Protectionism Will Cost Investors Dearly

The US government revealed on Friday that payrolls tumbled by 598,000 in January (the biggest one-month drop in 34 years) and the unemployment rate is now at a 16-year high of 7.6%. In a month of brutal layoffs, I guess the only bright spark was Obama’s inauguration but even that seems to have fizzled out.

One cannot fault the Obama’s administration for lacking enthusiasm; however, implementation of economic policies has been anything but smooth. Hurling accussations at China for manipulating its currrency disrupts the delicate balance between both countries.

Next up in the CHANGE regime is a controversial Buy American provisions in the $900 billion economic stimulus bill which caused America’s partners (Europe, Japan and Australia) to be wary about a trade war. A softer stance has been adopted since, and federal money spent on goods from US companies will suffice.

Another recent “protectionist” U.S. Senate bill was crafted to limit influx of foreign talents. Stricter limits are placed on banks and other recipients of taxpayer money through the Troubled Assets Relief Program, or TARP, that want to hire high-skilled workers from overseas under the H-1B visa program.

I was particularly annoyed with the currency provocation. Since China opened its doors and embraced capitalism, it has racked up huge trading surpluses due to its low cost goods and services. In order to alleviate upward pressure on its yuan, China channeled significant reserves into US Treasuries. The money flows back to US coffers and the virteous cycle of import-export starts again.

Today, for better or worse, China is US largest creditor and their retaliatory action by discarding or stopping purchase of US Treasury bonds (yielding pathetic returns), just when the world’s largest economy needs financing for its bailout and stimulus programs, may have a “catastrophic” impact. Already, US Treasury auctions run the risk of failure as many countries focus their limited resources on quelling turmoil in their domestic markets.

Fortunately, Obama’s phone conversation with China’s leader Hu Jintao managed to defuse a political timebomb. Nevertheless, a major sticking point remains. The multi-billion dollar trade imbalance is actually funded by credit and though it has transformed China from an agricultural economy into an industrial power house in a short period of time, it is not a healthy trend.

The US is as guilty of allowing trade deficits when former President Richard Nixon closed the gold window in the 70s. Let’s face it, China is an export country and unless it intends to survive on debt, the sensible objective is to export more than it imports to arrive at a positive trade balance.

The only country exempted from balancing its books is America which can print as much dollars as they like, due to its status as the world’s reserve currency. This accelerates an exodus of low-end manufacturing jobs as America has little need to produce, just print out dollars and look for the cheapest sources around the world.

If the US is really serious about eradicating currency manipulation and correcting their trade imbalance, then it should abolish fiat currency, and return to the gold system. All countries are forced to clear their outstanding balance every month and nobody will import excessively to conserve their gold reserves. Eventually, China will have to depend less on exports, create a self-sustaining domestic economy,  move up the value chain, raise its minimum wages and offer products which compete internationally at fair market value.

Using protectionism or trade wars to force China to raise its currency is not realistic as it is already sustaining immense domestic pressure from its crumbling export based industries -  20 million Chinese workforce is sitting idle today.

I believe protectionism is extremely dangerous and could cause the world economy to decline further into depression. It is tempting to set up trade barriers to conserve jobs but experience shows that “beggar thy neighbor” policies only cause more hardships.

In the l930s, Smoot-Hawley Tariff Act impose unpredecented tariffs on some 20,000 imported goods. According to government statistics, U.S. imports from Europe declined from a 1929 high of $1,334 million to just $390 million in 1932. Overall, world trade declined by some 66% between 1929 and 1934.

The tariff law ignited a domino effect of retaliation and counter-retaliation among trading partners, which contributed to a severe contraction of international trade, decimated growth and drove up unemployment around the industrial world. Personal income, tax revenue, prices and profits declined so much that 1,028 economists signed a petition against this “stupid” legislation.

In recent times, the 1998 Asian financial crisis was resolved through an increased openness to trade, rather than protectionism. Free trade has been instrumental in helping economies recover.

If protectionism is going to be the order of the day, what is an investor to do? History has already given us a painful lesson on the perils of protectionism, thus, throwing more money into the stock market when businesses are struggling to cope with the new economic landscape is dangerous.

What is the point of having zero interest rates when there are no viable opportunities for profits around as nations adopt “every man for himself” attitude? I will continue to stay as a sloth investor for now.

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Filed under Business, Deflation, Economy, Stocks

2 Responses to Protectionism Will Cost Investors Dearly

  1. I agree. Protectionism is not an answer. Increasing the protectionism in place now would only worsen the USA economy.

    John @ Curious Cat Investing Blogs last blog post..Sound Canadian Banking System

  2. Despite what we already know from the harsh lessons of Great Depression, history has strange ways of repeating itself.

    I am concerned that the politicking within US may just tip Obama’s hand. Hopefully, he is able to do the right thing and resist calls to set up trade barriers

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