The world economy
The return of economic nationalism
A spectre is rising. To bury it again, Barack Obama needs to take the lead
MANAGING a crisis as complex as this one has so far called for nuance and pragmatism rather than stridency and principle. Should governments prop up credit markets by offering guarantees or creating bad banks? Probably both. What package of fiscal stimulus would be most effective? It varies from one country to the next. Should banks be nationalised? Yes, in some circumstances. Only the foolish and the partisan have rejected (or embraced) any solutions categorically.
But the re-emergence of a spectre from the darkest period of modern history argues for a different, indeed strident, response. Economic nationalism—the urge to keep jobs and capital at home—is both turning the economic crisis into a political one and threatening the world with depression. If it is not buried again forthwith, the consequences will be dire.
Devil take the hindmost
Trade encourages specialisation, which brings prosperity; global capital markets, for all their problems, allocate money more efficiently than local ones; economic co-operation encourages confidence and enhances security. Yet despite its obvious benefits, the globalised economy is under threat.
Congress is arguing about a clause in the $800 billion-plus stimulus package that in its most extreme form would press for the use of American materials in public works. Earlier, Tim Geithner, the new treasury secretary, accused China of “manipulating” its currency, prompting snarls from Beijing. Around the world, carmakers have lobbied for support (see article), and some have got it. A host of industries, in countries from India to Ecuador, want help from their governments.
The grip of nationalism is tightest in banking (see article). In France and Britain, politicians pouring taxpayers’ money into ailing banks are demanding that the cash be lent at home. Since banks are reducing overall lending, that means repatriating cash. Regulators are thinking nationally too. Switzerland now favours domestic loans by ignoring them in one measure of the capital its banks need to hold; foreign loans count in full.
Governments protect goods and capital largely in order to protect jobs. Around the world, workers are demanding help from the state with increasing panic. British strikers, quoting Gordon Brown’s ill-chosen words back at him, are demanding that he provide “British jobs for British workers” (see article). In France more than 1m people stayed away from work on January 29th, marching for jobs and wages. In Greece police used tear gas to control farmers calling for even more subsidies.
Three arguments are raised in defence of economic nationalism: that it is justified commercially; that it is justified politically; and that it won’t get very far. On the first point, some damaged banks may feel safer retreating to their home markets, where they understand the risks and benefit from scale; but that is a trend which governments should seek to counteract, not to encourage. On the second point, it is reasonable for politicians to want to spend taxpayers’ money at home—so long as the costs of doing so are not unacceptably high.
In this case, however, the costs could be enormous. For the third argument—that protectionism will not get very far—is dangerously complacent. True, everybody sensible scoffs at Reed Smoot and Willis Hawley, the lawmakers who in 1930 exacerbated the Depression by raising American tariffs. But reasonable people opposed them at the time, and failed to stop them: 1,028 economists petitioned against their bill. Certainly, global supply-chains are more complex and harder to pick apart than in those days. But when nationalism is on the march, even commercial logic gets trampled underfoot.
The links that bind countries’ economies together are under strain. World trade may well shrink this year for the first time since 1982. Net private-sector capital flows to the emerging markets are likely to fall to $165 billion, from a peak of $929 billion in 2007. Even if there were no policies to undermine it, globalisation is suffering its biggest reversal in the modern era.
Politicians know that, with support for open markets low and falling, they must be seen to do something; and policies designed to put something right at home can inadvertently eat away at the global system. An attempt to prop up Ireland’s banks last year sucked deposits out of Britain’s. American plans to monitor domestic bank lending month by month will encourage lending at home rather than abroad. As countries try to save themselves they endanger each other.
The big question is what America will do. At some moments in this crisis it has shown the way—by agreeing to supply dollars to countries that needed them, and by guaranteeing the contracts of European banks when it rescued a big insurer. But the “Buy American” provisions in the stimulus bill are alarmingly nationalistic. They would not even boost American employment in the short run, because—just as with Smoot-Hawley—the inevitable retaliation would destroy more jobs at exporting firms. And the political consequences would be far worse than the economic ones. They would send a disastrous signal to the rest of the world: the champion of open markets is going it alone.
A time to act
Barack Obama says that he doesn’t like “Buy American” (and the provisions have been softened in the Senate’s version of the stimulus plan). That’s good—but not enough. Mr Obama should veto the entire package unless they are removed. And he must go further, by championing three principles.
The first principle is co-ordination—especially in rescue packages, like the one that helped the rich world’s banks last year. Countries’ stimulus plans should be built around common principles, even if they differ in the details. Co-ordination is good economics, as well as good politics: combined plans are also more economically potent than national ones.
The second principle is forbearance. Each nation’s stimulus plan should embrace open markets, even if some foreigners will benefit. Similarly, financial regulators should leave the re-regulation of cross-border banking until later, at an international level, rather than beggaring their neighbours by grabbing scarce capital, setting targets for domestic lending and drawing up rules with long-term consequences now.
The third principle is multilateralism. The IMF and the development banks should help to meet emerging markets’ shortfall in capital. They need the structure and the resources to do so. The World Trade Organisation can help to shore up the trading system if its members pledge to complete the Doha round of trade talks and make good on their promise at last year’s G20 meeting to put aside the arsenal of trade sanctions.
When economic conflict seems more likely than ever, what can persuade countries to give up their trade weapons? American leadership is the only chance. The international economic system depends upon a guarantor, prepared to back it during crises. In the 19th century Britain played that part. Nobody did between the wars, and the consequences were disastrous. Partly because of that mistake, America bravely sponsored a new economic order after the second world war.
Once again, the task of saving the world economy falls to America. Mr Obama must show that he is ready for it. If he is, he should kill any “Buy American” provisions. If he isn’t, America and the rest of the world are in deep trouble.
The Insolvency of the Fed
Since August 15, 1971 the US dollar has been an irredeemable paper currency. Every irredeemable paper currency in history has failed. Yet, the experiment of the US dollar and the rest of the fiat paper world continues.
During the current crisis, however, financial systems all over the world are increasingly struggling, and the end of the experiment seems closer. In fact, the Federal Reserve System has used up much of its "ammunition" for monetary interventions in an attempt to keep the experiment going, lowering its target interest rate almost to zero. Other central banks are also quickly approaching the "zero limit" for interest rates.
During these inflationary decades, economic structures have developed that can only survive with falling interest rates. As the world approaches a zero interest rate, it appears that finally there might be a full adaptation of the structure of production to the demands of consumers, and the experiment might come to an end.
Yet, has the Fed really "run out of ammunition"? First of all: what is the Fed shooting at? It is trying to artificially stimulate the economy with its monetary policy, thereby it is also unwittingly shooting at the value of the currency. Through its monetary policy, the Fed is trying to bail out an insolvent and illiquid banking system to maintain an unsustainable structure of production. As long as the currency is not totally destroyed, the Fed will never run out of ammunition. In order to assess the ammunition left, one should have a look at the balance sheet of the Federal Reserve — especially at the assets the Fed can still obtain. The Fed's balance sheet also gives insights on the condition or quality of the dollar.
Since the crisis broke out, the Fed has continuously weakened the quality of the dollar by weakening its balance sheet. In fact, the assets the Federal Reserve holds have deteriorated tremendously. These assets back the liability side of the balance sheet, which mainly represents the monetary base of the dollar. The assets of the Fed, thereby, hold up the value of the dollar. At the end of the day, it is these assets that the Fed can use to defend the dollar's value externally and internally. Thus, for example, it could sell its foreign exchange reserves to buy back dollars, reducing the amount of dollars outstanding. From the point of view of the buyer of the foreign exchange reserves, this transaction is a de facto redemption.
In the first stage of the crisis that lasted until September 2008, the Federal Reserve did not increase its balance sheet. Instead, the Fed changed its balance sheet's structure. These changes are very important for the value of the currency. Imagine that the Fed announces tomorrow that is has sold all its gold and has bought Zimbabwean government bonds with the revenues. The Fed would explain this move by arguing that the stability of the Zimbabwean economy would be crucial for the US economy and the welfare of mankind. This action by itself would not change the quantity of money at all, which shows that concentrating exclusively on the quantity of money is not sufficient to evaluate the condition of a currency. Qualitative issues can be even more important than mere quantities. In fact, an asset swap from gold to Zimbabwean government bonds would mean a strong deterioration of the quality of the dollar.
While this example might sound extreme, something similar happened during the first stage of the sub-prime crisis. The Fed weakened the composition of its balance sheet not in favor of the Zimbabwean economy but in favor of the US banking system. The Federal Reserve sold good assets in order to acquire bad assets. The good assets were not gold but mainly the still highly-liquid US treasury bonds in the category of "securities held outright." The bad assets were not Zimbabwean government bonds but loans given to troubled banks backed by problematic and illiquid assets. This weakened the dollar.
As can be seen in the chart, starting in August 2007, the lower-quality assets increased. They grew especially in the form of repurchase agreements and, later, new types of credits such as term-auction credits — through the Term Auction Facility (TAF) — starting in December 2007. As the Federal Reserve did not want to increase its balance sheet, it sterilized the increasing amount of bad assets by selling good assets to the troubled banking system. Swapping good assets for bad assets can in fact be considered a bail out of the banking system on a gigantic scale. Moreover, the Federal Reserve started lending securities (good assets) to banks in the so-called Term Securities Lending Facility (TSLF). This measure provided the banks with high-quality assets they could pledge as collateral for loans. As a consequence, the amount of securities decreased via selling and lending, as can be seen in the following chart.
Thus, the average quality of the Federal Reserve balance sheet deteriorated in the first stage of the crisis and continues to do so as shown in the following compositional graph.
In the second stage of the crisis, which started with the Lehman bankruptcy, it became clear that the policy of merely changing the balance-sheet structure was coming to an end. The Fed was running out of Treasury bonds. Moreover, this policy did not allow for the strong liquidity boosts that the Fed deemed appropriate in this situation. Hence, the Fed started to increase its balance sheet. It no longer "sterilized" the additional loans it granted with the sale of good assets. In fact, it would not have had enough good assets left to sell. In our imaginary example, the Fed would run out of gold. It would stop selling gold and keep on buying Zimbabwean government bonds. Of course, the Fed did not buy Zimbabwean government bonds but other assets of low quality, mainly loans to an insolvent banking system. As a consequence, the sum of the balance sheet has nearly tripled since June 2007.
The increase of the balance sheet in favor of the financial system required some unconventional policies. Thus, the Fed has invented new credit programs with a tendency for longer terms, such as the aforementioned TAF. It has granted special loans to AIG and bought Bear Stearns assets that J.P. Morgan did not want. It has allowed primary dealers to borrow directly from the Federal Reserve in the Primary Dealer Credit Facility (PDCF). In addition, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) was created. This facility allows depository institutions to borrow from the Fed with collateral of asset-backed commercial paper.
Later the Fed decided to supplement the AMLF with the Commercial Paper Funding Facility (CPFF). Now unsecured commercial paper is also eligible as collateral. (Unsecured commercial paper is not backed by specific assets but only by the name of a company.)
Furthermore, the Fed has set up the Money Market Investor Funding Facility (MMIFF), which allows money market mutual funds to borrow from the Fed via special purpose vehicles. Three characteristics of these policies can be found:
- they contain credits of longer maturities;
- they contain credits of a broader range of eligible institutions backed by a broader range of assets than was the case before; and
- they, thereby, reduce the average quality of the Fed assets and consequently the quality of the dollar.
Despite of all these efforts, credit markets still have not returned to normal. What will the Fed do next? Interest rates are already practically at zero. However, the dollar still has value that can be exploited to keep the experiment going. Bernanke's new tool is the so-called quantitative easing. Quantitative easing is when a central bank with interest rates already near zero continues to buy assets, thus injecting reserves into the banking system. In fact, quantitative easing is a subsection of qualitative easing. Qualitative easing can be defined as the sum of the policies that weaken the quality of a currency.
But what new assets is the Fed acquiring? The Fed has already started buying the debts of Fannie Mae, Freddie Mae, and the Federal Home Loan Banks. It has also bought mortgage-backed securities issued by Fannie Mae, Ginnie Mae, and Freddie Mac. Bernanke is also considering buying other securities backed by consumer loans, credit card loans, or student loans. Long-term government debt is also on the list of assets that the Fed might buy.
In the analysis of the Fed balance sheet and the condition of the dollar, another detail is extremely important. The equity ratio in the Fed balance has fallen from about 4.5 to 2%.
This figure implies an increase of the Fed's leverage from 22 to 50. As we have seen there are large new positions of dubious quality on the Federal Reserve balance sheet. More specifically, should only 2% of the Fed's assets go into default — or if there is a loss in value of 2% — the Fed becomes insolvent.
Only two things can save the Fed at this point. One is a bailout by the federal government. This recapitalization could be financed by taxes or by monetizing government debt in another blow to the value of the currency.
The other possibility is concealed in the hidden reserves of the Fed's gold position, which is only valued at $42.44 per troy ounce on the balance sheet. A revaluation of the gold reserves would boost the equity ratio of the Fed to 12.35%.[1]
It is ironic that in troubled times a revaluation of the "barbarous relic" could save the Fed from insolvency. Yet, this would only be an accounting measure and would not change the fundamental problems of the paper dollar. While shooting its last bullets and weakening the dollar, the Fed is outmaneuvering itself. The end of the experiment is getting closer.
Wednesday, February 4, 2009
What Is Congress Stimulating?
What's most striking is how much "stimulus" money will be spent on the government itself.
Contrary to conventional Beltway wisdom, the House Republicans' zero votes for the Obama presidency's stimulus "package" is looking like the luckiest thing to happen to the GOP's political fortunes since Ronald Reagan switched parties. If the GOP line holds, the party could win back much of the goodwill it dissipated with its big-government adventures the past eight years.
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Face the Nation, Karin Cooper'How big?' senator, is not the question.
For starters, notwithstanding the new president's high approval rating, his stimulus bill (ghost-written by Nancy Pelosi) has been losing altitude with public opinion by the day. People are nervous.
Then after Tim Geithner scampered through the tax minefield and into a Cabinet seat, the Daschle tax bomb went off, laying open for public view the world of Washington's pay-for-favors that makes the average Wall Street banker look like Little Bo-Peep.
Conventional wisdom holds that the Republican refuseniks shot themselves in the foot by staying off the House stimulus package. Real wisdom holds that congressional Republicans should consider putting distance between themselves and anything Democratic just now. The party's crypts are opening.
The Democratic Congressional Campaign Committee, with an apparently recession-proof cash hoard, is running radio ads against 28 House Republicans. The theme of the ads is "Putting Families First."
Families first? The only family standing at the front of the stimulus pay line is the federal family. Read the bill.
Check your PC's virus program, then pull down the nearly 700 pages of the American Recovery and Reinvestment Act. Dive into its dank waters and what is most striking is how much "stimulus" money is being spent on the government's own infrastructure. This bill isn't economic stimulus. It's self-stimulus.
(All sums here include the disorienting zeros, as in the bill.)
Title VI, Financial Services and General Government, says that "not less than $6,000,000,000 shall be used for construction, repair, and alteration of Federal buildings." There's enough money there to name a building after every Member of Congress.
The Bureau of Land Management gets $325,000,000 to spend fixing federal land, including "trail repair" and "remediation of abandoned mines or well sites," no doubt left over from the 19th-century land rush.
The Centers for Disease Control and Prevention are getting $462,000,000 for "equipment, construction, and renovation of facilities, including necessary repairs and improvements to leased laboratories."
The National Institute of Standards gets $357,000,000 for the "construction of research facilities." The Oceanic and Atmospheric Administration gets $427,000,000 for that. The country is in an economic meltdown and the federal government is redecorating.
The FBI gets $75,000,000 for "salaries and expenses." Inside the $6,200,000,000 Weatherization Assistance Program one finds "expenses" of $500,000,000. How many bureaucrats does it take to "expense" a half-billion dollars?
The current, Senate-amended version now lists "an additional amount to be deposited in the Federal Buildings Fund, $9,048,000,000." Of this, "not less than $6,000,000,000 shall be available for measures necessary to convert GSA facilities to High-Performance Green Buildings." High performance?
Sen. Tom Coburn is threatening to read the bill on the floor of the Senate. I have a better idea: Read it on "Saturday Night Live."
Such as the amendment to Section 2(3)(F) of the Longshore and Harbor Workers' Compensation Act, which will permit payments to guys employed to repair "recreational vessels." Under Incentives for New Jobs, we find a credit to employ what the bill calls "disconnected youths," defined as "not readily employable by reason of lacking a sufficient number of basic skills."
President Obama is saying the bill will "create or save" three million new jobs. The bad news is your new boss is Uncle Sam.
Senate Minority Leader Mitch McConnell says, "Everybody agrees that there ought to be a stimulus package. The question is: How big and what do we spend it on?"
Sen. McConnell should reconsider. He knows that the Bush-GOP spending spree cost them control of Congress in 2006. Thus, "How big?" is not the question his party's constituents (or horrified independents) want answered. This is a chance for the GOP to climb down from its big-government dunce chair. Until that reversal is achieved, there is no hope for this party.
I think that behind the bill's sinking public support is the sense that it won't work and its cost is dangerous. The bill's design, an embarrassment to Rube Goldberg, is flawed. Even were one to grant the Keynesians their argument, this is a very mushy, weak-form stimulus.
Rather than try to "reform" it, which won't happen, Sen. McConnell should ask President Obama to pull it and start over. One guesses that privately the president's economic team would thank the senator. If he won't pull it, the Senate Republicans should walk away from it. This bill is a bomb. It may wreck more than it saves.
Democrats Try Trickle-Down Economics
Growing government won't stimulate the real economy.
KARL ROVE
As a presidential candidate, Barack Obama attacked "trickle down economics" as "bankrupt" and an "old, discredited" philosophy that "didn't work." He was wrong. Even worse, though, is that he and congressional Democrats are embracing a Democratic version of trickle-down economics that won't work.
It's embodied in the House-passed "stimulus" bill, H.R. 1, whose deeply flawed assumption is that spending $1 trillion to grow government will trickle down to help people who lost jobs. The Democrats' spending is horribly mismatched with industries that have suffered job loss.
Since December 2007, Americans lost 791,000 jobs in manufacturing, 681,000 jobs in professional and business services, 632,000 jobs in construction, 522,000 jobs in retail, 167,000 jobs in hospitality, and 576,000 jobs in the rest of the service industry. It would be logical for policy makers to focus on job creation in these sectors.
Instead, Democrats want to spend $88 billion to increase the federal share of Medicaid. What American will be hired by a small business, factory, retail shop, hotel, restaurant or service company because of this spending? The answer is very few.
In H.R. 1, there's $41 billion set aside for school districts, $1.5 billion for university research grants, $2 billion for Energy Department labs, and $3 billion for the National Science Foundation. Yet education is one of the few sectors that added jobs last year.
There's also $4 billion for health programs like obesity control and smoking cessation, $2 billion for the National Institutes of Health, $462 million for the Centers for Disease Control, and $900 million for pandemic flu preparations. Health care also added jobs last year.
It is not surprising that the stimulus package is laden with new spending programs. Congressional appropriators, not job creators, wrote H.R. 1. Much of it is spending Democrats couldn't get approved in the normal course of affairs. And it should not shock Americans that Democratic appropriators would funnel tax dollars to the Association of Community Organizations for Reform Now, unions and other liberal special interests. Putting budgets of political allies above the budgets of struggling families is apparently the new Democratic trickle-down economics.
Mr. Obama has only his own lack of engagement and leadership to blame. He outsourced the drafting of the bill to House Appropriations Committee Chairman David Obey through inaction. He refused to get his administration's hands dirty in crafting the legislation by laying out a detailed plan in December. Then saying he looked forward to Congress passing a bill for him to sign on Inauguration Day was an invitation for liberal spenders to roll him. They did.
The package's size is disturbing. The federal government's discretionary, nonsecurity spending was $391 billion in fiscal 2008 and $393 billion was requested for this fiscal year. H.R. 1 contains $317 billion in additional fiscal 2009 discretionary nonsecurity spending. If passed, this 81% increase would be history's largest.
Nor will Democrats treat this additional spending as a one-time expense. They'll simply start next year's budget writing with a new baseline of $712 billion for the federal government's discretionary domestic budget, nearly doubling it in just a year. This is only part of the Democrats' spending damage. In H.R. 1, they also add $308 billion in new "mandatory" spending (for entitlement programs), which would help produce a 25% increase in 2009, the largest increase in mandatory spending in more than three decades.
About Karl Rove
Karl Rove served as Senior Advisor to President George W. Bush from 2000–2007 and Deputy Chief of Staff from 2004–2007. At the White House he oversaw the Offices of Strategic Initiatives, Political Affairs, Public Liaison, and Intergovernmental Affairs and was Deputy Chief of Staff for Policy, coordinating the White House policy making process.
Before Karl became known as "The Architect" of President Bush's 2000 and 2004 campaigns, he was president of Karl Rove + Company, an Austin-based public affairs firm that worked for Republican candidates, nonpartisan causes, and nonprofit groups. His clients included over 75 Republican U.S. Senate, Congressional and gubernatorial candidates in 24 states, as well as the Moderate Party of Sweden.
Karl writes a weekly op-ed for The Wall Street Journal, is a Newsweek columnist and is now writing a book to be published by Simon & Schuster. Email the author at Karl@Rove.com or visit him on the web at Rove.com.
There is also the question of timing. H.R. 1 spends $170 billion in fiscal 2009, $356 billion in fiscal 2010, and $293 billion in fiscal 2011 and after. Spending more in 2011 and beyond than this year tells Americans H.R. 1 is a mammoth spending bill, not a stimulus or jobs package.
White House adviser Larry Summers argued that any stimulus must be "targeted, timely and temporary." This bill does the opposite. Mr. Obama pledged to "scour our federal budget, line by line, and make meaningful cuts." His cuts are unspecific and fanciful, while Congress's spending will be real and record-setting. Discretionary domestic spending will have nearly doubled by the time Mr. Obama stops dithering and starts scouring.
Democrats are betting that Americans now embrace centralized, top-down government and are willing to pay for it. They are wrong and will suffer politically for their misjudgment.
Republicans are right, both substantively and politically, to oppose this monstrosity and smart to offer a bold alternative. The GOP's road back is about to be partly paved by Mr. Obama's embrace of Democratic trickle-down economics. It's terrible policy -- but for Republicans, it provides an opportunity for sharp contrasts that can reset the debate on more favorable terms for the GOP.
Mr. Rove is the former senior adviser and deputy chief of staff to President George W. Bush.
Congress Wants a Trade War
The president should veto "Buy American" if he doesn't want to be remembered like Herbert Hoover.
BURTON G. MALKIEL
As the world-wide recession deepens, protectionist sentiments are rising. The House of Representatives' version of the economic stimulus bill contains a provision that only American-made steel and other products be used for the infrastructure projects. Wrapped in the cloak of "Buy American" patriotism, the Senate version of the bill contains even stronger anti-free-trade provisions.
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David KleinThis Buy American momentum is bad economics, and by threatening to destabilize trade and capital flows, it risks turning a global recession into a 1930s-style depression. Asked about Buy American on Tuesday, President Barack Obama told Fox News that "we can't send a protectionist message." He said on ABC News that he doesn't want anything in the stimulus bill that is "going to trigger a trade war." He's right.
Suppose that we did not allow free trade between the 50 American states. Citizens like me in New Jersey would be far worse off if we could not buy pineapples from Hawaii, wine and vegetables from California, wheat from Kansas, and oil from Texas and Louisiana while we sell pharmaceuticals to the rest of the country. The specialization that trade makes possible allows all of us to live better.
The situation is the same with respect to world trade. Both we and the Chinese are better off if we can import inexpensive clothing from China and sell them large-scale computers and data storage equipment.
To be sure, such trade does not make everyone better off, and that is why free trade is often a tough sell, especially during times of hardship.
If I am a textile worker whose job is lost because Chinese imports have caused my factory to close, I feel the pain far more acutely than consumers feel the benefits of cheap clothing. The pain tends to be localized while the benefits are spread broadly. No one person's benefit can compare with the loss felt by the textile worker. But the total benefits do exceed the costs. And competitive markets have spurred the innovation revolution that has made the U.S. the economic powerhouse that it is.
The solution for the displaced worker is job retraining and adjustment assistance, and to improve the safety net available to displaced workers during the transition period. We also need to revamp our educational system so that it prepares workers for the jobs that are available today -- and imparts the flexible skills that make our citizens ready for the future jobs that we cannot even imagine.
Buy American provisions invite retaliation by other nations, and the spread of "beggar thy neighbor" policies throughout the world.
This House provision caused a palpable anxiety during the recent World Economic Forum at Davos, and America's closest allies are furious. "Buy American" would effectively ban Canadian steel products and other raw materials from infrastructure projects receiving stimulus funds. Foreign steel would only be allowed if domestic products were either unavailable or drove up the cost of the project by 25% or more. If the provision is not diluted, Mr. Obama will find a very hostile reception during his first international trip to Canada later this month.
Hostility has been no less evident in Europe and China. The European Union has said that it will not stand by idly if the U.S. violates its trade agreements and its obligations to the World Trade Organization. The risks of retaliation and a trade war are very real.
Since the U.S. is the biggest exporter in the world, retaliation could cost America more jobs than the provision would create. It could also destabilize the global capital flows on which the U.S. depends to fund its deficits. Moreover, the provision could delay some shovel-ready infrastructure projects, since sufficient American-made materials may not be immediately available. The U.S. does not manufacture enough steel to meet domestic demand.
In 1930, just as the world economy was sinking as it is today, the U.S. Congress passed the Smoot-Hawley Tariff Act, which essentially shut off imports into the U.S. Our trading partners retaliated, and world trade plummeted. Most economic historians now conclude that the tariff contributed importantly to the severity of the world-wide Great Depression.
Later, as one of his last acts, President Herbert Hoover made the situation even worse by signing a "Buy America Act" requiring all federal government projects to use American materials. (That act is still on the books although it was weakened during the 1980s.) We must avoid repeating the disastrous mistakes of the past.
Buy American provisions and other forms of protectionism will destroy jobs, not create them. They are an irresponsible and self-defeating response to a downturn in world economic activity. Beggar-thy-neighbor policies create more beggars and hostile neighbors. Let's hope that President Obama presses his Democratic colleagues in Congress to listen to him, and to British Prime Minister and Labour Party head Gordon Brown. As Mr. Brown put it at Davos, "Protectionism protects nobody, least of all the poor."
Mr. Malkiel is a professor of economics at Princeton University and the author of "A Random Walk Down Wall Street," 9th ed. (W.W. Norton, 2007).
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