Editor’s note: Thanks to U.S.-China trade negotiations, the confirmation of Brexit, and various other factors, 2019 was the year global trade felt a backlash. Some economists are worried about the return of a “Smoot-Hawley” mentality to the world stage — hence our holiday lookback at the original event.
In a speech to the House of Commons in 1948, Winston Churchill said: “Those who cannot remember the past are condemned to repeat it.”
Churchill was paraphrasing the philosopher George Santayana. To elaborate the point, Churchill added:
“We must always look forward, but we have to understand our history in order to not repeat the mistakes of the past. I have seen too many instances where people continue to pursue wrong courses of action because they do not take the time to think critically about what has happened in the past.”
The past does not predict the future. But it can provide lessons and serve as a guide. Knowing what not to do, by way of examining what failed in the past, can produce valuable insight.
In that light, as the world grapples with the prospect of trade war, it makes sense to look back at the Tariff Act of 1930, also known as the Smoot-Hawley Tariff Act.
The Smoot-Hawley Tariff Act is arguably the most destructive piece of legislation that ever existed. There is credible evidence that the Smoot-Hawley Tariff Act:
- Triggered a collapse of the global economy (including the U.S. economy)
- Ushered in the Great Depression (in which U.S. economic activity plummeted)
- Seeded the conditions that led to World War II, with a resulting 70 million to 85 million dead
- Played a significant role in the 1929 stock market crash
You might wonder, how could legislation dated June 17, 1930 have contributed to the 1929 crash?
It was only the final version of the Smoot-Hawley Tariff Act that passed in June 1930. An earlier version passed the U.S. House of Representatives in May 1929.
As early as May of ’29, it was clear to America’s trading partners that the United States was going full-blown protectionist, and that the Smoot-Hawley Tariff Act would have a disastrous impact on trade.
By September 1929 — a month before the famous stock market crash — the Hoover administration had received protest notes from 23 trading partners, including threats of retaliation if Smoot-Hawley was not dialed back. The Hoover administration ignored these warnings. The crash of 1929 happened shortly after.
You might think the crash would serve as a wake-up call. It didn’t. Then more warnings came.
In May 1930, a petition was signed by more than 1,000 of the U.S.A.’s most respected economists. The petition urged President Hoover to veto the Smoot-Hawley legislation before it was made law.
Top CEOs and bankers were horrified, too. Henry Ford went to the White House in person to try to persuade Hoover to veto the bill, calling it “an economic stupidity.” Thomas W. Lamont, the head of J.P. Morgan, recalled that he “almost went down on knees to beg.”
In the end, President Hoover opposed Smoot-Hawley, too. Originally designed to protect farmers, the legislation had sprawled across countless industries, to the point of demanding tariffs on more than 20,000 imported goods.
Hoover called the final version “vicious, extortionate, and obnoxious” and feared it would deeply undermine international cooperation.
He was right — but Hoover lacked the spine to go against his own party. Directly in the teeth of dire warnings, the Tariff Act of 1930 was passed into law with overwhelming Republican support.
“Tit for tat” retaliations from America’s trading partners immediately followed. The total volume of global world trade collapsed. Over the course of the 1930s, America’s exports and imports alike would fall by more than half. U.S. unemployment levels would skyrocket to 24.9% by 1933.
Meanwhile brutal economic conditions worldwide, coupled with severed trade ties and a collapse of Democratic norms, would lead to the rise of Hitler and Mussolini, the standoff of the Allied and Axis powers, and the horrors of World War II.
After World War II and the darkness of the 1930s — a terrifying time in which the whole world looked bleak — the United States learned that free trade has a double value. Not only does trade produce economic prosperity, it lowers the prospects for hostility and bloodshed.
This is partly why, by the mid-1940s, America had become the most pro-free-trade country in the world.
To set the tone for Bretton Woods discussions that kicked off in 1944, President Roosevelt said:
Commerce is the lifeblood of a free society. We must see to it that the arteries which carry that blood stream are not clogged again, as they have been in the past, by artificial barriers created through senseless economic rivalries.
Economic diseases are highly communicable. It follows, therefore, that the economic health of every country is a proper matter of concern to all its neighbors, near and distant.
Only through a dynamic and a soundly expanding world economy can the living standards of individual nations be advanced to levels which will permit a full realization of our hopes for the future.
Shortly after World War II ended, America pushed hard for the creation of GATT, the General Agreement on Tariffs and Trade. As spelled out in its preamble, the purpose of GATT was “the substantial reduction of tariffs and other trade barriers.”
GATT was a direct result of the horrors of the 1930s, and America’s determination to say, “never again.” It was signed by 23 countries in September 1947 and enacted in January 1948.
In a sort of reverse image of the Smoot-Hawley Tariff Act — one of the worst pieces of legislation ever created — GATT was one of the best agreements ever created. It helped usher in the more than 50 years of peace and prosperity that followed.
In the half-century that followed World War II, America became a champion of free trade not just out of generous spirit, and not just to lower the risk of future conflict, but because it was good for business.
In helping to rebuild allies and foes alike after World War II, America was doing more than adding layers of security to the global framework. It was creating prosperity.
By helping Britain, Germany, and Japan get back on their feet, the U.S. was creating future customers. It was increasing productivity for all by increasing the total volume of innovation and investment and two-way output. President Reagan understood this, which is why he was known as a champion of free trade, too.
But let’s back up a minute. What was the reasoning behind the Smoot-Hawley Tariff Act, and why did it happen in the first place?
In a cruel twist, it was the technology-driven productivity boom of the 1920s that led to Smoot-Hawley, by way of a drastic misunderstanding of how prosperity works.
The 1920s was arguably the first true age of modernization. In the ’20s the U.S. had made great strides in electrification, spreading the benefits of electricity use across the entire country.
The 1920s was also the decade when motorized vehicles, from cars to trucks to tractors, started replacing horses and buggies and plows. It was a very exciting time.
Thanks to the 1920s technology boom, the efficiency of American farming went up substantially. With the help of tractors and improvements, American farmers were able to get substantially higher crop yields than before, on reduced volumes of land.
You would think that productivity enhanced by technology is a good thing, which in general terms, it absolutely is.
But America’s farmers wound up producing a surplus, which in turn led to a sharp fall in grain prices. The drop in grain prices, due to the bumper crop surplus via technology upgrades, meant farmers were hurting.
This gave Sen. Reed Smoot and Rep. Willis C. Hawley an idea. They could help the farmers by placing tariffs on agricultural imports.
In his memoirs, Sen. Smoot made his rationale abundantly clear. He wrote that “the world is paying for… its failure to adjust purchasing power to productivity.”
To be clear, he was complaining about too much productivity, in the sense of farmers producing too much grain, which hurt their purchasing power due to market pricing — and his solution was to restrict foreign competition through tariffs.
The problem was that, as the Smoot-Hawley legislation made the rounds, politicians everywhere decided they wanted a piece. The thinking was that, “if farmers can be protected, why can’t my industry be protected, too?”
This is why the Smoot-Hawley Tariff Act ultimately expanded to include more than 20,000 imports, running the full gamut of industrial as well as agricultural goods. Every politician had to add their little piece of protectionism to the bill.
This is why President Hoover, who supported the idea of farmer relief in his 1928 election campaign, ultimately wound up opposing Smoot-Hawley in principle, calling the finalized version “vicious, extortionate, and obnoxious.”
Among other things, the awful legacy of the Smoot-Hawley Tariff Act shows how good intentions (like helping American farmers) can create tragic results if the economic logic is misguided.
It also shows how trade wars can easily spiral out of control. When the “tit for tat” process begins, in which cycles of retaliation escalate against a backdrop of rhetoric that can’t be taken back, the whole world loses — and the world is brought closer to the brink of conflict.
What is a concrete takeaway for investors in all this?
One lesson is that, when a cycle of real trade war breaks out, the economic risks are severe.
For example, the modern world depends on highly complex global supply chains, and many high technology goods cross borders multiple times on their journey towards installation in a finished product.
This, in turn, means the most highly profitable companies in the S&P 500 are simultaneously some of the most exposed to trade war (along with automakers, possibly the most exposed group of all).
It also means gold and gold stocks warrant close attention.
Gold stocks were one of the few industries to deliver incredible investment returns in the 1930s. This happened even though the price of gold was fixed because, while the gold price stayed the same, most other prices were in freefall due to rampant deflation. That made the gold mining business incredibly profitable.
TradeStops can also be used to monitor industries and companies that are “trade war resistant,” or otherwise have a history of performing well in multi-year economic downturns. Payday loan companies and asset recovery companies, for example, do booming business in harsh economic times.
If the world decides to ignore Churchill and Santayana, and ignore the tragic lessons of Smoot-Hawley in doing so, we won’t be able to stop it. But we can be prepared with TradeStops.
TradeSmith Research Team