The Great Depression was made worse by the introduction of trade protectionism, particularly in the U.S.
The Smoot-Hawley tariff act, adopted in 1930, raised duties on thousands of goods in order to defend domestic U.S. producers and thus U.S. workers from foreign competition. Retaliatory measures and the crippling effects of the tariffs on other economies ended up rebounding on the U.S. economy. Imports collapsed, but so too did exports.
Economists and politicians have learned from those mistakes. Or so they promise.
But politicians aren’t the only ones who have the capacity to destroy trade. A breakdown in cross-border finance can do it too. And there are risks something similar might be happening now.
When the financial hurricane hit in 2008, it lacerated international trade. Trade finance dried up and so did transactions. World trade flows fell off a cliff. One of the primary early palliative measures to reverse the global crisis was for governments to revive trade by shoring up banks.
There’s a risk some of these conditions are returning, however.
This is most apparent in Greece. Greek firms have complained about how their creditors have been tightening their trade credit terms for fear that the country might be forced into a sudden exit from the single currency. No one wants to have euro obligations paid back in new Drachmas — the spinoff currency would almost certainly devalue by 50% overnight.
Concerns about the state of the euro zone, how long it might survive and what impact its collapse might have on the financial sector have hurt Europe’s banks abroad. According to a Fitch report, U.S. money market funds have cut their exposure to new lows. With Americans refusing to lend to European banks, how long before they refuse to lend to European businesses?
As investors in the stronger economies turn their backs on foreign risk, the cost of trade finance will go up. The net effect will be to squeeze trade in much the same way that bank risk aversion has led to a drop in mortgage lending to all but the most credit-worthy borrowers. The result has been falling turnover and weak house prices.
Fears of global economic weakness will further dampen credit availability to companies involved in trade, even where end-demand might currently exist.
This, in turn, could lead to a vicious cycle of anticipated weakness leading to actual declines and further risk aversion and contraction of credit. All without a single tariff or mention of trade war.