posted 3/7/2012 on BBC News Business).

Japan has reported a record current account deficit because of rising energy imports, as the country’s economic recovery remains fragile…

In the aftermath of the 11 March 2011 tsunami and earthquake that triggered a meltdown at the Fukushima nuclear reactor, Japan shut 52 out of 54 reactors.

This led to shortages of fuel for generating electricity, which meant more of it had to be imported…

The yen slipped to trade at 81.26 to the US dollar, as the trade deficit raised fears about how long Japan would be able to manage its large public debt.

The massive earthquake created the massive tsunami.  The tidal surge of the tsunami caused the Fukushima nuclear disaster.  An extremely rare event.  It has only happened once in the era of nuclear power.  In fact, the nuclear part of the reactor survived all of this.  It was the old technology that didn’t.  The electrical distribution equipment.  Because it was located in the basement.  Which became flooded with sea water.  Which disabled the electrically driven cooling pumps from operating.  Despite backup generator power being available. 

The technology exists to move electrical distribution equipment to higher ground.  And to waterproof it.  There exists power cables rated for underwater use even.  There is no technological hurdle preventing the kind of electrical updates to prevent another extremely rare event causing another electrical failure like at Fukushima again.  And they’re simple projects, really.   Build new distribution equipment on high ground where a tidal surge can’t reach it.  And rerouting critical systems to this new distribution equipment.  You could do this.  Or you could shut down 52 of your 54 reactors for political reasons.  And import more fossil fuels (coal, natural gas and oil) to make up for the energy shortfall.  Increasing your trade deficit.  And risking your ability to pay one of the highest debt loads of any state (as a percentage of GDP).

One thing you can’t do, though, is make up this energy shortfall with solar or wind power.  Because the cost of building the infrastructure to produce that much energy is prohibitive.  And the power it produces is too unreliable.  For sometimes the sun doesn’t shine.  And sometimes the wind doesn’t blow.  So to please the antinuclear environmentalists who fear another extremely rare event from happening they have to replace clean energy (nuclear generated) with dirty energy (fossil fuel-generated).  Which doesn’t make a lot of sense.  Then again, political decisions rarely do.

To put this into perspective consider this.  Your odds of lightning striking you are greater than you winning the lotto.  Yet your chances of winning the lotto are greater than another Fukushima from happening.  And people will buy lotto tickets.  But they shun nuclear programs.  Unless, that is, a rogue regime is using it to enrich uranium that could also be used to make a nuclear bomb.  And that regime is Islamist.  Which wants to conquer the world.  Strange how Japan has to shut down their nuclear program while Iran doesn’t.  A country, incidentally, that sits on huge petroleum reserves.  And doesn’t need nuclear power.

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Japan Oil Imports increase and Exports of Manufactured Goods decrease resulting in First Trade Deficit in 31 Years

Posted by PITHOCRATES - February 19th, 2012

Week in Review

Japan sets another record.  The country that once could do no wrong in its export market sees its first trade deficit in 31 years (see Japan logs record trade deficit in January by Rie Ishiguro posted 2/19/2012 on Reuters).

Japan posted its biggest ever trade deficit in January…may undermine the country’s ability to finance its debt.

The trade deficit stood at 1.475 trillion yen ($18.59 billion), against median market forecast for 1.468 trillion yen, marking a fourth straight month of deficit, as weak global demand and a strong yen hurt exports and robust fuel demand boosts imports.

Japan doesn’t have a lot of oil.  They have to import most of it.  And as domestic oil demand rises and demand for their manufacturing exports fall their trade deficit increases.  If Japan had more domestic oil fields to exploit they probably wouldn’t have a trade deficit.  Even with their falling exports.  

You know, I can think of another country with a trade deficit.  Who has a far greater land mass than Japan.  And far more coast line.  With who knows how much oil beneath.  And they, too, have an oil-thirsty economy.  But they, too, import most of their oil.  Not because they have no other choice.  But because of anti-oil policy keeping that oil undiscovered.  And unrefined.  Can you name that country?  Here’s a hint.  Its initials are U.S.A.

The Obama administration stimulus of 2009 saved millions of jobs.  Though there is no way to actually measure this the administration claimed it nonetheless.  Because they have a magical crystal ball.  Just like the one I have.  And when I look into it I see remarkable things.  In particular I see the future where we exploit our domestic oil reserves.  In that future there is a trade surplus.  Millions of jobs saved.  And millions of new jobs added monthly bringing the unemployment rate below 5% (i.e., full employment).  A federal budget surplus.  A triple-A credit rating from all the credit rating agencies.  A strong U.S. dollar.  And a very low inflation rate.  A nice future.  A very nice future indeed.  And a future that can be supported by the math.

If we bring new domestic oil to market all of these things will happen.  How do we know this?  Because when we bring less domestic oil to market the exact opposite happens.  As the Obama administration has proven by their policies.

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Money, Gold Standard, Banknotes, Bills of Exchange, Checks, Credit and Debit Cards, ATMs and Online Banking

Posted by PITHOCRATES - January 4th, 2012

Technology 101

People storing their Gold in the Goldsmith’s Safe was a Precursor to the Gold Standard

Money is a temporary storage of wealth.  It improved on the barter system.  Instead of having to find people to trade our wealth-creating talents for the wealth-creating talents of other people we just stored the wealth we created in money.  If you built a plow and wanted a sack of wheat you didn’t have to find someone who had a sack of wheat who wanted a plow.  You could just go to the city market and sell your plow for money.  And use your money to buy the wheat.

Money took many forms.  Animals.  Grain.  Tobacco.  Alcohol.  And other commodities.  All of which had drawbacks.  Grain can become cumbersome to carry to market.  And it can be difficult making change with animals.  The precious metals gold and silver solved these problems.  Easier to carry.  Easy to exchange for goods.  You just weighed out whatever amount needed.  Durable.  Not easy to get so it would hold its value.  It was uniform.  Gold was gold.  Silver was silver.  Not so with animals.  They can be big or small.  Old or young.  One breed or another.  Making the value of animals non-uniform.  On top of not being very divisible in making change.

So gold and silver became the money of choice.  As it gained universality it became even more valuable.  And a bit dangerous to carry around on you.  Or leave at your home in your sock drawer.  Because other people wanted it, too.  And not the kind looking to trade with you.  The kind of people who just want to take your gold.  Se we needed a safe place to store it.  And few places were safer than a safe.  And who had a safe?  Goldsmiths.  So people took their gold to the local goldsmith.  Who placed their gold into his safe.  And the goldsmith gave the person a note stating the value of gold stored in his safe.  A precursor to the gold standard.

Merchant Banks Specialized in International Trade and Foreign Currency Exchange

And the banknote was born.  A promise to exchange that note for the amount of gold or silver specified on the note.  These notes were much easier to carry around than the heavier metal itself.  So the metal stayed in the safe and people started using the notes for currency instead.

And there were other notes that held value.  Such as a bill of exchange.  Popular with international trade.  Because ships rarely travel empty.  Which means at each port they are unloading one cargo (the import) and loading one new cargo (the export).   The people who do this importing and exporting are merchants.  They buy and sell.  That is, they pay money for one cargo and then collect money for another.  A good portion of these payments and collections equal each other.  So instead of paying money for one import cargo only to get most of that money back on a subsequent export cargo, they used bills of exchange.  And the merchants added the sum of payments and the sum of collections for each account (import/export company).  And carry any amount remaining owed or due on a ledger.  Or the company owning would send money to the company with the outstanding balance due to clear the difference.   Merchant banks carried out these transactions.  Who specialized in international trade and foreign currency exchange and acted as a clearing house for these bills of exchange.  The bill of exchange was a very valuable temporary storage of value.  And sometimes used as money.  One could even take it to a bank and exchange it for money for a small discount fee.

Buying and selling without exchanging money turned out to be very convenient.  And it spread.  Instead of taking cash to a utility we could mail a check.  Instead of mailing cash to a mail order company we could mail a check.  And we do.  We write checks from our bank.  That others deposit into other banks.  We write a lot of checks.  The volume is so great that massive computerized clearing houses process these checks.  Where computers read the magnetic ink on these checks and post payments and receipts to the individual bank accounts.  Where most payments and receipts cancel each other out.  Much like those bills of exchange at the merchant banks.

The Economy took off because of Banking and International Trade

As technology advanced we found other ways to pay without using money.  Credit cards were very popular.  Until people realize they have to pay the bank back.  Which led to debit cards.  Which is like writing a check at the point of purchase.  The merchant processes your debit card and your bank transfers money from your bank account to the merchant’s account.  Very convenient.  And no growing credit card balances.  Just declining bank balances.  Then came the Internet.  Which has taken the cashless economy to new heights.  And for those who still need cash while out and about you can always visit a convenient ATM.  One swipe of your debit card and the machine gives you cash.  And the ATM’s bank networks with your bank to transfer money from your bank account to theirs.  Automated by computers operating 24/7.  Spending money has never been more convenient.

Today most of our money is just numbers on some ledger.  Inside some computer.  Many of our employers even pay us electronically.  From our ‘pay check’ to the economic activity we engage in there is a whirlwind of banking activity behind the scenes.  As the banking community settles these accounts.  They do it quickly.  And efficiently.  Allowing ever greater economic activity.  And mobility.  Wherever you are you can log into some computer network (credit/debit card, ATM or Internet) to access your money and engage in economic activity.

People may not like banks.  But one thing for sure.  None of this would be possible without banks.  The economy took off because of banking.  Starting with those great Italian city-states of the 14th century.  And their international trade.  Their great merchant bankers leading the way.  Giving the world modern finance.  A modern economy.  And the way to a higher standard of living.

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The Great Depression

Posted by PITHOCRATES - December 20th, 2011

History 101

The  Roaring Twenties were a Time of Unprecedented Innovation and Manufacturing

The Roaring Twenties were good times.  Kicked off by the Warren Harding administration.  Thanks to one of the few honest guys in his administration besides Harding.  Andrew Mellon.  Secretary of the treasury extraordinaire.  Some say the best secretary of the treasury since our first.  Alexander Hamilton.  High praise indeed.

So what did Mellon do?  He did some research that showed rich people paid less in taxes the higher the tax rates were.  The higher the rate the less they invested in plant and equipment in America.  Instead they invested their money out of the country.  In other countries’ plant and equipment.  So Mellon was a tax-cutter.  And that was his advice to Harding.  And that’s what Harding did.  And Calvin Coolidge continued.  Kept taxes low.  And kept government out of the business of business.

And how business responded.  The 1920s were a time of unprecedented innovation and manufacturing.  Low taxes, little government spending and limited government produced record employment.  Record upward mobility.  And record per capita income.  Gains in the decade touched 37%.  How?  I’ll tell you how.

The auto industry was booming thanks to Henry Ford’s moving assembly line.  Everyone was driving who wanted to drive.  The car companies sold one car for every 5 people.  This production created a boom in other industries to feed this industry.  And cars did something else.  They gave people mobility.  And opportunity.  People left the farms in droves and drove to better jobs.  Which didn’t hurt the farmers in the least as mechanization on the farm put more land under cultivation with fewer people.  Housing and cities grew.  Radio debuted.  And radio advertising.  Motion pictures went from silent to talkies.  Telephones became more common.  New electric utilities brought electricity to homes.  And new electric appliances filled those homes.  Including radios.  New electric motors filled our factories, increasing productivity and slashing consumer prices.  More people than ever before flew.  An increase of nearly 1000%.  It’s nowhere near today’s number of flyers but it was a reflection of the new industrial dominance of the United States.  There was nothing we couldn’t do.  And Europe was taking notice.  And not liking what they saw.  And talked about a European union to compete against the Americans.

Businesses scaled back Production in Anticipation of the Smoot Hawley Tariff Act

So the spectacular economic growth of the Roaring Twenties was solid growth.  It wasn’t a bubble.  It was the real deal.  Thanks to capitalism.  And a government willing to leave the free market alone.  It was so dominating that the Europeans wanted to stop it anyway they could.  One way was protective tariffs on farm imports.

American farm exports boomed during World War I.  Because most of Europe’s farmers were busy fighting.  With the end of the war the Europeans went back to their farms.  Which reduced the need for American farm imports.  And the tariffs compounded that problem.  To make things worse, prices were already falling thanks to the mechanization of the American farm.  Producing bumper crops.  Which, of course, dropped farm prices.  Good for consumers.  But bad for farmers.  Especially with the Europeans shutting off their markets to the Americans.  Because they paid for a lot of that land and mechanization with borrowed money.  And this debt was getting harder and harder to service.  Throw in some weather and insect problems in some regions and it was just too much.   Some farms failed.  Then a lot.  And then the banks that loaned money to these farms began to fail.

We created the Federal Reserve to increase the money supply to keep pace with the growing economy.  By making money cheap to borrow for those businesses trying to expand to meet demand.  They weren’t exactly doing a stellar job, though, in keeping pace with this economic expansion.  And when the bank failures hit the money supply contracted.  Thanks to fractional reserve banking.  All that money the banks created simply disappeared as the banks failed.  Starving manufactures of money to maintain growth to meet demand.  Things were getting bad around 1928.  The Fed did not intervene to save these banks.  Worried that investors were the only ones borrowing money for speculation in the stock market, they shrunk the money supply further.  About a third by 1932.  Manufacturers had no choice but to cut production.

While businesses were dealing with a shrinking money supply they had something else to worry about.  Congress was moving the Smoot-Hawley Tariff Act through congressional committees in 1929 on its way to becoming law in 1930.  This act would add a 30% tax on most imports.  Meaning that the cost factories paid for raw materials would increase by up to 30%.  Of course, sales prices have to include all costs of production.  So sales prices would have to increase.  Higher prices mean fewer sales.  Because people just can’t afford to buy as much at higher prices.  Businesses knew that once the tariff was passed into law it would reduce sales.  So they took preemptive steps.  And scaled back production for the expected fall in sales.

It was Government Meddling that Turned a Recession in the Great Depression

This brings us to the stock market crash.  The Roaring Twenties produced huge stock market gains as industry exploded in America.  Things grew at an aggressive pace.  Stock prices soared.  Because the value of these manufacturers soared.  And investors saw nothing to indicate this growth was going to stop.  Until the contraction of the money supply.  And then the Smoot-Hawley Tariff Act.  Not only would these slow the growth, they would reverse it.  Leading to the great selloff.  The Great Crash.  And the Great Depression.

As feared the Europeans responded to the Smoot-Hawley Tariff Act.  They imposed tariffs on American imports.  Making things worse for American exports.  Then President Hoover increased farm prices by law to help farmers.  Which only reduced farm sales further.  Then the banking crisis followed.  And the Fed did nothing to help the banks.  Again.  When they did start helping banks in trouble they made public which banks were receiving this help.  Which, of course, caused further bank runs as people hurried to get their money out of these troubled banks.  Tax revenue plummeted.  So Hoover passed a new sales tax to raise more revenue.  Which only made things worse.

Hoover was a Republican.  But he was a Big Government progressive.  Just like his successor.  FDR.  And all of their Big Government Keynesian solutions only prolonged the Great Depression.  It was government meddling that turned a recession into the Great Depression.  And further government meddling that prolonged the Great Depression.  Much of FDR’s New Deal programs were just extensions of the Hoover programs.  And they failed just as much as they did under Hoover.  The Great Depression only ended thanks to Adolf Hitler who plunged Europe back into war.  Providing an urgency to stop their government meddling.  And to let business do what they do best.  Business.  And they did.  Building the arsenal that defeated Hitler.

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