1930's Economics Revisited?

The US very nearly resorted to old style protectionism last week. They can't go isolationist because they are oil dependent and most of their debts are owned by the Arabs and Asians, however there is ever a strand of feeling in the US that they can just shut the door and let the world go to hell.

At the last minute, they listened to veiled threats from the Canadians, Europeans and Asians that retaliation would be swift, if the US carried on with the "Buy American" clause of a economic recovery bill, and softened it. Speaking before a vote on that amendment, Mr McCain warned that if the provisions were passed it would "only be a matter of time before we face an array of similar protectionism from other countries - from 'Buy European' to 'Buy Japanese' and more".

Whether its enough to stop tit for tat legislation in the EU and Jap/China blocks remains to be seen but the amended bill passed through the Senate as well.

All this talk of the 1930's style economics reminded me that I had blogged about the similarities between now and the 1930's especially financially before. But more interestingly I had just read an economic article suggesting that protectionism wasn't all bad.

The article suggested that distinguished economists have established pretty convincingly that it was the staying on the gold standard that helped turn a mismanaged US stock market crash into a global slump, by causing a prolonged and devastating period of falling prices.

"The gold standard (in effect, a fixed exchange rate system anchored by the price of gold) led the world's leading economies into a deflationary spiral. That was because the only way for deficit countries to stem the resulting flow of gold (money) out of the country was by shrinking domestic demand, which led to a further downward spiral in prices and incomes.

Since everyone was doing the same thing (and surplus countries like the US were not allowing inflows of gold to stimulate demand), this didn't help countries out of their hole - they just collectively dug themselves deeper and deeper. The first countries to dump the gold standard were also the quickest out of deflation and the quickest to recover."

It then went on to point out the collapse of world trade was as a result of this deflation problem, rather than 'protectionism' being the cause of depression. However, as it goes on to say the world is too interdependent to go down the 'self-dependency' route theses days, as the American politicians were quickly made to realise this week.